The single most common question we have been asked by clients recently has been “How will the situation in Ukraine impact inflation and overall living standards for us in the UK?”
To consider this, we should know that the top-three living costs for UK households are –
- Transportation 14%,
- Housing and household expenditure 12%,
- Food 11%
(Source: ONS)
This article explains the effect on households in the UK and was inspired by the article by Jeff Tollefson in Nature Magazine[1]
Energy Prices
You probably have recent personal experience of the rising cost of energy. No matter if it is gas, electricity, oil, LPG, petrol or diesel – prices are rising at levels not known for many years. Currently, 12-month inflation rates for gas and electricity are at their highest level since early 2009, with gas at 28.1% and electricity at 18.8%.
The Office for National Statistics (ONS) reports that the price of wholesale gas is almost four times higher than in early 2021. As gas fuels a third of UK electricity generation, this leads to an increase in electricity costs. Overall, lower-income households spend a higher proportion of their income on utility bills and are disproportionally affected.
Like many things in life, the law of unintended consequences may come into play as Europe is the destination for nearly half of Russia’s crude and petroleum product exports, according to the International Energy Agency (IEA).
However, a host of European countries are now fast-tracking investment in alternative sustainable energy sources such as wind and solar. When completed, the demand for Russian oil and gas, and the foreign currency generated by the demand, should reduce significantly.
The US has declared a complete ban on Russian oil, gas and coal imports[2]. The UK is to phase out Russian oil by the end of the year and the EU is reducing gas imports by two-thirds[3]. And some IEA members have released the equivalent of 120 million barrels from oil stocks – the largest stock release in its history.
US President Joe Biden ordered a major release of oil from America’s reserves to bring down high fuel costs. The US also wants Saudi Arabia to increase its oil production and is looking at relaxing sanctions on Venezuela’s oil.
The energy world is shifting away from Russian sources. For UK consumers, the shift to renewable energy sources will take time. Until then heating costs are rising and have been capped in April and will be again in the autumn and could reach an average of £3,000 a year.
The table below from the RAC shows the annual fuel costs since the year 2000.
Prices at the pumps are high at present, but the period 2011 to 2014 also produced quite a spike.
In summary, energy prices for transport and heating/lighting are likely to remain high for some time. For UK households this means that a greater share of your domestic budget will be taken up by energy costs.
The International Energy Agency (IEA) listed reducing your thermostat by 1 degree Celsius in a 10-point plan of ways to reduce Russian gas imports by a third and could save between £80 to £100 a year for the average family.
Food Sustainability
Ukraine has long been known as the breadbasket of Europe. Ukraine and Russia represent around 10% and 20%, respectively, of global wheat production.
The top four exports from Ukraine to the UK are:
- Iron and Steel
- Animal, vegetable fats and oils
- Oil seed, fruits, grain
- Cereals
The recent conflict has prevented the outflow of the 2021 wheat harvest. Harvesting the 2022 crop may be impossible for the farmers who remain. An increase in wheat prices translates into higher prices for food. For example, the cost of pasta has increased by 41% (source: BBC).
Adam Leyland, editor of The Grocer magazine, tracks a weekly basket of goods and how prices differ across the supermarket aisles. He says, “we’re now in a ‘once in a generation’ moment for food inflation in the UK”.
“We’ve not seen anything like this since the financial crash in 2008. And this is just the start. It’s going to go on for two or two and a half years, probably as various costs and problems filter through into the system.”
Inflation is everywhere in the food supply chain, he says, from rising energy and labour costs to raw materials and packaging.
This may lead to bulk buying or more home cooking of meals. For manufacturers, it may lead to ‘shrinkflation’ where the prices remain the same but the content is reduced.
The rising cost of food as part of a family budget places a further strain when added to energy costs. As some journalists have written, for some families it comes down to the choice between heating and eating. Once again, those families with the lowest income spend more on basics like food. This relationship was found by Ernst Engel in 1857, the so-called Engel’s Law (please excuse the $ symbol in the chart below). Wealthy families spend more money on food and eating out, yet it represents a decreasing proportion as a percentage of household income.
One sign of positive change is that supermarkets are adding to their budget food range. Asda claims that their Just Essentials ‘will be the largest ever budget-friendly essentials range’. According to NielsenIQ shoppers are turning to own-label products.
Climate Change
Based on the direct and immediate rising costs of energy and food, many families can’t see beyond their next payslip. Climate change on the other hand is stealthy and subtle.
If oil and gas imports from Russia are to reduce, what will replace them? One consequence is a new lease of life for coal and fracking, and possibly nuclear energy. Fossil fuels may be back in fashion to fill the gap. How does this marry to the Paris Accord and the 1.5C degree target?
The UN Secretary-General called it madness to rush to fossil fuels as a solution. Mr Guterres says the solutions to the climate crisis mostly lie in the hands of the G20 group of richest nations, which produce around 80% of global emissions.
Europe has a problem on its hands. Germany is dependent on Russian fossil fuels because Russia supplies more than 50% of Germany’s gas, half of its coal, and a third of its oil. Switching to alternative fuels or fuel sources could hit German families hard, possibly leading to a recession which may spread throughout Europe.
This is another sign of the transnational nature of the conflict. In the view of Svitlana Krakovska, Ukraine’s leading climate scientist, the war on her home country is inextricably linked to climate change. ‘’This is a fossil fuel war. It’s clear we cannot continue to live this way.’’
There is a short term need and a longer-term solution. The spend by Europe on clean energy and non-dependency has been turbo-charged. It may prove to be similar to the COVID-19 solution when drug companies were given governmental traffic-free highways to speed up vaccine solutions.
A historic perspective in years to come may see those very same G20 countries as the saviour of climate change. All based on the pressing need to de-link dependency on fossil fuels (especially from Russia) and the desire for clean energy domestic solutions.
There may well be a green light at the end of this tunnel.
Don Fraser
Director
Footnotes
[1] Nature Magazine Article
[2] BBC War in Ukrain
[3] BBC Science Environment
