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The 2022 energy shock

by Tony Addison

The price and availability of energy is fundamental to the health of the global economy. The Russia–Ukraine war is intensifying an energy shock that began unfolding as the prices for oil, natural gas and coal started to recover from a COVID-19-induced slump.

Energy importers among the low-income countries are least able to cope with such shocks. On top of this, the pandemic already stretched their public finances to breaking point. Alarm bells are now ringing as inflation rates rise, currencies weaken, and debt-service grows in these countries. Meanwhile energy exporters are enjoying an earnings boom. Global energy markets are being reconfigured, with profound implications for producers and consumers alike.

Energy price inflation returns

Benchmark prices for liquified natural gas (LNG) hit new records in early March. Meanwhile, the international benchmark oil price (Brent) surged to almost US$130 a barrel from US$90 after Russia invaded Ukraine, and coal prices moved higher as electricity generators started switching back from more expensive gas to less expensive, but more polluting, coal.

Supply rigidity combined with the determination of the European Union (EU) to reduce its purchases of Russian gas pushed up the price of LNG. The EU’s additional purchases are equivalent to the annual demand of South Korea — which itself is a large market for LNG. But the prospect of additional gas from non-Russian sources is limited as Australia, the Gulf countries, and the United States are close to their supply capacity. LNG importers in the developing world are finding it hard to obtain supplies, notably Bangladesh and Pakistan.

The impact extends to crop yields and food security concerns as well, as natural gas is the main input of most nitrogen fertilizer, now three to four times more expensive than in 2020. Africa’s small importers are likely to find it hard to get fertilizer as traders prioritize larger markets. Further, this adds to upward pressure on wheat prices which are already rising due to lower supplies from Ukraine and Russia, that together constitute about one-third of global wheat exports.

Who is benefiting from price hikes?

Gas prices are not a one-way bet for commodity traders. Eventually demand destruction will occur as gas becomes unaffordable, with other substitute fuels also becoming more expensive. Factories will shut down and households will economize.

The recessionary impact of higher gas prices is compounded by the global oil-supply shock — one of the largest since the 1970s. Exports of Russian crude and oil products have fallen somewhere between 10–40% since the war began, due to a US embargo on Russian exports, other Western sanctions, and a reluctance among Western buyers to take Russian cargoes.

Consequently, many developing countries are finding it harder to pay for their energy imports. Yet not all developing countries are losers — oil exporters such as Angola and Nigeria, and coal exporters like Colombia and South Africa, are seeing higher earnings.

Energy market uncertainty

The markets for oil, gas and coal are now subject to considerable uncertainty. On the supply-side, we do not know when the war will end, or the eventual impact on Russia as a major exporter of fossil fuels. Prices are very volatile as expectations constantly adjust to news and rumour. Brent fell back to US$104 in late March after the United States and other advanced economies released oil from their strategic reserves into the market. However the impact of such efforts to dampen prices are relatively small when compared to the prospect of sanctions being lifted on Iranian oil exports if the Iran nuclear agreement is revived. Likewise, the United States is negotiating with Venezuela, which could potentially see a relaxation on sanctions and increased oil sales. Neither is a done deal. And neither would result in a rapid and large increase in supply as new investments are needed to raise Iranian and Venezuelan production after years of disinvestment. However, it could reduce expected future prices, which would be welcome news for importers.

On the demand-side, China’s difficulties in containing the Omicron COVID-19 variant has resulted in a growth slowdown, which could take some demand out of the global energy market. Also on the demand-side, the US Federal Reserve and some other major central banks are starting to tighten monetary policy to try and contain inflation. Central bank responses will be critical to determining the growth and inflation impact of the 2022 energy price shock. Overall, the global economy is much less energy-intensive than it was in the 1970s, when oil-price shocks resulted in high inflation and deep recession, but the energy-importing low-income countries are the ones who will be hit hardest. This will undoubtedly further set back progress on the 2030 Agenda for Sustainable Development.

However, on a positive note,  the situation is encouraging Europe, Japan, and North America to accelerate their investments in renewable energy, to help cut their imports of Russian oil, gas and coal. This won’t happen overnight, but it will bring forward the date at which the global demand for fossil fuels starts to turn down. Whether the 2022 energy price shock accelerates — or delays — the energy transition to a net zero world is a fascinating question, but one that we leave for another day, and another blog.

Tony Addison is a Professor in the Department of Economics at the University of Copenhagen and Senior Non-Resident Research Fellow and former Chief Economist at UNU-WIDER. You can follow him on Twitter @TonysAngle.

The views expressed in this piece are those of the author(s), and do not necessarily reflect the views of the Institute or the United Nations University, nor the programme/project donors.

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