Energy price fluctuations and implications for Bangladesh

There is no denying that maintaining Bangladesh's macroeconomic stability and achieving its development goals requires consistent and uninterrupted energy supply. Bangladesh's energy landscape is predominantly shaped by fossil fuels, with natural gas including Liquefied Natural Gas (LNG), coal, and oil accounting for over 98 per cent of the nation's electricity generation. Despite efforts to diversify the energy mix, renewable sources such as hydro, solar, and wind contribute only marginally to the overall power generation. However, the high dependency on imported fossil fuels leaves Bangladesh vulnerable to fluctuations in global energy prices, which can have far-reaching implications for the country's macroeconomic stability and developmental aspirations.

In the fiscal year (FY) 2020-21, Bangladesh consumed 45,080 kilotonnes of oil equivalent (ktoe) of energy, primarily in the residential (51 per cent), industrial (33.4 per cent), and transport (10.7 per cent) sectors. A significant portion of residential energy consumption is met by biofuel, accounting for 66.1 per cent of its total usage. The industrial sector relies heavily on natural gas and coal, with 43 per cent of its energy needs met by natural gas and 30.3 per cent by coal. Notably, the industry sector is the sole consumer of coal, predominantly used by the brick industry. In the transport sector, energy demand is entirely fulfilled by oil and natural gas, with oil making up 77.9 per cent and natural gas 22.1 per cent of its total energy use (SREDA, 2021).

To meet its overall energy demand, Bangladesh relies on both domestic production and imports. Specifically, the country depends on imports of coal, oil, and petroleum products, with over 90 per cent of the coal and oil supply and 100 per cent of the petroleum product supply being imported. However, Bangladesh can find some relief in the natural gas sector, as 78.6 per cent of natural gas is produced domestically, while only 21.4 per cent is imported. Despite the relatively low volume of natural gas imports, the amount has rapidly increased since its introduction in FY 2018-19 (SREDA, 2021).

On the other hand, fossil fuel energy prices on the international market are highly volatile. According to the IMF's primary commodity price data, the average price of crude oil surged from USD 44.20 per barrel in Q4 2020 to USD 85.20 per barrel in Q4 2022. Similarly, the average price of natural gas skyrocketed from USD 5.36 per thousand cubic feet (tcf) in Q4 2020 to USD 20.99 per tcf in Q4 2022. Average coal prices increased significantly, from USD 70.10 per metric ton in Q4 2020 to USD 310.01 in Q4 2022. LNG prices jumped from USD 8.18 per million metric British thermal units (mmbtu) in Q4 2020 to USD 28.56 per mmbtu in Q4 2022. This rapid increase in energy prices can be largely attributed to the COVID-19 pandemic and the Russia-Ukraine war.

The question now is how energy price fluctuations affect the macro economy. Energy, along with labour and capital, is a critical factor of production. On the demand side, when energy prices increase, consumption of these resources tends to decrease. This reduction in consumption leads to a decline in the aggregate demand or output.The magnitude of this impact depends on the economy's ability to substitute energy with other factors such as labour or capital, including substitution among various energy sources (coal, gas, or crude oil). The short-term impact of rising energy prices is typically stronger than the long-term impact. While the economy can adjust its production process in response to factor prices, its ability to substitute input factors is limited.

An increase in energy prices has a more pronounced impact on the supply side than on the demand side. Higher energy prices compel producers to reduce energy usage in production, lowering output levels. Consequently, the productivity of other input factors decreases due to the reduced availability of energy sources. At this stage, nominal wages/interest rates may remain unchanged due to rigidity, resulting in a higher overall price level and lower real wages/interest rates. The higher overall price level prompts consumers to curtail their consumption, thereby affecting overall demand. The impact of energy prices on the supply side is greater because energy prices directly influence the production system. As a result, the economy experiences lower output and a higher overall price level.

Increase in energy prices deteriorates the balance of payment, especially for a country like Bangladesh which depends fully on oil importation. First, the direct increases in oil price increase the cost of oil importation, as a result, reduced imported raw materials cause production crunch. Second, an increase in oil prices in the international market reduces demand in developed countries that are major export destinations for Bangladesh, which results in reduced export income. So, increase in oil prices eats up national income since the rise in the cost of importing oil is greater than the rise in national income.

Bangladesh has been experiencing consistently high inflation since August 2022, with rates mostly exceeding 9 per cent. Despite efforts, the central bank has been unable to contain it. The root cause of this inflation surge can be traced back to a combination of post-COVID-19 supply shortages and the Russia-Ukraine war. The COVID-19 pandemic had a twofold impact on the global economy that significantly contributed to the inflation scenario. Firstly, during the pandemic, trade restrictions, factory closures, and the China-USA trade war caused disruptions in the global supply chain, leading to supply shortages. Secondly, as economies began recovering from COVID-19 and businesses reopened, there was a surge in global demand. To meet this increased demand, factories required more energy, which in turn drove up energy prices. Compounding this situation, the Russia-Ukraine war introduced another significant shock. Following Russia's invasion of Ukraine in late February 2022, prices of oil, natural gas, and coal surged, peaking around June and July of that year. Given that Russia is a major exporter of oil and gas, and that 45 per cent of the EU's gas supply was sourced from Russia, the sanctions imposed by the USA and its allies on Russia led to a rapid increase in energy prices. Consequently, the production and transportation costs of goods escalated sharply, directly impacting Bangladesh's inflation.

Higher energy prices significantly impact a country's foreign currency reserves, particularly for a net energy-importing country like Bangladesh. The effect is predominantly negative. Since the lifting of COVID-19 restrictions and the reopening of businesses, Bangladesh's reserves of US dollars have been steadily decreasing. As of April 2024, Bangladesh's foreign reserves stood at 19.98 billion dollars.

In addition to policy failures by the central bank, the lack of remittance inflows through formal channels, and low foreign direct investment (FDI), the rise in energy prices contributes to the depletion of foreign reserves. Since mid-2022, Bangladesh has been meeting its energy demands by purchasing oil, coal, and natural gas at elevated prices. However, the country's productivity has remained relatively unchanged. As a result, Bangladesh is producing the same amount of export goods but at higher import costs, which deteriorates its balance of payments. In other words, Bangladesh is purchasing more dollars from the international market, increasing the supply of taka and the demand for dollars. This phenomenon also causes the taka to depreciate against the dollar. A depreciating domestic currency influences trade balances with other countries, as the dollar is the standard currency for international trade. Depleting foreign reserves and a depreciating domestic currency further exacerbate inflation by raising the cost of intermediate goods and raw materials. This, in turn, increases overall production costs, leading to higher prices for consumers and additional economic challenges for the country.

The constant threat of a volatile energy market and its impact on the domestic economy can be mitigated by diversifying the domestic energy mix towards renewable energy. While renewable energy has high installation costs, these costs are offset by the absence of ongoing fuel purchases, leaving only operational and maintenance expenses. Additionally, the high installation cost positively impacts the domestic economy by creating more jobs. Permanent employment opportunities will also arise for maintaining the facilities and providing jobs for thousands of unemployed graduates. This shift towards renewable energy can yield benefits in two significant ways. First, the country will need to import fewer fossil fuels, thereby spending fewer dollars. This will reduce the pressure on foreign reserves and potentially increase them significantly. Second, Bangladesh will no longer face uncertainty regarding its essential energy supplies, leading to a more stable domestic market with stable prices. Although these changes will not entirely eliminate inflationary pressure, they will certainly lessen a portion of it.

Abdul Zabbar Sakil is Research Analyst at International Food Policy Research Institute (IFPRI). [email protected]. Md. Tuhin Ahmed is Lecturer of Economics at Mawlana Bhashani Science and Technology University and Senior Research Associate at SANEM. [email protected]