UK and EU likely to have a 'pretty nasty' recession amid energy crisis: Economist

RSM Chief Economist Joe Brusuelas examines the state of Europe's energy shortages, the Nord Stream pipeline's shutdown, and the Russian-Ukraine War's impacts on energy commodity markets.

Video Transcript

- Price caps, rationing, subsidizing. Just a few of the brutal options to solve the European energy crisis as a long and cold painful winter awaits. Joe Brusuelas is the RSM chief economist here with more on all of that. Good to see you, sir. Let's start with what they're doing in the UK. The brand-new prime minister has her hands full. She's going to subsidize energy costs for the UK citizens. Is that the best of the bad options she has?

JOE BRUSUELAS: Well, I think that that's probably not the best one she could have chosen. But nevertheless, they're going to cap energy prices at 2,500 pounds per year for households. Details have to be filled in about how that's going to work. And of course, one should expect that they're going to provide assistance to small and medium-sized enterprises. And the transition is really going to be paid for by the large firms and the government.

Now, what's going to happen here, though, is they're going to what we call in the economic world, they're going to basically damp down on the price signal. That's going to result in a weaker pound over time, narrower fiscal space, and over the medium to long term, probably higher inflation. So from my point of view policy wise, this is not the best of the least worst alternatives, not to confuse anybody, but this is the policy path that they've chosen. And this is one that's deeply rooted in the politics of Britain, where they're on their fourth prime minister in six years.

- Joe, if this isn't the best option, what is?

JOE BRUSUELAS: Well, in my estimation, a windfall tax probably would have been the best. That way you preserve the price signal. You can see where prices actually are relative to demand and whatever constraint portion of supply they get this winter. Then what you do is that you allow the big firms and the wealthy households to basically bear the burden of transition. But everyone has to have skin in the game, as we like to say on Wall Street. Therefore, you don't attempt to offset the real income losses of households or the small or medium-sized firms. Here that's not the way they're going. You'll probably see the European Union, though, do something closer to that.

- Interesting. So there wasn't really a part of this plan to reduce energy levels. And to make a strange correlation what we saw in California a week ago is they sent out a text message and they literally avoided blackouts like that because the power grid dropped. Is that what the UK is missing is some across the board production and usage cuts?

JOE BRUSUELAS: Well, unfortunately, this has gotten to the point where the decline in production and closure of firms is happening. There's no mandatory pullback on the part of firms or households. Everything's voluntary at this point. We'll have to see how this evolves. What I'm certain of is that the UK is better off than the European Union. Whereas in the European Union, I expect probably in February and March you're going to have outright rationing.

- Joe, give us just-- stepping back just a bit and talking more broadly about the economies over there, UK and the EU, likelihood that we will see a recession. Of course, there's talk of a financial crisis. I guess just how bad could it potentially get?

JOE BRUSUELAS: All right. So from just a very economic fundamental point of view, the UK and the EU are already in or soon will be in a recession. My sense is they're going to have a pretty nasty recession that's going to last a year or more. You're going to see an increase in unemployment. You'll probably see second order bankruptcies. I think we mentioned unemployment. And what you want to try to do with the policy path is to avoid permanent damage to company balance sheets and productivity. So when we take a look at what's likely to happen, it's going to be a very mean winter in 2023.

- Of course, one of the most meaningful energy stories, certainly as it relates to Europe, is Russia now weaponizing energy. I guess is a two-part question. One, the caps on Russian oil, will that have any success without India and China joining the G7 in that? And number two, those slight gains from the Ukraine, will that impact how Russia is weaponizing energy?

JOE BRUSUELAS: All right. Let me answer the second question first. No, I don't think that the battlefield improvement for the Ukrainians really is going to impact the energy situation. If anything, it might make it worse because the Russians may feel they need to take more desperate measures to stave off a battlefield defeat. OK. We'll set that aside. And let's get to the first question, which I believe-- can you just restate that one more time?

- Yeah, the caps--

JOE BRUSUELAS: [INAUDIBLE] first part of the question?

- The price caps on Russian oil. Can we have any success in that effort?

JOE BRUSUELAS: OK. So it's a very innovative proposal that Janet Yellen and the Biden administration has put forward. It's going to rely on-- get this-- the cudgel of the insurance markets to prevent the shipment of Russian oil into major ports around the world in an effort to cap the price let's say somewhere between $40 and $45 per barrel. Now, I want to see how this is going to work again. It's an economist proposal.

So I'm very partial to it. And it's very innovative. But we haven't tried anything like this before. So we'll want to see how it evolves. Probably more important will be, what will the Russian countermeasure be? Will they actually cut off all sales of energy that is natural gas and oil? Will they cut off their nose to spite their face in Moscow in order to show resolve to their own domestic audience who clearly now, according to news headlines, are beginning to question the look what looks like a failed adventure in Ukraine.