runaway energy prices | financial times
This article is an on-site version of the unprotected newsletter. Participation Here To send the newsletter directly to your inbox every day of the week
welcome back. It seems that I was wise not to write about the effects on the market because of the debt-limit split; a truce He was set to postpone the entire chaos until the end of the year. Like everyone else, I watch default swaps prices in the US go up as these stupid arguments mount, but I always assume it’s SFSN in the end (sound and fury say nothing). Maybe I’ll be wrong someday. message me: firstname.lastname@example.org
Energy prices, inflation and growth
Here is a diagram:
These are the various global fossil fuel prices, which were repriced to 100 six months ago. The only problem in putting them all together means that the massive rise in prices for natural gas in the UK and LNG in Asia is casting a shadow over the staggering doubling of Chinese coal and natural gas prices in the US. The objectively impressive rise in Brent crude prices of 30 per cent looks favorably weak in comparison.
The big question about the increase in global energy costs is how long it will last. That is, are we looking at a temporary supply/demand imbalance – a much larger version, say, of the runaway rise in US lumber prices, which peaked at four times normal levels in May only to be back in full swing by August ? Or is this something more permanent?
Depending on the answer to this question, there are two sub-questions: To what extent will these price movements stimulate broader inflation? What is the impact of this on global growth?
On the big question, part of the answer is that the supply of fossil fuels has been declining for years, due to lower investment in extraction. Here is for example a graph of capital expenditures, both in absolute terms and as a percentage of sales, by energy companies in the S&P Global 1200 Energy Index (data from Capital IQ):
If investment from privately owned companies were included, the picture might look a little different, but I think the trend would be the same. Part of this is due to efforts to reduce carbon emissions. This is most evident in the case of coal, but governments and investors generally discourage new energy projects, and energy companies are listening.
But decarbonization is only part of the supply story. Another part of that is that the management of energy companies, especially in US energy producers, is listening to shareholders, and shareholders want to return capital to them, rather than investing in new projects. This is from the last great Financial Times to interview With Scott Sheffield, who runs Pioneer Natural Resources, one of the largest producers of shale oil in the United States:
everybody [in the industry is] It will be disciplined, regardless of whether it is $75 Brent, $80 Brent or $100 Brent. All the shareholders I spoke to said that if anyone went back to growth, they would punish those companies. . .
There are no growth investors investing in major US companies or US shale oil. Now they are dividend funds. So we can’t just play with the people who buy our shares. . .
I will get as much dividends from my stock next year as I will get in my total compensation. This is a total change in mentality.
Shows a change of mindset. This is the number of active US oil and gas rigs since 2000 (Baker Hughes data):
If prices increase further, investors and operators can change their stance on new investments in oil and gas. There may already be a change in feelings. I spoke to Andrew Gillick, strategist at energy consultancy Enverus, and he told me that while investors focus on returns on capital, investor interest in oil and gas is growing and energy fund managers are raising money again:
Speaking to oil and gas funds a year ago, they were dealing with recoveries. Now, those who can still invest are excited about the opportunity as a hedge against inflation and a hedge against a longer energy transition — and because they see operators stick to discipline and capital returns.
But the big shift in spending will take time. It takes six months or so to get a new device up and running. Fossil fuel supply pressure will not subside quickly.
Will a higher plateau in energy prices fuel inflation in other regions? To be sure, the last jump in the 10-year inflation break-even rates (from 2.28 percent two weeks ago to 2.45 percent now) was on a large scale. attributed for energy prices. But the relationship is not defined. Consider this chart of breakout levels and Brent crude:
As Oliver Jones of Capital Economics points out, the early 2000s show that although the relationship is close, it is not static. At that time, the price of Brent crude rose and the inflation equations were ignored. Here Jones:
At the time, the merging of China’s booming economy with the rest of the world helped push goods “superbikes”, but it also put downward pressure on prices for manufactured goods globally. Meanwhile, there was only limited inflation within the United States. The Fed raised interest rates by 425 basis points in two years, and fiscal policy has not been particularly loose. In contrast, China’s economy is slowing down today and is decoupling from the United States. At the same time, we believe that domestically generated price pressures in the United States will remain stronger in the coming years than in the 2000s or 2010s, reflecting the effects of the pandemic on the labor market and changing priorities of policy makers.
As a result, Jones believes inflation could rise further even as energy prices fall again as supply and demand rebalance.
Finally, to what extent might a sustained jump in energy prices affect the economy? Well, look at the price of gas in the US and US consumer spending on energy (advice to Tweet embed):
Now this is a specific relationship. Here’s how Ian Shepherdson, of the Macroeconomics Pantheon, sees the math:
People currently spend about $7 billion a month on energy services and $31 billion a month on gasoline, which together account for 7.3 percent of the consumer price index. Retail sales excluding gasoline totaled $569 billion in August, so a further 5 percent increase in energy prices would reduce other retail sales by as much as 0.3 percent, by forcing people to shift spending away from other goods and services. . Or at least that’s what would happen under normal circumstances.
But these are not normal conditions. Americans have saved a lot of money in the pandemic, which Shepherdson plotted like this:
So perhaps the excess liquidity will simply increase the additional spending on gas, and non-gas consumer spending will not be affected. But the problem is that surplus cash is mostly in the pockets of the rich, who tend to save rather than spend the increased wealth. By contrast, working- and middle-class Americans may feel price-tight at the pump and shorthand elsewhere. This graph is from Fed Guy’s Blog It shows how the wealth accumulated during the pandemic is distributed:
Those Americans who have always been worried about gas prices will be especially worried now, and that will likely be important for growth.
Speaking of oil This is amazing scary.