The impact from events in MENA (Middle East / North Africa) in the past couple of months has been uncompromisingly bullish for the energy complex, and specifically crude oil. However, with the coming of a second ‘black swan’ event in quick succession to this first outlier through the earthquake in Japan, markets this time have been dealt a very different hand, in that the impact to the energy complex is not quite as clear cut.
This reaction is also affirmed by trading of the Japanese currency, the Yen. It has reached a post-World War II high versus the US dollar as funds are repatriated to finance a recovery. The Bank of Japan sold 2 trillion Yen in September 2010 to shore it up from strengthening further above 83 Yen. This intervention proved successful, as the FX rate hasn’t strayed too far from this level in the past six months. That is until last week’s earthquake :
But despite price action being overarchingly bearish for equities and bullish for fixed income – both in Japan and globally - things have played out a little differently for our dearly beloved energy commodities. So let’s do a quick review of some of the global commodities to see how they have reacted, and why:
Crude oil: initially prices have sold off, not only on the immediate drop in oil demand due to a third of Japan’s oil refining capacity being offline, but on the expectation that economic growth will be materially impeded, hence a lower level of oil demand going forward.
Coal: prices are rallying on the expectation that nuclear facilities will be offline for a sustained period of time, and coal will become a substitute fuel to make up for this shortfall in the power generation sector.
EU natural gas: prices are rallying on a similar theme as for coal. European natural gas prices are charging higher on the concern that LNG cargoes will be diverted away from Europe to Japan should nuclear facilities remain offline for a sustained period. LNG imports to Japan account for virtually all of their natural gas consumption (which makes up approximately 17% of total energy consumption).
US natural gas: despite a minor initial bullish influence on prices due to the concern that LNG cargoes could be diverted away from the US to Japan, it has become a non-issue due to LNG accounting for less than 2% of total US supply (compared to the UK where it makes up closer to 20%). The US is also not competitive in the spot market, and a portion of current LNG imports are due to long-term contracts already in place.
European Power: prices are rallying on surging coal and European natural gas prices. They are also being spurred on by the announcement from German Chancellor Angela Merkel that the country’s seven oldest nuclear reactors are being closed for three months to undergo safety checks; this takes just under 10% of German power generation offline – not an insignificant amount.
European Carbon: emissions prices are following the trend in natural gas and power markets, and rallying also.
In summary, the ongoing events in Japan appear to be supportive for the majority of global energy prices, barring the bearish impact of a slowing Japanese economy on energy demand. However, the knee-jerk rallies we have seen across the various energy commodities look driven by panic, and somewhat overdone. All this being said, I leave you with an ominous thought: don’t bad things come in threes, even black swans?