Must Read Research

Energy speaks louder than words. This week we discuss three energy market scenarios around conflict in the Middle East, how extreme heat is driving U.S. energy demand, and how energy-hungry A.I. could both help U.S. power companies and hurt Emerging Market currencies.

The three potential Iran-Israel scenarios: a limited conflict, a direct Iran-Israel war and a broader regional war each have a different impact on energy prices.

In a limited Iran-Israel tit-for-tat skirmish that causes no disruption to energy supplies, Head of Global Commodities, Cross-Asset Quant Strategies & Equity Derivatives Research Francisco Blanch believes oil prices could move up $5-10 per barrel. A direct war between these two countries that lasts several months could lead to a $30-$40 oil spike. Lastly, an all-out regional war in the Middle East impacting energy infrastructure could push up oil prices to $150/bbl and would also have a major effect on liquified natural gas (LNG). Emerging markets in Europe and the Middle East are most exposed to higher oil prices, than developed Europe and Japan. The U.S. is basically energy independent, so the first two scenarios would have little impact but a broader regional conflict could delay Fed cuts and weigh on economic growth. Importantly, we take no view on the likelihood of each potential outcome.

Although BofA Institute is separate from BofA Global Research, in celebration of the Institute’s 2-year anniversary, we are highlighting their analysis of how rising temperatures are impacting American consumers.

The U.S. got warmer from 1991-2020 and the average length of the heat wave season has exceeded 70 days in recent years, up from around 20 days in the 1960s. Extreme weather will likely mean more demand for household utilities like air conditioning and higher expenditures for the American consumer. According to Bank of America internal data, average utility payments in March were nearly $300, a 23% increase from 5 years ago. Individuals earning less than $50K saw utility payments increase 38% over the same time, while the Northeast and West have experienced the fastest regional price increases. Heat-exposed industries are affected, too. In 2021, data showed that 2.5 billion hours of labor were lost to heat exposure in U.S. agriculture, construction, manufacturing, and service sectors.

Warmer weather is one driver of power demand but there are many more, ranging from U.S. reshoring to Artificial Intelligence (A.I.)

The impact of A.I. data centers (DCs) could have on a breadth of industries. DCs currently under construction are expected to use about 3.4GW of power, equivalent to more than half of the power used by today’s DCs. Once completed, this power usage could likely double again. Rising demand for power comes at a time when U.S. electricity demand growth has already begun to inflect. This demand should boost both the power producers with excess capacity, as well as the copper miners selling the metal used to wire and cool facilities.

Emerging markets (EM) might face two long-term challenges if A.I. development means more energy demand.

The first is power sources could become harder to secure for energy importers. The second, as Head of Global Emerging Markets Fixed Income Strategy David Hauner argues, is A.I.-driven productivity growth in developed markets (DM) could weigh on emerging market currencies (EMFX). Productivity growth is widely accepted as the key long-term driver of exchange rates, but EM has lower exposure to A.I. It’s estimated 60% of DM employment is exposed to A.I. compared to just 35% for EM (India is 25%). On average, A.I. preparedness scores (infrastructure, R&D, education, and regulation) for DM are 1.5x higher than EM scores. That said, China and Korea present the biggest long-term opportunity among EM peers given relatively high A.I. sector exposure and preparedness. David remains cautious in the near-term but EMFX is back to fair value, providing a neutral starting point as any productivity impact from A.I. starts to kick in.

Please visit our Must Read Research webpage weekly for our latest insights.