Assessing Energy Price Dynamics and Their Impact on Inflation in the Short and Medium Term

Energy prices

Energy must be the starting point when thinking about a second wave. Our base case sees oil edging higher this year, and the risk is that we continue to see a lack of investment in upstream production while demand continues to move higher. That would point to an increasingly tight oil balance in the years ahead. Stricter legislation on new US oil/gas drilling, though unlikely, would be a key source of upside risk given America has been a major driver of supply growth over the last decade. That aside though, the US is largely energy-independent and that makes it far less exposed to 1970s-style shocks.

Europe is more vulnerable, though the situation is evolving. National gas reserves are currently well filled and the eurozone looks better prepared to enter the winter heating season. Russian gas exports to Europe are marginal now, so any further supply cuts would be unlikely to take us back to 2022 highs.

We’d also argue that natural gas demand has peaked and suspect it will be gradually lower over the next decade. RePowerEU, the bloc’s flagship energy strategy, puts emphasis on moving aggressively towards renewables. At the same time, last winter’s price spike appears to have resulted in a permanent demand loss in energy-intensive industries.

Still, in the short to medium term, the continent is more reliant on liquefied natural gas (LNG). The combination of strike action at Australian producers and a colder-than-usual European winter could prompt a significant price response. So, too, would any disruption to Norwegian natural gas supply.

For inflation though, remember that in Europe electricity/gas prices are still more than 50% higher than they were in 2021 in Germany, and roughly double in the UK, according to CPI data. Even if we got another 2022-style shock to wholesale prices, arithmetically, the scope for a similar shock to inflation at this point is more limited.