{"id":6039,"date":"2022-04-10T02:26:10","date_gmt":"2022-04-10T02:26:10","guid":{"rendered":"https:\/\/euromenaenergy.com\/?p=6039"},"modified":"2022-04-10T02:26:10","modified_gmt":"2022-04-10T02:26:10","slug":"is-putins-war-driving-up-commodity-prices","status":"publish","type":"post","link":"https:\/\/emimer.com\/?p=6039","title":{"rendered":"Is Putin\u2019s war driving up commodity prices?"},"content":{"rendered":"
\n

By Daniel Gros\/ Florence<\/p>\n<\/div>\n

\u2022\u00a0Understanding why prices are high is essential to devise the right policy response
\n<\/strong>
\nSky-high commodity prices have the world reeling. Inflation has reached 7% in both the United States and in Europe \u2013 a level unseen for decades \u2013 with European consumers facing losses of purchasing power equivalent to those caused by the oil shocks of the 1970s. The economic recovery from the pandemic is now at risk of stalling, and the spectre of stagflation looms over developed countries from the European Union to Japan.
\nOne might assume that Russian President Vladimir Putin\u2019s war in Ukraine is the primary cause of spiking energy and commodity prices. Russia is, after all, the world\u2019s largest exporter of oil and petroleum products, and, together with Ukraine, it accounts for a third of global wheat and barley exports. But there are two compelling reasons to doubt this explanation.
\nFirst, the war has not led to large-scale interruptions in the supply of oil, gas, or other important commodities (at least not yet). Of course, the mere expectation in markets that a shortage is imminent can be enough to drive up prices. But such an expectation so far seems to have little basis.
\nYes, wheat deliveries from Ukraine have been halted, and this year\u2019s harvest is in doubt, because Ukrainian farmers cannot work their fields. But Ukraine produces only about 3% of the world\u2019s wheat. Russia, meanwhile, produces 11%, and both production and exports remain uninterrupted. Moreover, while Russia has threatened to cut off gas supplies to \u201chostile countries\u201d unless they pay in roubles \u2013 an ultimatum Europe has so far rejected \u2013 there is little indication that Russian oil or other commodities will be withdrawn from the market. For most commodities, the war should not affect supply.
\nA second reason to doubt that the war is responsible for today\u2019s high commodity prices is that most of the price increase happened before the invasion. The International Monetary Fund\u2019s commodity-price index remains below its 2008 peak, standing close to levels seen in 2012-13. And spot prices for gas are in line with their \u201cpre-war\u201d level from the end of last year, when few expected a full-scale invasion of Ukraine.
\nWhile oil prices have risen since the start of the war, the increase has been a modest 20%. Although natural-gas prices have been attracting more attention, because they directly affect household heating bills, oil prices are much more important for Europe, because the value of its oil imports is traditionally about five times higher.
\nIf the Ukraine war is not to blame for high energy and commodity prices, what is? One contributing factor might be what economists call the \u201chog cycle.\u201d The term stems from a phenomenon observed in the Danish hog industry: farmers would rear more animals when prices were high, thereby producing a glut, which reduced prices the following year, causing farmers to rear fewer animals, which then sold for higher prices.
\nLikewise, when commodity prices are high, there is a larger incentive to invest in exploration and mining. But when they are relatively low \u2013 as they have been in recent years \u2013 the profitability of such investment declines, leading to reduced production and higher prices in later years. And, indeed, the International Energy Agency has provided powerful evidence that years of under-investment in exploration have reduced production capacity.
\nThe fall in demand in 2020, caused by the Covid-19 recession, masked this development. But when Europe, Asia, and the US began to recover strongly, there was not enough spare capacity to meet rising demand. This put upward pressure on prices throughout 2021.
\nAnother factor contributing to high energy and commodity prices might have been the rise of environmental, social, and governance (ESG) investing, which has increasingly led investors to refuse to finance fossil-fuel exploration and development. They hope that denying the fossil-fuel industry capital will discourage production and spur progress toward a green economy based on carbon neutrality.
\nThis phenomenon has been concentrated in the West. While upstream investment by the major Western oil and gas firms fell by nearly half between 2015 and 2020, such investment remained stable among Middle Eastern producers and rose in China. All of these producers have the same price incentives, but Western firms are the ones that are subject to ESG guidelines.
\nUnderstanding why prices are high is essential to devise the right policy response. If the war was responsible for high prices, it would be politically difficult to refuse price caps and generous compensation to help consumers and enterprises cope. Moreover, one could hope that prices would fall when the war ends.
\nBut if high commodity prices are the result of a hog cycle and ESG pressures, they are sending an appropriate signal to markets; in fact, ESG rules are supposed to lead to higher prices. In this case, the economy needs to adjust to a new level of scarcity \u2013 and consumers should not be compensated for their lost purchasing power.
\nOf course, these explanations are not mutually exclusive; all three factors \u2013 the hog cycle, ESG standards, and the war \u2013 are probably contributing to higher commodity prices. But price trends before the invasion suggest that the war is a minor factor.
\nThis is not the most politically convenient explanation: if the war is the culprit, it absolves consumers and government of the responsibility to adjust, with the former receiving compensation and the latter running higher fiscal deficits. But it is the more economically sound explanation, and thus the one that should dictate a responsible policy response, despite the pain that adjustment might bring. \u2014 Project Syndicate<\/p>\n

\u2022\u00a0Daniel Gros is a member of the board and a distinguished fellow at the Centre for European Policy Studies.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

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