We often write here about the global economy being at an inflection point. Many of the great trends that have shaped the last few decades are coming to an end. The age of cheap labour is ending as politics restricts easy migration and the world’s population ages. The easy growth, productivity gains and deflationary impulses from the integration of China into our economic systems are all fading. At the same time companies and countries are changing the way they think about supply chains (just in case rather than just in time). All this is disruptive and inflationary in itself. But there is one more factor to add into the mix – the price of energy is rising and going to keep rising. This matters.
In 2013, in his book Life After Growth, Tim Morgan noted that the real economy is at heart nothing but an energy equation. Without a steady supply of cheap energy (to provide everything from our fuel to our chemicals and fertiliser) there is nothing to drive long-term growth. What matters then is how much energy costs to produce.
There was a time when we didn’t need to worry about this much: when we could use “rudimentary wellhead equipment to access billions of barrels of energy in the sands of Arabia”, we got “at least 100 units of energy for each unit invested in the infrastructure” (the energy return on energy invested – EROEI – was 100:1). It didn’t last long. In 1990, the global energy EROEI was about 37:1. When Morgan was writing it was 14:1. Today there is much debate on EROEI – you will find endless papers online claiming that fossil-fuel numbers are lower than once thought (once refining and transport are taken into account) and that renewable numbers are higher than they first look (it depends on the life of each project, for example).
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But however you cut it, one thing that is coming out of the COP26 meetings in Glasgow this week is a promise that energy is going to be more expensive for a long time before it gets both cleaner and cheaper.
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Carrot and stick will both play a role. The global financial sector seems set on defunding the fossil-fuel industry and we should expect to see rising carbon prices layered on top of the supply crunch that may cause. We should also probably expect to pay higher taxes to finance the subsidies government will keep offering to low-carbon energy production. As renewables scale up, notes Arthur Kroeber of Gavekal, we should expect the end price of electricity to rise too – the intermittency of solar and wind means we must invest more in spare-capacity storage and grid upgrades. Other problems will come in the sharp rise in demand for the metals renewables need – lithium, cobalt and nickel in particular – and in the waste created by replacement cycles for solar panels and turbine blades. None of this is insurmountable. But it is disruptive (and the more serious anyone is about net zero, the more disruptive it is) and it is almost certainly quite inflationary. We might (in many decades) end up with a clean energy system. But getting there is going to be an inflationary journey into “the unknown and the unpredictable”.
This might all seem a bit long-term (carbon prices won’t soar the minute the 400 private jets that landed in Glasgow this week leave), but it should add to the list of things making investors feel a little uneasy about valuations. Market corrections are impossible to forecast. But it really does feel like our next one is a tad overdue.
