UK energy costs fuel inflation on post-Brexit weaker pound

With the UK now firmly -- and seemingly irreversibly -- on track toward Brexit after Prime Minister Theresa May notified Brussels of its intention to leave the EU on March 29, question marks still hang over what impact the persistent weakness of the pound may have on the UK's fuel costs.

The UK is -- since 2004 -- a net importer of energy, meaning the fall in the value of sterling makes dollar- or euro-denominated commodity purchases more expensive.

In February, the UK's inflation rate jumped to 2.3%, its highest level since September 2013, on the back of higher fuel costs, especially transport fuels.

Average retail gasoline prices have risen by more than 10% since Brexit to around GBP1.20/liter, according to the AA.

The increase in retail gasoline prices since the start of the year has been particularly marked, coming off the back of a rise in global oil prices after the OPEC/non-OPEC pact from November 2016 to cut back crude oil production.

Any further weakening of the pound will also impact on the cost of the UK’s oil, gas and coal imports, which in the third quarter last year accounted for 39%, 62% and 65% of demand, respectively.

Watch our video: How much is the Brexit-related weaker pound impacting energy costs?

It is worth remembering that UK fuel costs are still well below their levels from five years ago, though, and the relatively low wholesale gas and power prices since Brexit have also dampened the impact on retail energy prices so far.

Data from the UK Office for National Statistics show the UK electricity price index basically stable over the last 12 months at 99.7, barely changed since 2015, while that for gas is actually down slightly over the same period.

This is because UK gas and power wholesale prices have been relatively low over the past year or so, save a period of market tightness this winter due to the unavailability of some of the French nuclear fleet, which had a temporary knock-on effect on capacity and prices across Europe.

But UK gas and electricity customers may have some belt-tightening to prepare for after most of the "Big Six" energy providers announced hefty price rises in 2017 -- blamed on government policy as well as the cost of buying energy.

Some of the "Big Six" -- including RWE, Uniper and Iberdrola-owned Scottish power -- are euro-reporting utilities whose UK wholesale market earnings have been in steep decline.

On June 22, 2016, the day before the referendum vote, UK year-ahead baseload power was assessed by S&P Global Platts at GBP42.28/MWh, converting that day to Eur55.03/MWh.

By March 10 this year, a year-ahead assessment of GBP42.26/MWh converted to just Eur48.15/MWh.

A 2 pence/MWh drop in sterling value has translated into a near-Eur7/MWh for euro-reporting generators like RWE and Uniper.

Wild currency fluctuations are likely to continue in the coming months, impacting on the relative value of commodities, as Brussels and London begin the separation process.

Ahead of us are two, long years of negotiations about the UK/EU divorce and the status of their future relationship.

Currency and commodity traders will have their ears permanently to the ground listening out for any kind of steer on how the talks are progressing.

A prolonged period of uncertainty is a given.

But -- despite similar uncertainty since June 23, 2016 -- the UK economy has proven to be fairly resilient, flying in the face of some expectations of slowing economic growth, or even recession.

It is actually getting a boost from increased exports due to the weak pound.

But rising inflation, combined with uncertainty over the future UK-related operations in certain sectors such as banking and airlines, raises the specter of a future worst-case outcome of Brexit -- that the UK could in the future be set for a period of potential "stagflation", a stagnant or weakening economy twinned with price and cost inflation due to a weaker pound.

But this is all uncharted territory, and no one can be sure of the outcome, not least the negotiating parties themselves. And with that, volatility will inevitably be the order of the day.

Read our related analysis -- Brexit: Commodities Implications