Over the last month the news has been dominated by stories of energy shortages around the
world.
China has seen major industrial output cuts caused by power outages over the last year,
European gas prices are trading near record highs and the UK is reeling from the political
fallout of a surge in energy prices.
This crisis in Europe could possibly foreshadow future difficulties in the rest of the world.
The continent’s energy shortage right now has governments warning of blackouts and factories
being forced to shut.
Nations today – in particular in western economies - are more reliant than ever on
natural gas to heat homes and supply electricity.
This is due to a global push to quit using coal and move towards lower carbon energy
sources.
But this year there hasn’t been enough natural gas available to meet the demand of the post-pandemic
recovery while also refilling depleted stocks before the cold winter months.
In many countries there has been a push to stop extracting fossil fuels locally, but
they still buy in fuel from abroad to meet their energy needs.
Countries are trying to outbid one another for supplies as exporters like Russia move
to keep more natural gas for domestic use.
The crunch could get a lot worse in Europe if there is another cold winter this year.
Natural gas prices in the United States have stayed lower, as not only does the United
States have more natural gas than they need to meet domestic demand, but they have insufficient
infrastructure in place to compress and export natural gas to meet international demand.
Meaning that the resource mostly stays in the country.
For these reasons gas prices have stayed lower in the United States than elsewhere, but they
are still trading near the highest levels since 2014.
US gas inventories are also running below their five-year seasonal average.
There are a lot of reasons for the current shortages and price spikes that we are seeing
around the world.
A drought in Brazil – who rely heavily on hydroelectric power has forced utilities to
import natural gas to meet the nation’s electricity demand.
Brazil boosted gas imports to an all-time high this summer, and power bills in the country
are rising.
There is also the long running issue of supply chain disruptions caused by the Covid pandemic,
which have made it difficult and extremely expensive to transport natural gas around
the world.
We have seen worldwide policy shifts towards renewable energy sources to combat climate
change, and then because there was less wind than was expected in Europe this summer there
was a big drop in wind-generated power.
Texas and California experienced a similar squeeze too due to unusual weather.
Germany is expected to shut down its last remaining nuclear power stations next year.
Today these power stations produce 10% of the electricity used in Germany.
Germany is the European country that uses the most renewable power, but equally has
the most expensive electricity.
In the rest of Europe, most notably France, nuclear reactors are aging fast, requiring
an increasing amount of maintenance work to keep them running.
This has caused the percentage of nuclear sourced electricity in France to fall from
80% a few years ago to 67% last year.
This trend is likely to continue, as only one new plant is currently being built.
In the UK the two remaining Drax coal fired power plants are scheduled to close next September.
Gas production in western Europe is expected to continue falling.
Some are arguing that this is a key moment in the global energy market, a preview of
things to come as the energy transition accelerates and demand shifts from dirtier fossil fuels.
Over the last year we have seen the oil price almost double from $40 to $77, but this increase
in price has not been met with any meaningful increase in US production, particularly at
controversial shale sites.
Exploration and production capex is down dramatically among the oil majors, with resources being
concentrated on transitioning to renewable energies.
U.S. shale drillers are reluctant to boost production out of fear that this would destroy
their profitability and put off investors.
Pioneer Natural Resources – The biggest oil producer in the Permian Basin, told the
press last week that America’s shale producers would keep using cash to pay shareholders,
not fund new drilling.
This could lead to sustained upward pressure on oil prices over the near term as economic
recovery and increased demand for oil is met by little new supply and a renewables network
not yet sufficiently developed to pick up the slack.
The US government has been sending mixed messages by restricting US oil production while asking
OPEC to increase their output.
This morning OPEC announced that they will not be increasing production.
High oil prices are partially the result of cuts to exploration budgets after investors
pulled their money from the energy sector.
Globally, crude producers appear to have cut back capital spending by about half over the
last ten years, and they are unlikely to start spending again until they see sustained high
prices.
Of course, the higher that oil prices go, the more financial sense it makes to invest
in green energy production.
Governments and consumers have not just moved their interests towards green energy sources,
there has also been a surge in demand for other sustainable products.
This has been driven by a change in consumer tastes, but also by new government regulations.
This increase in demand combined with the ongoing Covid-19 supply chain disruptions,
has pushed up up prices for green goods in sectors ranging from vegetable protein used
for non-meat foods, the raw materials required for batteries in electric vehicles, and the
rare earth materials used in all sorts of green energy technologies.
So, welcome to the world of “greenflation”.
Bill Gates describes greenflation in his recent book ‘How to Avoid a Climate Disaster’
as the ‘green premium’.
This premium is, in Gates’s terms, the “difference in cost between a product that involves emitting
carbon and an alternative that doesn’t”.
The idea being that it is simply more expensive to shop at Whole Foods than at Walmart, and
going forward the Whole Foods style products will be mandated.
Spikes in energy prices like we have just discussed don’t just make heating your home
or running your car more expensive.
The cost of energy finds its way into almost every product that we buy.
High European Natural Gas prices have forced European fertilizer producers to reduce output.
A shortage in available fertilizer can then be expected to drive up costs for farmers,
or reduce farming yields, potentially adding to global food inflation.
Two of the most important metals for green electrification are copper and aluminium (yes,
that is how it is pronounced and also how it is spelled).
Renewable technologies require more wiring than the fossil fuel alternatives.
Solar or wind power plants use up to six times more copper than conventional power stations
do.
Over the last year and a half, as governments announced new green spending plans and pledges,
analysts steadily increased their estimates for growth in demand for copper.
This has pushed up the price of copper by more than 60% in the last year.
While demand has increased, investment in the production of these metals has also been
reduced by ESG issues.
Electrification and wind energy production cannot go ahead without more copper and aluminium
production, but environmentalists recently blocked a new mine in Alaska over concerns
of the impact on local communities and salmon.
The changes that we are seeing in the world as we focus on a move towards cleaner technologies
are a lot more complex than they might first appear.
The International Energy Agency warned last month of a “looming mismatch” between
“climate ambitions and the availability of critical minerals” such as copper, nickel,
lithium and cobalt.
Apart from these infrastructure requirements, we live in a global economy where most of
the things we buy are shipped around the world.
The cost of shipping these goods can be expected to rise in line with energy prices, or if
we are to move to locally produced goods we can expect to pay more for them.
Phasing out coal, oil and gas and replacing them with renewable energy is an expensive
proposition; rolling out electric vehicles and their charging infrastructure will be
expensive too; insulating homes and offices to meet new environmental standards is expensive.
Installing an electrical power grid that can meet the new green requirements is once again
expensive.
So, in short, the green premium that could hit many of the items that we use in our day
to day lives should be expected to be inflationary.
If the world is going to move from buying goods that can be made at the lowest possible
price to buying higher quality goods that meet new environmental standards, we shouldn’t
really be surprised that these new goods cost us more.
As governments emphasize climate action and push every corner of the economy to decarbonize,
manufacturers are being left with little choice but to change not only the way they make goods
but also the types of goods that they make.
The technical hurdles and investment involved mean that these goods can be expected to cost
much more.
Glass manufactured using sustainable energy costs 20% more, cleaner steel is up to 30%
more expensive.
In Italy where the unemployment rate is still above 9 per cent and people spend more of
their income on energy costs than in the rest of the eurozone, the rising prices “are
forcing poorer families to give up basic needs” according to the Financial Times.
Environmentalists will argue that inflation is a small price to pay to prevent planetary
catastrophe, and economists might add that a bit of extra inflation makes it easier for
governments to inflate away their pandemic bailout debts.
But the 2018 Gilets Jaunes protests in France over fuel price hikes show that when greenflation
hits the poor, it can bring about populist revolts and halt green reforms that may be
necessary in the long run.
While this type of inflation might require us to tighten our belts in the west.
Economies that can barely afford fuel today like Bangladesh, could grind to a halt.
India’s power stations cut back on coal imports in recent months, as international
demand pushed up the price.
This means that India now has less than three days of supplies remaining and could face
a severe power crisis that threatens to undermine its recovery from the pandemic.
The current climate conversation has some embedded contradictions.
On one hand the IEA states that achieving net-zero by 2050 will likely be “the greatest
challenge humankind has ever faced.
On the other hand, The U.S. climate envoy told world leaders in April that “No one
is being asked for a sacrifice.”
The green transition that is being discussed is likely to be complicated, messy, uneven,
and require huge technological breakthroughs if our lifestyles are to stay anything like
they are today.
Governments might need to plan a bit more for times like right now when the renewable
energy technologies that we have don’t seamlessly replace traditional energy sources.
Individuals should possibly expect new greener products to cost more than the products they
have bought in the past.
I would love to hear your thoughts on greenflation and the energy transition in the comments
section.
I tend to be an optimist and believe that while greenflation may be here for a while,
we can expect innovations going forward that mean that life will be better in the future
than it is today, as has been the case throughout human history.
See you next week, bye.