The Solution to the Cost of Living Crisis is to cut Energy taxes
This article follows on from my previous article on the cost of living crisis, which I named The Great Inflexion, back in September 2021. In The Great Inflexion I talked about how energy costs underpin all costs in the economy, from transportation costs, to food costs, clothing prices and consumer electronics costs. Any increases in energy costs can quickly have a spiralling effect on inflation. And, of course, we have record inflation in energy prices, both in the home, and at the pump. Here in the UK, pre-pandemic, we were used to seeing prices of around 130 pence per litre at our forecourts. Post pandemic, we started to see prices rising towards 150 pence per litre. Then, in the aftermath of the Russian invasion of the Ukraine in February 2022, prices have surged to 160p/L, and now 170p/L. It’s becoming almost dizzying keeping up with the increases, and price shock is becoming an all too normal experience when refuelling your vehicle.
Compounding these price shocks are equivalent home energy cost spikes, with gas prices, in particular, soaring in Europe in response to the war in the Ukraine, as shown in this chart published on the British Gas website.
When taken into account with the anaemic post-pandemic economy, Europe is experiencing some of the worst ‘stagflation’ since the 1970s, with rampant energy cost inflation and pay packet increases struggling to keep pace.
Pivoting into the world of politics briefly, politicians are telling us that these inflationary shocks are a global problem and there is only so much they can do to cushion their impacts on ordinary citizens. Whilst this may be true, it’s still worth examining these inflationary forces.
- Firstly, the war in the Ukraine is adding anxiety around gas supplies into Europe, with the Ukraine a major artery for gas pipelines from Russia into Europe. Also exacerbating the problem is the cancellation of the Nord Stream 2 undersea pipeline from Russia to Germany, which was designed to increase gas supplies into Western Europe, and do so with more modern technology that was expected to increase transport efficiencies
- Whilst the COVID-19 pandemic is fortunately behind us now, the effects are still lingering. This includes damage to energy infrastructure due to the prolonged economic shutdowns globally, as well as the impacts on the health of the global workforce plus any inefficiencies introduced by COVID-19 regulations (paperwork, testing costs, quarantine costs etc). Adding to this, the vast amounts of public money that was spent on keeping the lights on during the shutdowns, and on COVID-19 vaccination and mass testing programmes, means that there has generally been a massive inflation of the money supply in most economies, resulting in post-pandemic inflation as economic activity starts to return to pre-pandemic levels
Adding to these inflationary pressures is a reluctance from major oil supplying nations to increase supply to meet demand. Here it’s worth mentioning the role of OPEC, the global oil cartel, and its ability to control global oil supplies. OPEC, or the Organization of the Petroleum Exporting Countries, is a global organisation of major oil producing nations, including Iraq, Iran, Saudi Arabia, Venezuela, Nigeria and Libya. Altogether, OPEC member states supply almost 50% of the world’s oil, and have over 75% of known global oil reserves (as of 2018), so their decisions have huge global consequences. The influence of OPEC was highlighted once again when the United States released record amounts of oil from its national strategic reserves back in March, and oil markets reacted largely indifferently; fundamentally it only highlights how conventional supply and demand mechanics don’t always apply to oil markets.
Pivoting back to the UK, there has been some debate over how to tackle the cost of living crisis. To date, actions by the UK Government have included a one-time council tax refund per household — equivalent to one months’ payment — and a temporary cut in fuel duty of 5p/L. Furthermore, the Chancellor recently announced a £400 energy bill rebate for each household later in the year, partially funded by a 25% windfall tax on oil and gas company profits, and in response to the daunting autumn energy price cap review announced by the UK energy regulator, Ofgem. Now, handily the BBC has already done some analysis of the component costs of both home energy and fuel costs. I’ve converted their pictograms into slightly more accessible pie charts below.
As you can see, in both cases, taxes make up a significant portion of the total costs; for energy bills, it’s a combined total of nearly 20%, including VAT and green energy taxes; for fuel costs, VAT and fuel duty make up nearly 60% of the pump costs. And fuel duty has long been a bumper tax crop for the UK Chancellor, but with the slow, but steady, pivot over to electric vehicles, this source of tax income is going to slowly dry up. However, at the moment, electric vehicles are still prohibitively expensive, even with innovative and flexible finance deals, and most people who need financial support are effectively priced out.
So, here we are, it’s 2022, and the COVID-19 pandemic is fortunately finally in the rear-view mirror. However, the fact remains that global energy supplies are going to be a problem for the foreseeable future. As global energy demands only continue to increase, and as fossil fuel reserves continue to deplete - and as more fossil fuel production is coming from expensive and harder to refine sources, such as heavy ‘sour’ crude from Venezuela - the world finds itself at a cross-roads. With energy prices soaring, do we continue to invest in fossil fuels, or do we take the plunge into the green industrial revolution and start heavily investing in renewable energy, as well as affordable and safe nuclear energy technologies?
One thing is for sure, with energy taxes as they are, it’s unlikely that the global economy can rebound from the COVID-19 pandemic without at least some action on sanctions on Venezuelan and Iranian oil, to replace supplies from the Russian Federation. Also, continued energy subsidies will only prolong the inflationary spiral that is gripping the world. Only targeted energy tax cuts, twinned with investment in renewable energy production, and efforts to increase global oil supplies will work.
