Energy and commodity prices have soared since the pandemic began and are fuelling concerns that elevated inflation levels are here to stay. Higher energy prices have already translated into higher input costs, especially for energy-intensive manufacturers in places like China.
As debate continues on whether the global economy is heading for stagflation over the next few months, energy prices continue to move higher due to supply shortages and robust demand following economic reopening.
While energy and commodity investments are a good hedge against inflation, recent prices are very high, especially when compared to historically adjusted levels.
It’s likely that the worst of the energy crisis is behind us in China, though the near-term outlook is less certain in the US and Europe – much depends on whether these regions experience a typical winter season. It’s difficult to see energy prices being much higher in six months time.
If they remain elevated, which is foremost in the minds of investors, a positive side-effect could be more capital expenditure by businesses on energy-efficient equipment. This could be the start of a mini capex cycle since many large companies are flush with cash and funding costs remain ultra-low.
In the US, high energy prices haven’t had a significant impact on production and core inflation mostly because energy costs are far less important than labour costs in a predominantly service-oriented economy and the US is a net energy exporter.
If we look at the September US manufacturing output data, the 0.6 per cent month-on-month seasonally adjusted decline was due primarily to a 7.3 per cent month-on-month decline in automobile manufacturing as a result of the semiconductor chip shortage – interestingly, output excluding autos declined 0.3 per cent.
From a US consumer inflation perspective, higher energy prices only have a modest impact since energy costs make up only a marginal share of core consumer prices. To put it in perspective, oil, coal and natural gas account for roughly 2 per cent of the US’ core consumer prices, with the vast majority coming from oil. Around one-third of US energy comes from natural gas which is just a fraction of the price of oil.
From a headline inflation perspective, higher energy prices have already pushed up inflation levels by 2.15 per cent year on year and these prices could peak in the fourth quarter.
So, even if the headline inflation rises in the coming quarter, it’s important to remember that economists and the Fed pay attention primarily to core personal consumption expenditure. It’s possible that elevated inflation levels could be a small drag on domestic spending over the next 12 months.
Looking at China, it is experiencing its worst power shortage in more than a decade, mainly stemming from coal shortages which have led to electricity outages in many areas.
The conundrum for Chinese utility companies is that they have to pay the market price for coal – which doubled in September from 2020 levels and is on course to double again – while the electricity prices they receive is largely regulated. So, it doesn’t make much financial sense for coal-fired utilities to continue supplying electricity at the artificially low rate.
China’s post-pandemic economic rebound relied heavily on energy-intensive industrial production and property construction, creating sizeable demand for electricity over the past year.
Faced with increasing demand, power outages began in May in Guangdong province. High coal prices led to power companies winding down their inventory in the hope that prices would go back down soon, according to initial remarks by policymakers. They did not, leading to shortages at coal-fired plants across the country and electricity cuts spreading from industrial producers to residential users.
Policymakers have recently accelerated new mining approvals that instruct miners to increase coal supply while the National Development and Reform Commission recently announced a raft of measures to liberalise electricity prices.
These measures should encourage power companies to produce more electricity though it doesn’t address the coal shortage, caused by recent floods and mine accidents. Recent coal prices in China are close to 2,400 yuan (US$375) a tonne versus the average of the past three years of around 600 yuan.
It’s possible that the government will step in with more measures, though prices are likely to remain elevated for a while. Energy-intensive sectors such as building materials, chemicals and metals will continue to face supply-cost headwinds, pushing up China’s near-term producer price index.
That said, China’s economic growth is slowing, and construction sector activity has already cooled and should continue to do so in the coming months – all of which should reduce electricity demand. It’s logical to think the worst of the crisis is behind us.
An increase in mining and coal-fired electricity demand may seem at odds with China’s pledge to achieve peak carbon neutrality by 2030.
Even though carbon emissions are likely to creep up further in the near term, the government’s decision to liberalise its power pricing policy should raise electricity prices, which in turn should dampen demand and lead to better conservation from the country’s energy-intensive industries.
David Chao is Invesco’s global market strategist for Asia-Pacific