Tracking the price of carbon: price substitution effects across energy markets

Dooho Shin and Rebecca Mari

The Bank of England Agenda for Research (BEAR) sets the key areas for new research at the Bank over the coming years. This post is an example of issues considered under the Financial System Theme which focuses on the shifting landscape and new risks confronting financial policymakers.

Carbon pricing has emerged as one of the main mitigation measures adopted around the world to fight climate change. In the UK and EU, increases in carbon prices in the Emissions Trading Schemes (ETS) work as an incentive to substitute away from emissions-intensive activities and sources of power. Such increases can be a result of direct government policies, but as we explain in this post, changes in carbon prices appear to be also endogenously linked to developments in energy markets. An understanding of the possible transmission channels underlying the relationship between the two is important to assess how climate-related risks are linked to broader macroeconomic developments and thus monetary and financial stability.

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Monetary policy in a gas-TANK

Jenny Chan, Sebastian Diz and Derrick Kanngiesser

In recent years, increases in global energy prices have posed significant challenges for net energy importers such as the UK or the euro area. In addition to the inflationary impact, increases in the relative price of energy imply a decline in real incomes for the energy importers. In this blog post, we introduce a macroeconomic model that captures the direct adverse effects on aggregate demand caused by energy price shocks (a notion that resonates with policymakers’ concerns, ie Schnabel (2022), Broadbent (2022), Tenreyro (2022), Lane (2022)). We show how the transmission of energy price shocks differs from other supply shocks, thereby contributing to a better understanding and more effective mitigation of the disruptions caused by energy price shocks.

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The transmission channels of geopolitical risk

Samuel Smith and Marco Pinchetti

Recent events in the Middle East, as well as Russia’s invasion of Ukraine, have sparked renewed interest in the consequences of geopolitical tensions for global economic developments. In this post, we argue that geopolitical risk (GPR) can transmit via two separate and intrinsically different channels: (i) a deflationary macro channel, and (ii) an inflationary energy channel. We then use a Bayesian vector autoregression (BVAR) framework to evaluate these channels empirically. Our estimates suggest that GPR shocks can place downward or upward pressure on advanced economy price levels depending on which of the two channels the shock propagates through.

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Tradable cost shocks and non-tradable inflation: real wages and spillovers

Ambrogio Cesa-Bianchi, Federico Di Pace, Aydan Dogan and Alex Haberis

The recent steep rise in energy prices led to a rise in the price of energy-intensive tradable goods, with inflationary pressures subsequently broadening into services in many economies. Because services are less traded and have little energy input some have suggested this broadening might indicate inflationary pressures becoming more persistent. In this post, we explore the issue through the lens of a stylised two-country model with a tradable and a non-tradable sector. It suggests that following an energy price shock: i) the broadening of inflation from goods to services need not imply more persistent inflationary pressure or changed longer-run expectations, but may reflect one-off adjustments via domestic labour markets; and ii) Inflationary pressures in non-tradable sectors can still have sizable international spillovers.

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‘There is all the difference in the world between paying and being paid’: margin calls and liquidity demand in volatile commodity markets

Gerardo Ferrara, Gerardo Martinez, Pelagia Neocleous, Pierre Ortlieb and Manesh Powar

The Russian invasion of Ukraine in February 2022 and subsequent sanctions led to unprecedented increases in key commodity prices. While prices briefly abated in late spring and early summer, these surged again over late July and August, with EU and UK gas prices reaching new peaks on 26 August. These moves created a sudden and significant demand for liquidity from market participants with derivatives positions. This post examines how non-financial firms (henceforth ‘commodity traders’) reacted to this liquidity pressure, and how their reactions impacted the functioning of commodity derivatives markets. Commodity derivative markets are important for the real economy and the recent events underscored the need to better understand the interdependencies between margin and counterparty risk management practices.

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Bitesize: Power and progress

Arthur Turrell.

Energy is the fundamental currency of the physical world, while GDP is the imperfect catch-all measure of economic progress. The plot shows electricity generation per capita against GDP per capita for 2015. The bubble areas represent population size, while the colours are the fraction of power which is produced from renewable sources – with light green a high percentage and dark green a low percentage.

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