Energy, cost of living and recession

The G7 governments have a problem.  The war in Ukraine against Russia is not won.  It looks set to be a long grinding conflict, possibly with no end.  And yet the world and particularly Europe depends on Russian energy supplies.  The G7 has agreed to stop buying Russian oil, as part of its programme of using economics sanctions as a war weapon.  But up to now, energy imports from Russia have not been stopped because it would mean a catastrophe for the EU countries, particularly Germany.  And Russia is still selling huge volumes—globally – albeit at a discount from the world price—to India, China and other energy-thirsty economies.

At the beginning of June, the European Union agreed to bar its companies from “insuring and financing the transport, in particular, through maritime routes, of [Russian] oil to third parties” after the end of 2022 to make it “difficult for Russia to continue exporting its crude oil and petroleum products to the rest of the world.”  But that is still not being implemented and Greek-owned tankers are delivering Russian oil exports across the globe and until this week, Russian gas was still being imported into Europe.  As a result, the Russian trade surplus has rocketed as oil and gas export revenues rise, driven mainly by huge price increases.

In a mirror image, the Eurozone trade balance has sunk into a severe deficit and the euro has slumped in value below the dollar for the first time in over 20 years.

European governments have been desperately trying to find alternative sources of energy supply and have shopped around the world to buy gas and oil at going market prices.  This has led to spiralling natural gas and oil prices.  However, at great expense, Europe has been building up its gas storage to get through the coming winter.  Gas storage levels are now at 80%of capacity and even higher in Germany.

This has been done by switching to expensive liquid natural gas (LNG) imports brought in by ships.  Europe has reduced its gas imports from Russia (partly by policy but mainly because Russia has cut gas supplies down to 20% in the key pipeline – and now this week to zero).  To replace that loss, it has bought LNG from Spain and North America.

Even so, it will have to use up all its storage capacity to get through the winter without electricity cuts.  And then what?

That’s why the G7 leaders have decided on a new sanction against Russia which they hope will speed up Russian capitulation on the war in Ukraine.  Led by Janet Yellen, the US Treasury Secretary, they propose to introduce a price cap on all oil imports from Russia.  Instead of applying a blanket ban on insuring or financing any Russian oil shipments, credit and insurance will be made available, as long as the price paid for Russian energy is below a certain level. 

What level is still to be decided for the new year 2023.  Currently the Brent crude oil price is about $90-100/barrel.  So if the price cap were fixed at, say, $50/b, then Russian export revenues would presumably plummet and so Putin would lose funding for his war, while energy prices would drop sharply.  Indeed, on this news gas and oil prices have dropped back, although they are still four times higher (gas) and 80% higher (oil) than before the war started.

Will this price cap weapon work?  There are many holes in it.  Russia could refuse to export oil at the lower price, though that would not only reduce one of its few sources of external revenue, it also would require shutting down oil wells that aren’t easily restarted. An extended shutdown of Russian oil wells could do severe and lasting damage to its production capacity.  But Russia could continue to export oil to countries that refuse to abide by the G7 price cap, eg China and India. Indeed, before the invasion, India imported almost no Russian oil. By July it was importing close to 1mn b/d of Russian crude (heavily discounted), or about 1 percent of global supply.  And then all countries must agree to use G7 insurance facilities and not resort to those outside their restrictions.  Many countries may not follow the G7 strictures.

Meanwhile, the huge rises in global energy (and food) prices are creating a cost of living catastrophe.  Everywhere in Europe, real wages are crashing.

It’s worst of all in Britain.  The Bank of England (BoE) forecasts the inflation rate to peak at 13.3% in October and real household disposable income is set to fall by 3.7% across 2022 and 2023, making those two years the worst on record.  But it may be even worse than that.  Citibank forecasts inflation is on course to rise to 18.6 per cent in January, the highest peak in almost half a century, due to soaring wholesale gas prices.   And Goldman Sachs goes further as it expects even larger gas rises, and now expects UK inflation to peak at 22%!

As always, it’s the poor that take the hardest hit.  Over 40% of UK households will not be able to heat their homes properly in January when energy bills rise yet again. Yes, this is Britain in 2022.  About 28mn people in 12mn homes, or 42 per cent of all households, will not be able to afford to adequately heat and power their properties from January, when a typical yearly energy bill is forecast to exceed £5,300.  Even by October, when Britain’s energy price cap will rise 80 per cent to £3,549 9m households will face fuel poverty.  With the current cost-of-living crisis being felt hardest by low-income households, absolute poverty is on track to rise by three million over the next two years), while relative child poverty is projected to reach its highest level (33% in 2026-27) since the peaks of the 1990s

But what is this energy price cap that is applied in the UK?  Supposedly it is to stop energy companies hiking their bills too much and making super-profits at the expense of households.  In the UK, a regulator called Ofgem sets a price cap every six months that supposedly regulates the profitability of the privatized energy retail companies that charge customers for gas and electricity.

But this price cap has rocketed from under £1000 a year in 2021 to £3549 in October and then is forecast to reach an eye-watering £6600 by summer next year.  These sorts of rises are completely impossible for average households and small companies to absorb, let alone the poorest and those with uninsulated homes.

How can these price rises be explained?  Much is made of the profits being made by the retail energy monopolies and it is true that they are making big profits and distributing millions to their shareholders. But when you look at the breakdown of the costs for these retailers it tells a deeper story.

What you find is that the energy retail companies are restricted by Ofgem to just a 2% profit rate on (total, not operating) costs.  But those costs include the costs of getting the gas and electricity distributed down the pipes and lines to households.  The suppliers of these services are a separate bunch of monopolies (in the UK, the Big Six).  The Big Six can charge up to a 40% profit rate in their prices to the retail companies and so take up about 7-10% of the price to the householder.  The distribution companies are owned by various hedge funds and private equity companies who take their cut. 

But the biggest part of the household bill is the price charged by the global energy companies for their gas and oil ie the likes of Shell, BP, Mobil, Exxon etc.

This is where the real profits bonanza is.  The profits bonanza in the second quarter included a record $11.5bn profit for BP’s rival Shell, record profits of $17.6bn and $11.6bn respectively for the US’s ExxonMobil and Chevron, plus $9.8bn for France’s Total. In the first six months of the year the companies made combined adjusted profits of nearly $100bn.

So when the head of the UK’s Ofgem, Jonathan Brearley says that “We can’t force companies to buy energy for less than the price… we all need to work together”, in a way, he is right.  If the market rules, then his regulatory powers can do little because he works on the principle that companies must make a profit.  But if the goal of Ofgem is to ensure a fair deal for households in conditions of natural monopoly, then it has clearly failed in this mandate.  The privatisation of gas and electricity distribution in the UK since the late 1980s and early 1990s has resulted in a handful of very large and very powerful firms enjoying large profit margins with shareholders reaping big dividends, while UK households are subjected to sky-high energy bills.

For example, the big six distributors have paid out almost £23 billion in dividends, six times their tax bill in the last ten years.  But then as one CEO said, “Businesses are there to make a profit, and dividends are one way of sharing that with shareholders”.

The powers-that-be are also shocked by the energy price explosion.  Indeed, several have put into question the economic principle of market pricing, calling it “frankly ludicrous” (Boris Johnson), 1 absurd” (Emmanuel Macron), 2 and concluding that “this market system does not work anymore” (Ursula von der Leyen).  The EU chief admitted that this was“exposing the limitations of our current electricity market design”. But what’s the answer? Well, “we need a new market model for electricity that really functions” (!).  “Alternative market designs that could potentially include the decoupling of gas from the formation of the market price”.  So gas prices would be controlled and not subject to the market – but how?

I won’t go further into the myriad of proposals coming from the UK government, the opposition Labour party and various think-tanks about how to relieve or avoid the catastrophe ahead for millions of households in Europe and particularly the UK.  I won’t because there is one thing that they all have in common – there are no proposals to end the market for energy prices or to bring into common ownership the energy companies, retail, distribution and wholesale (the UK TUC proposes nationalization of retail only).  To do so would require a revolutionary transformation of the structure of economies starting with energy.

And yet even on a limited scale, public ownership of energy works. In Germany, for instance, two-thirds of all electricity is purchased from municipally owned energy companies and, since 2016, the Munich city council has supplied enough renewable energy for the needs of every household.  Denmark has a fully publicly owned transmission grid, and the highest proportion of wind power in the world.  A publicly owned energy system can be complemented by smaller-scale developments, like community-owned energy. In 2008, the isle of Eigg was the first community to launch an off-grid electric system powered by wind, water and solar, allowing local people to have a greater stake and say in their energy.

But these steps are limited and partial.  Overall, the market rules and Big Oil runs the show. And now market pricing is being aggravated by the desperate attempts of the G7 leaders to defeat Russia in the war. 

As a result, efforts to control carbon emissions and meet global targets are being reversed as fossil fuel energy production is accelerated and fossil fuel subsidies to help control energy prices are increased.  Energy tax subsidies not only enforce the EU’s reliance on fossil fuel imports but also work against achieving the climate targets of the European Green Deal.

In the US, coal-fired power generation was higher in 2021 under President Joe Biden than it was in 2019 under then President Donald Trump, who had positioned himself as the would-be saviour of America’s coal industry. In Europe, coal power rose 18 per cent in 2021, its first increase in almost a decade.

Economist Dieter Helm, professor of energy policy at Oxford university, says the shift away from fossil fuels has rarely looked more complicated. “The energy transition was already in trouble — 80 per cent of the world’s energy is still from fossil fuels,” he said.  “I expect that in the short term, the US will increase oil and gas output and EU coal consumption could increase”.

There is no escaping from the obvious conclusion.  To avoid the energy catastrophe and reverse the huge loss in living standards already under way, we need to take over the fossil fuel companies and phase out their production with increased investment in renewables, to reduce fuel prices for households and small businesses. 

But that means a global plan to steer investments into things society does need, like renewable energy, organic farming, public transportation, public water systems, ecological remediation, public health, quality schools and other currently unmet needs.  Such a plan could also equalize development the world over by shifting resources out of useless and harmful production in the North and into developing the South, building basic infrastructure, sanitation systems, public schools, health care.  At the same time, a global plan could aim to provide equivalent jobs for workers displaced by the retrenchment or closure of unnecessary or harmful industries. 

Fat chance of that now.  Instead, millions face a cost of living crisis of record proportions.  And don’t forget the prospect of a new global slump in production, investment and employment. According to the IMF, real GDP in the G20 countries (or more exactly 18 top economies exc Saudi Arabia) fell in Q2 2022. But the inflation rate continued to rise.

And the IMF notes, “The global outlook has already darkened significantly since April. The world may soon be teetering on the edge of a global recession, only two years after the last one.”  Jacon Frenkel, head of the Group of 30 consortium of global policy makers, summed it up: “We have the energy crisis, we have the food crisis, we have the supply chain crisis and we have the war, all of which has profound implications for the economic performance of the world’.

16 thoughts on “Energy, cost of living and recession

  1. President Macron of France gave two historic speeches in a short interval: the “end of the era of abundance” (for the First World) and the “end of universality” (of the USA-led world order). Marxists already knew of all that since 2008, but it’s important that a member of the capitalist elite is speaking about that publicly (with a 14 year delay).

    Whatever the outcome of the Russian-Ukrainian War (my opinion remains the same: Russia has already won it; it’s only a matter of when), one thing is certain: the Western peoples are treating it as an existential war. I’m curious to see what exactly will cease to exist when Russia finally consolidates its victory.

    The attempt to isolate Russia economically is certainly not working: only the Global North is sanctioning it. There’s a huge flank in the Global South, specially China and India, which is keeping the flow going for the Russian economy. Russia’s GDP is taking a good beating (-6%; -4%), but that’s normal for a country in war: the concept of lucrative wars is a postwar American invention. There will be no regime change in Russia.

    The problem with renewable energy as it exists right now is the scale: even when exploited to their maximum potential, they would still not be able to fully substitute fossil fuel (specially for the First World countries, which are not blessed by abundant hydroelectric power). Besides, some of those technologies are highly pollutant in other ways. The only serious solution to fossil fuel is nuclear fusion.

    Last but not least, there’s the problem of nationalism disguised as internationalism. The peoples of the Third World are very upset about the ecological friendly discourse of the First World because of the timing, not of the substance: now that the “oil geography” has shifted unfavorably for the Global North, they’re talking about “green energy”? When the time came for the Third World to finally reap the benefits of favorable trade balance against the First World, the First World is trying to change the rules of the game? Just a few days ago, The Washington Post has published an article “suggesting” Chile to not vote for its new Constitution because it would, most worryingly, nationalize its huge lithium reserves. Do the peoples of the First World think this is funny?

  2. What a week this is going to be in the energy markets. Europe thinks it is in the driving seat and that the war in Ukraine can be won. This at a time when even the Pentagon is warning it is running out of ammunition tipping the scales towards the use of nuclear weapons in any future war with China.

    I was hoping you would deal with marginal pricing in the silly wholesale energy market. Not only is neo-liberalism dead, even the way way out of her depth new British Price Minister is entertaining a price cap, but it is dead theoretically as well. Market prices based solely on marginal costing and pricing was always the dream of neo-liberalism and that dream came true with the privatization of the energy wholesale market. It resulted in daily price fixes being determined by the marginal cost of producing energy on that day. Of all the industries on the planet to choose this form of pricing, energy had to be the most unwise. Fluctuating production and consumption due to adverse weather events has turned this dream into a nightmare. It seems the dinosaurs, including Marx were right, market prices in a capitalist economy were and should remain based on weighted average cost prices plus margin if there is to be any price stability. Expect marginal pricing to be shown the door.

      1. Yes there is. There are daily price fixes in the European wholesale energy market where generators have to pay the marginal price set at the fix. I am exploring this fiasco in my next post.

      2. No, there isn’t. In the market, you have only one price for one commodity. You can’t have multiple prices for the same commodity in the same market, at the same time. Marginal pricing is a contradiction in terms.

  3. Perhaps limiting comments to questions would be acceptable?

    In the fourth chart above, are the bars for network costs and operating costs (pale blue and medium blue bars, respectively) represent more or less the expenditures of the retailers, the Big Six as you call them?

    And the dark blue bar for wholesale costs represent largely the energy companies like BP and Royal Dutch Shell? And, pardon any insult to patriotic feeling, aren’t those companies and their decisions largely above the UK government’s paygrade, so to speak?

    And, last, isn’t the only end game for the war on Russia acknowledged to be Russian surrender, including the opening of the Black Sea by the surrender of Crimea, permitting a new power to coordinate operations in Georgia, Armenia, Azerbaijan, at the minimum, if not regime change in Russia or the division of the Russian Federation, and no negotiations will be permissible?

  4. Everyone here is adults, soon we will be serious. Finding that Europe can have 100% clean energy is something that is not supported by the nuclear Fusion.
    The right thing was instead of spending trillions on sun panel subsidies (for a non -sun continent) or filling land and seas with wind generators and investing in minimizing the damage of climate change.

    1. Marginal pricing, utility, cost etc. is a logical fallacy, and doesn’t exist in the real world. When you go to the supermarket to buy an orange, the cashier doesn’t ask you what you’re going to do with the orange in order to charge this or that price. The cashier will only charge you one price, which is the price listed for the commodity at that specific point in time.

      Prices of commodities don’t change because of the plethora of use values they may or may not have, or to whom they might be going to. The differences in prices given the distance and scale of the purchase arise from the costs of circulation, not marginal utility: it is the value of the freight and storage that are added to the already existing value of the commodity, not a recalculation of the price of the commodity based on its use value. In this case, if you’re buying an orange in Alaska, you’re purchasing two commodities (in relation to the place it is produced, and all the other places nearer to the place it was produced than Alaska): the orange itself and the freight used to transport the orange.

    2. Paul Cockshott observes on his blog:
      ”The work of Jevons, Marshall, Samuelson etc. on value theory does not stand up to even the most elementary scientific scrutiny. By the standards of rigour taught in the hard sciences their maths and curves would be a joke, falling somewhere below the standard of astrology.”

  5. “Marginal pricing” or “marginal cost pricing” is but another iteration of the old horse the bourgeoisie ride on in response to every question: “Supply and demand.” It’s the perfect steed, and answer, for the political economist– it applies to everything, and explains nothing.

    The bourgeoisie utter a tautology and regard it as fact. They have to explain everything by price precisely because they can’t explain value. Price itself can’t be explained as a function, a relation, of private production, a distributive function allocating portions of the total value presented in the markets as that would require a recognition of the origin of value, and the origin of the mediation of value in markets.

    Do “supply and demand” exist? Of course they exist. However, supply and demand are results, products, effects of the organization of labor power as a value producing values. Profit, value after “vetting” so to speak, determines the direction of capitalism, the supplies and the demands.

  6. Michael Roberts only addresses the increased energy prices as the cause of the rampant inflation. Aren’t the huge unfunded checks – in grants and otherwise – injected into their economies by the Western states any cause of inflation ?

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