Thailand: Energy Prices May Keep Inflation High for Years

• Aug 01, 2022

Of all the drivers behind the dramatic rise in U.S. inflation in the past year, perhaps the most acute is the surge in energy prices. It may also be among the most persistent.

High prices for electricity and fuel are likely to put continued pressure on inflation in coming years, forcing central banks to keep interest rates higher than otherwise.

Prices are also likely to become more volatile, which could make it even harder for central banks to control inflation, economists say. That raises the prospect of inflationary episodes, recessions and volatile financial markets.

“There is a risk that we’re in for an extended period of structurally higher energy prices,” said Jason Bordoff, an energy expert and co-founding dean of the Columbia Climate School at Columbia University.

Energy shocks aren’t uncommon.

Geopolitical turmoil in particular has often caused big jumps in prices, for example, after the Arab oil embargo in 1973 and the Iranian revolution in 1979.

“But this episode is different in that higher prices are also being driven by changes in the structure of energy supply as countries try to cut carbon emissions,” said Tiffany Wilding, an economist at Pimco.

The low inflation of the prior decade was in part due to relatively cheap energy, buoyed by the shale revolution and intensified by the market-share war among OPEC members in 2014 that flooded the market with oil, said Bob Ryan, chief commodities and energy strategist at BCA Research.

Energy accounted for 4.1% of consumer spending from 2015 to 2019, on average — the lowest share for any five-year period since records began in 1929, outside the pandemic.

High prices drove up energy’s share of consumer spending to 5% in June. Energy accounted for about a third of the 9.1% rise in consumer prices in the 12 months through June.

That contribution could turn negative in the short-term if gasoline prices continue to fall. But over the long term, upward pressure is likely to persist.

Consumer prices could increase by as much as an additional 4% by the early 2030s if higher carbon costs — from sources including taxes, other government policies and changing consumer preferences — are passed on to users, according to analysis by BlackRock Investment Institute.

That could add 0.4 percentage points to inflation each year if the transition to net zero emissions by 2050 is smooth, the authors found. A faster shift would push up inflation more dramatically.

In Congress, the Senate Democrats’ $369 billion legislative package would, if passed, boost government spending on climate programs.

The clean-energy provisions could put upward pressure on prices in coming years, but that might be offset by the legislation’s other initiatives, economists said.

An analysis by the Penn Wharton Budget Model found that the act’s impact on inflation would likely be negligible. However, the deal also involves an agreement on reforming permitting procedures later this year, which could ease supply constraints if it makes it cheaper to develop clean-energy and natural-gas pipeline projects.

Central banks typically focus on the average price of a basket of goods and services rather than any single commodity when targeting inflation, usually 2%. But energy prices are unusually important because consumers tend to pay close attention to them and they are an input into most other goods and services, said Franziska Fischer, economist at Credit Suisse.

Frequent shocks, big price swings and consistently higher prices could lead consumers to anticipate more inflation, and change their behavior in a way that perpetuates it.

The pass-through of higher energy prices to other goods and services, along with their volatility, could make it harder for the Federal Reserve to tell what price shocks are temporary and thus set interest rates appropriately.

“This is what makes it dangerous for central bankers,” said Ms. Fischer. “You don’t want to overreact to high energy prices because that will worsen the business cycle effects. But if you ignore it for too long, then you have a real problem.”

The longer-term outlook is better. Over the next decade or two, energy prices should become cheaper and less volatile than they have been historically as the mix of sources shifts toward renewables, said Mr. Bordoff.

“There’s a view I hear often that the transition to clean energy is going to be economically devastating, and I don’t think that needs to be true. In some cases, it’s going to be more expensive. But I think the dramatic declines we’ve seen in solar and battery costs show that over time these technologies can become a lot cheaper,” he said.

“And more importantly, the cost of not making the transition is much bigger from reduced crop yields and faster spreading disease to rising seas that consume coastal property and more severe weather events.”

Energy prices are likely to rise in large part due to constrained supply from slumping global investment in oil and gas exploration and development, which has fallen by nearly half since prices collapsed in 2014, according to BlackRock’s analysis.

However painful they might be, though, higher fossil fuel prices are also necessary to meet emissions targets set out in climate agreements, said Isabel Schnabel, executive board member of the European Central Bank, in January.

But renewable energy sources aren’t anywhere near the scale needed to fill the gap. And weak investment in mining and processing capacity for the raw materials used in solar panels, wind turbines, batteries and other renewables is making it hard for supply to keep up with demand, pushing up installation costs.

The prices for power purchase agreements — long-term contracts for electricity generated by renewable systems — have gone up sharply in the last year, driven in part by high input costs, though also because permitting and the lack of grid infrastructure are causing delays.

An index of the most competitive PPA prices, which broadly reflects the price at which renewable project developers are willing to sell, rose 5.3% in the second quarter of 2022 from a quarter earlier to nearly $42 per megawatt hour, according to LevelTen Energy, a renewable energy platform that runs PPA marketplaces in North America and Europe.

Sluggish investment means supply of key minerals will struggle to keep up as demand accelerates during the transition.

The International Energy Agency recently estimated that if the world were on track to meet Paris Agreement goals, demand would jump 40-fold for lithium and 20-fold for nickel and cobalt between 2020 and 2040.

Renewable energy projects are also more expensive to procure and install than natural gas projects, and require upgrading the power grid in many parts of the U.S.

All told, the transition process would raise the global average cost of producing and delivering each unit of electricity by 25% by 2040, compared with 2020 levels, which could be passed on to consumers’ electricity bills, said Humayun Tai, senior partner who co-leads McKinsey’s electric power and natural gas practice.

“There’s not enough gas and not enough renewable manufacturing capacity, and the world is reluctant to replace gas with coal,” said Audun M. Martinsen, head of energy service research at Rystad Energy.

Due to the shortfall, he said he expects power prices to stay high for the next 10 years.

Source: https://www.bangkokpost.com/business/2358309/energy-prices-may-keep-inflation-high-for-years