Gas prices, ‘greenflation’ and governmental gatherings

Gas prices in the UK shot up by 37% in a single day in early October. This was on top of a near trebling in price since the Summer of last year.

The UK has become more dependent on gas as a backup to intermittent renewables on the electricity grid and consequently, electricity prices have also risen precipitously.

According to recent studies, 86% of the rise in electricity prices is because of gas. Across the European Union, it is 80%.

Much has been written about the cause of the gas price spike. Principal contributors are variously thought to have included:

• A decision by Gazprom (and likely the Russian government) to supply lower volumes of natural gas to Europe
• Competing demand from Brazil, China, and South Korea for liquified natural gas (LNG) as their economies emerge from pandemic lock-downs
• Lower levels of storage across Europe due to the cold winter and amplified in the UK by the decision to lose — and not replace — our largest gas storage facility in 2017
• Lower wind speeds across much of Europe during the Summer. Orsted, for example, reported that average wind speeds during the Summer were 10% below the long-term average.

Missing the wood for the trees

But focusing on the current turmoil in energy markets misses a wider change. COVID-19 revealed the inherent fragility of global supply chains. These networks have been made even more brittle by the severe geopolitical tensions between China and the US.

Extreme weather caused by climate change, which will only get worse in the medium-term, makes a fraught situation even worse.

Whether it is semiconductors, steel, pork, or pasta, it seems highly likely that volatility in almost any global commodity will be with us for some time.

Just-in-case rather than just-in-time

We’ve previously commented on the shift that we are seeing in corporate procurement practices. ‘Just-in-case’ is replacing ‘just-in-time’ as the dominant paradigm.

Near-shoring of manufacturing, diversifying supply-chains by qualifying more suppliers, and even holding more working capital are all efforts to build more resilience into business operations.

Greater storage capacity for natural gas/electricity/hydrogen would play a similar role in energy markets. As would requirements for energy companies to guarantee capacity and hedge what they pay for energy.

Resilience and greenflation

All these efforts make sense given what we see as a more volatile trading environment. But they are also likely to be inflationary, at least in the short term. Creating redundancy may support long-term resilience, but it will likely come at the cost of short-term efficiency.

Similarly, efforts to decarbonize the economy may also stoke so-called ‘greenflation’. Accelerating efforts to decarbonize have already reportedly pushed up prices for pea-protein used in vegetarian alternatives to meat through to the commodities required for electric vehicles.

Most debate about the causes of current inflation and how persistent it is likely to be is focused on the economic recovery following the coronavirus pandemic. Many of these most likely will be transitory. It is increasingly apparent though that climate change is far from transitory, and neither are efforts to mitigate it.

COP26

For much of the financial industry, COP26 is of only passing interest. After all, the argument goes, just how much can the 26th meeting of anything really matter?

This, however, is the wrong way to think about it. Climate change is no longer only an environmental issue. It is now an economic issue with the power to reshape whole industries, impact public finances, drive inflation and even affect economic growth.

thIn its leader article on the 9 October, The Economist speculates that "scarcity has now replaced gluts as the biggest impediment to global growth" and that decarbonisation, along with protectionism are the leading causes.

It seems likely that in the short-term at least, policies aimed at decarbonization may well dampen growth and boost inflation. In the medium-term though, the outcome could well be a more resilient and more efficient system.

The CEO of Audi recently stated that battery electric vehicles are now just as profitable as combustion cars. For drivers, they may already be cheaper to own. They’ll be cheaper to buy within a few years.

And the same is already true for renewable energy where onshore wind and solar have been the cheapest forms of power in most places for some time.

None of this will be much comfort though to consumers smarting over their latest energy bills. Managing these impacts effectively will be a key preoccupation for governments in the coming years. Some countries, like China, have quickly loosened environmental constraints in order to increase power production and ease shortages.

In the UK at least, it looks like the government sees further decarbonization as the cure for, and not the cause of, higher and more volatile energy prices. With the COP26 talks opening in only a few weeks, we hope other governments will be listening.

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Sources

1. Soaring fossil gas costs drive 86% of UK electricity price increases
2. From Just in Time to Just in Case
3. Soaring pea costs set to hit plant-based meat producers
4. ‘Greenflation’ threatens to derail climate change action
5. The world economy’s shortage problem
6. EVs Are Now Almost As Profitable For Audi As Its Other Cars
7. Consumer Reports Study Finds Electric Vehicle Maintenance Costs Are 50% Less Than Gas-Powered Cars
8. Electric cars ‘will be cheaper to produce than fossil fuel vehicles by 2027’
9. Wind, Solar Are Cheapest Power Source In Most Places, BNEF Says
10. China liberalises coal-fired power pricing to tackle energy crisis