The sudden surge in the price of gas and other energy sources such as coal and oil is set to
force central bankers around the world into more hawkish, less growth-friendly monetary policy just as emerging economies look to recover from the Covid-19 pandemic.
“For net energy exporters it is good news, but it pushes up inflation in all EM countries, meaning central banks have to be on the defensive,” said Simon Quijano-Evans, chief economist at Gemcorp Capital. “We’ll be facing more interest rate increases.
“I’m still in the camp that this inflation spike is transitory, but that transitory period is lasting longer than anticipated.”
Much of the blame for the volatility is being laid on Russia. “Russia has been sending the minimum gas required by contracts through the Ukraine pipeline, which has contributed to the rundown of European stocks,” said Caroline Bain, commodities economist at Capital Economics. “Russian and Ukrainian relations are very poor, so Russia has been curtailing its use of the pipeline to minimise the transit fees it pays Ukraine.”
Russia will be hoping that the surge in gas prices and low stocks will hasten approval of the controversial Nord Stream 2 pipeline — from Russia to Germany — which, if approved by European regulators, would effectively eliminate the need to use the pipeline through Ukraine.
Under the weather
However, Bain was quick to point out that Russia should not take all the blame. Extreme weather events have pushed up the demand for energy.
“Typically, extreme weather events cause an increase in demand,” she said. “But this year, the frequency and geographical reach of unseasonable weather has meant that there has not been time for demand to normalise, stocks to be rebuilt and prices to come back down.”
Even before the latest gas surge, weather had already been pressuring some major EM central banks. Brazil’s worst drought in 90 years has severely hurt the power supply from the country’s hydroelectric dams, and the central bank has increased base rates from 2% at the start of the year to 6.25%. Even so, annual inflation has hit double digits for the first time in five years. Meanwhile, flooding in Northern China is shutting coal mines, driving prices higher.
“It’s raining where you don’t want it to rain but not raining where we need it to rain,” said Gustavo Medeiros, deputy head of research at EM investment manager Ashmore Group.
Yury Sentyurin, secretary general of the Gas Exporting Countries Forum (GECF), said several factors were behind the price surge, including delays to maintenance schedules caused by Covid-19 and the “EU’s push towards the adoption of spot pricing mechanism, [which] contributed to exacerbating the volatility of prices”.
How high for how long?
There is some uncertainty as to how long the impact of higher gas prices will last. Some countries will be shielded from the initial price moves by the fact that the majority of their gas is sourced through long term contracts, for example. And the GECF advocates long term gas contracts as a means of providing stability and protection from volatility.
However, as countries look to transition to non-fossil fuel energy sources, long term contracts are becoming less popular, according to Sean Kidney, CEO of the Climate Bonds Initiative.
Edward Glossop, EM economist at Abrdn (formerly Aberdeen Standard Investments) in London, said rising energy prices were “fairly unwelcome for EM central banks, and will likely keep them in a hawkish mood for a while yet”.
He highlighted, however, that domestic gas is a “modest component” of CPI measures in most countries, around 2%-3%. In Mexico, tortillas alone have a similar weighting to gas.
“We think it is hard to make the case that year-on-year energy price inflation will continue to trend higher,” said Glossop.
Medeiros at Ashmore agreed that “we are probably in the eye of the hurricane in terms of energy disruptions and the worst should be over by December,” highlighting that food inflation had been declining in most countries.
But the effects of higher prices can go beyond monetary policy. Brazil, which has been dealing with an inflation shock for longer than most this year, may be an omen of what is to come.
“There’s a more general point here about higher electricity prices,” said Nikhil Sanghani, Latin America economist at Capital Economics. “It means there is less disposable income to consume or invest. We’ve seen this already in Brazil, where retail sales had a shocking collapse in August.”
Relief may be some way off, given that winter looms in the northern hemisphere. “Colder than average temperatures could trigger extreme volatility for natural gas prices,” said Sentyurin.
“Europe’s natural gas scare is not going to disappear overnight,” said Quijano-Evans at Gemcorp. “The only consolation would be any milder weather outlook.”