European policymakers fiddle with energy prices, again

“THERE ARE genuine people there with genuine concerns,” said Helen McEntee, Ireland’s defence minister, after the army had been called in to help deal with protesters who had clogged roads with slow-moving convoys and blockaded fuel depots, ports and the country’s only refinery. Their frustration, as in much of Europe, is with fuel prices, which have jumped because of the war in the Gulf.

And the protests are succeeding, with policymakers starting to give in. The Irish government is planning a €500m ($589m) package to cut taxes on fuel, along the lines of similar fuel-tax cuts introduced by Spain and Poland and planned by Germany. Motorists and lorry drivers are not the only beneficiaries. Many of these programmes also include fuel subsidies for farmers and fishermen. The European Commission, meanwhile, is considering loosening its strict state-aid rules to allow a wide range of subsidies.

As the stand-off between America and Iran over the Strait of Hormuz continues, European policymakers are once more under pressure to contain inflation, ease the stress felt by households and businesses, and limit the economic fallout. Christine Lagarde, the president of the European Central Bank, said on April 14th that economic growth in the euro zone is already below the bank’s baseline projection. On the same day, the IMF published lower forecasts projecting growth of just above 1% in the euro zone for this year and next.

Yet the efforts of Europe’s politicians to protect consumers from higher energy prices show they have learned little from the past. For a start, petrol is not particularly expensive. Comparing its price with that of years ago without accounting for overall inflation is a common fallacy. In real terms, which makes prices comparable across time, petrol is about as expensive today as it was on average during the ten years before 2015. In Poland petrol is about 25% cheaper than it was back then. Moreover, the fuel accounts for only about 2% of the overall consumption basket that measures inflation, so there is little economic reason to cap or lower its price.

Diesel, another 2% of the price basket in some countries, is more expensive than the longer-term average (see chart). It also indirectly raises prices of other goods, like food, by increasing logistics or farming costs. That points to a deeper problem for Europe, which makes price caps even worse. Although the continent is a net exporter of petrol (made from mostly-imported crude), it is a net importer of diesel and kerosene. “Europe consumes about 6.6m barrels a day of diesel, and imports about 1.2m of that,” says Michael Connolly of ICIS, a research firm. Half of those imports came from the Middle East. “We are running down inventories, and we haven’t cut the demand yet.” With jet fuel, the situation is similar.

In 2022 Europe was able to redirect liquefied-natural-gas tankers heading from the Gulf to Asia. But with the Gulf closed, there are few tankers at sea to redirect. Moreover, Asia itself cannot come to the rescue because it lacks the crude to fill its own refineries in the first place. As a result, the European “crack spreads” (the price premium over crude oil) on these fuels has ballooned from $10-20 per barrel before the Russian invasion of Ukraine to $60 for diesel and even $100 for jet fuel, according to ICIS. If Gulf supplies are not going to come back soon, European prices will have to climb higher still to force demand down in order to balance it with supply. Yet price caps exacerbate the problems, because they subsidise demand.

Policymakers have other options. Income support for vulnerable households is one. Yet the German government’s plans to allow firms to give employees a tax-free bonus will probably serve the well-off most. Another is the approach of France, which will double state support to €10bn a year to help households and firms to electrify. Such a focus on investment is promising, because capital spending is usually a big casualty of geopolitical and energy shocks.

A study by Dario Caldara of the Federal Reserve and co-authors looking at Russia’s invasion of Ukraine shows that firms with exposure to the conflict reduced investment substantially. The ECB has found that oil shocks depress capital expenditure and R&D investment. Rather than self-defeating price caps, governments should boost investment where they can. ■