The rise in prices could, of course, prove temporary; a warmer-than-normal fall/winter in the Northern Hemisphere could bring prices down. However, if prices remain high throughout the fall and winter, they could have wide ranging economic consequences for consumers and businesses worldwide, even ones in the Americas, likely pushing consumer prices upward while lowering corporate profit margins.

Manufacturing is energy intensive. Heavy industry is powered by a mixture of coal, natural gas, electricity (much of which is generated from coal and natural gas), and crude oil, with a small assist from renewables. Over the past few decades, U.S., Canadian and Mexican manufacturers have built up significant cost advantages due to the relatively low North American price of natural gas. According to a 2014 study by the Boston Consulting Group --The Shifting Economics of Global Manufacturing: How Cost Competitiveness is Changing Worldwide -- natural gas accounts for about 2% of North American manufacturing costs while electricity adds an additional 1%. In most other countries natural gas costs add up to 5-8% of the cost of manufactured goods while electricity costs add another 2-5% (Figure 3). 

If natural gas and electricity averaged 10% of the cost of manufactured goods across Eurasia prior to the recent rise in prices, a sustained 500% rise in coal and natural gas prices could inflate the cost of manufactured goods by much as 50%. Meanwhile, a doubling of energy costs in North America could potentially add 3% or so to the cost of manufactured goods produced in that region. Eurasian countries account for approximately 75% of the world’s manufacturing production, with the U.S. (18%), Mexico (2%), Canada and Brazil (1% each) accounting for most of the rest (Figure 4).

One might conclude from this that the rise in Eurasian natural gas and electricity costs could advantage manufacturers in North America relative to their Eurasian counterparts. This may be true to some small extent, but the reality is more complex. North American manufacturers rely heavily on global supply lines for raw materials and component parts in their manufacturing processes. As such, the impact of higher Eurasian natural gas and electricity costs is likely to be felt even in seemingly faraway places.

Even before the recent spike in natural gas and coal prices, global supply lines were under severe stress. Though by no means a perfect proxy for supply line disruptions, the cost of shipping, as measured by the Baltic Dry Index, has risen by 350% since the beginning of the year (Figure 5). The “just-in-time” delivery revolution began in Japan in the 1980s and spread worldwide in the 1990s, lowered inventory costs and freed up working capital, leading to enormous gains in efficiency and productivity. However, the just-in-time model left manufacturers will little buffer in the event that supply lines became disrupted. While the pandemic and its aftermath have demonstrated the vulnerability of just-in-time supply lines to disruption, soaring natural gas and electricity prices are likely to stress those supply lines further over the fall and winter months of 2021-22. This could especially be the case if governments respond by not allowing prices to adjust higher, instead favoring rationing/rolling blackouts that could impair manufacturing production. 

Thus far, the sharp rise in core inflation has largely been confined to the U.S. among the major economies. Inflation rates in the eurozone, U.K., China, Japan and South Korea have lagged behind (Figures 6 and 7). The surging Eurasian cost of electricity may begin to change that, bringing about a rise in inflation in Europe and Asia while further accentuating price pressures in the U.S. and elsewhere. If electricity costs rose in just one country, its producers might have difficulty passing on those costs to consumers. However, soaring costs spread among 75% of the world’s manufacturing base could make it easier for manufacturers to pass on price increases with far broader consequences for inflation.

One potentially overlooked consequence of higher natural gas and coal prices might be higher prices for crude oil. Although oil is used primarily for transportation while coal and natural has are used mainly for heating and electricity generation, there are certain places where oil can be used to power electric grids and manufacturing processes.

Since the onset of the pandemic, the price of oil tracked travel demand quite closely (Figure 8). Amid soaring coal and Eurasian natural gas prices, however, crude oil and travel demand have begun to diverge. The recovery in travel was proceeding along nicely until late June as the delta variant spread across the globe. At first, oil prices reacted negatively to this development. Since, mid-August however, rising natural gas and coal prices, along with reduced inventories and OPEC’s refusal to increase production, have contributed to a surge in prices even as travel demand remains soft.

Looking beyond fossil fuels, other energy sources are also seeing substantial price increases including uranium as well as battery metals such as lithium and cobalt. Uranium prices rose 67% over the course of Q3 2021, while cobalt and lithium prices increased by 30% and 50%, respectively (Figure 9). Apparently, some investors are seeing battery storage and nuclear power increasing in attractiveness as fossil fuel prices skyrocket.

Natural gas is used to make many fertilizers and also can be used in the making of compressed CO2 gas. In Europe, fertilizer production has fallen by as much as 40% as a result of decreased supplies of natural gas. The shortage has sent fertilizer prices soaring worldwide, including a 270% rise in the U.S. Gulf NOLA Urea Granular spot price (Figures 9 a and 9 b). Meanwhile, in the U.K. there is a shortage of compressed CO2 gas used to anesthetize pigs before slaughter. Reduced supplies of fertilizer could potentially push crop prices higher while the shortage of CO2 gas could potentially contribute to a rise in the prices of meat to the extent that it impedes the functioning of processing plants.

Elsewhere, higher oil prices might also entail higher prices for ethanol and vegetable oil. Corn and soybean oil prices often move in tandem with prices of crude oil. Soybean oil prices, which had been falling for much of Q3, have begun to rebound in recent days.

Higher natural gas and coal prices could potentially benefit currencies of key natural gas and coal exporters such as Australia, Russia and the United States at the expense of the currencies of key importers such as China, Japan, Korea, eurozone and U.K. The Australian dollar in particular has often closely tracked prices of natural resources. Coal and natural gas account for 43% of Australia’s natural resource exports (Figure 10). 

Lastly, there is the issue of how long high natural gas, coal and electricity prices might last. A warmer-than-normal fall and a mild winter combined with increased supplies could potentially lower prices quite quickly. By contrast, continued supply disruptions and a colder-than-expected fall and winter could strain supplies further and send prices even higher.

Currently, the futures forward curves for coal and TTF (European) natural gas suggest that traders anticipate coal and Eurasian natural gas prices remaining relatively high during the fall and winter of 2021 and 2022 before moderating to levels that are still significantly above their H2 2020 and H1 2021 levels by the middle of 2022 (Figures 11 and 12). This suggests that while investors may expect some of the most acute cost pressures to abate by mid-2022, they are bracing themselves for a difficult winter. If so, the world might experience a significant rise in inflation during the next six months combined with additional supply disruptions whose impact could ripple across commodity and financial markets.