The energy checker-board

Soaring energy prices are adding fuel to fast-growing shortages that have already caused an inflationary spurt in the last few months across Europe. Consumers everywhere have seen their shopping bills rise as producers try to pass on their cost hikes to them. The EU and its Member States are struggling with the growing political fallout of what some are calling the ‘energy price crisis’. Various governments are reacting with transfers, tax reductions or tax holidays to help embattled consumers and businesses.

So far, the impact in Malta has been rather contained, but it would be imprudent to think that this could remain the case if inflation persists. For now, government support has cushioned the blow. In Malta, consumers have been shielded from the hike in gas prices by the government freezing the excise taxes paid on imports by EneMalta. But, small firms are particularly vulnerable. In an economy already facing shortages, the production and shipping cost increases can have large knock-on effects.

Most experts expect inflation to continue rising over the coming months. For 2022, they foresee bottlenecks slowly easing, and disinflationary forces re-emerging in the medium term.

If firms pass on price hikes caused by supply chain bottlenecks to consumers, could it throw the post-pandemic recovery off track? Well, it appears that there is a consensus that any demand fallback is likely to be limited in the short run, but that still leaves open the risks with the supply side of the economy. Further inflation could well amplify demand fallbacks over the course of 2022.

In Malta, consumers have been shielded from the hike in gas prices by the government freezing the excise taxes paid on imports by EneMalta.

While this poses downside risks to the economic outlook, as I said so far trend growth in the EU and eurozone has held up. In fact, the latest data from Eurostat shows that in the third quarter of 2021, growth in seasonally adjusted GDP was identical to that in the previous quarter at around 2.1%. However, third quarter growth in 2021, compared with third quarter growth in 2020, was sharply down from around 14.3% to 4.0%.

The result for Malta is quite interesting. Growth in the third quarter this year rose by almost three times to 1.5% compared to the previous quarter of the year. However, third quarter growth this year was sharply down to 9.8% from the 14.9% growth in the same quarter last year. It is evident that the recovery in Malta started slower than it did in the rest of the EU but is now exceeding it, being more than twice as much on a year-to-year comparison.

Earlier in 2021 most economists predicted that recovery from the outbreak of the COVID-19 pandemic would be much faster in the US than in Europe. However, within a few months the situation has changed completely.  Recovery in Europe has exceeded expectations, whereas the US economy has slowed down.

The quick recovery of the euro area economy has potential important implications for the role of fiscal policy. In the US the fiscal support has been extraordinary with the deficit reaching close to 16 % of GDP whereas in the euro area the average fiscal deficit is now (according to the Commission’s autumn forecast) estimated to be only slightly over 6 % of GDP.

The negative effects of inflation on GDP growth in the near future will depend on what Russia does with its gas supplies to the EU. Putin’s sabre-rattling and his decision not to raise supply to meet the spike in demand has contributed to higher prices, but the impact is difficult to quantify. After all, prices had already more than doubled between January and June, so arguably this was just the continuation of a pre-existing trend.

Putin’s game is to ensure that Germany approves Gazprom’s use of the just-finished Nord Stream 2 pipeline quickly. But the Germans are under intense pressure from the USA because this would allow Russia, if it wishes, to turn off the gas supply to Ukraine (with which it has been in a low-intensity war since 2014). Ukraine would also lose out financially on the transit fees it earns on the current gas pipeline route.

Putin’s aggressive stand also includes securing a reversal of reforms that had forced Gazprom to offer most of its gas at market prices, to be replaced by a return to long-term fixed-price contracts for European customers. These types of contracts disincentivise investments in energy efficiency, diversification and the transition to cleaner energy sources. 

This confluence of short-term factors has made Europe especially vulnerable to Gazprom’s decision not to increase supply. This makes it even more important to push forward the EU’s energy strategy, moving away from fossil fuels toward renewables. Renewables reached 42% of the EU energy mix between April and June and 36% between July and September, as opposed to 32 and 35% respectively for fossil fuels.

Once Europe gets more renewable generating capacity and technologies, gas would lose its place in the electricity market, lowering energy prices and reducing Europe’s dependency on energy imports. This transition will, however, require additional investments in electricity storage, as well as more grid interconnections between different European regions – to allow energy to be traded between regions with different weather profiles.

In the short term, Europe can do little to resolve the crisis. In the toolbox published last October, the Commission suggested several measures that EU member-states could use to help poorer consumers – such as income support, temporary bill deferrals and energy tax cuts, and protection against disconnection from the grid. Provided they are designed not to reduce consumers’ incentives to limit their energy consumption, these measures are sensible.  

The worst thing the EU could do would be to pull the brake on green policies, for fear of additional impacts on consumer energy prices. Instead, redouble their efforts to ensure that these policies result in a just energy transition should be redoubled.

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