September 2022
Extreme heat and drought in large swaths of China, Europe and the US is snarling already constrained power supplies, threatening crops, and hindering efforts to revive economic growth.

China’s worst drought in 60 years and an 11-week heatwave has crippled massive hydropower dams in the southwest, forcing cities to slash power usage. Sichuan’s power generation has been cut by 50%, as hydropower counts for 80% of installed capacity. Foxconn, Toyota, Volkswagen, CATL and BYD are among the companies that have curtailed production at factories or closed for lack of power.

Europe’s worst drought in 500 years is curbing hydropower, threatening nuclear reactors, and dampening coal transport. And that’s on top of the sharp reduction in Russian gas supplies. In the first seven months of 2022, Russian gas exports to Europe fell 40% from a year earlier. High gas prices have already curtailed 70% of the region’s fertiliser production, which in turn threatens food production. 

In the US, a megadrought in the southwest has brought water levels in the critical Colorado Basin to historic lows. This has triggered a second straight year of water cuts in 2023. Arizona will lose 21% of its supply, compared to 8% in Nevada and 7% in Mexico. The Basin provides water to 40m people and 5m acres of agriculture, an industry valued at US$15bn a year.

 

Europe

The energy crunch is driving a cost-of-living crisis. European benchmark electricity prices have risen 10 times above the decade-long average, driven by a 14-fold increase in the cost of gas.   

AME expects Europe’s composite natural gas price to average US$40/MMBtu in the September quarter, up from US$32.7/MMBtu a year earlier. Hot weather and restocking demand for winter has been met with constrained supples.

Russia’s Nord Stream 1, a key conduit of fuel to Germany, has been flowing at only 20% of its 5.6Bcfpd capacity. A series of technical issues at global LNG facilities is exacerbating the shortage. Hydropower output has also been under pressure, sliding 20% in Western Europe in the June quarter. Around 64% of Europe is under drought warning or alert, according to the European Drought Observatory in August.

The European Commission said it was preparing emergency measures to curb electricity prices by separating it from surging gas costs. The UK energy regulator will raise the energy price cap by 80% from October, owing to soaring wholesale gas prices. That will increase the bill for a typical British household to GBP3,549 (US$4,154) per annum.

In the latest sign of the strain on power providers, Finnish state-backed utility Fortum on Monday asked the government for more support after the collateral to hedge surging power prices jumped by EUR1bn (US$1bn) in a week to EUR5bn (US$5bn).

In another blow for Europe’s energy supply, Norway plans to curb electricity exports to Europe if water levels for its hydropower plants remain low. Water levels in the country’s south are at just 49%, compared with a seasonal average of 74%.

France’s hydropower output has also taken a hit. Production fell by 5.7TWh or 25% in the first half of 2022, from a year earlier. The country has the largest installed hydropower capacity in the EU. France has also had to reduce output from nuclear power stations because of a lack of water to cool the reactors.

Drought and heat waves have reduced forecasts for this year’s summer harvest. Yield forecasts for maize, sunflowers and soyabeans are between 12% and 16% below the five-year average, according to data from the EU Joint Research Center. Compounding the danger to food crops is a reduction in nitrogen-based fertiliser due to high gas costs. Norway’s Yara, Germany’s BASF and Poland’s Grupa Azoty have started to shut down or reduce production.

In the past decade, the European land mass has seen mean annual temperatures about 2C warmer than the pre-industrial period, according to the European Environment Agency. This is compared to about a 1.1C global average.

 

China

The hydropower shortfall is being felt far from the southwest, including in China’s eastern cities, which are buyers of hydropower. Some factories and commercial buildings in cities including Hangzhou and Shanghai are rationing electricity. Automakers SAIC and Tesla have reported supply chain disruptions stemming from Sichuan’s power crunch.

The Yangtze River has receded so much that many oceangoing ships can no longer reach ports upstream. That is leading to more truck usage. But a single ship can require 500 or more trucks to move its cargo. This summer, rainfall in the Yangtze basin is around 45% lower than normal. Asia’s longest river provides water for 400m people.

Extreme weather is also disrupting food production, sending prices higher. On 24th August, China’s cabinet approved US$1.5bn for disaster relief to rice farmers and another US$1.5bn for overall farm subsidies. Fresh fruit and vegetable prices jumped in July, up by 16.9% and 12.9% from a year ago, respectively, according to the NBS.

 

United States

While US natural gas futures are around 10 times less than in the EU at US$10/MMBtu, this is the highest price since the GFC as traders divert LNG cargoes to Europe.

AME forecasts the Henry Hub spot gas price will average US$7.80/MMBtu in the September quarter, up from US$4.32/MMBtu a year ago, as scorching temperatures stoke electricity demand. Gas is expected to account for 37% of US power consumption this year, the same as in 2021.

Heatwaves and rising economic activity are fuelling power demand, while higher natural gas prices are driving up costs. The US residential electricity price will average 14.6c/kWh in 2022, up 6% from 2021, according to the EIA.

Soaring electricity prices is driving record numbers of late utility payments. About one in six American households are behind on their bills, a new high. The amount owed has risen to US$16bn, from US$8.1bn at the end of 2019, according to the National Energy Assistance Directors Association.

The first six months of 2022 was the sixth hottest for the period on record, according to the US National Oceanic and Atmospheric Administration. Around 93% of the western US is experiencing drought or unusually dry conditions, according to the US Department of the Interior.

 

AME’s Economic Expectations

AME expects global economic growth of 3.2% for 2022, up from our previous forecast of 2.9%, as we have revised our 2021 figure to 6.1% from 5.7%. The outlook is being weighed down by negative supply shocks and tightening monetary conditions to rein in soaring inflation. In 2023, we expect global GDP growth of 2.9%, on stagflationary headwinds, rising financial instability, and supply strains.

AME expects US economic output to come in at 2.3% in 2022, down from our previous forecast of 2.5%, on reduced household purchasing power and tightening monetary policy. In 2023, we expect growth of 1%, down from 2.4%.

We expect China to grow 3.3% in 2022, down from our previous forecast of 4.3% and below the Chinese government’s official target of 5.5%, as Covid-19 lockdowns and property sector woes hit growth. In 2023, we expect GDP growth of 4.6%, down from 4.8%.

We expect the Eurozone to grow 2.6% in 2022, as surging energy prices lash the region’s rebound from the pandemic. In 2023, we expect growth of 1.2% in 2023, down from our previous forecast of 1.9%.

The need to tackle inflation is outweighing concerns about a slowing economy. More than 75 central banks have increased interest rates so far this year, often at levels unseen in decades. By contrast, China’s deeper economic slowdown is likely to prompt looser monetary policy and fiscal stimulus.

US Federal Reserve Chairman Jerome Powell confirmed at the Jackson Hole Symposium that the central bank won’t be pivoting its “forceful” strategy anytime soon. “We will keep at it until we are confident the job is done,” he said on 28th August.

The consumer price index rose by 8.5% in July, easing from the 9.1% increase in June. While this is still well above the Fed’s 2% inflation target, we expect broader signs of easing price pressures over the next few months. The Fed is expected to raise rates by 0.5-0.75% in September. The central bank broadly expects interest rates to rise to 3.4% by the end of 2022, the highest level since 2008, and then to 3.8% in 2023.

The European Central Bank has growing concerns about rising prices, according to the minutes from its latest meeting on 25th August. Inflation hit a record for the Eurozone of 8.9% in July, up from 8.6% in June. The ECB ended its eight-year era of negative interest rates in July.

In 2022, inflation is expected to come in at 6.6% in advanced economies and 9.5% in emerging market and developing economies. Over the next two years, inflation will gradually come down as demand moderates, driven by cost pressures and higher interest rates.

 

Climate Change Implications

Extreme weather has potential implications for the global battle to halt climate change. China is burning more coal to help offset lower hydropower output, as the Yangtze River reaches record-lower water levels. In July, electricity generated from coal increased 22% from June, accounting for 69% of the country’s electricity supply. That’s up from 67% in 2021.

In Europe, a tight power market is leading to more coal-fired power generation. France, Italy, Austria, and the Netherlands have all announced plans to reactivate old coal power plants. But the plans are the most extensive in Germany, which is allowing 21 coal plants to restart or work past planned closing dates for the next two winters.

Germany has allowed a second hard coal plant to re-join the grid. The 875MW Heyden 4 will start producing electricity from 29th August until 30th April 2023. It follows the 690MW Mehrum plant, which restarted on 2nd August. The country is still aiming for renewables to account for 80% of electricity consumption by 2030 and 100% by 2035, up from 49% in the first half of 2022.

The longer-term picture remains focused on accelerating the shift to cleaner energy systems. In 2022, global renewable capacity is expected to increase over 8% from a year earlier, pushing through the 300GW mark for the first time. 

In the US, President Biden signed into law a landmark bill in August with US$369bn in spending and tax credits to fight climate change. The investment is expected to reduce US greenhouse gas emissions by roughly 40% below 2005 levels by 2030, according to the Princeton-led REPEAT Project. While that falls short of the Biden administration’s goal to cut US emissions by at least 50% by 2030, additional policies, such more aggressive state action, could help close the gap.

Global cities are becoming increasingly creative to counter rising heat. In London, where temperatures recently hit 40C for the first time ever, wants to cover half the city with green areas by 2050. The London borough of Hackney plans to plant 5k trees this year. Britain is aiming to cut carbon emissions by 78% by 2035, compared to 1990 levels.

In Seville, a EUR4m (US$4m) pilot project on Cartuja Island aims to lower average temperatures by 10C by using underwater aqueducts to funnel cool water from the Guadalquivir River through nearby buildings. In Los Angeles, the Pacoima neighbourhood is painting nearly 1m sq-ft feet of black asphalt with a solar reflective epoxy paint to lower the surface temperature by as much as 6C.