Are we going back to the 70s? No, the bell bottoms are not back, and the economy is not like the 1970s either , but we do face supply shocks in the economy again. Of course, the price of energy, as then, does not stop rising and is already through the roof. Also, as we anticipated a few months ago, inflation has returned in practically all developed countries. But we do not have, at least for the moment, stagflation, that is, an increase in unemployment with inflation.
The reason is that, although we are facing, not only in Spain, but throughout Europe, two simultaneous supply shocks, this coincides with the reopening of the economy after the Pandemic, which is accompanied by a rebound in growth after the sharp drop in 2020.
The reasons for the first supply shock are various: on the one hand, the Central Banks injected massively money to maintain income and demand during the last year and a half. Also, for quite some time, many individuals were forced to save. Now this forced saving , under the motto of “you only live once” has been transformed into effective demand and consumption.
After the great disaster of the Pandemic, demand has recovered before supply, and that always produces inflationary tensions. And the money injected massively by the Central Banks also produces inflation, but only when it moves, that is, when it is transformed into consumption and investment, and it is now when it is happening.
But, in addition, the Pandemic led to important errors in the economic planning of States and companies. For example, future demand for some raw materials , or for key products in production chains, such as semiconductors or steel , was underestimated .
Once production has stopped, it often takes months or even years to get back into production at the previous rate. In addition, international production chains have also been broken, causing shortages and rising prices. If we add to this the bankruptcy of companies in delicate situations, we will have another element in the same direction.
One sector where all this has happened is energy. We have enjoyed lower oil and gas prices because fracking technology has proliferated in countries like the United States and Canada . However, in 2020 the demand for oil and gas fell, and many companies, which were highly leveraged, that is to say, indebted, could not hold out.
When the demand for oil and gas was restored, with the economic recovery, the supply was sufficient. And we are not only talking about a temporary issue, but that this industry had suffered structural damage from the Pandemic. Therefore, it could take several months, or even longer, for oil and gas production to return to pre-Pandemic levels. And that meanhigh levels of gas, oil and electricity prices in Europe.
To this first shock effect, derived from the Pandemic, from the restrictions, from the monetary measures taken to alleviate its economic damage and also from the structural damage, we must add a second shock. Here we are talking about the acceleration of the ecological transition .
As the ecological transition is fundamentally a process of massive internalization of costs that were not previously paid, accelerating this process is by definition a supply shock. If CO2 rights are paidFor example, to produce electricity with some energy sources, which are also the ones that set the price in a marginalist market, and these rights triple in price, the obvious effect is to pay much more for a basic source of energy that we all use. And I’m not exaggerating, in April 2020 the right was trading at 20 euros and yesterday at 62.
In a recent study , Jean Pisani-Ferry points out that the economic transition has serious macroeconomic implications and that it could be assimilated to a negative supply shock. The rationale given is that the ecological transition will render a part of the capital stock useless and unusable before its natural repayment term . This is like having to change cars two years after buying the previous one, and it is an economic sacrifice, because that money cannot be consumed elsewhere.
We are already checking all this. For example, coal plants have become obsolete in Spain precisely because, to produce energy, they had to use many more CO2 rights than combined gas cycles. P or course, coal plants to close early as in Spain or nuclear, as Merkel did in Germany has a cost.
But, in addition, if the price of gas shoots up, this plant is no longer available. We have become more dependent in Europe, and also in the United States , on the supply of Natural Gas. And that has geopolitical consequences, as did the increase in oil prices in the 70s, but that is another story.
Europe cannot do much about Gas and Oil prices , compared to the first shock, but it can do much about CO2 emission rights. Indeed, the CO2 right is a useful instrument to direct consumption and investment towards cleaner technologies. However, if it is not applied in all markets in Europe, nor, and this is even more important, does not apply, in practice outside Europe, a right whose price rises at this speed brings many more disadvantages than advantages.
This second shock is not even serving to improve decarbonization . It is neither industrially nor technologically possible to change production processes, nor the energy mix, at this speed. But, in addition, in the medium term there will be carbon leaks, that is, some companies will leave Europe. As Josu Jon Imaz, CEO of Repsol, pointed out at the elEconomista Energy Forum : “The CO2 rights cannot be at 60 euros and there is no border adjustment mechanism.”
But implementing this mechanism is not exactly easy and can lead to a tariff war. In addition, decarbonisation happens, at least partially, to electrify, and this will not be possible if the price of electricity continues to rise, driven by gas and CO2.
I think it is time to rethink completing the CO2 market and the level of rights that the European Commission authorizes to issue to Member States. Admittedly, we are facing a double supply shock, and we can only do something about the pace of the ecological transition, especially in the short term, and not the price of gas or oil.
It is true that in Spain the transfer of electricity prices to the consumer is being faster than in other countries, but in the other States it will arrive soon, accentuating the problems of costs and inflation throughout Europe. Maintaining the recovery after the Pandemic requires facing the energy problem in Europe and rethinking some strategies when they do not produce the expected results.