A Looming Energy Crisis?

One of the biggest influences on inflation is energy prices. Everything we buy in a shop, no matter what it is, has been transported to the shop from the manufacturer and transported from the shop by the consumer. Include the energy use to manufacture non food products and you can see why the energy prices are so important to the economy.

When the switching off of one of British Petroleum's Alaskan oil pipes (Aug 2006) caused oil prices to spike to $78 per barrel, it looked like we might have been heading for  the $100+ per barrel we predicted early in 2006. The oil price dropped down to about $55 per barrel by mid 2007, when the BP issue was resolved, and the US refineries knocked off-line by the 2005 hurricane season, were up and running again. Since then we have had an unbroken upward trend with the oil price now standing at around $90 per barrel.

In Britain we also saw the opening of a new gas pipeline from Norway which helped ease energy prices locally, and of course we've had a couple of fairly mild winter recently meaning we used a little less 'winter' energy anyway. One thing seems reasonably certain, and that's that UK's oil and gas won't last forever, so we are increasingly reliant on energy imports from elsewhere in the world, until we get to grips with improving our own independent energy generating capacity.

The continuing political instability in the Middle East still continues to hinder energy price stability, and we have seen Russia attempting to reassert its might by turning off gas supplies to their near neighbours. In 2006 it was the Ukraine, and in 2007 it was Belorussia, and again this year (2008) the Ukraine was under threat again. Unfortunately a large portion of Europe's Natural gas requirements come from Russia through these countries. Although the Russians say they would not wish to spoil what is currently their largest market, they continue to demonstrate how they will make  political points to get their own way with their ex-Soviet satellites, and so even this energy supply is not guaranteed. The Russians also want to remind the West that they are still major players on the worlds political scene and they will no doubt use whatever means available to them to continue to make this point.

China's energy demand is also rising fast and those regimes based on an energy economy who have oil and gas but who do not particularly wish to sell to the West will have a ready market in the Far East. 

It seems that our energy problems are not going to be easily resolved in the short term and so inflation will creep up. Even the UK Governments 2006 report on energy generation in the UK has finally recognised that no amount of new wind farms will be enough to take over the generation capacity of our gas and oil fired power station let alone the remaining nuclear stations. Even the Germans who have the most experience with wind farms over the last 25 years concede that it isn't economically viable to continue building wind farms to try replace oil and coal fired power stations. The nuclear option is back on the agenda as a generation method which doesn't produce CO2 and has a realistic chance of making a large contribution to generation capacity (but only in about ten years time and only if the decision to invest and build is made now).

So will interest rates continue go up from here? Well we have a complex interplay of inflation coming from different areas. Apparently if you take the effects of the oil and agriculture inflation out of the picture then inflation for other goods and services is still falling. However we all need to eat and power our homes so while the cost of buying a new fridge might still be falling, the cost of shipping it to your home and running it will still rise, as will the cost of the things you put in it. 

The Bank of England (BoE) are treading a fine line between dealing with the credit crunch, preventing a recession and controlling inflation, simply because these problems require different interest rate policies to reduce their effects. As gloomy as all this sounds, BoE interest rates would have to go up by another 1.0% to get back to the long term average of 6% and although we might see another rate cut in 2008 interest rates are unlikely to go much lower and in two to three years could stand higher. Even so they will still only be around the historic average.

Also consider the property market in the UK. In research done in 2005 by the Royal Institute of Chartered Surveyors (RICS) using the Land Registry house price figures over the last 50 years, which demonstrated that in every ten year period going back from 2003 to the late 1950's, you would not have lost money if you bought a house and owned it for at least 10 years, for any ten year period in that half of last century. This included those periods where interest rates rose to 15%. So if you are prepared to live in a house or invest in a property for at least 10 years you would be unlikely to lose money on the purchase price while gaining the benefits of a home to live in. Even with the current reduction in property prices, we are probably seeing a much needed correction in asset value. If the property market values drop by 20% from it's peak in Q3 2007 than we go back to prices of just 5 years ago (Q3 2003 - based on Nationwide house price data adjusted for inflation). So if you've owned your home for more than 5 years and are in no immediate hurry to move, then you shouldn't have much of a problem. Of course, people who have been active in the property market within the last five years (especially 2006/07) may suffer from negative equity, but again if you are in now hurry to move then you can sit the downturn out. For those people who need to move or remortgage right now having bought recently, these people may have difficulty raising a new mortgage and so should speak to a mortgage adviser to see what options are available.

Will these trends continue? Well consider the following. We live on an island, and as my old granddad used to say, 'They don't make land anymore!'. It's estimated by the Government that about 220,000 dwellings a year need building for the next 10 years just to catch up with current demand which is rising year on year due to demographic trends. All this at a time when the new build rate last year was running at about 190,000 houses per annum.

And then we have global warming. Whatever the arguments about whether global warming is caused by man or nature, it seems clear that the Polar ice caps are melting, the weather is changing, and all that water has to go somewhere, leaving the definite possibility of rising sea levels and even less land to build on in Britain. 

All these issues are going to limit the supply side of the equation. Hey ho, there's always a silver lining to any cloud (assuming you already own a property not built on a current or future flood plain)!

As always, when buying property, pick your location carefully and be prepared to own the property for a decade or more and you won't go far wrong. Of course, that's only our opinion and as the investment disclaimer goes, 'past performance is no guarantee of future returns', even if its all we've got to go on.

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