Report Explores the Looming Energy Supply Crunch on Europe's Economy

The Economist Intelligence Unit (EIU) provides a stark warning: "Europe is heading for an energy supply crunch this winter. Russia's weaponization of gas deliveries will result in energy shortages, high prices and an economic downturn."

In its report, the EIU points out that "Since its invasion of Ukraine in February 2022, Russia's aim has been to make gas supply to Europe as unpredictable as possible and thus undermine economic confidence and EU resolve on sanctions." What is more, the UK-based organization assumes "that Russia will not increase gas flows to Europe above the current 20% and that cuts to supply may become more severe in the coming months. Efforts to replace Russian gas with other pipelines and liquefied natural gas (LNG) have yielded some results, but cannot go much further in the short term given the limited availability of global LNG supplies and regional regasification terminals."

The report importantly notes: "On the demand side, Europe's gas needs will be suppressed both by the EU's plan to cut demand by 15% and by the impact on consumers of much higher prices. Nevertheless," the EIU expects "some countries to be unable to meet their gas needs this winter, with Germany in particular forced to implement industrial rationing.

Through this report, the EIU aims to answer the following questions:

• How will gas rationing affect the growth outlook?
• Which economies are most vulnerable to gas shortages?
• What is the outlook for the winter of 2023/24?

A cold winter and fraying European Union solidarity could make things worse, the EIU warns. "The economic damage caused by this energy crisis will vary by country. It will also depend on a number of factors that remain uncertain":

• How cold will the winter be? EU winter gas consumption since 2014 has varied between 130bn cu meters and 148bn cu meters. Currently the EU has 79bn cu meters in storage, just over two-thirds of its total capacity. More countries would face gas shortages in the event of a severe winter.
• Will EU solidarity prevail? Solidarity could break down, not only over demand reduction—a 15% voluntary reduction has been agreed, to become mandatory under certain circumstances, albeit with a long list of opt-outs and incentives—but also over gas sharing between EU member states. Gas sharing would limit the economic pain for the most exposed countries, but agreeing to domestic shortages to help a neighboring country would be unpopular.
• How extensive will substitution be? Reports are emerging of German industrial firms substituting oil or electricity for gas in their processes, or importing energy-intensive inputs from elsewhere. The extent and effectiveness of these efforts will have a significant impact on total EU gas demand this winter.
• Which sectors will be hit? EU and firm-level efforts to reduce demand will limit the amount of gas needed this winter, but the most exposed countries will still need to make difficult policy decisions to cut demand further. These could include idling industrial production and imposing price rises and even outright restrictions on household heating use.

The EIU points out that Hungary, the Czech Republic, and Slovakia are the at-most risk economies. "Central European countries will be the worst hit as they will not only face gas shortages this winter, but also suffer from the effects of gas rationing in the German industrial sector, given their integration into German supply chains," the report explains. "Hungary, the Czech Republic and Slovakia have historically relied on Russia for almost all of their gas supply needs, and do not have access to LNG terminals given their landlocked position." Furthermore, "Alternative supplies would have to come via countries that are also set to run short of gas (Germany, Italy and Austria), so supply diversification will be limited, especially if EU solidarity frays."

Recognizing that "Germany is a systemically important economy in the EU" as "it accounts for a quarter of the bloc's GDP," the EIU predicts that "a downturn prompted by gas shortages will have serious spillover effects. The industrial sector accounts for almost 30% of Germany's GDP, and reliance on Russian gas is high, at 35% (albeit down from a pre-war 55% owing to higher imports from Norway, greater LNG supplies and the restarting of coal-fired power plants)." The organization also expects "the main damage to the economy to come from energy-intensive industries such as chemicals, steel, glass and fertilizers, which will be the first to face gas rationing. However, higher prices and collapsing confidence are already affecting other sectors such as machinery and automotive manufacturing, with spillover effects being felt in Italy, Austria and central Europe."

As for France, the report says the west European country "is a wildcard: problems with corrosion as well as scheduled maintenance have taken half of the country's 56 nuclear reactors offline." Moreover, "The newly nationalized energy company, EDF, plans to reopen enough capacity to have sufficient energy for the winter, but uncertainty is high, and for now France is having to import more energy than usual, including from the UK. Should this continue, this could divert further gas supplies from their usual markets, and cause shortages even in countries that appear well supplied."

The report notes that reducing vulnerabilities in Europe's energy supply will take time.

• Short term: The EIU expects a recession in Europe this winter, with the brunt of the economic impact coming in the fourth quarter of 2022 and first quarter of 2023. An unsupportive global context—given US monetary tightening, China's growth slowdown and growing investor nervousness—will exacerbate the European downturn."
• Medium term: "Replenishing gas storage in 2023 will be difficult given that stocks are likely to be fully depleted this winter. Transitioning away from Russia as an energy source and towards LNG and renewables will take time, while a revival of coal-fired power in some countries will mean a temporary setback to emissions reduction. The winter of 2023/24 is likely to be challenging."
• Long term: "the EU's energy supply will be greener and more resilient (albeit still dependent on imported inputs for renewable technologies). High energy prices will incentivize households and firms to invest in greater energy efficiency. Russia's geopolitical leverage over the bloc will have been weakened. However, this transition will take several years and will entail considerable economic pain and political turbulence."

Whether it was during last month's trip to Granada, Spain to attend a conference featuring Spanish startups or more recent online discussions with people living in Europe, I am surprised by the general lack of concern about the looming energy supply crunch and its impact in the economy. Very few people, myself included, expected the Russian military to quickly overtake Ukraine in the former's unprovoked invasion of the latter. Now that sceptics of Ukraine's resilience have been proven wrong, Europeans must be prepared for a protracted war that may last for another two years and perhaps longer. 

One consequence of the war in Ukraine is higher energy costs in Europe. According to an article from The Economist: "For most people and businesses, the vague summertime prospect of having to pay more to keep homes warm and factories humming is about to become a harsh wintertime reality."

As another article by the EIU warns: "High energy prices would lead to a surge in bankruptcies as firms become unprofitable. Governments could also halt price protections for households, increasing heating costs further and eroding consumers' purchasing power."

What are your recommendations for how Europe can mitigate the impact of an energy supply crunch on the economy?

Aaron Rose is a board member, corporate advisor, and co-founder of great companies. He also serves as the editor of GT Perspectives, an online forum focused on turning perspective into opportunity.

Returns Are a Headache for Retailers

Whether through my capacity as a strategic advisor at Koba, LLC, which owns the e-commerce platform Koba Roots, or being a long-time shareholder of Amazon.com, I have learned that returns are a significant problem online retailers face which can negatively impact their financial performance. Therefore, it was with great interest to read an article by The Economist that notes 21% of online orders in the United States, "worth some $218bn, were returned in 2021, according to the National Retail Federation, up from 18% in 2020. For clothing and shoes it can reach around 40%. It is a headache for retailers."

The article adds that online shopping in the U.S. "now makes up 15% of retail sales by value, up from 10% at the start of 2019." What is more, "only 5% of returned goods can be resold immediately by retailers. Most go to liquidators at knock-down prices or are thrown away. Retailers typically recoup about a third on a $50 item, says Optoro, a firm that helps with returns." Interestingly, "Over half of items are returned because they are the wrong size."

Some companies like Japan-based Uniqlo, or Zara, a global retailer based in Spain, are levying "a small fee for posted returns." The article point out that "Other firms, including Amazon, are selling more refurbished goods as a way to cut loses."

Online retailers are starting to use artificial intelligence (AI), virtual reality (VR), and augmented reality (AR) to simplify the ordering process for the costumer and reduce returns. According to The Economist, "Using artificial intelligence to help retailers decide what to do with the returned goods, taking into account factors such as price trends in second-hand markets is the brainchild of goTRG," a Florida-based startup which helps retailers sort returns. The article adds that Walmart, through its planned acquisition of AR startup Memoni, will let "shoppers virtually try on glasses. Walmart also offers ways to try on clothes and arrange furniture in rooms using AR. Amazon recently launched a VR feature that lets users try on shoes." The article concludes that "Retailers will now try virtually anything to cut down on returns."

In a CNBC article, Mehmet Sekip Altug, associate business professor at George Mason University, said: "In the past, retailers tended to overlook what happened after the sale. But 'as online sales increase, the return rate has also increased significantly, and I don't think it's a secondary problem anymore.'"

What are your recommendations for how retailers can reduce their return rate?

Aaron Rose is a board member, corporate advisor, and co-founder of great companies. He also serves as the editor of GT Perspectives, an online forum focused on turning perspective into opportunity.

Big Tech to Remain Resilient Despite Macroeconomic Headwinds

In a report published by the Economist Intelligence Unit (EIU), "The macroeconomic environment is worsening" and the "EIU expects global economic growth to slow to 2.8% in 2022, while inflation reaches 9.2%— and big tech companies are not immune to the downturn." The report adds that Alphabet, Amazon, Apple, Meta, and Microsoft, in the quarter ended June 2022, "have reported their softest results in over a year."

According to the EIU, "The slowdown suggests that the strong growth seen as a result of the pandemic is now normalizing. Although big tech companies retain strong assets, such as their market positions, sizes and cash reserves, they will have to cope with weaker demand and higher costs over the next few years."

American enterprises with global operations that conduct commercial transactions in US dollars may be seeing a decline in sales outside of their home market as a result of a strong dollar. The EIU, however, explains that "With the exception of Meta, revenue growth is slowing, not declining, showing that big tech can still find pockets of growth despite the gloomy macroeconomic environment."

Furthermore, "Among the factors hurting big tech in 2022, the strong dollar is the most prominent one: these companies make between 40% (Amazon) and 60% (Apple) of their revenues outside the US. The impact of exchange rates was between 3-4% in the second quarter of 2022, but could reach as much as 6% in the third. We forecast that the euro will start to regain some ground in 2023, but the yen, sterling and some other currencies will remain weak."

In addition to macroeconomic conditions, especially the strong US dollar, are weighing on big tech earnings, the report's key findings include:

• Meta was the worst affected, reporting its first-ever quarterly revenue decline (-1%).
• The enterprise side remains strong, with cloud services growing at over 30%; premium services and subscriptions also remain positive on the consumer side.
• Big tech companies retain huge cash reserves (over half a trillion dollars combined), which will enable them to weather the storm
  

The EIU encouragingly notes that selling cloud services to enterprises "remain robust for big tech." The UK-based organization further says "High growth in cloud revenue suggests that businesses are sticking with their digital transformation plans despite tougher macroeconomic conditions. They view these investments as important for driving revenue and saving costs in the long term."

The report, however, points out that "The consumer environment was more difficult. As well as weaker consumer demand hitting the advertising market, online retail growth has also slowed (after surging during the pandemic years)."

On the topic of large cash reserves keeping big tech ahead, the EIU predicts that "The five companies will slow down hiring this year and next as they look to contain costs, but this follows a period of heavy hiring—Meta grew its headcount by 32% in the past year." Moreover, "Slower hiring does not suggest a lack of investment or innovation: big tech companies are increasingly competing with each other, and many other players, across a number of markets, such as healthcare, gaming or extended reality, and will continue to do so. Nevertheless, the environment is getting tougher, not only in terms of macroeconomic conditions and the competitive landscape, but also in terms of regulation."

The EIU adds that while it remains "skeptical that the US will pass any major tech laws before the November 2022 midterm elections, the EU has recently passed the Digital Markets and Digital Services Acts. Both will impact big tech companies if properly enforced." As reflected in the image to the right, the tech firms "can still use their size as well as their large cash reserves, which combine to over US$500bn for the five companies, to cope with tougher conditions."

I appreciate how this technology outlook analyzes the recent slowdown, outlines some of the critical challenges facing big tech and why, despite tricky external conditions, EIU expects these companies to remain resilient. What do you think of the report's findings? How are you making your company resilient to macroeconomic headwinds?

Aaron Rose is a board member, corporate advisor, and co-founder of great companies. He also serves as the editor of GT Perspectives, an online forum focused on turning perspective into opportunity.