COULD SOARING ENERGY PRICES INCREASE STAGFLATION FEARS?

Oil and natural gas prices around the globe are surging. In the wake of the pandemic, demand has come back online quickly, while the supply needed to satisfy this demand is slow to return. Rising energy prices can act as a tax on consumers. Instead of using their discretionary income to buy goods and services, the increase in the price of gasoline, natural gas, and electricity are sapping any extra funds. This could reduce purchases during the holiday season. One of the issues with rising energy prices is that they can remain stubbornly high and elevated even when growth remains stable. A situation like this could lead to stagflation.

To answer the question “what is stagflation,” you first have to understand the meaning of inflation. Inflation is when a basket of goods or services rises. Prices will naturally arise, but when they grow beyond your income, then inflation becomes a problem. For example, if you are on a fixed income, and the price of your weekly groceries rises, it will erode the value of your income. The same can be said if there is an increase in your heating or cooling bills. 

Stagflation is a term used to describe a period of rising prices and declining economic growth. Prices of goods and services are increasing, but at the same time, job availability is declining, and output is contracting. This type of scenario can arise given certain situations, but in general, when wages start to fall, prices will adjust because of a lack of demand. Stagflation can occur when the supply of a product or group experiences a supply shortage despite declining demand. If the supply rate drops faster than the decline in need, then prices can still rise despite declining demand.

An example of energy prices rising during economic malaise is during the oil embargo in the early 1970s. In 1973 the Organization of Petroleum Export Countries (OPEC) issued a ban against Western Countries. The shortage in supply accelerated quicker than demand, which pushed oil prices higher. Typically, the increase in oil prices spills over into transportation costs. Higher shipping and trucking costs eventually eat into business profits and lead to more job reductions.

The situation in 2021 is similar, but it’s not because of an embargo. The pandemic created a cascade of lockdowns throughout the globe. The lockdown forced energy producers to shut down as demand came to a halt. For example, the number of people screened through the U.S. TSA checkpoint to experience air travel was 50% of the current figures one year ago. Already low at the beginning of the pandemic, the numbers shrank to 5% of the prior year’s figures. A drop of this magnitude forced energy producers to shut wells. Total oil and natural gas rigs active in the United States dropped by 75% during the pandemic. While the numbers have rebounded, they remain less than 50% of the highs seen in 2019. 

Demand for goods and services has rebounded sharply since the pandemic began, but the volume of energy produced has not. Lower volumes of supply in conjunction with more robust demand have pushed prices higher. The higher energy costs in conjunction with the layoffs experienced during the pandemic have exposed the shipping industry. They need to pay more for employees as well as more for energy. 

In areas with elevated demand (like Europe) but where supply is based on imports, the price has surged to all-time highs, which can be seen in oil prices for those who engage in online trading as CFDs. Natural gas is shipped to the EU via a Russian pipeline and through liquid natural gas (LNG) from the United States. The cost to ship has increased, which has spilled over to the fee that the consumer pays. 

The upshot is that the pandemic has created a situation in which prices are rising. Due to government subsidies, people are slow to return to work but have money in their pockets in some countries. Central banks have flooded economies with cash to help buoy demand.

Growth is also moving higher, but central banks are considering raising interest rates to fend off rising prices. Rising interest rates will stunt growth and eventually bring down costs. The lack of demand from consumers forces producers of goods and services to lower prices to attract customers. One issue is that the decline in the supply of goods or services (like energy and shipping personnel) could accelerate lower at a greater rate than the decline in demand. This could force the price paid for these goods and services to rise. This scenario is called stagflation. Higher energy costs are a potential catalyst that could generate stagflation.