Energy tensions will play out further in 2022

The influential role of energy in inflationary pressures is set to continue into next year with countries’ varying policies impacting local prices - and Central Bank actions.

| 6 min read

Part of the inflationary surge in 2021 has come from the rapid rise of energy prices. The world price of oil rose by more than a half as the recovery got underway. The European gas price has hit eye-watering highs as European energy policy left the continent short of power when the wind did not blow much and as Russia constrained gas exports. As it moved partially out of lockdown, the world turned out to be short of energy at exactly the time the advanced countries wished to reduce fossil fuel use and speed their journey to net zero.

2022 will see the energy tensions play out further. Overall demand for oil this decade is likely to stay around 100m barrels a day despite the efforts of some richer countries to cut their use. As emerging economies grow so their demand for oil will expand. Some advanced countries will cut their own carbon dioxide output by stopping activities that require large quantities of fossil fuel, only to import the products from elsewhere from countries less concerned with an early path to net zero.

The energy mix

Many will redouble their efforts to find lower or zero carbon ways of fuelling their activities. The year begins with a continued delay in agreeing a contract between the EU and Germany on the one hand and Russia on the other for the supply of gas from Russia by the new NordStream 2 pipeline. It seems likely there will eventually be an agreement to use this new facility and to cement more EU dependence on Russian gas. Germany needs gas if it is to implement its new government’s policy of a faster phase out of coal, still a crucial part of its energy mix. Wind and solar energy will play an increasing part in European provision, leaving the system in need of fossil fuels for times when the weather is unsuitable for these renewables. This provides erratic demand on world markets, with the danger of continuing price spikes when demand is especially strong.

The US has much lower domestic gas prices than Europe thanks to the policy of finding and exploiting much more natural gas at home. President Biden talks about speeding transition away from fossil fuels, but has recently been allowing more gas to be produced as he is aware of the sensitivity of voters and business to higher energy prices. In recent months the President has approved over 3,000 new permits to drill on public lands, reversing his earlier attempted ban. He argues he lost a court case over the original tougher policy. He has also put 80 million acres of the Gulf of Mexico up for auction for gas and oil drilling. Environmentalists have been disappointed by these actions, pointing to how they contradict the early promises to stop such activities and querying the extent of the court direction. This means the US is likely to keep lower domestic energy prices than Europe next year, assisting its work in combatting inflation and helping its industry rebuild against import competition. The US continues to provide some offsetting force to higher oil prices on the world market through its oil output.

Energy divide

2022 will see the divide at COP26 between the advanced world led by the EU and the emerging economies become more visible as they follow different paths of energy development. The emerging countries will press their case for more financial assistance to entice them to take net zero more seriously, whilst the advanced countries will continue to experiment with new technologies that might help them achieve their own carbon targets. There will be more talk of a bigger role for green hydrogen, more work on battery stores to provide backup to wind and solar dependent systems, more efforts to raise insulation standards to curb energy use in a variety of activities and more efforts to find longer term nuclear and hydro schemes that can help.

Many voters will be concerned about the big rise in their own personal energy costs and will be expecting governments to find or fund cheaper solutions.

There will be more talks between all the countries and more pressure for every country to produce a stretching plan to cut carbon dioxide produced on its territory. There will be more discussion of carbon border taxes to raise revenue and reduce import dependence that is in part encouraged by carbon accounting. There will, however, be another imperative coming into the argument in advanced countries, as we already see in Biden’s change of stance. Many voters will be concerned about the big rise in their own personal energy costs and will be expecting governments to find or fund cheaper solutions. These in the short term may include needing to produce more fossil fuel to get the price back down a bit.

Winter tensions

This winter will see more tensions over high energy prices, which would worsen were the winter to get colder in the northern hemisphere. From spring onwards, we might well be seeing some relapse in prices as action taken to bring more energy on stream interacts with lower seasonal demand to ease the pressures on price. Central Banks will breathe a sigh of relief if it turns out like this. It would mean their view that inflationary pressures would be transitory would at last receive some assistance from energy markets. In the meantime, energy remains a net negative for real incomes and economic growth, whilst providing windfall profits for those selling the more valuable fossils fuels temporarily in short supply.

Energy remains a net negative for real incomes and economic growth.

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Energy tensions will play out further in 2022

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