Now is not the time to be rationing North Sea oil and gas

How do those who are tasked with delivering economic policy prepare for a future that may involve much higher energy costs? Such costs would inevitably spill over into the price of food, manufactured goods, and construction costs. The weekly basket may be about to get dearer, or lighter. What should be the policy response to a surge of refugees from conflict zones, and persistent disruption to travel and trade? It is all very well dusting off the manuals - and the data - from the start of the Ukraine War, but it is also true that none of these things may come to pass. The uncertainty and jeopardy right now from events in the Middle East is acute.

Political strategists are split. On the one hand there is deep suspicion that Trump and Israeli Prime Minister, Benjamin Netanyahu, have unleashed events that - despite their overwhelming military dominance - they no longer control. This is the experience of parallel twenty-first century military interventions in Iraq and Afghanistan. But a more contemporary intervention in oil-rich Venezuela has been quickly contained. This fuels the suspicion that the Trump administration will pivot to any outcome that ensures lower energy costs for the US electorate in time for the November US mid-terms. Both outcomes can be credibly argued. They generate very different outcomes for the world economy.

For those whose job it is to set interest rates, manage national finances, or run a business, recent events open up two very different paths for this year based, largely, on the whim of one man. For European economies shorn of military and energy independence they are little more than bystanders. Europe is a price taker of economic events with the potential to have profound impacts on living standards. For a UK Chancellor who set her stall out in 2024 to deliver Securonomics, the international backdrop is as insecure as any time since Rachel Reeves made that original pitch. Her task, when she revisits that speech next week (in a rare, second Mais Lecture) is to simultaneously show how she hasn’t squandered two years of power, whilst also signalling a readiness to respond to fast-moving events in the Middle East. That is quite the balancing act.

The backdrop to that Lecture is the potential that, within weeks, a sharp increase in oil and gas prices on international markets brings back uncomfortable echoes of 2022. The initial economic impact on the UK economy of the Ukraine War was soaring inflation, a surge in inward migration, and whole new demands for increased defence spending. It destroyed the Conservatives reputation for economic management. Four years on these consequences continue, and may about to be amplified.

For many Britons even though the official inflation rate has come down from more than 11% to just 3%, the cost of living squeeze has never gone away. Last month the ONS reported that 88% of Britons reported the cost of living as an important issue facing the UK. This data has barely improved since Russia’s invasion of Ukraine in 2022.

Financial markets are already starting to factor in the impact of higher inflation. A widely forecast UK interest rate cut this month now looks unlikely. At the very least the Bank of England officials will want to see how durable the increase in energy costs proves. If the price of oil and gas stays elevated there is a good chance we have seen the last cut in this UK economic cycle. In the Eurozone, markets are pricing that the next move will be up for the ECB’s headline interest rates.

Back in the UK, the frustration in the Treasury will be that Gilt yields - the interest rates the UK pays for its borrowing - have, again, moved higher in an outsized way to other benchmark economies. This speaks to a vulnerability in the UK public finances born of successive reactions to events including the Global Financial Crisis, COVID-19, and the Ukraine War. Another bailout to insulate UK businesses and households might prove to be politically expedient, but it would also further add to a sense that the UK economy is not making the difficult decisions in peacetime to build resilience.

One such area is the UK’s ongoing rationing of North Sea Oil and Gas. Whilst the current energy secretary, Ed Miliband, makes the loosely coherent argument that UK production of Oil and Gas does not change the international prices of these commodities - UK production certainly does impact the UK’s Balance of Payments, and the value of the Pound. Increased revenues would act a stabilising function for the UK’s currency when global commodity prices rise, bearing down on imported inflation, interest rates, and supporting the cost of living. It remains a mystery to me why the Treasury - aware of the insecuronomics of this approach - is not making this a cost of living argument. Just because the UK’s energy production doesn’t impact prices doesn’t mean it wouldn’t impact UK economic conditions. A charitable interpretation is that Ed Miliband is being partial in his analysis. It also speaks to successive governments being ignorant to the impact on UK living standards from rationing of important inputs into the UK economy. Constrained energy production, as well as rationing of land for development, and capital for investment, all represent an economy that has not made growth its number one mission. This matters in the minds of investors when they consider the attractiveness of owning UK debt. The UK under successive governments has used the peace dividend since the end of the Cold War to build a ration pack economy. The Chancellor has the opportunity to make the argument - from a centre-left position - for an end to rationing. A more affordable cost of living for UK citizens depends on it