Macro Moments Weekly: Circling back to the industrial revolution

The market rally last week was predicated on things getting back to normal. In this context, ‘normal’ means stable prices for energy, including gasoline/petrol, and for fertilisers and aluminium, as well as for food and mortgages, as interest rates no longer need to rise. At the time of writing, oil prices are up (compared with pre-war levels): 73% for crude, 60% for Brent, 100% for gasoil (diesel) and 72% for TTF natural gas.¹ Only the outcome of the peace talks that started 11 April will determine whether these prices hold or whether they fall, in the same way they did in 2022. The problem is that the fall in 2022 did not prevent inflation running through and staying in the system.

The answer to higher oil prices in Europe is literally to drive electric. The fragility of reliance on carbon-based fuel, first from Russia amid the invasion of Ukraine in 2022, and then from the Persian Gulf this year amid the US-Israel-Iran conflict, has accelerated the political will to build renewables, whether solar or wind, to produce energy locally. We all know that the sun doesn’t always shine, and the wind doesn’t always blow, so we also see proposals for backup sources in the form of nuclear or gas alongside the development of energy storage systems.

In the old carbon-based economy, one’s energy storage system was a tank full of fuel, be that in a car or in an oil terminal. The new systems are equally large—industrial estates of batteries. Rolls-Royce has recently won a contract to develop a battery plant in Falkirk,² while Canadian Solar is supplying the battery systems for two plants for the Drax Group, with one in Marfleet, England, and the other in Neilston, Scotland.³  But the problem becomes one of the cost of such security of supply.

The United Kingdom’s domestic energy prices are not the highest in Europe—that unwanted accolade goes to Germany—but they are 70% higher than the European average and 2.5x that of the Netherlands.⁴ The actual energy cost to the UK consumer is 45% for fuel itself and 55% for other components, including distribution, operating costs and profits, green subsidies and tax.⁵ The switch to renewables while running a traditional energy system raises costs instead of lowering them. But once the switch is achieved, then the inflation impact of energy on an economy would all but disappear.

The problem is that any one country, such as Germany, France or Spain, by ensuring security of supply produced locally, would be left with a long-term cost of energy that would not be the same as others globally. The price of oil and gas is global, and by being global it has levelled the playing field for costs. Recall that the industrial revolution progressed in the United Kingdom thanks to abundant supplies of cheap coal within Great Britain. Security of supply does not equate to competitive prices, and in the energy-hungry world of artificial intelligence (AI) and associated data centres, global competitiveness will likely depend on local energy cost, as it did during the industrial revolution.

So, whatever the outcome of the Iran war, the long-term result is likely to be a far more varied cost of energy around the globe. That security of supply will be less inflationary, so the need for central banks to change interest rates could diminish. Understanding the neutral interest rate for an economy will become a far more important discussion, and it will be based on productivity, profitability and labour supply. This feels like a profound shift in economic prospects and forecasting for decades to come—or is it just the reassertion of a very old rule set way back in the industrial revolution?

Parting shot

Having spent the Easter week in Switzerland, one cannot help noticing the Swiss system of referendums. Big policy decisions are not taken at elections, but via quarterly referendums. In March, a referendum decided that ‘cash is king;’ that cash will always be available and accepted. In June, the Swiss will vote on whether to cap the population at 10 million. It is currently 9.5 million.