In our first world bubble, the most immediate impact of Russia’s invasion of Ukraine has been on energy prices. We saw it first in petrol pump prices, and more recently in the utility bills landing on our doormats. But our supermarkets are generally full of food and while check-out may be 20% more expensive, we can still get what we want.
This is not to decry the very real effect of this on the less well off in the West. When autumn comes the squeeze on their pockets is going to become intolerable. As an aside, I’d put some money on there being an interest rate cut before the end of this year.
Fertiliser costs are directly related to energy
But there is another unexploded bomb yet to go off, which is likely to compound the problems with energy and food. It is the cost of fertiliser. One of my favourite blog sites, Thunder Said Energy, which focuses on the energy transition, has published some scary data here.
Since 2000 the world’s use of fertiliser has increased by about 35% - it’s how we feed the growing population. For a glimpse of the future, consider that U.S. use of nitrogen fertiliser has increased 5-fold in the last 60 years. The cost is directly related to energy. That means (for example) that the cost of urea has risen by 150% since the recent surge in oil and gas prices. To add fuel to the fire, more energy contracts are now done at or close to spot. In 2000 95%+ of LNG sales were through long term contracts, but today about 40% of sales are effectively done at or close to the spot price.
Worse than that, 10% of ammonia production comes from Russia, and European producers have cut back on production as energy prices have risen. The consequences of this are dire. At one level, less fertiliser means less food, which will directly impact the poorer, largely African and South Asian, nations. Market economics will decide the price, and the spot price could go stratospheric, as we have seen in other commodities. If supply is insufficient, also a possibility, even nations willing to pay up may struggle to obtain any. No fertiliser means even less food.
It also suggests much higher energy prices yet to come. Prices have been damped in recent weeks because the U.S. has released some strategic supplies. But they cannot do that for ever. To replace the oil and gas from Russia requires bringing new sources of energy on stream, primarily nuclear and fossil fuels. It is no secret that nations such as China and Germany are turning even to coal because it is the quickest way of bringing new energy supply to the market.
Investors will face some hard ESG choices
Investors will be faced with some substantial conflicts on the ESG front. In the short term they will have to choose between concentrating on UN SDG goals 1 (No Poverty), 2 (Zero Hunger), 10 (Reduced Inequality), or alternatively 7 (Affordable and Clean Energy) and 13 (Climate Action), because the two are in direct opposition. In the longer term there will be more alignment, but we have to get there first.
In practical terms, it is morally hard to sustain the arguments for fossil fuel divestment in a world which is desperately short of energy. For pension funds whose primary role is to pay pensions, the financial arguments are equally hard to sustain. It is no coincidence that the great majority of active managers underperformed the indices over the last six months: they have been underweight the carbon heavy sectors such as fossil fuels for ESG reasons. The data above suggests that, “stranded” assets or not, dirty fossil fuel companies will throw off even more cash for some time to come.
Investors may have to reverse some of their ESG thinking; in this new world it is not going to be as simple as focusing on carbon emissions and climate change, and the merits and demerits of sectors such as energy, defence, nuclear power, and even construction, will need to be considered in a more sustained manner. There is a phalanx of advisers to assist decision-makers, but will they be open-minded enough not to lock themselves into their old ways of thinking?