Come Back of Energy Prices in 2023
Since late 2020, there has been a continuous increase in energy prices, culminating in a peak in June 2022, a few months after the Russian invasion of Ukraine. I have been consistently vocal, since 2020, about the weaponisation of monetary policy, and its role in financing fiscal deficits aimed at subsidising an energy transition. This type of monetary and fiscal policy should be a cause of concern for all major energy exporters to the EU. Ultimately, the EU's goal of achieving energy independence poses a national security risk for big exporters such as Russia.
Energy prices have fallen significantly since their peak following the invasion of Ukraine. However, in my opinion, there exists a dynamic of leverage that is exerting pressure on the price and remains largely unaddressed.
In February 2022, there was widespread pessimism about the EU's prospects regarding the winter, prompting massive inflows into the energy sector due to speculation and front-running the “catastrophic winter”. These inflows included several leveraged bets through futures, FOPs, physical ETFs, etc.
To provide a rough estimate, the chart above indicates a substantial decline in WTI net long positions as the price of oil decreases and carry costs rise, including interest on leveraged positions and the opportunity cost of capital. Levered traders are experiencing pressure and are being forced out of the market. This technical factor is essentially providing a form of subsidy to energy prices.
As most of these speculators approach capitulation, the price is likely to trend higher. When considering the discussion surrounding external credibility, as mentioned in my previous post (link), it further underscores the significance of these factors in shaping the future of the energy market.
The decision to pause the normalization of conventional and non-conventional monetary policy at this point would result in a loss of external credibility. This, in turn, would likely lead to a reduction in output of net energy exporters and cause prices to rise.
As we have seen the balance sheet of the Federal Reserve has increased substantially since the banking crisis in the US.
Since the invasion of Ukraine, the European Union (EU) has seen a significant decline in its imports of energy from Russia. In the chart below we find monthly diesel imports into northwest Europe by region.
However, it is important to note that this trend is primarily a result of a rerouting of commodities through the value chains, rather than a reduction in overall energy imports from Russia.
Commodity prices are highly sensitive to changes in demand, and fluctuations in demand can have a significant impact on supply-demand balance and price levels.
External credibility can play an important role in shaping market expectations, including expectations about future inflation. However, it is important to note that monetary policy actions are not the only factor that can influence inflation expectations and price dynamics.
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