Higher Energy Prices and The Economy

 

Energy prices are a basic cost. They are semi-variable for most businesses, in that a basic fixed cost of energy is generated by the need to heat or to cool buildings, and to carry out operations. In addition, a marginal cost exists for producers in terms of the energy required to increase production. Finally, energy costs are also built into the transport of raw materials, and the distribution of finished goods and services, which again contribute to marginal costs.

If global energy prices are rising wholesale, it is unlikely that businesses or individuals will be able to lower the retail cost of energy by switching between suppliers. Energy storage is expensive and encourages economies of scale and oligopolies, in which consumer choice is limited at times of higher wholesale prices. When energy prices are low, smaller companies can purchase wholesale and make money at the margin undercutting bigger companies as storage costs will be a burden for the latter and the small companies can avoid them. This advantage disappears when prices rise, and it is more likely that smaller companies will collapse, or pass on higher prices to customers, forcing customers onto the oligopoly providers.

Price caps can also distort markets and worsen the position for small companies in such circumstances. Recent experience in Britain has shown that the gas price cap, for instance, did very little for the market between 2016 and 2021, except limit investment and encourage the growth of smaller companies which then collapsed leaving consumers with higher bills. By contrast, however, a lack of cap and a lack of regulation in parts of the Texas electricity grid led to ruinous and incredibly quick rises in price in the winter of 2021, which had much the same effect but on a much swifter scale, taking days rather than months to saddle consumers with very high prices.

Energy prices affect supply chains and depending on the elasticity of consumers or the ability of suppliers to absorb rises, rises will chill markets generally. They could contribute to the breakdown of global supply chains and ‘just in time’ production and encourage investment in previously uneconomic storage and local sources which were previously redundant.

The energy mix also matters in microeconomic markets. If countries are dependent on one energy source, then increased competition for that energy will raise prices everywhere. For instance, a rise in demand for natural gas in 2020 and 2021 was partly occasioned by a rise in demand for the fuel in east asia, which was backed by large reserves of cash. This rise in demand meant a global competition for a limited resource began and introduced European and American markets to high natural gas costs. Efforts to ameliorate such rises would normally include attempts to increase supply, but political disputes with Russia led to the restriction of the nordstream 2 pipeline, and constrained supply.

Oil, coal, gas, and nuclear power are not equal substitutes for each other. Many countries, such as Britain, have not pursued a strategy of redundancy, storage, or diverse development, and in good times have compounded this policy by prioritising subsidised renewable energy. They have paid for this renewable growth by imposing a higher tax burden upon energy consumers. This has grossly distorted a market in which supply is already brittle because of the closure of nuclear plants, and a refusal to develop sources based on clean coal.

Oil is also in great and composite demand, as it is vital not just for fuel, plastics, transport, and production, but also for food. The consequent rise in food prices, which is another basic cost in addition to energy, has constrained household and business budgets and led to more pressure on those buying gas.

At some point, if food and energy prices rise, households may find themselves unable to pay for present levels of energy consumption, which will then have a knock-on effect on the revenue streams of the remaining power companies, their levels of investment, and their share prices. Equally, healthcare costs may result from consistently higher energy prices if very hot summers or cold winters coincide with an inability to afford air conditioning or heating. This effect will be worsened by modern building standards, which tend to assume central heating and high energy use, whereas buildings in the past, based around coal fires, could heat one room and leave others unheated without causing structural damage to homes. A programme of insulation and subsidies for double glazing may therefore be in order in developed countries.

Those houses which have invested in solar power, and which have the capacity to sell energy back to grids will benefit, but this will be conditional on grids, which will be strained because of the growth of electric vehicles and the need for continual charge at all times of such vehicles. It may be that more houses and businesses will respond to ‘brown outs’ and ‘black outs’ by investing in local generators, which inevitably will place pressure on oil prices.

In macroeconomic terms, cost-push inflation caused by higher energy prices is particularly troublesome. This is because it is difficult to respond by adjusting fiscal and monetary policy, as it would be with demand-pull inflation. Cost-push pressures tend to lead to stagflation, in which one set of inflationary pressures from outside then make many businesses unprofitable and raise the level of unemployment. This leads to pressure on governments, as tax revenues decline and welfare payments increase, and if it goes on for some time, the unemployment becomes structural. In circumstances where households are having to react to higher food and energy bills, cutting interest rates does not stimulate demand so much as increase debt for those in work but in the ‘precariat,’ and it does not encourage people who are unemployed to spend or businesses to invest. Raising interest rates runs the risk of credit crunches.

This means that stagflation is difficult to control, as inflation in one part of the price index will be met with deflationary pressures caused by a collapse of demand, constraint on spending, and rises in unemployment in another. The one certainty is a fall in gross national income unless the country involved can export energy or food to inelastic clients, at the same time as a rise in the price level.

The macroeconomic effect of pressures on global supply chains, government activities such as the provision of public and merit goods, rising costs of inelastic fuel imports, even if not carried on alongside attempts to continue subsidising underperforming renewables, is potentially disastrous. The scale of the problem depends upon the extent of price increases and how long they are sustained for.

To avoid problems, lower energy prices (which have a regressive effect and worsen existing differences between rich and poor, as well as depressing demand) must become an aim of government policy. Practical elaboration of such a policy would include the reversal or slowdown of a transition to green energy, the construction of new public or private nuclear and clean coal facilities aided by tax breaks, subsidies, spending, or deregulation, the reintroduction of fracking, innovative national policies such as the creation of an energy investment bank paid for by government credits, windfall taxes, or redirected levies, a national insulation programme, and consideration of the reorientation of VAT on energy so that modal and below-average billpayers as well as vulnerable older people pay less.

This could be integrated with a transport and freight policy which considers the utility of electric vehicle standardisation versus the encouragement of private overprovision of charging points, and the effect on the national grid, and the development of new and traditional forms of public transport.  Many cars and trucks are now leased, for instance, and shared or multiple ownership, or time-limited ownership across days, weeks, or months, might be ways to reduce the strain of recharging, parking, and road maintenance on transport budgets. Investment in long-term power systems such as fusion reactors, new forms of small nuclear power plant, and houshold inductive fields will not be likely to deliver macroeconomic results within a decade.

In the absence of such policies, the global economy will suffer from rising prices, lower aggregate demand, stagflation, and pressure on the west and former ‘first world’ to improve productivity by lowering wages and the expectations of previously normal high-energy living standards. There will be more investment in potentially destructive ‘cheap win’ technologies in the rest of the world, such as coal and wood burning, and an environmental cost will result. Governments will also see a decline in revenues, a sustained need to cut spending, and a heavier burden of debt.

In microeconomic terms, the global auto industry, supply chains, the food industry, and healthcare systems (because of the importance of oil and power to pharmaceutical companies and to hospitals) will be placed under strain. The British experience of a shift from coal in the mid-to-late twentieth century was not pleasant for the communities involved and could be replicated in a shift to much more expensive oil and gas in the twenty first for everyone, accompanied by greater depletion of those resources.