In Theory It Should Work
In Theory It Should Work
But in practice it doesn't
A trip to the land of Theory
When I was a researcher in biochemistry, we had a joke for when experiments did not work the way we expected them to, and we had no idea why.
In Theory, it should work.
But we are in Switzerland here, not in Theory.
I realize the joke is sort of lame, but it contains a deep truth very useful to researchers and analysts. The theory is just a theory and often fails to match real-world results. I have the same feeling when I see the forecast for Europe for this winter.
Here are some of the things that should happen in the magical land of (European) “Theory”.
Germany should have enough gas for the winter, as storages are mostly full.
Shutting down German nuclear power plants will not have adverse effects, as we have enough gas (see above).
Nuclear power is experiencing a renaissance (never mind the point above).
The economic effects should be contained, as gas rationing will be scheduled ahead if needed.
Consumers will manage, as the government will distribute stimulus.
The currency and inflation will stabilize, as the ECB is rising rates (the stimulus above never creates inflation of course).
Russia and its evil ruler are soon defeated (you see, mobilization doubling or tripling the number of Russian troops is a sign of weakness).
We have plenty of alternative suppliers to replace Russia (making the imminent victory above even not needed of course).
I would really like to learn how to get a visa and a plane ticket for Theory and move there.
The Eurocrats, bankers, journalists, and politicians seem to live there, but the commoners like me have not been invited I think.
Myself, I live in the gloomier land of “Practice”.
Life in the land of Practice
Let’s look back at some of the features of Theory, and see how Practice might differ.
Gas storage
So if Russia stops entirely sending gas to the countries providing weapons against Russia, Germany right now has enough gas stored for … 2.5 months. I am writing on 20th September, so that brings us to … mid-November?
Do other countries have enough gas reserves? I am not sure, but this sounds dubious at best. For sure, Finland does not. Neither does Hungary nor the Czech republic or Slovakia. Nor France. Or Italy.
Considering we barely filled up storage WITH Russian gas somewhat flowing during this summer.
How are we refilling said storage for winter 2023?
No idea.
But in Theory, it should work.
Nuclear
Germany in 2021 got 13% of its power from nuclear. 3 out of 6 of these plants are now closed, and the last 3 are closing soon. This is a large amount needed to be replaced by gas/coal/oil in 2022. I am sure it will do wonders to refill storage in 2023.
No change of plan by the way. Just keeping some plants as “backup”, but still planning on closing them as soon as possible.
I must say that other countries have more sense. The UK, Poland, Romania, Estonia and Czechia are all expanding or launching nuclear capacity. France has plenty of it.
The average starting date I saw for these new projects is 2029. Often 2032 or later. Developers are vehement that it will NEVER be before 2028 for both technical and regulatory reasons.
Maybe that is why I cannot find a visa for Theory.
It is not a place but a time.
Behold!
The future!
Let’s try to make it there though…
In Theory, it should work.
Economic effects in Theory
I have talked before about the effect of rising prices on the European industries. But let’s not get lost in numbers.
Let’s keep it simple.
To melt metal, you need a LOT of heat. To get heat, you need either power and/or gas. Because current energy prices are way higher than what any price smelters could sell the metal for, they are shutting down.
This ALL metals. Iron, steel, aluminum, copper, zinc, tin, magnesium, silver, gold, titanium, … If you operate a factory needing those (aka ALL factories), good luck keeping the production line running.
Same for fertilizers, with 70% of nitrogen production down already. The one thing that keeps crop yield high, food cheap, and people fed.
Same for glass.
Same for paper. “Toilet Paper Shortage, The Return”
This also shuts down silicon production, the base component for semiconductors and chips. The same chips that have already been in short supply since 2020 and forced factories to stay idle.
No need to panic though, this is just a bad winter.
Things will be back to normal soon.
In Theory, it should work.
Economic effects in Practice
In Practice, there are plenty of supply chain issues popping up all over the place. For example, no fertilizer = no concentrated CO2. No CO2, no soda, and beverage makers go bankrupt. Also, no gas to knock out animals in slaughterhouses. So no meat.
No chips mean no new cars, no new electric appliances (including heat pumps, solar panels, etc…).
No metal means no infrastructure, cars, planes, trains, armored concrete …
Accessorily, no chips and metal probably means fewer guns, missiles, tanks, armored vehicles, etc.
In Practice, it doesn’t work
Consumers’ Sentiment in Theory
In theory, the transitory trouble of high energy bills for consumers can be buffered by the government through stimulus.
I am losing track of all the ongoing and planned stimulus. €65B in Germany, £130B in the UK, and the rest of Europe is doing pretty much the same.
Some are more creative, like the French putting the burden on the national electric company before nationalizing it. Or the Austrian bailing out municipal utilities.
So you see, the problem is solved.
In Theory, printing money can solve all problems.
In Theory, it should work.
Consumers’ Sentiments in Practice
In practice, stimulus can only have 2 possible effects.
Option 1, it works!
Consumers do not feel pain and use power as usual. The problem is that there is not enough PHYSICAL supply. What happens when power demand exceeds supply is called a blackout. Not what you want in the middle of winter.
Option 2, it is not enough.
Then companies that stopped factories will not miss much, as the consumer will have no money to buy anything anyway. This is the recipe not for a recession but a Depression.
Option 1, blackouts.
Option 2, depression.
In Practice, it doesn’t work
Inflation in Theory
Inflation in theory is still “transitory”. Rising rates by the ECB and Fed will reduce inflation back to 2%, or maybe at worst 3% or 4%.
Of course, this implies inflation is due to too much demand, and not a shortage of physical goods. Like grain, oil, gas, coal, electricity, and semiconductors. And downstream of the supply chain, metals, fertilizers, and foodstuff.
Also, the rising rate will not meet the stimulus design to KEEP demand up no matter what.
In Theory, it should work.
Inflation in Practice
Despite (or maybe, just maybe partially BECAUSE) stimulus, there is now persistent inflation. A friend of mine saw rent going up from €400/month to €600/month in one year. Another one expects the monthly gas bill to go up from €100 to €300-€500.
In a country with a minimum salary of €654, it will hurt terribly the poorest segment of society, as well as the middle class.
In the last few months, yearly inflation in Estonia has gone from 20% to 25%. We already had one government coalition collapsing over disagreement on increasing benefits for families.
Is more inflation coming? For sure, producers’ input costs are not getting cheaper. They are actually up 45% (German data above).
In Practice, it doesn’t work
What to do?
The first thing is recognizing life in the land of Theory sounds marvelous, but most of us live in the land of Practice.
Practice is supply chains functioning less well or not at all.
Practice is consumers who will likely panic and either max out debt or reduce spending drastically.
Practice is energy shortage/rationing/blackouts in the EU.
Practice is a political backlash building up, like a quasi-fascist party recently elected in Italy.
Practice is the Ukraine war dragging on and getting uglier (as I described in the article Ukraine war 2.0).
Theory is nice but will leave you clueless.
Practice is ugly, but it’s real.
Making money from it
There is one difference between the lands of Theory and Practice that I left out so far. It’s the actual carrying capacity of tanker fleets for the energy Europe needs. Especially for LNG.
This will be the topic of my next Cyclical Value Investing report, to be published to subscribers soon. I will uncover an LNG company poised to benefit from desperate buyers and last-minute decisions made by politicians leaving the land of Theory for the land of Practice.
It will come as a pair with the (premium) next Eurasian Century report, “the Future of Russian oil & gas”, which follows the (free) analysis of the next steps of the Ukraine war.
If like me you already live in Practice, you know our leaders will join us down to Earth.
Eventually.
And we can make money betting on owning one of their landing spots when reality sets in.