Natural gas prices adding to inflationary cost pressures

Commodities in the form of metals and agricultural products are not the only goods facing price inflation this year.
Power costs have been driven higher by a combination of pandemic bounce-back, extreme weather in the U.S., Europe and Russia this summer, and supply constraints.
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Natural gas prices surge

Supply and demand

Demand is undoubtedly a driver, but so is constrained supply.

Normally, elastic U.S. fracking supplies have not responded this time around to higher oil or natural gas prices as the industry goes through radical restructuring into the hands of super independents via a series of consolidation plays.
After a decade of free-for-all growth, the focus is on containing costs, profitability and a more sustainable return to shareholders. Contrary to earlier expectations, a resurgence in fracking supplies has not capped a higher oil price (and, now, higher natural gas prices).

Russia to continental Europe supply

In Europe, the continent’s largest supplier, Russia, is not responding to higher demand and rising prices as would previously have been the case.
The Financial Times and many commentators paint this as Russia squeezing the European market in a blatant move to force prices higher.
While there may be some truth in this, it is also possible Russia has limited additional supply to give.
Russia’s exports to China have increased after it commissioned new pipelines east. Furthermore, Russia’s domestic energy demands will be higher as it battles a heat wave in Siberia and strong domestic industrial demand. Meanwhile, Europe’s own production has been falling — down 10% since 2019 — and reportedly the largest field off the coast of the Netherlands is due to close permanently next year.
In Asia, power demand in the face of reduced water supplies to hydro have driven up not just natural gas but coal prices, something that hasn’t been a significant feature in the U.S. yet.
But power costs are adding to manufacturers’ supply-side cost pressures this year. In turn, those costs are adding to the debate about inflation in the wider economy as manufacturers pass these costs through.
For now, the Federal Reserve seems fairly sanguine, suggesting inflationary pressures are temporary.
But as supply costs remain elevated through this year and into next, what temporary means may well change.
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