Europe is in the process of losing its industry. It didn’t start this year, it was already going on for decades now. However, in 2022 the process has switched from a long slow grind to a considerably higher gear.
Energy is the economy. This is the key point in understanding not only economics, but geopolitics and history as well — especially the recent events in Europe and around the world. Too bad, that this rather self-explanatory observation has been completely left out of modern (i.e.: neoclassical) economics theory, where everything revolves around prices of goods and services, demand and supply, and ultimately: infinite growth on a finite planet.
In the real world, however, every single economic activity requires an irreversible expenditure of energy: from cutting a client’s hair, to melting or forging steel. Take energy away and all economic activity stops, starting with the ones using the highest amount of energy and continuing with the rest as the loss of one business leads to the loss of another.
There is a very important point to understand here though. Complex self-adapting systems, like the Economy, very rarely collapse completely. As the knock-on effects take their toll, the falling of dominoes usually stops at a certain point. It’s like an avalanche: it starts slowly beneath the surface. As the fundamentals deep inside the snow-pack slowly give way to gravity, a large piece breaks away: all of a sudden half of the mountain is on it’s way towards the valley! However, there are many natural stopgaps in the process, and the avalanche remains concentrated to a certain area. It destroys everything in its path, but it eventually stops.
We will be witnessing something very similar in Europe. The fundamentals of energy supply are getting weaker by the day — and this physical reality will eventually show its teeth to the industries most heavily relying on cheap and abundant energy. First, the lack of adequate power supply will manifest in even higher inflation (feel free to scroll up a bit for the list of most energy intensive businesses). Food. Chemicals. Fertilizer. Glass. Metals.
Here comes the difficulty though. While we cannot live without food, and thus its production cannot stop, we think we can get on by imports from chemicals, metals and the rest. Globalization — at least what’s left of it — is still with us: there is still a huge competition between suppliers of these energy intensive products, and China with its cheap coal and cheap oil from Russia still seems to be a viable option. The question is: how far can this substitution avalanche go, and what will remain in its path? Will Europe’s woes trigger a global financial meltdown?
European companies smelting ores or manufacturing goods out of metals found themselves between a rock and a hard place, as electricity gas and coal prices shot through the roof — a cost they simply could not pass on to their customers. If you need a certain amount electricity or gas to heat metals to their melting point (a pure physical requirement no human ingenuity can circumvent), then you have to pay for this energy no matter how much it costs. Of course you can recycle some heat from the cooling process, or switch to high pressure die casting — but all these technologies require large upfront investments and ultimately are no panacea to exponentially rising costs of energy.
If you think that all this energy price increase is temporary, or driven by market speculation and monopolies jacking up prices, I need to remind you what economist John Maynard Keynes said in the 1930s:
“Markets can stay irrational longer than you can stay solvent.”
As a direct consequence of rising energy costs half of EU metal companies now face an existential threat from rising energy prices. Eurometaux — the European metals industry association — wrote an open letter to the European Commission recently to express their utter desperation:
50% of the EU’s aluminium and zinc capacity has already been forced offline due to the power crisis, as well as significant curtailments in silicon and ferroalloys production and further impacts felt across copper and nickel sectors. In the last month, several companies have had to announce indefinite closures and many more are on the brink ahead of a life-or-death winter for many operations. Producers face electricity and gas costs over ten times higher than last year, far exceeding the sales price for their products. We know from experience that once a plant is closed it very often becomes a permanent situation, as re-opening implies significant uncertainty and cost.
The recent closure of several blast furnaces and stainless steel mills across Europe only adds to these woes. And it’s not only about the metals industry. This is a fundamental issue to the entire European economy, most of it relying on locally available metal supply and cheap energy to continue running production. Automotive. Aviation. Batteries — including those shiny new factories just completed. Windmills producing ‘renewable’ electricity... How should they build batteries and electric cars of the future without affordable local steel, aluminum, nickel, or copper…?
Should this wave of closures continue long enough, the oh-so treasured German car industry itself would be quickly loosing its competitive edge in the world — forcing another round of closures, this time in and around its local supplier base. Stripped of its vital businesses Europe could easily turn into a sweat-shop for offshore companies: a mere assembly plant and logistics hub for the goods arriving from the Far East.
Services will also take a huge hit, as heating and lighting costs rise through the roof. The real size of the issue though will only show itself in October, then again in January, when annual contracts for gas and electricity will have to be renewed at a much higher price — if these contracts could be renewed at all.
Utility companies are now asking for disproportionately large monetary deposits from their business customers. In theory to prevent insolvent businesses to stop paying their bills, in reality though, it is utility companies themselves who are having serious problems presenting enough cash, an amount mounting up to a whopping $1.5 trillion — exposing a giant vulnerability of the financial system.
Money is ultimately a derivative of energy. No energy — no money.
Other businesses and municipalities are not even getting these costly contracts with deposits, but receive quotations on a daily price basis, or in some cases: no quotations at all. I expect a lot of small and not so small businesses closing in January as this energy crisis avalanche rolls through the entire economy.
This is indeed the end of abundance — as Macron told his audience recently in a somewhat timid admission that energy and materials are indeed the economy, and that we in Europe have just helped ourselves passing the peak in technological civilization:
“What we are currently living through is a kind of major tipping point or a great upheaval … we are living the end of what could have seemed an era of abundance … the end of the abundance of products of technologies that seemed always available … the end of the abundance of land and materials including water”
I’m sure this was not what they were thinking back in April, despite all logical conclusions pointing in this direction (at least the ones based on physical realities). Europe, however, had little say in this. Neither politically, nor in real economic terms.
I’ve touched on the former a week ago, discussing how this sanctions war was a setup for Europe many years ago to wean it off from Russian gas supplies — thereby overextending the West’s old adversary and making room for US LNG shipments. As for the economics part of it: having the most of it’s own high quality, low cost coal and iron ore reserves depleted during the Industrial Revolution and after giving these resources a final shot in WWII (turning them into tanks then blowing them up in the enormous battles for Eastern Europe) the only viable energy alternative for generating electricity and economic activity in general for Europe was oil, and increasingly, natural gas.
After the Arab oil embargo, oil was ceased to be burned en masse by utilities — some of which has returned to coal, some have converted to natural gas, while others were focusing on nuclear, and most recently, renewables. Nuclear energy, though, was always controversial: riddled with cost overruns and occasional accidents — a source for strong opposition. None of the projects were finished on time or on budget, making nuclear one of the most expensive form of electricity once all costs were considered, from build up to complete decommissioning. Renewables also needed a significant amount of financing in the form of subsidies and back-up power plants to provide a stable current of electricity — mostly supported by natural gas.
It is by no accident then, that after opening the North Sea for oil and gas extraction in the eighties it was increasingly natural gas which has become the cheapest source of heat and electricity. As these fields duly started to deplete at the turn of the century, together with the Groeningen-field in the Netherlands, an alternative source had to be found.
Pipeline gas from Russia was a ready option, and undeniably the cheapest of these sources. Liquid natural gas was, and will always be, a more expensive option: the gas would have to be chilled to –260° F (–162° C) using electricity (ultimately produced from natural gas itself) then transported over the sea by burning fuel oil, then regasified (reheated and pumped into pipelines) at a similar energy expense. In a rather ironic twist of fate LNG has not only proved to be more expensive, but it has actually sped up the depletion of the resource what it aimed to replace — while having a much larger CO2 footprint than pipeline gas at the same time.
Was it a sensible choice from Europe to invest in gas pipeline infrastructure in the 2000’s then? From an economic return on investment point of view: absolutely. As the authors of the RAND report pointed out already in 2017:
…alternative gas supplies are likely to be more expensive in terms of both infrastructure costs and gas prices. If governments subsidize the infrastructure, they will have to reduce expenditures for other purposes or raise taxes, both of which might create a drag on the economy. Higher gas prices will reduce the ability of Europeans to purchase other goods and services, also creating a drag on the economy.
It was clear, years before the war, that there was never a real, scalable and versatile alternative to pipeline gas for Europe. It was either plentiful, cheap gas from a potentially hostile state, or much less, much more expensive gas from elsewhere. Europe has taken a bet on the former, and now, as hostilities between the former superpowers have reached new heights, has found itself under the bus. At a time, when the other, possibly even greater blow to the economy: the oil embargo / price cap, haven’t even came into force yet. (That is scheduled conveniently at December 5, after the mid-terms in the US.)
The third option, namely giving up on the infinite growth chalice and preparing for a soft landing into a post-industrial world was never even discussed… Instead of investing in dubious projects to extend the shelf-life of an inherently unsustainable system (based on the drawdown of finite reserves of fossil fuels and metals), Europe could’ve invested in communities, small scale farming, small local grids, limited transportation, weatherized all housing and all the rest.
Of course all this would have flown right in the face of the wealthy ruling elite’s interests — people, seeking their rents from large monopolies — and thus was destined to fail from the get go. Instead, something utterly bizarre has emerged: “You will own nothing and you will be happy” — as Klaus Schwab, Executive Chairman of the World Economic Forum used to say. The idea was (and it still is) that as usual in such cases of deep crisis, the wealthy would get wealthier while the rest of Europe would suffer a serious setback to living standards and left to pay ever higher mortgages and rents to the owner class, thanks to rapidly increasing interest rates.
The wealth pump must not stop. Growth, no matter how marginal and how limited to the very top of the pyramid, has to be maintained. The entire system, driven by its own momentum, is predicated on it: even though the real economy — which made it possible in the first place — crumbles to the dust. The Great Reset marches on as high tech civilization slowly gives way to something utterly different.
I wonder, if the Mayans or Romans had such a fancy name to their own period of decline and fall… Maybe our civilization is indeed special — at least in this regard.
Nothing lasts forever though. Not even sudden falls of this kind. Natural stopgaps which we cannot see at this moment will eventually stop the fall of the economy at a certain point, and a new period of revival will set in — based on the recently liberated resources, no longer tied up by the old industries. If the collapse is big enough, it will be indeed a great reset, if not, we can expect a rerun of the current crisis in a couple of decades time. It’s important to note, that neither resource depletion, nor climate change will stop in the meantime. A seemingly endless ‘rinse and repeat’ cycle is all but guaranteed until the system uses up all its remaining resources or gets washed away by the rising seas and finally settles at a much lower, although much more stable state.
Until next time,