Energy Services Inflation

Adventures in bottoms up forecasting

At this point inflation woes need no introduction - they are bad and they have a multitude of causes from supply chains to real estate to European land wars. I’ve been spending some time digging into more bottoms up approaches since more standard approaches to forecasting inflation have done… poorly, and quite egregiously so. Having understeered the initial inflationary burst when things were quite clearly going very weird in the factory of the world we now have forecasters pointing to persistent inflation for years and years, structurally higher bond yields and various other doom laden predictions. Given how much the usual time series stuff missed the rip upwards and how more bottoms up approaches worked well, I think it is worthwhile going through some more micro approaches to pick price dynamics especially in the sticky services segments the Fed seems particularly concerned with. There are some great explainers on the calculation of owner equivalent rent and for all things used cars you have Blackbook, Manheim and perhaps User Car Guy on twitter.

For energy services I have not seen much written so here are a few basic pointers. Energy services have a big weighting - almost as high as gasoline which is what most poeple think of when considering inflation.

The marginal price of power in the US is mostly gas. One year forward power in Houston is in green, the 12 month gas strip in pink and EIA power prices paid by consumers in yellow, CPI electricity in blue. So, gas prices and gas balances rule the roost here - both for pipeline gas services and marginal cost of power.

So, how are gas inventories looking? Pretty excellent. Storage levels look great after a deranged summer that pushed power prices and gas prices to $10 per mmbtu. Prices are now about half that and inventories are building fast. Eyeballing the chart we should be seeing outright deflation over the coming months.

That is all well and good, but what about longer term forecasts? Happily EIA short term energy outlook reports oblige. A massive increase in renewables from the IRA bill as well as classic “the cure for high prices is high prices” dynamics would indicate that gas demand is likely to go backwards over the next 12 months for domestic demand with limited LNG export demand coming before 2024. The only part of the country that is going to experience higher prices is New England which imports LNG and due to the Jones Act cannot buy LNG from the United States. On top of that, they shut down nuclear plants and refuse to build pipelines to Appalachia to reduce gas flow constraints. One might say, if one was mean, that if you outsource your energy policy to the Sierra Club you deserve the prices you get good and hard. I am not mean, so I am not saying that - but many people do say things like that and they are not factually incorrect as far as I can tell.

Energy services inflation should come off and quickly except where infrastructure cum maritime regulation cum political constraints bind. This is good news but also a little lesson in the weakness of the structural inflation narrative. If you make bad enough choices time and again you probably can have inflation - but ultimately that is up to your state and its particular neurological nematodes and not some hand wavy macro phenomenon.