Standard Digital Edition

Rupert Harrison Demand from China is why gas prices are rising ... and it’s not going away

JANUARY’S headlines have been dominated by Omicron and political drama but for most of us the biggest story of 2022 is likely to be gas prices. And this won’t be true just here in the UK — the whole of Europe is facing a serious energy crisis.

Underlying all of this is a fascinating story about the impact that increased energy demand in China is having on the rest of the world. The implications for household incomes, economic activity and public policy are going to be extremely tricky. So what’s going on?

The market price that energy suppliers have to pay for gas has more than quadrupled since before the pandemic. Among the reasons often given are a lack of gas storage capacity — including the UK decision to close the Rough storage field in the North Sea in 2017; the rapid economic restart after the pandemic and a deliberate lack of supply from Russia to try to accelerate approval of the politically-sensitive Nord Stream 2 pipeline.

All of these are factors, but by far the biggest is soaring demand for gas in China as they try to meet the huge energy needs of their growing economy while starting to shift their energy mix away from highly-polluting coal. International markets can often be opaque, but China’s impact may be seen directly in the routes taken by ships carrying Liquified Natural Gas (LNG).

Most gas is supplied through pipelines — China is currently building a new one from Russia — but LNG is often the swing source of supply. In December so much LNG was heading for China that the wholesale price of gas in Europe almost doubled again in the space of a week as energy companies scrambled to secure enough supplies. The price spike was big enough that many tankers literally turned around mid-journey to head for Europe where their cargo would be worth more.

You might well ask why the reason behind spiking gas prices is important? The answer is that the intensity of China’s demand for gas isn’t going away any time soon. That means high prices are likely to be with us for the foreseeable future. Prices may fall back a bit as the speed of the economic restart cools down, but it doesn’t look like we’re going back to the world as it was before.

This poses a very difficult challenge for governments. Trying to smooth out the impact of a temporary price spike is one thing — and reports suggest the UK government is looking to use direct payments to energy suppliers to do just that — but dealing with permanently higher prices is a lot more painful.

In the UK the impact of higher gas prices on our bills has so far been muted by the household energy price cap, but the next cap review is looming, and the level is set to rise in April. Estimates suggest it may have to rise by almost half from £1,277 to £1,900, with another increase to well above £2,000 likely in the autumn. Coming on top of the highest inflation for 30 years these are huge increases. The share of household spending going on heat and power would likely end up exceeding the peaks of the Eighties in the wake of the oil shocks of the Seventies.

Speculation is building that the Government will have to respond with more cash support for household incomes, especially to help lower income households adjust. The Treasury also faces a difficult decision about the increase in National Insurance planned for April.

The implications of higher gas prices extend beyond household incomes. We could see widespread shutdowns in energy intensive sectors across Europe as energy prices make production uneconomic.Those sectors make up a much smaller part of the economy than in the Seventies and Eighties but this would still be a stark illustration of the impact on growth. Perhaps most importantly, there are far-reaching implications for the UK’s energy mix. For example, the new nuclear power station at Hinckley Point is vital, but we will need significantly more base load capacity — and the clock is ticking.

This energy crisis also reminds us of the challenges faced by policy makers in ensuring continuity of affordable energy supplies during the net zero transition. At the moment many energy companies are reluctant to invest in new gas supplies despite high prices because they recognise the need to avoid investing in assets which one day risk becoming stranded. Finding the right balance is going to be another challenge for markets and policy makers.

Rupert Harrison is a former chair of the Council of Economic Advisers and a multi-asset portfolio manager at BlackRock

The new nuclear power station is vital, but we will need far more capacity — and the clock is ticking

Comment

en-gb

2022-01-20T08:00:00.0000000Z

2022-01-20T08:00:00.0000000Z

https://eveningstandard.pressreader.com/article/281728387892130

Evening Standard Limited