The legacy of the oil price shock

Spark Global Limited reports:

Matthew Lynn says after the recent surge in gas prices, we can expect slower growth, industrial decline, and a newly confident Russia. Anyone looking at their heating bills in the coming months will be painfully aware that gas prices have soared. Over the course of 2021, that number has increased more than fourfold. In frenzied trading last week, gold rose by more than 20 per cent a day. Why is that? Renewables are an important part of the energy mix, but they are not generating as much electricity as expected, while the massive stimulus package and post-pandemic rebound have led to a surge in demand.
Energy markets have not seen such a sharp rise in prices since the “oil shock” of the 1970s. That was when Opec, the oil producers’ cartel, discovered it could hold the developed world to ransom by switching supplies on and off. The result was an era of “stagflation”, in which prices rose rapidly, economic growth stagnated and power shifted to the Middle East. The turmoil it unleashed destroyed governments on both sides of the Atlantic.

It’s not the ’70s anymore, but energy is still important
This one is unlikely to be so dramatic. We use much less energy as a percentage of GDP than we did 50 years ago. It now accounts for 4% of GDP, compared with a peak of 11% in the 1970s. Services are far more important than they used to be, we are far more energy efficient, and all the investment in green energy means we at least have alternatives that are increasingly important, even if they are not yet a substitute for natural gas. But that does not mean that big increases in energy prices are irrelevant. In fact, they will affect the economy in three important ways.
First, they slow economic growth. Rising energy prices will eat into demand in all major economies. There is little difference between higher industrial costs and higher consumer prices. Either way, people will have less money to spend. It is true that some of this money will be recycled, because energy exporters will be able to buy more energy. But early commodity cycles show that the process is rarely smooth. A lot of demand would be lost and all the major economies would be in trouble. Worst of all, this will happen when they are just beginning to recover from the pandemic.
Second, industrial decline is expected. Soaring energy prices are a pain for consumers, but they can largely be absorbed by cutting some costs elsewhere. However, it could be disastrous for many industries that use a lot of electricity. If costs can’t be passed on to consumers — and often they can’t if the product is made with a substitute, or if it’s not essential — the company may really be in trouble. Industries such as chemicals, building materials, paper, glass and food production are likely to be shut down.