Could energy inflation drive rate hikes?

The absolute madness of the energy crisis is on display today as Morgan Stanley mulls inflation pass-through to food:

Energy costs are escalating rapidly in Australia which we think will lead to cost pressure and potentially a return of food inflation. Consumers will also face higher energy costs, which could dampen sentiment, in our view. The cost of energy is rising; As outlined by our Australia Utilities analyst, Rob Koh ‘Inside Industrials: Pool prices are strong… will retail prices follow? (27 Mar 2017)’ the cost of gas and electricity is spiking as coal fired generation plant close (i.e. Hazelwood), the resumption and growth of large industrial demand and sharply rising gas costs. As we show in Exhibit 1, the cost of spot wholesale electricity in major Australian states has increased by 2-3x in recent years. Energy is the largest cost for retailers after labour and rent. We estimate that energy costs represent 1-5% of costs for our coverage companies. We analyse the National Greenhouse and Energy Reporting database which shows retailers have already been proactive in becoming more energy efficient since 2010.For

Energy is the largest cost for retailers after labour and rent. We estimate that energy costs represent 1-5% of costs for our coverage companies. We analyse the National Greenhouse and Energy Reporting database which shows retailers have already been proactive in becoming more energy efficient since 2010.For instance Woolworths’energy use is broadly the same in 2016 as 2010 despite operating c.20% more stores across the group as Project Enlighten took effect. Assessing the impact of rising energy costs. Retailers tend to enter into

Assessing the impact of rising energy costs. Retailers tend to enter into long term energy contracts so we believe that the recent pricing increase will likely be spread over the next 3-4 years as these contracts are renegotiated. As an illustration we show that for Woolworths’ supermarkets division (where we estimate its energy costs are $220m p.a.) should the contracted cost per GJ increase from A$28 to A$58 by 2020 the headwind to EBIT margin is 59bps. We believe the impact for non-food retailers would be less given energy cost to sales ratios are lower. Might

Might higher energy costs lead to the return of food inflation?Inflation in food prices has been absent from the Australian market, with deflation accelerating since Woolworths lowered prices in early 2015 (see Ex 6/7). Recent comments by Woolworths’ CEO Brad Banducci that it would ‘very cautiously and carefully, pass those (higher energy costs) to our customers’, suggest that food inflation might be returning to the Australian market. While supermarkets will bear higher costs from operating refrigeration, its suppliers will also face higher costs of preparing products, hence we would expect the Australian food prices start to rise through 2017. So while margins may face a cost squeeze the revenue outlook is improving for supermarkets, in our view. Each Australian household spends A$2000-A$2500 on electricity and A$250- A$1000 on gas costs annually. So given the rise in electricity pool prices it seems likely that the cost of energy for households will rise double digit, which implies an extra A$300 annually. We believe that this increase (with no extra utility) will likely dampen consumer sentiment over the coming year.

Energy is a base input into everything in the production chain. It will inflate the lot.

Letting this run is insane when the solution so simple. Third party gas exports need to be banned, domestic reservation installed and “use it or lose it” rules applied.