Thursday, September 28, 2023

Fossil fuels make inflation and climate change worse

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Shreya Christina
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It’s an everyday grocery shopping day: you run to the store to get some groceries, some drugstore supplies, and fill the gas tank. Then you cook lunch on the gas stove.

For all this you would spend about 8.5 percent more than you were a year ago, based on the Bureau of Labor Statistics’ July report on prices for consumer goods and services — over the month, that means about $500 more for most households than last year.

Economists have pointed to energy prices as the main reason for high inflation. Americans have had to spend more on gasoline, on natural gas for stoves, boilers and furnaces, and on electricity from oil and gas. But the impact of fossil fuels is bigger than that: energy prices indirectly affect almost every part of the economy.

The effect of higher energy prices is especially evident in food prices, as most of the cost of food is based on how expensive it is to get from farm to shelf. But it also affects other consumer goods. Amazon recently for example increased its Amazon Prime rates in European countries, citing rising fuel and transportation costs.

Moody’s chief economist Mark Zandi said fossil fuels have been a major cause of every period of inflation since World War II. “It’s always the high cost of oil and fossil fuels in general that is driving wide swings and overall inflation,” Zandi said. “Every recession since World War II has been preceded by a jump in oil prices.”

Higher oil and gas prices are responsible for about 40 percent of price increases across the economy (or 3.8 percentage points of the 8.5 percent inflation rate as of July, according to Moody’s calculations).

A major reason that inflation cooled this month could be that energy prices are falling; natural gas and petrol are cheaper than earlier in the year. But even though prices have fallen, they are still higher than they were a year ago. In general, consumers can still expect to pay much more for goods and services in the near future.

The trade-off between the price of fuel and the price of everything else over the past year shows what a strong hold fossil fuels have on the economy. The US is stuck in a cycle of rising oil and gas prices, and political leaders are trying to do everything they can to bring them back down to ease inflationary pressures. It pits renewable energy sources against the economy. Breaking free from this will require you to switch to more electricity powered by solar and wind energy to fuel cars, homes and businesses.

Reducing dependence on fossil fuels “will significantly loosen the grip on inflation in the broader economy,” Zandi said.

It’s why economists ultimately expect the Inflation Reduction Act to live up to the bill’s name.

Fossilflation, explained

A complicated array of factors is currently driving inflation – including but not limited to supply chain problems, under-worker labor and projected gas shortages in Europe – but dig a little deeper, and one common element is fossil fuel reliance.

Inflation isn’t just a problem in the US or because of federal spending during the pandemic. It has doubled in the past year in 37 advanced economies.

In some circles, economists have preferred to use “fossiflation” as the more accurate description of current inflation problems. Member of the Governing Council of the European Central Bank, Isabel Schnabel, used the term in a march speech in the new era of inflation. “Fossils reflects the ancient costs of reliance on fossil fuels,” she said.

Volatility is always a feature of relying heavily on fuels to power the economy. These are goods that need to be stored, refined and transported; as Gernot Wagner, a climate economist at Columbia Business School, explained, “commodities always fluctuate.”

This was especially true in the 1970s and 1980s, when the economy suffered from even higher inflation. The circumstances leading to higher prices today are of course different. The oil industry has had a turbulent couple of years during the pandemic, drilling fewer wells and struggling with limited available refinery capacity that cannot cope with soaring demand. And the Russian invasion of Ukraine and ensuing global sanctions have reduced available oil and gas supplies, and prices are correspondingly higher in anticipation of winter shortages in Europe.

“A hundred years into the oil age, it shouldn’t surprise us anymore that every decade something happens somewhere and prices are rising,” Wagner said.

BLSs July report actually showed no growth in inflation last month. The reason is the same: the prices of fossil fuels. Zandi explained that the June highs reflected Europe’s decision to sanction Russian oil and gas. But investors seemed to have overestimated the impact on actual global oil and gas supplies, causing prices to fall slightly over the next few weeks.

It’s not ideal to be so tied down to the ups and downs of oil. The oil industry is reaping the benefits, while consumers suffer from higher prices. The 50 largest oil and gas companies have so far raked in $113 billion in profits in 2022, due to high prices, according to a calculation. And they’re still getting billions in subsidies, while the entire U.S. oil and gas industry gets more than $20 billion in tax breaks, according to one analysis 2017 of Oil Change International.

The solutions to climate change have a double function and help consumers to get out of this circle. Green technology is not a panacea for the economy; in reality, “greenflation” is the term coined for increased demand for copper, lithium and cobalt needed for clean technology. But moving away from fossil fuels helps in one important way. Rather than relying on fuel, a commodity, Wagner argues that the adoption of renewables in the US will mean a shift to technological solutions. “Technologies are by definition getting better and cheaper,” he said. “That’s the way out of the unfortunate cycle of fossil inflation.”

Break the cycle of “fossiflation”

What Congressional investments could do, if they really help to wean the US economy from its reliance on fossil fuels, is to free the economy from the volatility of oil markets.

The Inflation Reduction Act promises to help because it does a few things simultaneously. It invests in solutions that help reduce consumer demand for fossil fuels and encourages manufacturers and companies to do the same. It also raises taxes on corporations, another way to curb inflation, “not unlike raising the Fed” [interest] rates,” said Robbie Orvis of Energy Innovation, an economic modeler who has studied the bill’s impact.

The IRA’s nearly $370 billion in climate action won’t dent current inflation. But as the decade progresses, economists like Zandi expect Americans to start feeling some difference.

Moody’s estimates that by 2030, the bill could reduce the energy expenditure of the typical American household by more than $300 a year, in today’s dollars. It can also help with insurance rates for residential and commercial properties because of the investments that reduce emissions (which exacerbate climate change) and in physical climate adaptation.

Another report from Rewire America finds even greater gains when adding up the total tax credits from the bill for electric vehicles, rooftop solar, and electrical appliances such as heat pumps. Rewiring America found that a household would save $1,800 annually if it used all this clean technology. Doing all this in your household obviously costs a lot of money in advance. There are still some policies in the bill that specifically target low-income households, such as extending a low-income home discount that covers the entire cost of installing a heat pump, up to a maximum of $8,000.

“That could go a long way in mitigating the ups and downs in the wider economy and our standard of living,” Zandi said.

These policies are too late to help with high prices in the near future, but they will slow the impact of the next major crisis.


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