Ripple

Europe energy crisis, China economic slowdown will affect Australian investors

But the property sector has been largely unmoved by repeated efforts by the national and local Chinese governments to stimulate activity; sales in July were 29 per cent lower than the prior year.

Later on Monday night, the People’s Bank of China released a statement urging banks to boost credit growth. But how banks boost lending to customers that don’t want to borrow remains to be seen.

Drought hits manufacturing

China’s GDP growth target of 5.5 per cent in 2022 is dead and buried. But as President Xi Jinping prepares for the Chinese Communist Party’s 20th National Congress in the coming months, his efforts to get the economy moving again are being hampered by a crippling drought in the southern part of the country.

In addition to bringing extreme temperatures, the drought has also slashed electricity production from the region’s hydroelectric power stations, forcing power rationing in the Sichuan province.

While the region accounts for less than 5 per cent of the Chinese economy, it has a population similar to that of Germany and is a key manufacturing hub for electric vehicle batteries and solar panels. Industrial users have already been forced to curtail production and these cuts look likely to drag on.

About 8000 kilometres away in northern Europe, another energy crisis is forcing industrial production to curtail. As European gas and electricity prices have soared recently, big energy users such as zinc and aluminium smelters have closed their doors as losses mounted.

The situation worsened on Monday night, as Russia turned off a crucial gas pipeline for “planned maintenance”. That caught the market off guard and raised fears Russia might turn off gas flows permanently to try to force the West to lift sanctions.

Benchmark European gas prices in Holland surged by 13 per cent on Monday night towards all-time highs, about 15 times higher than typical average prices for this time of year. Coal prices jumped, as did German and French electricity prices, and British gas prices.

‘Paying the price for our freedom’

In a neat and frankly frightening illustration of what energy prices are doing to household budgets, Citi warned Britain’s inflation rate could peak near 18 per cent early next year.

What is perhaps most frightening is that this fresh European energy crisis is occurring in August, months before winter, when energy use will really rocket.

The hints of desperation are becoming plain to see, whether it is French President Emmanuel Macron warning of hardships ahead and asking his people to “accept paying the price for our freedom and our values”, or German Chancellor Olaf Scholz openly wondering what happens if gas from Russia stops flowing.

An expensive and potentially volatile winter lies ahead for Europe. As JPMorgan boss Jamie Dimon told this column a few months ago, energy shortages could rip the European Union apart as individual countries go their own way in the scramble to keep the lights and heaters on.

A spike in internet searches for firewood in Germany might elicit a chuckle, but the prospect of social unrest if energy costs keep surging and shortages of goods emerge because of the spread of industrial production curtailments suddenly don’t seem so far-fetched.

So, how do these crises in China and Europe reach Australia?

The China ripple effects are most obvious; we are already seeing pressure on iron ore and other commodity prices due to the slowdown in the property sector, and the broader economic weakness suggested by China’s latest rate cut hardly bodes well for broader commodity demand.

Higher energy prices in Europe will flow across the world; US natural gas prices hit levels not seen since 2002 on Monday night, and Asian gas prices also jumped. Expect pressure on Australian gas prices to build too, as export parity prices rise.

Thermal coal prices have been high all year, and with Europe (particularly Germany) reluctantly turning back towards coal, this can also be expected to continue.

There will be swings and roundabouts in these ripple effects – positives for oil and gas companies, negatives for miners and electricity users. But the bigger question for investors is, how heavily would a deep European recession and further weakness in the Chinese economy weigh on global sentiment?

Even the most resilient results at home could be overwhelmed by bad news from abroad.

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