September 15, 2022 - 1:00pm
Earlier this week there were a slew of headlines claiming that the energy crisis had been solved and that prices were expected to come down imminently. The stories cited a report released by Goldman Sachs entitled ‘Natural Gas: The End of an Era’, which attempts to model the complex dynamics of the natural gas market amid the backdrop of major changes since Russia brought gas deliveries to Europe to a halt.
Note two of those words: ‘complex’ and ‘model’. The paper is not one built on facts but rather on assumptions. We all remember those models during the early pandemic warning of 250,000 Brits dying by Spring 2020 or 2.2 million Americans gone within months, which turned out to be fanciful (to put it kindly). Those too were attempts at modelling a highly complex phenomenon and used assumptions to do so.
The truth is that models are just stories told using mathematics and data. The assumptions plugged into the models are like fictitious characters in a novel. Ultimately the assumptions — like the characters — do what the writer tells them to do. By changing the assumptions in the model, it can be determined whether the outcome of the story is tragic or not.
Immediately then, the headlines claiming that the energy crisis was resolved were far-fetched. A more honest headline would have run something like: “Goldman Sachs analysts model scenario in which energy crisis is resolved”.
At that point the question becomes: based on what assumptions? If we dig into the model a few immediately catch our eye. First, the analysts assume a substantial drop in energy consumption. ‘Consumer demand assumptions through the end of winter embed an 11% drop,’ the authors write, ‘with most of this reduction impacting industrial and generation demand for gas (-18% vs average, a deeper decline vs what we have observed recently).’
To my eyes, an 11% drop in energy usage and an 18% drop in industrial energy usage is not a resolution of the energy crisis, it is the energy crisis. The analysts are assuming that industrial capacity in Europe drops by around one fifth, which in turn means shortages and potentially runaway inflation.
In addition, the authors appear to make a number of rather rosy assumptions about Liquid Natural Gas (LNG) supply. These include: ‘higher LNG supply from new projects in the US and Mozambique vs last winter, the restart of the Hammerfest facility in Norway, and a recovery in feedgas in Trinidad allowing for higher exports’.
But it is important to remember that these have not actually happened yet. The authors admit as much, writing: ‘Alternatively, LNG supply could disappoint… a sustained drop in LNG into Europe would likely trigger a surge in gas prices’. Well, quite.
It doesn’t stop there. The authors go on to list yet more assumptions about a ‘cold spike during winter’; Russian gas imported by Italy being curtailed; ‘a colder-than-average winter in Asia’; and ‘a stronger-than-expected rebound in China’s economic activity’. The list goes on and on.
Contrary to the headlines, if this report shows anything, it is how difficult it will be to resolve the energy crisis. As much as we may be comforted by reports like those produced by Goldman Sachs, it is wishful thinking to believe that there is an easy way out of this situation we find ourselves in.
Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics
philippilk
Join the discussion
Join like minded readers that support our journalism by becoming a paid subscriber
To join the discussion in the comments, become a paid subscriber.
Join like minded readers that support our journalism, read unlimited articles and enjoy other subscriber-only benefits.
SubscribeThere’s a revolving door that separates Goldman (Government Sachs) from the actual government – allowing people to cycle back and forth between highly lucrative jobs and selfless public service. You don’t mess with that kind of power and influence by putting out ‘research’ that doesn’t support government propaganda. Start with the model outputs you want, then build the model and assumptions to match.
If you want to know what GS really thinks, don’t read their propaganda – look at their market positions.
Which are?
Its a company with assets of $1.5 trillion – you could read thousands of pages of public disclosure and not come close to knowing what their net positions are. But generally speaking, if you believe you know what’s going to happen to the price of something in the future – the best way to capitalize on that is to convince everyone else of the opposite.
I was coming here to basically say the same thing. The only reason Goldman Sachs puts anything in a report is to facilitate them ripping people off, including their own clients. You can almost be guaranteed that they are actually betting the cost of LNG will go up.
Also this: https://www.cbsnews.com/news/goldman-sachs-diversity-ipo-women-minorities-david-solomon-davos/
Jim R is correct in asserting that Goldman Sachs is barely separate from the (Democrat) government. While it may sound very noble on the surface, small struggling companies can’t afford to have an all-diverse governing board. It also means companies have to fall into an ideological line to become public.
Sachs just wants people to ‘Buy The Dip’ in stock prices so they can harvest yet more money during the engineered recession; so they talk up the future of the economy. They do not want people taking money out of risky stocks; how can they harvest the wealth when they crash the market unless people keep their risky investments?
This comment displays, a with respect, complete lack of knowledge and understanding of Goldman, capital markets, derivatives, prop trading and hedge and commodity funds, all of which make massive profits from taking positions that profit by betting on prices dropping as well as rising and from commodities ditto.. AND the fear and perception whether right or wrong. All stock, bond and commodity market investment is essentially betting in any event.
Remember, most retail savers have no idea that investing in nice safe bonds is actually lending institutions money!
This article lost me when it said “the model depends on assumptions”. All models depend on assumptions. All human beings live their lives based on assumptions. We cannot make sense of the world without assumptions.
The question, then, is only whether assumptions turn out to be right or wrong, good or bad, accurate or inaccurate.
And we often can’t know how good they are in advance of testing them in the real world.
Forecasting things is therefore always fraught with difficulty and chance, which is why any one who can do it with any accuracy, particularly for commodities, is filthy rich.
The paper’s assumption that there will be a fall in demand seems fair to me. Where this assumption may fail is that the presiding government may decide to distort the market by shielding consumers from price rises, in which case demand won’t drop as they assume.
As for the other assumptions: yes, they do seem a little far-fetched.
Assumptions offered by those with ulterior motives should be viewed with suspicion. Trust only when verified. Predictions on the LNG market and the “what may happen with the weather” would be a long shot gamble.
But models aren’t reality – though global warming and the Covid predictions do seem to have become reality. Global warming in particular is laughable – a model with thousands of variables can predict the earth’s temperature to a tenth of a degree in a hundred years based on only one magic variable – CO2 concentrations. It hasn’t been predictive going forward (remember The Pause) and it can’t explain patterns going backward either. Yet it is treated like it is a hard fact.
Generally, when I see a position being dismissed as “laughable”, I tend to take the utterer’s views with a large pinch of salt.
For instance, I’ve been visiting Iceland for 30 years. Even in my lifetime, the extent to which the glaciers are shrinking is dramatic, and can be measured. You’re saying its laughable – why? Do you think I’ve imagined it?
https://climate.nasa.gov/evidence/
I’m betting you’re right wing, right?
And this is due to human-generated CO2?
His point isn’t that there is no warming, we’re coming out of an ice age. It’s that the computer model itself, and the way it’s used, is laughable. Having done computer modeling of complex systems, it’s worse than laughable. It’s deliberate manipulation for political purposes.
Right wing. Is it all that simple?
Goldman Sachs prop trading, prime brokers and FICC need dumb counterparties.. that is all you need to know!
Here we go again – Putin’s Project Fear
My dogs think every odd noise is evidence of an intruder, the trick is to tune out the random barking.