Energy transition poses inflation risks

Context:

The one member of the RBI’s Monetary Policy Committee (MPC) to vote against continuing with the central bank’s ‘accommodative’ policy stance said that the ongoing worldwide transition to green energy poses a significant risk of triggering energy price shocks similar to the 1970s, which would accelerate inflation.

Relevance:

GS-III: Indian Economy (Growth and Development of Indian Economy, Inflation), GS-III: Environment and Ecology (Environmental Pollution and Degradation, Conservation of Environment and Ecology)

Dimensions of the Article:

1. Connecting the 1970 energy crisis and the present
2. What are the Immediate Causes of the Current Crisis?
3. Was Global Energy Crisis an impending issue?
4. What would be the Impact of the Crisis on the World?
5. Back to Basics: What is Greenflation?

Connecting the 1970 energy crisis and the present

• There were a series of energy crises between 1967 and 1979 caused by problems in the Middle East but the most significant started in 1973 when Arab oil producers imposed an embargo.
• The energy shocks of the 1970s, prompted by the 1973 Arab oil embargo and the 1979 Iranian revolution, factored heavily in the inflationary forces of that decade.
• The decision to boycott America and punish the west in response to support for Israel in the Yom Kippur war against Egypt led the price of crude to rise from $3 per barrel to $12 by 1974.
• This period was also marked by ramped-up government spending on social programs and the war in Vietnam. Increased government spending fueled high consumer demand.
• The price of petrol rocketed, making all transport more expensive.
• There were no offsetting tax hikes or spending cuts in other programs to offset the spending. Consequently, demand exceeded supply in the economy for several years, and inflation moved up.
• This is relatable as currently, oil prices are trading over $80 a barrel even though oil demand has not returned to pre-pandemic levels yet. Many experts think it is only a matter of time before they reach $100.

What are the Immediate Causes of the Current Crisis?

• Demand Rebound: The rise can be attributed to the bounce back witnessed in consumer demand as economic activity returns to normal after the pandemic. Production, however, has failed to bounce back as quickly due to disruptions to the supply chain caused by the pandemic.
• Greenflation: The rise in energy prices can also be seen as an example of ‘greenflation’ caused by increasing restrictions placed by governments on traditional energy sources.
• Unviable Renewable Energy Sources: A fall in generation from other sources has also affected the availability of electricity. Lower production from hydropower plants in the southern regions of China and a decline in output of wind turbines in Europe exacerbated the energy crisis.
• Coal Output Disruption: Globally, the output of coal mining was affected by heavy rains in countries such as Indonesia and Colombia. Elsewhere, labour shortages caused by the pandemic affected production.

Was Global Energy Crisis an impending issue?

• Depleting Resources: Currently, fossil fuels contribute to 80% of our energy needs. The supply chains are so severely depleted, the system cannot accommodate any type of disruption. Energy prices are expected to remain high and to go even higher.
• Access to Energy: The majority of the world’s energy reserves is concentrated in a few regions. Oil reserves are located mostly in Africa, the Caspian Basin, and the Persian Gulf. Around half of the world’s gas reserves are located in Iran, Qatar, and Russia. The strained relationship between many of the nations/regions and high-energy-consuming nations makes future access a bit uncertain.
• Climate Change: A series of extreme weather events and unusual seasonal patterns have impacted both gas demand and supply. Extreme Winter and Summer temperatures have boosted demand for gas for electricity.
• High Interdependence: Everyday goods and services are dependent on a complex, international logistics system that has little room for error, with companies prioritizing costs over diversification.
• Climate Change Policy: Climate policy itself is pushing up energy prices. Carbon allowance prices are reaching record levels, driven by climate reforms. Policies to address climate change may lead to carbon price volatility, which, in turn, could feed energy price volatility.
• Pace of Energy Transition: Uncertainty about the pace of transition may lead to periodic shortfalls in supply if climate action shutters traditional fossil fuel infrastructure before alternatives can pick up the slack. And if fossil fuel supply is curbed faster than the pace at which fossil fuel demand falls, shortfalls can result in market crunches that cause prices to spike and exacerbate existing geopolitical risks.

What would be the Impact of the Crisis on the World?

• Sky-rocketing Energy Prices: The prices of natural gas, oil, coal and other energy sources have hit multi-year highs. The price of natural gas in Europe, for instance, has risen by over 400% since the beginning of the year while the price of electricity has risen by over 250%.
• Impact on Production: China’s factory output in September shrunk for the first time in 18 months, thus putting the brakes on the country’s recovery from the coronavirus pandemic, owing to power disruptions caused by inadequate coal supplies.
• Supply chain disruption: Since energy prices affect economic decisions across the supply chain, the rise in prices has had a significant impact on economies. The price of domestic natural gas in India, which was hiked by over 60% recently, too has risen in tandem with international prices. Thermal plants that run on imported coal have slashed imports due to rising prices
• Indian consumers are already paying more for their cooking gas delivered through pipelines and cylinders. Pump prices of petrol, diesel, and compressed natural gas have also been rising.
• Backlash against Renewables: Going forward, there could also be a backlash against renewable energy as more people realise the economic cost of achieving emission targets. With renewable energy sources such as wind and solar energy turning out to be unreliable especially during winters, countries may be forced to rely on traditional fossil fuels and governments may need to rethink their energy policy.

Back to Basics: What is Greenflation?

• New government-directed spending is driving up demand for materials needed to build a cleaner economy. While tightening regulation is limiting supply by discouraging investment in mines, smelters, oil fields, or any source that belches carbon.
• The unintended result is greenflation – rising prices for metals and minerals such as copper, aluminium and lithium, which are essential to solar and wind power, electric cars, batteries and other renewable technologies.

-Source: The Hindu