Energy, cost of living and recession

Image: Artyom Malyukov
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By MICHAEL ROBERTS*

Russia's energy imports were not stopped because that would spell catastrophe for the countries of the European Union

G7 governments are facing a big problem. The war in Ukraine against Russia is not being won. It looks like it's going to be a long, drawn-out conflict, with seemingly no definite end. And yet the world, and Europe in particular, depends on the energy supply provided by Russia. The G7 agreed to stop buying Russian oil as part of a program to use economic sanctions as a weapon of war. But so far, energy imports from Russia have not been stopped because that would spell catastrophe for EU countries, particularly for Germany. And Russia is still selling large volumes – globally – albeit at a discount from the world price – to India, China and other energy-hungry economies.

In early June, the European Union agreed to prevent its companies from “insurance and financing the transport, in particular, by sea, of [Russian] oil to third parties” after the end of 2022. The objective is to make it “difficult to for Russia” to continue exporting crude oil and petroleum products to the rest of the world”. But this is still not being implemented and Greek tankers are delivering Russian oil exports across the world. Until last week, Russian gas was still being brought normally to Europe.[I]

As a result, that country's trade surplus soared as oil and gas export earnings increased, driven mainly by huge price increases (left graph). In a mirror image, the eurozone's trade balance has plummeted; there was a severe deficit and the value of the euro fell below the dollar for the first time in over 20 years (right graph).

European governments have been desperately trying to find alternative sources of energy supply. They traveled all over the world to buy gas and oil at market prices. This has led to soaring natural gas and oil prices. However, at great cost, Europe has been increasing its gas storage to face the coming winter. Gas storage levels are now at 80% capacity and even higher in Germany.

This result was obtained through more expensive imports of liquefied natural gas (LNG), which are brought by ships. Europe has reduced its gas imports from Russia (partly for political reasons, but mainly because Russia has reduced gas supplies to 20% in the main pipeline – and now this week to zero). To replace that loss, it bought LNG from Spain and North America.

Even so, it will have to use all its storage capacity to get through the winter without power cuts. One question, however, remains: what next?

That's why the G7 leaders decided on a new sanction against Russia; they hope it will hasten Russia's capitulation in the war in Ukraine. Led by Janet Yellen, US Treasury Secretary, they propose to introduce a price cap on all oil imports from Russia. Rather than 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.

The cap level is yet to be decided and will be in place for the new year 2023. Currently, the price of Brent crude oil is around $90-100/barrel. Thus, if the price cap were set at, say, $50/barrel, Russian export earnings would likely fall and Vladimir Putin would lose some funding for Russia's war against Ukraine. Furthermore, energy prices would fall sharply. In fact, just with this news, gas and oil prices have already dropped, although they are still four times higher (gas) and 80% higher (oil) than before the start of the war.

Will this price cap gun work? There are many holes in this extreme measure. Russia could refuse to export oil at a lower price, as this would not only reduce one of its few sources of foreign revenue, but also require the closure of oil wells that are not easily restarted. A prolonged shutdown of Russian oil wells could cause serious and lasting damage to their production capacity.

But Russia can continue to export oil to countries that refuse to respect the G7 price ceiling, for example China and India. In fact, before the invasion, India hardly imported Russian oil. By July, it was importing around 1 million barrels a day of Russian oil (at deep discounts), or about 1% of global supply. The measure will work if all countries agree to use the financing and insurance restricted by the G7 and not resort to those outside these restrictions. Many countries may not wish to follow the financial norms imposed by the G7.

Meanwhile, huge increases in global energy (and food) prices are creating a cost-of-living catastrophe for the world's populations at large. Across Europe, real wages are falling as seen in the graph below.

The worst situation occurs in Great Britain. The Bank of England (BoE) predicts that the inflation rate will peak at 13,3% in October and households' real disposable income is expected to fall by 3,7% between 2022 and 2023, making those two years the worst on record. But it can be even worse than that. Citibank forecast inflation to rise to 18,6% in January, the highest peak in nearly half a century, due to soaring wholesale gas prices. And Goldman Sachs goes further, as it expects even greater increases in gas; thus now expect UK inflation to peak at 22%!

As always, it is the poor who are hardest hit. More than 40% of UK households will not be able to heat their homes adequately in January when energy bills rise again. Yes, this is the situation in Britain in 2022. Around 28 million people in 12 million households, or 42% of all households, will not be able to afford to adequately heat and power their property from January, when a typical annual energy bill is expected to exceed £5.300.

Even in October, when Britain's energy price ceiling rises by 80% to £3.549, 9 million households will face fuel poverty. With the current cost-of-living crisis being felt most by low-income households, absolute poverty is on track to increase by three million over the next two years), while relative child poverty is set to reach its highest level (33% in 2026 -27) since the peaks of the 1990s.

Now see why an energy price cap is being applied in the UK countryside? Supposedly, this is to prevent energy companies from raising prices too high and making super profits at the expense of households. In the UK, a regulator called Ofgem sets a price cap every six months with the purported purpose of regulating the profitability of retail energy companies, which have been privatized and therefore charge customers for gas and electricity.

But that price cap has skyrocketed from less than £1.000 a year in 2021 to £3.549 in October and then set to reach £6.600 by the summer of next year. This type of increase is completely impossible for medium-sized households and small businesses to absorb; still less can be absorbed by the poorest.

How to explain these price increases? Much is said about the profits made by retail energy monopolies and it is true that they are making huge profits and distributing millions to their shareholders. But when you break down these retailers' costs, you uncover a more secret story.

What is found is that retail energy companies are restricted by Ofgem to only a 2% profit rate on costs (total, non-operating). But these costs include the costs of distributing gas and electricity through pipes and lines to homes. The providers of these services are a separate group of monopolies (in the UK, the Big Six). The Big Six can charge as much as a 40% mark-up fee on their prices to retail companies and thus take about 7-10% of the price back to the homeowner. Distribution companies are owned by various hedge funds and private equity who receive their share.

But most of the domestic bill is the price charged by global energy companies for the gas and oil they supply, like Shell, BP, Mobil, Exxon, etc.

This is where the real bonanza in the profit account lies. The raft of second-quarter earnings included a record profit of $11,5 billion for BP rival Shell, record profits of $17,6 billion and $11,6 billion, respectively, for US-based ExxonMobil and Chevron, in addition to US$ 9,8 billion for France's Total. In the first six months of the year, the companies earned combined adjusted profits of nearly $100 billion.

So when the head of Ofgem UK, Jonathan Brearley, says that “we can't force companies to buy energy for less than the price… we need to all work together”, in a way he's right. If the market governs, then, given its regulatory power, little can be done; behold, he works with the systemic imperative that companies should make a profit, as much profit as possible. But if Ofgem's aim was to secure a fair deal for households under conditions of natural monopoly, then it has clearly failed to achieve that aim.

The privatization 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 companies enjoying large profit margins with shareholders reaping large dividends while UK are subject to sky-high energy bills.

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

The powerful are also shocked by the explosion in energy prices. Indeed, several heads of state have questioned the economic principle of market pricing. One of them, Boris Johnson, said that it was “frankly ridiculous”, another, Emmanuel Macron, stated that it was “absurd”, finally, Ursula von der Leyen concluded that “this market system does not work anymore”. The president of the European Union admitted that this was “exposing the limitations of our current electricity market project”. But what is the effective answer? Well, “we need a new electricity market model that really works” (!). “Alternative market designs that could include decoupling gas from market price formation”. Thus, gas prices would be controlled and not subject to the market – but how?

I will not delve into the myriad of proposals coming from the UK government, the opposition Labor Party and various think tanks on how to alleviate or avert the catastrophe that lies ahead for millions of homes in Europe and particularly in the UK. I won't do that because there is one thing they all have in common – there are no proposals to end the energy price market or bring energy, retail, distribution and wholesale companies into common ownership (in the UK the best proposal suggests the nationalization of retail only). Doing 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 example, two-thirds of all electricity is purchased from municipally owned power companies, and since 2016, the Munich city council has provided enough renewable energy for every household's needs. Denmark has a fully publicly owned transmission grid and the highest proportion of wind power in the world. A publicly owned power system can be supplemented by smaller-scale developments such as community-owned power. In 2008, the island of Eigg was the first community to launch an electrical system powered by wind, water and solar energy, allowing local people to have a greater share and voice in their energy.

But these steps are limited and partial. In general, the rules of the market, as well as the big hi” have command of the situation. Now market prices are being compounded by the G7 leaders' desperate attempts to defeat Russia in the war.

As a result, efforts to rein in 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 reinforce the European Union's dependence 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. Note that the latter positioned himself as the supposed savior of America's coal industry. In Europe, energy from coal increased by 18% in 2021, its first increase in almost a decade.

Economist Dieter Helm, professor of energy policy at the University of Oxford, says the shift away from fossil fuels has rarely looked more complicated. “The energy transition was already in trouble – 80% of the world's energy still comes from fossil fuels,” he said. “I hope that in the short term, the US will increase oil and gas production and the EU's coal consumption may increase,” he added.

There is no escaping the obvious conclusion. To avert energy catastrophe and reverse the huge loss in living standards already underway, we need to take over the fossil fuel companies and phase out their production with greater investment in renewable energy to lower fuel prices for homes and small businesses.

But that means a global plan to target investments in things society needs, like renewable energy, organic agriculture, public transport, public water systems, ecological remediation, public health, quality schools and other currently unmet needs. Such a plan could also equalize development across the world, shifting resources from useless and harmful production in the North to development in 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 downsizing or closure of unnecessary or harmful industries.

Instead, millions are facing a cost of living crisis of record proportions. And don't forget the prospect of a further global slump in output, investment and employment. According to the IMF, real GDP in the G20 countries (or more exactly 18 major economies except Saudi Arabia) fell in the second quarter of 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 on the brink of a global recession, just two years after the last one.” Jacon Frenkel, head of the Group of 30 consortium of global policymakers, summarized: “We have the energy crisis, we have the food crisis, we have the supply chain crisis and we have war, all of which have profound implications for economic performance. of the world".

*Michael Roberts is an economist. Author, among other books, of The Great Recession: A Marxist View

Translation: Eleutério FS Prado.

Originally posted on the blog The next recession.

 

Note


[I] NT: on 5/09/22 the export of Russian gas to Europe was stopped.

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