Will the energy transition in the United States result in higher electricity costs for householders?

At a recent gathering I attended, a friend asked me for my thoughts on what is happening with electricity prices at the moment, as they are increasing really quickly and we have the new Inflation Reduction Act in the United States, “Isn’t that meant to be reducing inflation and electricity costs?” I paused, I topped up my drink and then started a long conversation explaining that in my opinion, electricity prices will continue to rise for at least another decade. It wasn’t the news that my friend really wanted to hear.

I’ve had a chance to reflect on this conversation and it made me think more about energy and economics. Specifically, the basic relationship between supply and demand and if we have too much demand and not enough supply, this can cause inflationary pressure on goods or services. Far too often these simple economic principles are lost on the general public, policymakers and with our politicians. This was particularly evident in the 1970’s as the world economy experienced high inflation and since then, economists often debate whether this inflationary period was due to the large amount of money supply that occurred at the time and/or that high energy costs were possibly the main source for this inflationary period. You could draw a comparison between what occurred economically in the 1970’s to what is actually occurring now; specifically the recent easy money supply over the last 10 years, the recent significant increase in energy costs and the current high inflation. All of these factors led me to think further on this topic:

Will inflation for the next decade be similar to the 1970’s or will inflation actually be worse than the 1970’s for the forthcoming decade due to the energy transition?

The economist Mohamed El-Erian was a recent guest on the New York Times podcast called The Ezra Klein Show. During the podcast Mohamed openly discussed the supply chain issues, the energy transition and inflation. When the host asked Mohamed what is generally occurring with supply chains around the world, he responded with;

“The critical energy transition is inherently inflationary. So when you take all this back, you have supply chains that are less responsive in terms of quantity and more responsive in terms of price. And this is beyond the pandemic. This is just the reality of an economy that’s being rewired for better resilience and for the realities of climate change.”

The United Kingdom was an early leader in the energy transition, as this country was the first major grid in the world to take significant steps towards decarbonizing the grid. Since 2010 the carbon intensity of the United Kingdom grid has reduced 55% from 457gCO2/kWh in 2010 to 207gCO2/kWh in 2020 and this is due to the increased generation from wind, solar, hydro, biomass and natural gas generations assets. Over the same time period, the residential electricity price in the United Kingdom increased 59% from 13.86 Euro/per kWh in 2010 to 22.03 Euro/per kWh in 2020.?

During this significant energy transitionary period in the United Kingdom, the retail electricity price increased 59% and the carbon intensity of the grid was reduced by 55%. However it is important to understand the United Kingdom experienced relatively stable natural gas prices and the sector did not experience any major supply chain issues for the materials and commodities used to decarbonize the grid (wind, solar and biomass assets). The 2010 to 2020 data from the United Kingdom further supports Mohamed El-Erian’s recent comments, regarding the relationship between the energy transition and how the energy transition is inherently inflationary. The next question I found asking myself was:

Will the energy transition in the United States result in higher electricity costs for householders and would these increases be similar to what occurred in the United Kingdom from 2010 to 2020?

The energy transition is extremely complicated as it’s intertwined with multiple layers of technical, economic, political, and environmental themes and these differ greatly from region to region around the world. Unfortunately, the transition hasn’t become easier since 2020, as we experienced a global pandemic and the Ukraine war commenced in February 2022. These unfortunate events have resulted in the supply chains for materials and commodities used in energy production and the energy transition, becoming significantly constrained. This has caused several energy transition projects around the world to be canceled due to the poor economic return on the proposed initial investment. At the same time, multiple other projects are not being completed on time, due to longer than originally forecasted delivery schedules.

Another major political event occurred in the United States on August 16th, 2022, as President Biden signed the Inflation Reduction Act. This historic act is the United States' commitment to accelerate the speed of the energy transition towards a new cleaner energy future. The Act also provides a considerable change in the supply chain for materials and commodities used in energy production and for the energy transition, as these items will be manufactured locally in the United States. The Act also highlights numerous energy opportunities and these vary from lowering energy costs for households, decarbonizing industrial processes, deploying more electric vehicles, developing new clean energy technologies and rebuilding the electricity grid in America.?

The Inflation Reduction Act will stimulate the manufacturing process for key components required for the energy transition, but it will take a considerable amount of time to develop these new production processes.?It is difficult to determine when the new supply chain facilities will be online, but based on the current delivery profile for other major projects in the United States (e.g.; current manufacturing facilities, wind, solar generation projects, etc), the new facilities could possibly be between 4 to 8 years away from full production. Therefore the existing material supply chain constraints in the energy sector will be with us for at least 4 to 8 years and this will result in significant inflationary pressure in the electricity sector, due to the lack of supply of these critical components.

The benefits of the Inflation Reduction Act will filter through to United States consumers sometime in the future, as the country undertakes the bold vision to rewire its economy. Until that occurs, the electricity prices for householders in the United States will increase year on year, for at least the next 10 years. However, I do believe the rate of increase will be significantly higher than what was experienced by customers in the United Kingdom from 2010 to 2020. This is due to several factors that are fundamentally different now compared to 2010 to 2020, especially the reduction of readily available materials and commodities required for the energy transition. This imbalance will result in the costs for these materials or commodities being adjusted higher based on the basic principles of supply and demand, ultimately these costs will be passed through to the electricity prices for householders in the United States. Only when the equilibrium between supply and demand is nearly restored for these essential materials and commodities, will electricity prices flatten in the United States.

In the meantime, brace yourselves for a bumpy and economically challenging transition in the electricity sector and it definitely won’t be boring for us.