Macro Insights Weekly: Commodity price spike and energy transition

Food, metals, and energy prices are rising sharply, reflecting tight supplies and considerable risks around the conflict in Ukraine. A stagflationary scenario is an increasingly plausible one.
Taimur Baig, Chang Wei Liang14 Mar 2022
  • Extreme situations like these galvanise policies and shift previously intransigent positions
  • Already, the US is reaching out to past adversaries to boost crude oil production
  • However, Europe‚Äôs energy vulnerability is far greater
  • Is the solution to slow energy transition and double up on fossil fuels? We think the opposite
  • This episode underscores that the financial and climate cost of fossil fuels is intolerable
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Commentary: Commodity price spike and energy transition

The charts are grim—key commodity prices, including food, metals, energy are rising sharply, reflecting tight supplies and considerable risks around the conflict in Ukraine. A stagflationary scenario, under which supply side factors keep inflation elevated as demand falters, is an increasingly plausible one. The fact that nearly 50% rise in commodity prices in the past year has been accompanied by hardly any change in long-term interest rates provides strong support to the notion that this level of prices would start eating into demand.

Extreme situations like these galvanise policies and shift previously intransigent positions rapidly. Nowhere is this more visible than the overtures of the US government in the past week, during which period its decision to ban energy imports from Russia was accompanied by overtures to Opec members, Iran, and even Venezuela to boost crude oil production. Additionally, the Biden administration is strongly encouraging US Shale producers to pump substantially more.

Given that only a very modest fraction US energy imports come from Russia, the move by the Americans is not particularly seismic. But if the conflict deepens and energy supply to Europe comes under pressure, it would be a completely different ballgame. About 40% of Europe’s gas and more than a quarter of its oil is supplied by Russia, with virtually no near-term chance of such large supplies being replaced by idle capacity available worldwide.

How should European nations deal with this energy insecurity? How would the rest of the world deal with the outsized role played by Russia and Ukraine on industrial metals, wheat, and corn? Do recent developments show that slowing down fossil fuel production was a mistake? Is it time to go back to drilling, recognising that the world is nowhere close to securing a future where most of our energy comes from renewable sources?

We think the lesson is the opposite. Near-term considerations of shoring up supplies notwithstanding, the key takeaway for global leaders ought to be that being held hostage to energy and food insecurity is intolerable. Surely the solution is to double up on investment in existing and pipeline technology and solutions to ensure that in the future major suppliers cannot corner global markets. The stakes on food and energy are simply too high, the risk too concentrated. 

In the coming days, we will surely hear from sceptics that countries should double-up on fossil fuel exploration and production until cheap alternative sources are secured. But high energy prices is perhaps the right signal for the world; the financial and environment costs of fossil fuels are unacceptable; transition needs to be hastened, not slowed.   

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Taimur Baig, Ph.D.

Chief Economist - Global

Chang Wei Liang

FX & Credit Strategist, Global
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