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Economic implications of the energy crisis

Rayhan Ahmed Topader
01 Apr 2023 00:00:00 | Update: 31 Mar 2023 22:36:40
Economic implications of the energy crisis

Global energy system has been plunged into chaos by a perfect storm of market forces which threatens to rip through the economy from home energy suppliers to heavy industry, and from factories to farmers. This has stoked fears that a wave of energy suppliers will collapse, and that households will be saddled with unaffordable bills. As the colder weather draws in, these are the factors shaping the energy crisis.

The energy crisis has led to calls for nations to move faster in building renewable energy sources, while governments have turned to polluting fuels such as coal to ensure security of power supplies.

Soaring energy prices triggered by the Russia-Ukraine conflict could push up to 141 million more people around the globe into extreme poverty, a study has found. The cost of energy for households globally could have increased by between 62.6 per cent and 112.9 per cent since Russia’s invasion of Ukraine, according to a modelling study by an international group of scientists published in Nature Energy.

The study modelled the impact of higher energy prices on the spending of 201 groups, representing different expenditure levels, in 116 countries, covering 87.4 per cent of the global population. Soaring food and energy prices could persist for next two years.

Despite efforts by governments to insulate consumers from the price rises, researchers estimated that overall household expenditure rose by between 2.7 per cent and 4.8 per cent. As a result, they estimate that an additional 141 million people worldwide could be pushed into extreme poverty. Ensuring access to affordable energy and other necessities is a priority for those countries, but short-term policies addressing the cost of living crisis must align with climate mitigation goals and other long-term sustainable development commitments.

The UK and Europe have been urged to follow the US’s lead in encouraging green investment through Joe Biden’s Inflation Reduction Act.

As shipments of gas have turned from Europe towards China, flows of pipeline gas to Europe from Russia have failed to make up the shortfall. Gas prices across Europe surged by another 10 per cent after Russia’s state-backed gas company, Gazprom, refused to increase its exports to Europe despite record-high prices across the continent. The company has met its contractual obligations for gas delivery over recent months but Gazprom has come under fierce criticism for appearing to send little extra to help meet the enormous demand in Europe. Bangladesh, like many other net-energy-importing countries, has been facing persistent high inflation in the last one year of the Russia-Ukraine war. The inflation in our domestic market is largely related to the supply and prices of different types of fuel used in major economic activities, which are significantly affected due to the massive disruptions in global energy supply chain caused by this war. With the depletion of domestic natural gas reserves, Bangladesh's energy market has become increasingly dependent on imported energy mainly petroleum and coal. Hence, price unpredictability in the global energy market automatically impacts our energy sector as well as our economy as a whole. The Russia-Ukraine war has aggravated the global energy market crisis both in terms of supply and prices, which have multidimensional adverse impacts on developing countries like Bangladesh.

Over the last 10 years, fuel prices have been changed only seven times that is, they are not adjusted regularly.

In fact, the International Monetary Fund (IMF) reported in March 2012 that the government was expected to adopt an automatic adjustment formula by December 2012 that would ensure full pass-through of changes in international prices, but that did not happen. Under the new understanding between the government and the IMF in 2022, the energy ministry will adopt a market-based price setting mechanism by December 2023. The table above shows the changes in fuel prices in the past 10 years. Except for 2016, fuel prices have been increasing periodically. The highest increase was affected on August 6, 2022, when fuel prices rose by 40-50 percent. According to the interviews with stakeholders conducted for this study, this price hike was a direct impact of the rising international fuel prices due to the Ukraine war. When the Bangladesh Petroleum Corporation (BPC) and other regulatory agencies start making huge losses due to rising import costs, prices are generally revised in Bangladesh. But there are very few examples of domestic downward adjustments of fuel prices by the BPC in view of its profit-making trends. BPC generally targets a five percent margin or mark-up in their pricing strategy, but sometimes the organisations make more than the five percent margin or supernormal profits. These profits were deposited to the government coffer, and now they're more or less at the break-even point due to a sudden increase in the international fuel prices. Whatever formula is applied for the calculation of fuel prices is never revealed by the relevant organisations to the public and is treated as confidential information.

A rigorous analysis of data collected from the regulatory bodies responsible for energy pricing and the Bangladesh Bank database reveal that the rise in diesel price had the most telling impact not only on food and non-food inflations, but also on most of the components of the consumer price index. This might be due to the fact that most of the public transport in Bangladesh runs on diesel; hence, changes in diesel price have both short-term and long-term effects on the whole economy. Upward changes in fuel prices also affect the sub-groups of CPI, such as gross rent, fuel and lighting, education, entertainment, transport and communication, etc. In most cases, the impact of the initial price hike continues throughout, and it sustains in the long run albeit at a lower rate of impact.

The long-term impacts of fuel price hike on all of the components of consumer spending are not clear cut, but it is crystal clear that the increase in consumer spending due to fuel price hikes do not decrease much in the next year or so, at least.

There is also evidence that transportation costs such as fare for taxis and buses, etc. jump upwards at a very high rate following an increase in pump-level oil prices, and food prices as well as the prices of some other commodities are also increased by the concerned suppliers citing rising production costs. Ironically, when oil prices are lowered at the domestic level in response to the reduced international prices, which has happened only once or twice in the past 10 years or so, transportation costs don't go down pro rata to maintain an equivalent state, and food prices don't go down either. Hence, each and every sector should have better coordination with government agencies, with a parameter or formula in place for price adjustment.

In order to better handle these issues, the state-owned bodies who are responsible for determining the quantity of imports, energy pricing, etc. should analyse the links between the economy and the energy sector, both at the disaggregated and the aggregate levels as a prerequisite for energy pricing. Given that the exact formulae applied for price calculation are treated as confidential, there is a need for better transparency and responsiveness regarding energy pricing.

Many countries trade in futures and options and also go for longer-dated futures contracts in order to hedge transaction risks of volatile fuel prices. Saudi Arabia is one country that benefits from rising fossil fuel prices, and Russia is another. The Kremlin’s gas revenues have been two to three times greater than normal in the first half of this year, increasing the country’s ability to withstand a long economic siege.

According to the consultancy Capital Economics, if gas prices stay at current levels Vladimir Putin could keep exports to Europe at 20 per cent of normal levels for the next two to three years, and could cut off supplies entirely for a year without adverse effects on the Russian economy. Europe, as was the case in the 1970s, is a net importer of gas and oil so it is at the sharp end of the energy crisis.

Oil prices rose more than fourfold in late 1973, while gas prices have risen by fifteen fold since the start of 2022. Import costs are rising much faster than the value of exports, worsening the terms of trade. Even on the cautious assumption that gas prices will fall back in the coming months, the blow to some European countries Germany and Italy among them will be more severe than it was in either of the oil shocks of the 1970s.

Europe is in for an extremely tough winter. It is not a question of whether there will be a recession but how deep it is and how long it lasts. Britain, despite its North Sea oil and gas production and growing renewables sector, will be hit by rising global energy costs. As in 1973, rising energy prices have taken European governments by surprise. They were quick to impose sanctions on Russia after its invasion of Ukraine, but slower to think through the economic consequences. There seems no immediate prospect of an economic collapse forcing the Kremlin to end the war.

The writer is a researcher based in London, UK

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