Green culture fuels inflationary surge

The following comment by me appeared in this week’s Fund Strategy. It is related to my cover story on the rising trend in oil prices which you can read here.

Although this week’s cover story is about oil it also helps explain why inflation is rising so strongly. It is not just that energy prices are rising – such an assertion simply begs the question of why energy is becoming more expensive. Insufficient investment in energy supply is a key factor in rising prices more generally.

Showing that inflation can largely be attributed to rising food and energy prices at present is simple mathematics. It can be seen by looking at the breakdown of various inflation indices that are available.

It is also clear that rising energy prices are a significant contributor to rising food prices. Energy is used to fix nitrogen from the atmosphere to make fertilisers and it powers farm machinery. The diversion of crops from food to biofuels is another related factor. There are other reasons for rising food prices (see 12 May 2008 cover story) but energy is key.

There may also be other factors pushing up inflation. And at other times a different explanation for rising inflation might be necessary. But at this juncture the energy sector seems to be central to the explanation.

As this week’s cover story argues the broad story in relation to energy is that supply is not keeping up with rising demand. As developing economies grow they rightly want and need more energy. The challenge is to ensure there is sufficient investment to guarantee such needs are met.

In the abstract there should be no problem in meeting such needs. There is no absolute shortage of energy resources. There are ample reserves of oil, hundreds of years’ worth of coal reserves, plentiful hydroelectric power sources and nuclear.

The problem is insufficient investment to exploit these resources fast enough. That in turn is pushing up prices as rising energy demand exceeds supply growth.

The obstacle is environmentalism in its broadest sense. It is not a question of a few “tree huggers” protesting outside proposed power stations.

Rather it is a culture that is reluctant to invest in energy supply. America, for example, has not built an atomic power station since the 1970s. In Britain too the investment in renewing the energy infrastructure is pitiful.

The best response to inflation would be to invest to make energy too cheap to meter.