Surging Energy Prices May Not Ease Until Next Year

IMF Blog, October 21, 2021

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Soaring natural gas prices are rippling through global energy markets—and other economic sectors from factories to utilities.
Authors: Andrea Pescatori, Martin Stuermer, Nico Valckx
Date: October 21, 2021
Spot prices for natural gas have more than quadrupled to record levels in Europe and Asia.
Energy futures indicate that prices are likely to moderate in the coming months and natural gas prices are expected to normalize by the second quarter.

Pandemic-induced collapse in energy consumption led energy companies to slash investment, leaving supplies relatively low when demand rebounded.
Industrial production accounts for about 20 percent of final natural gas consumption; fast rebound in industrial activity boosted demand.
Energy supply has reacted slowly because of labor shortages, maintenance backlogs, longer lead times for new projects, and lackluster investor interest in fossil fuel energy companies.
Natural gas production:
- United States: remains below precrisis levels.
- Netherlands and Norway: production is down.
- Russia: has recently slowed its shipments to the continent.
Weather effects:
- Northern Hemisphere’s severe winter cold and summer heat boosted heating and cooling demand.
- Droughts in the United States and Brazil curtailed hydropower output as reservoirs ran low.
- Below-average wind generation in Northern Europe this summer and fall reduced renewable power generation.

Brent crude oil prices recently reached a seven-year high above $85 per barrel.
Coal has been in high demand as a substitute for gas, pushing prices to the highest level since 2001.
Rising coal demand has driven up European carbon emission permit costs.

Logistical and weather-related factors have disrupted coal production from Australia to South Africa.
China’s coal output has fallen amid emissions goals that disincentivize coal use and production.
Chinese coal stockpiles are at record lows, raising the threat of winter fuel supply shortfalls for power plants.
In Europe, natural gas storage is below average ahead of winter, increasing the risk of more price increases as utilities compete for scarce resources.

Coal and natural gas prices tend to have less of an effect on consumer prices than oil because household electricity and natural gas bills are often regulated and prices are more rigid.
Industrial sector impacts: higher natural gas prices are confronting producers that rely on the fuel to make chemicals or fertilizers.
If energy prices remain at current levels:
- The value of global fossil fuel production as a share of gross domestic product this year would rise from 4.1 percent (estimated in our July projection) to 4.7 percent.
- Next year, the share could be as high as 4.8 percent, up from a projected 3.75 percent in July.
- Assuming half of this increase in costs for oil, gas, and coal is due to reduced supply, this would represent a 0.3 percentage point reduction in global economic growth this year and about 0.5 percentage point next year.

Expectation: prices will revert to more normal levels early next year when heating demand ebbs and supplies adjust.
Natural gas prices are expected to normalize by the second quarter as the end of winter in Europe and Asia eases seasonal pressures and as futures markets indicate.
Coal and crude oil prices are also likely to decline.
However, uncertainty remains high and small demand shocks could trigger fresh price spikes.
The current situation does not compare to the early 1970s energy shock, when oil prices quadrupled and caused a global recession; energy prices would need to rise much more significantly today to cause a similar dramatic shock.

Monetary policy:
- Central banks should look through price pressures from transitory energy supply shocks.
- Be ready to act sooner—especially those with weaker monetary frameworks—if concrete risks of inflation expectations de-anchoring materialize.
Fiscal and energy policy:
- Governments should act to prevent power outages if utilities curtail generation because it becomes unprofitable; blackouts, particularly in China, could dent chemical, steel, and manufacturing activity and add to global supply-chain disruptions during peak sales seasons.
- Provide support to low-income households to mitigate the regressive impact of higher utility bills.

Source: IMF blog post "Surging Energy Prices May Not Ease Until Next Year", October 21, 2021.