The Financial Express

Surging prices and energy war in Europe

| Updated: October 13, 2022 21:09:42

Surging prices and energy war in Europe

According to Eurostat, the European Union's (EU) statistical office, the Consumer Price Index (CPI) in  27 EU member countries went up to 10.10 per cent in August  from 9.8 per cent in July this year. Baltic states are the front runners in this respect with the inflation rate varying between  21 to 25.2 per cent. A year earlier the rate was 3.2 per cent. Rapid rise in Inflation in the EU has created a serious cost of living crisis.

The Eurozone area (currently, the euro (€) is the official currency of 19 out of 27 EU member countries which together constitute the Eurozone, officially called the euro area) inflation rate was 9.1 per cent in August up from 8.9 per cent in July. A year earlier the rate was 3 per cent. In the UK (a non-EU member European country) annual inflation rate could go up to 15 per cent by the start of 2023; other estimates put the inflation figure  for the UK at 18 per cent or more in 2023.

Price hikes in food and fuel are among the factors that are contributing to rising inflation in Europe. Energy inflation in Europe stood at 38.3 per cent in August compared to 39.6 per cent in July according to Eurostat. Also, beyond Europe, much of the wider world was already hit by soaring energy prices even before the conflict in Ukraine started in February this year.

Now the conflict has exacerbated the energy crisis by the fear that it may cause further interruptions of oil and gas supplies from Russia. The most immediate cause of  the energy crisis is a lack of natural gas. The energy shock has now turned into a full-blown political and economic crisis. The euro has sharply depreciated against the US dollar. The Wall Street Journal warned that "sharp movements in exchange rates create uncertainty and can lead to economic and financial instability".

However, the big energy companies are flush with cash. The six oil multinational giants reported combined profits of more than US$64 billion for the second quarter of 2022. Almost 15 per cent of families in the UK are behind on their utility bills and many manufacturing plants are running at a lower capacity. In fact, the UK's economic woes much predate the current economic crisis. Now close to 30 per cent of the working population in the UK are considered as working poor.

The UK's economic woes that started in the 1970s led to even more profound economic transformation since the early 1980s with the onset of neo-liberal market economy. The socio-economic changes have been so profound since then that the UK economy has become the vanguard of a new global economic system now known as "rentier economy", where economic activities are singularly guided by to earn unearned income which is also known as economic rent.

High energy bills are forcing households to cut spending on other items and with increasing supply bottlenecks adding to inflation will weigh down demand further. As demand declines that will  be dragging down growth, pushing the EU into recession late this year or early next year.

The European Central Bank (ECB) is faced with very painful choices now. Any stimulus package in the form of quantitative easing (QE) -- a particular economic policy that was introduced to slow or stop a sharp economic decline -- that had started in 2020 and was worsened by the pandemic, and if  the decline continues now, it will further fuel inflation and damage the bank's credibility to fight inflation mandate.

So, to fight inflation, the ECB's other policy option now is quantitative tightening (QT) which reduces the quantity of money in circulation and raises interest rates. Therefore, such a policy tightening will only lead to slow growth, even further precipitating an economic downturn, or more  precisely a recession.

But ultimately, the ECB will go for fighting inflation to bring it down to the target range at 2 per cent. Their argument is based on the premise that while there are unfortunate costs of reducing inflation, without price stability the economy does not work for anyone. With coming interest rate hikes a recession to take hold has become more than a possibility.

The prices of  many commodities including food have been rising at the onset of the Covid-19 pandemic due to disruptions in supply chains resulting from lockdowns. Now the US led NATO proxy war against Russia in Ukraine dramatically worsened the outlook for food grain supply as Russia and Ukraine account for two thirds of wheat supply in the global market. The Ukraine war has turned into a war of attrition, claiming thousands of victims while the front lines hardly move much except occasional push back and forth.

More alarmingly, US President Joe Biden in a television interview with CBS on September 18 told the interviewer (Scott Pelley)  that his commitment to backing war against Russia was "ironclad", while acknowledging this commitment contained the possibility of nuclear war. Biden's interview with Pelley clearly indicates Washington's entire geopolitical strategy is one of unrelenting recklessness.

Meanwhile, within the EU itself neo-fascists are increasingly gaining political popularity. In the very recent past in Italy and Sweden neo-fascist have gained commanding position in elections, either to form the government or to be  a coalition partner of the government. In Europe, economic crisis is now giving rise to political crisis with the rise of far right neo-fascists.

The economic sanctions against Russia with particular focus on the energy sector have led to rapid escalation of prices of natural gas triggering the highest inflation in decades in Europe. Outside NATO, not many countries have  joined the sanctions as well as NATO member countries such as Turkey and Hungary.

Members of G7 in a meeting early this month agreed to impose a price cap on Russian energy exports to financially weaken Russia as part of NATO's war efforts directed against Russia to encircle the country.  EU President Ursula Von der Leyen also declared that  EU countries should  also follow suit like G7 countries by setting a cap on Russian natural gas.

Russia already declared that it would stop selling oil to countries that impose price cap on Russian energy resources. Moscow further added that caps would only lead to further destabilization of the global oil market.

The stipulated price cap on Russian energy imports as envisaged by the EU could help the ECB to contain inflation, but inflation is already very high and has been so for some time. So, the ECB is  unlikely to have the ability to get out of the inflationary pressure - price cap or no price cap. 

In fact, Russia could call this Europe's  bluff and refuse to sell energy to EU countries. Russia has already shown its ability to do exactly that  when Moscow refused to  sell oil to countries that did not settle the account in rubles. On last Monday, powerful underwater explosions blew gaping holes in the Nord Stream 1 and 2 pipelines, which carry Russian natural gas under the Baltic Sea to Germany. While neither pipeline was delivering gas to Europe at the time, the incident scuppers any remaining expectations that Europe could receive gas via Nord Stream 1 before winter. This is a  development that could have a more immediate impact on gas supplies to Europe.

Furthermore, President Putin  declared that Russia would not abide by current supply contracts in the event of a price cap.  G7 and  EU countries are making a very risky bet by thinking that Russia would buckle under the pressure. Also, Russian gas flows westward have already become little more than a trickle. So, a price cap on Russian gas would have little-to-no influence on the little supply still coming.

It is   estimated that, coal fired power plants account for 22.9 per cent of Europe's total electricity generation. Natural gas power plants generate 22.0 per cent of Europe's electricity with nuclear power plants being most dominant at 25.5 per cent. The most immediate cause of the energy crisis is the lack of natural gas which as indicated earlier accounts for 22 per cent of power generation in the EU. They receive natural gas from Russia through Nord Stream 1 pipeline but Russia has significantly reduced supply due to problems associated with the maintenance of the pipeline even before the explosions. This has caused prices to soar stoking fears of energy shortages.

But Europe's energy problem rather predates the current crisis resulting from supply shortages originating from Russia. The EU's embrace of the neo-liberal economic doctrinaire view led to the creation of electricity market to introduce competition in the generation and supply of electricity in the 1990s. For decades electricity generation and supply have been  based on vertically integrated local or national monopolies. These monopolies are considered natural monopolies and they  were able to exploit significant economies of scale and scope and the expansion of electricity grids to ensure universal access to electricity in EU countries.

A natural monopoly exists when average costs continue to fall as output increases because fixed costs continue to spread out  with increased output. An electricity company is a perfect example of a natural monopoly. Now having two or more electricity companies will spit electricity production each with its own power generation and supply grids leading to doubling or tripling of price. As a consequence, electricity prices have gone up much faster than costs enabling private electricity suppliers to amass massive economic rent.

Therefore, ideologically motivated economic policy of competition is not always the answer to every economic management issue. No wonder 14 per cent of UK families and 17 per cent of EU households are behind their electricity bills. Also, 80 million EU households struggle to stay warm in winter.

Energy prices in Europe have soared 10 times their average level over the last decade as ideologically motivated restructuring of the energy industry has started to take root leading to dependence on massive amounts of cheap energy imports from Russia.

The consequences of that energy policy became quite visible even before the Russia-Ukraine conflict started in this February. Oil prices were already in the US$100 per-barrel range before the conflict. Natural gas and electricity prices saw 1000 per cent spike in late 2021. 

Now high energy prices triggered by supply disruptions caused by Western  (i.e., the US and EU) sanctions on Russia added a very serious dimension to the already existing energy crisis in Europe which has led to spikes that throttled industries and left households scrambling to pay their energy bills.

Wars are fought on many fronts. Soaring energy costs  resulting from the US led NATO proxy war against Russia as well as  sanctions imposed on Russia are hurting EU economies including its largest economy Germany. So far Western sanctions failed to have any major impact on Russia's oil and gas export revenues; in fact, Russia's current account balance stands at record highs.

The Russian economy so far appears to have been spared the worst of the energy war guarded by its own rising energy export revenues. But Russia's long-term success in its economic war with the EU is seen as the critical factor by both sides in deciding the outcome of the war  in Ukraine.

Also, no Western sanctions' roll back is likely before a détente in Ukraine but that is unlikely to happen as the US and NATO are massively arming the Ukrainian army, thus further bolstering the far right neo-Nazis  hold on the Ukraine government. The neo-Nazis have already become part of Ukrainian armed forces. In fact, the far right neo-Nazis in Ukraine are now emerging as a danger to post-conflict stability. It is now clearly evident that the EU is putting up a spirited fight against Russia and seeking to move away from Russia despite its dependence on Russian energy supply. A sense of collective responsibility with its root in the cold war period guided the EU to join the US in promoting NATO expansionism threatening Russia's security which led to the Russia-Ukraine conflict.

But the US supported by the EU and the UK  quickly turned that conflict into a proxy war against Russia in Ukraine along with  imposing sweeping sanctions on Russia. But the proxy war against Russia in Ukraine has created an energy crisis for the EU resulting in rising inflation and economic slowdown threatening European unity. The way out of this crisis for the EU is to implement the Minsk agreement and to offer Russia security guarantees.

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