How the EU economy is circling the drain

How the EU economy is circling the drain

Inflation and other factors have been on everyone’s mind for the past 6 months here.  The price of everything has increased but disproportionately in the energy sector.  The story in the EU, however, is far worse and about to get more acutely painful as the weather turns cold in Europe.  

The Russia-Ukraine war has led to retaliatory sanctions against Russian oil.   Russia in turn, shut off gas through its largest pipeline Nord Stream 1.   Although Russia has other pipelines of gas to Europe, only about 20% of its normal volume is flowing to Europe (see Figure 1).  

Figure 1.  Everything is down and to the left in the EU

Due to the sudden depletion of supply to the EU, gas is being rationed to protect home heating and hospitals at the expense of industrial usage.   While this is the correct response, the tragedy here is that the EU heavily relies on gas for two things on the industrial supply: energy and as an input good.    Without gas, industries from steel, ceramics, automotive, glass, ceramics, sugar, fertilizers, and others will have to shutter.  

The extent to which this can decimate the European economy can’t be understated: the EU is an $17.9T economy of which manufacturing accounts for €5.2T.    A sizable part of that economy will no longer be competitive with energy prices rising 10x after long term energy contracts run out later this year for many companies.   The EU industrial sector will likely take 5-10 years to recover from an event like this and lead to further supply chain shortages around the world.  

Figure 2.  The only helpful advice I have to offer

Value investing rules still apply as always.  Many companies are going to be available in the next 6 months for significant discounts to their long term value.  I would recommend everyone start compiling a list of great businesses to hold for the long term.  In the next few weeks I will be compiling a list here.  But before that comes, it’s probably a good idea to run around screaming in the streets.

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