The increase in oil prices is filtering through to consumers according to the BBC:
“Petrol prices have reached an eight-year high after nine straight months of rises… the average price of a litre of petrol is now 135.13p, a level not seen since September 2013, as rising oil prices push up fuel costs. Diesel now costs an average of 137.06p a litre, its highest price since 2014.”
The report was met with the usual comments about oil cartels and price-gouging corporations. Although people were warned more than a year ago that rising fuel prices would be one of the many adverse consequences of locking down the global economy in 2020. To the ordinary Joe who doesn’t think much about such things, fuel is some infinite resource that can be supplied at will. And so when prices rise, it must be the result of profiteering, government tax gouging or some combination of the two.
Unfortunately, oil is not an infinite resource. Indeed, despite there being at least as much oil beneath the ground as we have used since the dawn of the oil age, most of it is in such small, remote and energy-expensive deposits that it will never see the light of day. Worse still, the oil which is available to us is in far smaller and more expensive deposits than ever before. It is one thing to drill a relatively shallow well into the ground in Texas or California. It is another matter to drill miles beneath the seabed in the deep waters of the Gulf of Mexico or the northeast Atlantic. And so, for cost reasons alone, fuel prices were always going to go up in the course of the twenty-first century.
The response to the pandemic has added considerably to the problem of increasing oil prices. Oil deposits are not like storage tanks which can be turned on and off at will. Rather, they are complicated geological structures which, once tapped, must be continually pumped. Shut them down in the face of a massive drop in demand – as happened in the spring of 2020 – and you may never reopen them. And even the fields which do reopen will have lost some of their pre-pandemic rate of extraction. Something similar happens to pipelines and refineries when they are forced to cease or slow production. Gunk builds up in the pipes, causing additional cleaning and servicing costs before full production can be restored. And then there are the simple economic limitations. Tanker drivers didn’t just sit around on welfare until demand for fuel rose once more. As the UK has been discovering recently, they went and found work elsewhere. The same goes for drilling rig crews.
While rising oil prices were inevitable as economies attempted to reopen, in the UK consumers faced the added burden of taxation. The UK government recovers more than £27bn a year from the duty on fuel. And for drivers that is only the first round of taxation, because the government also levies 20 percent VAT on the price of fuel plus the duty – effectively taxing a tax!
For the moment, people in the UK are merely griping about rising fuel prices; quite likely because large numbers are still furloughed or working from home. But contrary to popular belief, rising oil prices are a cause of falling demand rather than rising inflation. As Frank Shostak from the Mises Institute explains:
“If the price of oil goes up and if people continue to use the same amount of oil as before then this means that people are now forced to allocate more money for oil. If people’s money stock remains unchanged then this means that less money is available for other goods and services, all other things being equal. This of course implies that the average price of other goods and services must come off.
“Note that the overall money spent on goods does not change. Only the composition of spending has altered here, with more on oil and less on other goods. Hence, the average price of goods or money per unit of good remains unchanged.”
In the current crisis, the money stock has not remained stable. Governments have conjured billions of dollars, pounds and euros into existence to fill the gap in demand resulting from people voluntarily and later compulsorily self-isolating to avoid Covid infection. The fear is that when the lockdowns come to an end, all of that money will suddenly be spent as people seek to restore their pre-pandemic way of life. This is unlikely because of the grossly unequal manner in which the new currency was spent into existence. While furloughed workers received 80 percent of their wages, the unemployed, sick and self-employed had to make do with just £92.50 per week from Universal Credit. People in the bottom half of the income distribution generally lost money and increased their debts. It was those toward the top of the income ladder who were able to save; and it was the large corporations which saw their share prices rise into the stratosphere even as small businesses were collapsing in their thousands.
This has important consequences because of the scope to misunderstand what is happening. The price rises which we are currently experiencing are not inflation in the original definition of the term – as an expansion of the supply of currency. Rather, since the expanded currency supply is currently locked down in the savings accounts of the already wealthy and the financial instruments of the large corporations, there is little chance – at least in the short-term – of that new currency leaking out into the real economy. The price rises which we are currently experiencing are the supply-side consequences of the actions we took a year ago in an attempt to halt the pandemic. Broken supply chains have left us with shortages in everything from pet food to timber and from semiconductors to garden furniture. As a result, manufacturers and suppliers face a form of Liebig’s law of the Minimum in which they are put on hold for want of the least available component.
Rising oil prices though, point to a more profound crisis – not least because the financial chicanery which allowed the US fracking industry to squander billions of dollars of investors’ cash producing millions of dollars of unconventional oil is at an end. There will be no repeat of 2015, when fracking caused oil prices to plummet down to the level of 2005; allowing for a small amount of additional economic growth. With prices pushing toward $80 per barrel and with no respite in sight, the additional cost of energy must result in an economic slowdown:
Griping may not – yet – be the same as open revolt. But fuel prices have been a political issue for more than a decade. The fuel duty escalator introduced by the Major government in 1993 was an environmental measure designed to raise the duty on fuel by more than inflation every year. But following the fuel protests in September 2000, then chancellor Gordon Brown pegged the rise in fuel duty to the rate of inflation. In 2011 and in the face of massive oil price rises, George Osborne replaced the escalator with a “fuel duty stabiliser” in which duty would only rise if oil prices fell below $75 per barrel. In practice though, fuel duty has remained frozen at 2012 rates as successive chancellors have feared the electoral consequence of further fuel price increases.
Prior to the advent of US fracking, economists had anticipated oil prices rising toward $200 per barrel by 2020. Fracking delayed this but probably hasn’t removed the threat. Global oil extraction peaked in 2018 and has taken a big hit as a result of the response to the pandemic. And so, even if prices do not immediately spike to $200, a return of the kind of prices last seen either side of the 2008 crash is very likely.
The increased fuel prices which would follow are likely to force the government to cut the duty on fuel and to delay the switch to road use taxes as more – currently tax-free – electric vehicles are purchased. This though, creates a headache for a government which borrowed hundreds of billions of pounds to keep the economy afloat during the pandemic; and must somehow convince currency speculators that this borrowing can be repaid by future taxpayers.
With the economy facing a slowdown from business closures, supply shortages and rising energy prices, the main sources of government revenue – corporation tax, income tax, national insurance and Value Added Tax – are likely to be off-limits. Any increase in these would be regarded as an attack on an already struggling economy, since further cuts to disposable income can only result in even more economic stagnation. But it is far from clear that any of the other indirect taxes can be raised either. As we have seen, fuel duty is already a political issue and will become more troublesome as prices rise. Business Rates rises are likely to become a serious political issue too. Britain’s High Streets are becoming ghost towns as small businesses close across the country; and exorbitant business rates are widely believed to be a key reason why businesses are becoming unprofitable. Nor is the issue solely limited to High Street businesses. The rents on city centre shops and offices are a large part of the UK’s private pension investments. And so, when the shops go down, they eventually take the pension funds with them.
Most of the other incidental taxes – such as duty on alcohol and tobacco – are designed as a deterrent; and increases will no doubt have precisely that effect. At a time when most people’s incomes are shrinking, prices are rising and household economies must be made, cutting down on items that are heavily taxed becomes inevitable.
If not tax increases, then what? Instinctively the Tories might go for spending cuts; particularly those which disproportionately impact the poor. However, in addition to the dampening effect on an already struggling economy, those types of spending cut would likely hand the so-called “red wall” seats, which gave the government its majority in 2019, back to the Labour Party. This is because the obvious cuts – social security, health, policing and education – had already been made during the Cameron-Osborne years. Political pressure today – including from the red wall Tories themselves – is for at least modest increases in spending here. That leaves only the unpalatable option of cutting corporate welfare; although this too, would indirectly result in a wave of unemployment.
In the short-term at least, the path of least resistance points to even more government borrowing and currency creation in an attempt to kickstart another round of economic growth. And so long as the government can convince the currency speculators that future taxpayers will eventually repay the debt with interest, they may just succeed. After all, there are few safer (and more open to tax-evasion) places to invest your ill-gotten gains – Europe is a museum, China is a mafia operation and bitcoin is a money and energy sink.
In any case – at least for now – the government doesn’t have to concern itself with the long-term. A borrowing-based, post-pandemic give-away budget with lots of public investment on a raft of shovel-ready projects – particularly in key marginal seats – in 2022, followed by a snap early election in 2023, should be enough for the government to hold onto its majority and possibly even take seats from the opposition.
It will be in the next parliament that the true cost of the response to the pandemic will have to be faced. And it is far from clear that there will be a route that leads anywhere other than to a stagflationary decline.
As you made it to the end…
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