The Rising Energy Prices

An unprecedented combination of factors is affecting the world’s energy markets, reviving memories of the energy crisis of the 1970s and complicating the already uncertain outlook for inflation and the global economy.

The spot price of natural gas more than quadrupled to record levels in Europe and Asia, and the persistence and global nature of the increases are unprecedented. In general, these changes are seasonal and localized. Prices in Asia, for example, saw a similar increase last year, which was not linked to a similar increase in Europe.

We expect prices to return to more normal levels early next year, as heating-related demand decreases and supply adjusts. However, if the price level remains high, it could start to affect global growth.

In the meantime, the ripple effect is being felt in the coal and oil markets. Brent crude oil prices, the global benchmark, recently reached the highest level in seven years (above USD 85 per barrel) as more buyers sought alternatives for heating and power generation against a backdrop of already tight supply. There is strong demand for coal, the most immediate substitute, as power plants begin to use it more. That pushed prices to the highest level since 2001 and drove up Europe’s carbon permitting costs.

Boom, bust, and undersupply

In this context, it is useful to remember the beginning of the pandemic, when restrictions disrupted many activities in the world economy. This led to a collapse in energy consumption, which caused energy companies to reduce investments. However, natural gas consumption recovered quickly – thanks to industrial production, which accounts for about 20% of final natural gas consumption – boosting demand in a context of relatively low supply.

Energy supply, in fact, reacted sluggishly to price signals because of labor shortages, maintenance backlogs, longer lead times for new projects, and a lack of investor interest in fossil fuel power companies. Natural gas production in the United States, for example, remains below its pre-crisis level. Production in the Netherlands and Norway has also declined. And Russia, Europe’s largest supplier, recently reduced its shipments to the continent.

The weather also accentuated imbalances in the gas market. The extreme winter cold and summer heat in the northern hemisphere boosted the demand for heating and cooling. Meanwhile, renewable energy generation declined in the United States and Brazil due to droughts, which reduced hydroelectric production due to reservoir depletion, and in northern Europe due to lower wind generation in the second and third quarters.

Coal supply and stocks

While coal can help offset natural gas shortages, some of those supplies also have disruptions. Logistical and climatic factors are hampering production from Australia to South Africa, and output from China, the world’s largest producer, and consumer were reduced amid emissions targets that discourage coal use and production in favor of renewables or gas. Want to learn more? You can try here for further info.

Indeed, China’s coal stocks are at unprecedentedly low levels, increasing the risk of supply shortfalls for winter power plants. And, in Europe, natural gas stocks are below average in the run-up to winter, heightening the risk of further price increases as utilities compete for scarce resources ahead of cold weather.

Energy prices and inflation

Coal and natural gas prices tend to have less of an effect than oil on consumer prices, as household electricity and natural gas bills are often regulated and prices are more rigid. Still, in the industrial sector, the higher price of natural gas is affecting producers who use it to make chemicals or fertilizers. These dynamics are of particular concern because they affect the already uncertain inflation outlook, supply chain disruptions, food price increases, and more consistent demand.