investment insights

    Energy shock unlocks EU investments in independence

    Energy shock unlocks EU investments in independence
    Stéphane Monier - Chief Investment Officer<br/> Lombard Odier Private Bank

    Stéphane Monier

    Chief Investment Officer
    Lombard Odier Private Bank

    Key takeaways

    • The war in Ukraine has triggered an energy shock. The EU has responded with plans to reverse its dependence on Russian oil and gas
    • That plan would cut Russian gas imports by two-thirds in 2022 and accelerate the green energy transition
    • Solar, wind, green hydrogen and LNG developers will all benefit from infrastructure investments. Nuclear power can help to meet some of the energy shortfall
    • We remain positive on industrial metals for their role in sustainability, planned infrastructure, and as a portfolio hedge against inflation.

    Russia’s invasion of Ukraine is transforming the European Union’s energy policy. The bloc is committed to severing its reliance on Russian resources and accelerating the shift to alternative energy sources. The drive has repercussions for renewable energy firms, the liquefied natural gas (LNG) value chain, utilities and industrial metals.

    Europe urgently needs to diversify its energy supplies. Russia accounted for 35% of EU gas imports and around 30% of oil in 2021, making it the bloc’s biggest supplier. Supply disruptions in 2006, 2009 and Russia’s annexation of Crimea in 2014 all alarmed European policymakers. That did not prevent Russian gas imports from steadily rising. The Ukraine invasion has now pushed prices up, leaving Europe facing an energy bill worth around 8% of gross domestic product (GDP).

    “We must become independent from Russian oil, coal and gas,” wrote European Commission President Ursula von der Leyen. The diversification process is underway. On 22 February, Germany suspended final approval of the Nord Stream 2 gas pipeline that connects Russia with the EU. More recently, an 8 March report on energy independence, ‘REPowerEU,’ sets out the EU’s ambition to slash gas imports from Russia by two-thirds within one year. That would make the region independent “well before 2030.”

    Russia exported between 170 and 190 billion cubic metres (bcm) of natural gas per year to the EU before 2020. In total, the plan aims to remove the equivalent of 155 bcm of Russian fossil fuels from its energy network, worth around EUR 310 billion. That is the equivalent of almost 2% of European GDP, but represents almost one quarter of the Russian economy.

    This plan has implications across energy markets. Germany is now considering re-starting coal power plants, while Belgium has postponed a planned phase-out of nuclear energy.

    Improved energy efficiency in homes may save 14 bcm, with another 4 bcm saved from photovoltaic panels and heat pump installations. The EU wants to find an extra 10 bcm from other piped gas supplies, and another 23.5 bcm equivalent from new wind, solar and biomethane power, plus renewable hydrogen storage.

    Limited Natural Gas

    The biggest shift is for LNG, where the EU plans to replace half of Russian gas supply with other sources. New LNG investment will be positive for suppliers, transporters and companies involved in building infrastructure. The EU wants to replace around 50 bcm of Russia’s gas supply with LNG by the end of 2022.

    …we expect gas prices to remain high well into 2023, as buyers compete for limited supplies

    That looks ambitious. The International Energy Agency estimates that there is an additional 20 bcm in world markets. With LNG supply growth at around 5-6% per year, we expect prices to remain high well into 2023, as buyers compete for limited supplies. We expect the US in particular – currently accounting for only 15% of the global market – to benefit significantly, as well as suppliers in Africa and the Middle East. Qatar already plans to expand its LNG export capacity.

    On 20 March, Germany agreed a deal with Qatar to import LNG. That allows German energy companies to begin negotiations with Qatar, without specifying the volumes available. Qatar exported 106 bcm of LNG in 2020. Germany, which currently has no facilities for transforming LNG into gas, has just approved the construction of two such terminals.


    Green transition

    The EU’s policy shift also supports the green energy transition. Wind and solar power costs were already falling rapidly before the war, and compared with current gas prices are becoming even more favourable.

    High input prices in industrial metals and labour, as well as supply chain issues, are limiting new construction projects. In other areas, the crisis is forcing change. Germany, for example, looks set to relax planning restrictions for new wind farms.

    New energy finance, and new sources of financing, may help with steep infrastructure costs

    Infrastructure spending

    New energy finance, and new sources of financing, may help with steep infrastructure costs, including for poorer EU members. As in the past, a crisis is proving a catalyst in the EU. On 10-11 March, EU leaders considered plans to issue bonds to finance energy and defence spending. The precedent was set during Covid. In 2020 the Commission issued ‘social bonds,’ loaning the proceeds to member states to help fund national furlough schemes.

    Energy-intensive industries such as electrification and renewable hydrogen infrastructure will attract spending, in addition to the EU’s Green Deal and Next Generation pandemic recovery fund. France is already investing in retrofitting buildings, Germany plans to spend on electric mobility, and Spain on public transport, renewables and smart grids.


    Nuclear power? Yes please

    While no current energy sources nor saving measures would compensate for the complete loss of Russian gas flow, much attention since the invasion has focused on nuclear power in Europe. The need to wean the continent off Russian gas has stalled debates on its future. In January, the bloc changed its classification of investment activities to label nuclear and gas as ‘green energy.’

    Nor is nuclear power a short-term solution. New facilities need as much as a decade to construct and commission. Total European nuclear energy production currently amounts to the gas equivalent of 90 bcm, or 23% of European electricity in 2019, of which around half was produced by French sites. If Europe’s power stations were to increase utilisation, and countries halted their plans to retire plants, the EU may be able to generate additional nuclear energy equivalent of around 13 bcm.


    Plugging industrial metals

    Green electrification is also key to the EU’s energy plan, especially for domestic heating which accounts for more than 40% of European gas consumption. Sustainable heating, industrial batteries, inverters, transformers, and power cables will all benefit from technological advances in photovoltaic panels, air and ground-source heat pumps, as well as upgrades to ‘smart grids.’

    We have long been positive on industrial metals

    We have long been positive on industrial metals and these policy changes will boost demand for copper and nickel used in batteries and electrification. They play a key role in the transition to sustainable energy and offer a hedge against inflation.

    Shares of European renewable firms were among the first to gain since the Ukraine conflict, supporting valuations.

    Investors need to be more selective and disciplined as these stocks become more expensive. However, with additional government spending now possible, we expect positive earnings revisions going forward. We favour pure renewable energy developers and component producers for solar and wind products. In wind power, offshore installations are one of the fastest-growing segments and tend to benefit manufacturers of larger turbines. In solar, we prefer new panel technologies including nanomaterials, or parts that can be built directly into roofs and windows.

    We remain neutral on utility firms since while the EU’s emergency plans will offer some support, they still face tariff freezes to shield consumers from high energy prices and rising interest rates.

    Russia’s invasion is not only reshaping Europe’s energy policy but also defence strategy. With government spending targeting greater military and energy independence, French economist Jean Pisani-Ferry estimates Europe’s total fiscal response may reach EUR 175 bn in 2022 alone. That would support economic growth in the wake of higher energy prices.

    Wichtige Hinweise.

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