Energy prices and Stagflation 2022

 

 

The United Kingdom in 2022 is facing an historic energy problem.  An island sitting on top of vast reserves of coal, surrounded by gas and oil in its waters, and with great hydroelectric potential, has seen vast increases in energy pricing and has become dependent on foreign gas, without having significant storage capacity. In addition, a ‘green’ environmental agenda, recently compounded by ‘net zero’ policies with regard to carbon, has generated massive subsidies to underperforming renewable resources, and a confused and restrictive policy with regard to nuclear power. As world gas prices rise because of competition from East Asia and declines in supply, a price cap and marketisation policy in gas markets has caused the collapse of a large number of domestic gas suppliers and a forced increase in the cap which caused many bills to rise by over 50%. There is every indication that these bills will rise further.

The microeconomic effects of this rise are simple to list and do not require a great deal of analysis. Consumer surplus disappears in the face of forced price rises because of wholesale rises alongside an inelasticity of supply. Although the price rises in gas are projected for April (and the UK does not rely on air conditioning during the summer) they will be combined with price spikes in petrol and diesel costs, and compound a separate food price inflation. This means lower disposable incomes, lower revenues for firms producing normal or luxury goods, and a decline in investment.

It is possible that the fall in disposable income could lead to a negative multiplier in the economy as a whole. This is because rising costs and a lack of alternatives could lead to unemployment, and to extended falls in aggregate demand. An alternative, however, could be that an accumulation of covid savings by families over the years of lockdown and low travel since 2019 could create a boom in cheap supermarkets and in non-branded supermarket options, as well as warehousing that could see the release of savings into the economy. The maintenance of quantitative easing policies, which move money to banks, and negative real interest rates, could also encourage financial institutions to continue to extend credit in the form of overdrafts and credit cards, allowing families to adapt.

In the mid- to long-term, the UK is also capable of being a net energy producer. This means that it could replace the more expensive energy, provided that its companies and government can be persuaded to offer it to British people rather than selling at profit on the open market. Energy price increases affect every stage of the supply chain globally, however, and when set alongside food price increases because of poor harvests and oil-related increases in the price of foodstuffs, animal feed, and fertiliser, the likelihood is that increases in domestic production will not impact positively on cost-push inflation.

Similarly, the projected pattern on the balance of payments is mixed. British terms of trade could decline as the exports of the country—goods and services such as tourism, insurance, legal services, education, aircraft engines, biochemicals, and luxury goods—declined globally. This could be offset by a decline in non-elastic imports as households moved away from retail consumption towards food staples and energy, and endured another year of reduced tourism.

Changes to the student loan system could see universities and schools attempting to attract more than a million international students a year, which would represent a strong rise in exports, but this could be offset by students studying in home countries or being discouraged by the effect of war and government policy in places such as the People’s Republic of China.  This points to a deficit in the current account (the balance of trade) which, if not offset by inflows of money to the capital account, will result in a decline in the balance of payments. Such a decline will be represented by a fall in the pound and a decrease in living standards.

A decrease in living standards in the UK could also impact upon the ability of the financial system to function. The UK has high levels of household debt, and a ‘precariat’ class of people on reasonable incomes who are one to two salary cheques away from being unable to pay bills, mortgages, rents, or loans.  It has a very large gap between rich and poor, and a very poor allocation of housing and property ownership which worsens every year.

Conversely, the incomes of workers in energy industries, and of those in key transport and warehousing facilities, might increase because of the combination of derived demand for their services and labour shortages. UK inflation may remain less than global inflation, leading to arbitrage-related investment into the UK, and the creation of an oligopoly in energy markets as smaller firms go bust could lead to competition to buy those firms by global concerns.

In the short run, the UK cannot grow and sustain a radical net-zero agenda in which energy for a growing electric car market is provided by highly-subsidised and currently unreliable ‘renewable’ sources.’ Reliable non-carbon sources of energy include small- and medium-sized nuclear plants and clean coal initiatives. Opening mines, re-acquiring mining expertise, or building new nuclear stations, is not easy or quick, however, and might take years to bring into effect.

 The construction of new storage for gas would require significant investment and given that private companies have no incentive to create the storage as demand is inelastic and the price cap is high enough to guarantee large profits, only government action would cause new storage to be built. The government has taken no action to increase storage rapidly. In addition, the government, concerned at the growth of a trillion-pound national budget and a huge £327 billion deficit as a consequence of covid spending in 2021, has instituted a policy of fiscal contraction powered by national insurance rises which will hit all employees and employers below those classed as rich.

The short-term outlook is therefore bleak. Some environmentalists might celebrate a potential decline in carbon dioxide emissions as economic activity contracts, car and aircraft journeys fall, and consumption decreases. The agricultural industry will also see a post-Brexit fall in meat production as diesel prices, which impact farms, rise, and imports of cheaper Australian and Canadian meat rise following trade deals. Rises in energy use may also be associated with more electric cars, which the green movement sees as environmentally better than petrol-driven cars. More electric vehicles means more use of rare metals, more pressure on the electricity grid at all times, and more dependence on large oligopoly producers with proprietorial rights over the maintenance or repair of such vehicles, which means higher costs for drivers. The growth in positive externalities, and the decline in negative externalities, from all of these developments, will not offset stagflationary losses in terms of human and economic capital.

It is therefore worth pointing out, once again, that the UK faces very tough economic headwinds for the rest of the decade.