Impact of High Energy Prices on US and Chinese Economies

Energy prices and commodity prices have soared since the pandemic began and are fueling concerns that elevated inflation levels are here to stay. Higher energy prices have already translated into higher input costs especially for energy-intensive manufacturers in places like China.

As debate continues on whether the global economy is headed for stagflation over the next few months, energy prices continue to churn ever-higher based on supply shortages and robust economic reopening demand. 

While energy and commodity investments are a good hedge against inflation, recent prices are very high, especially when compared to historically adjusted levels. It’s likely that the worst of the energy crisis is behind us in China, though the near-term outlook is less certain in the US and Europe – much of it depends on whether the region’s experience a typical winter season or not. It’s tough to see energy prices being much higher than where they are now in 6 months from now.

If energy prices remain elevated, which is top of mind for investors, a positive side-effect could be more capital expenditure spending by businesses to more energy efficient equipment. This could be the start of a mini-capex cycle since many large companies are flushed with cash and funding costs remain ultra-low. 

USA：

High energy prices haven’t had a significant impact on US production and core inflation mostly because energy costs are far less important than labor costs in a predominantly services economy and the US is a net energy exporter¹. If we look at the September US manufacturing output data, the -0.6% m/m decline was due primarily to a -7.3% m/m decline in automobile manufacturing due to the semiconductor chip shortage – interestingly, output ex-autos rose +0.3%². 

From a US consumer inflation perspective, higher energy prices only have a modest impact since energy costs make up only a marginal share of core consumer prices. To put it in perspective, oil, coal and natural gas account for roughly 2% of the US’ core consumer prices with the vast majority coming from oil³. Around 1/3rd of US energy comes from natural gas which is just fraction of what oil costs. 

From a headline inflation perspective, higher energy prices have already pushed up inflation levels by 2.15% y/y and could peak in Q4. So even if the inflation headline print pushes up in the coming quarter, it’s important to remember that economists and the Fed pay attention primarily to core PCE. It’s possible that elevated inflation levels could be a small drag on domestic spending over the next 12 months.

China：

China is now experiencing its worst power shortage in more than a decade, mainly stemming from a shortage in coal which has led to electricity outages in many parts of the country. The conundrum for Chinese utility companies is that they have to pay market price for coal – which has doubled in September from 2020 levels and is on par to double again since the past month – while the electricity prices that these companies receive is largely regulated. So, it doesn’t make much financial sense for coal-fired utility companies to continue supplying electricity at the artificially under-water rate.  

China’s post-pandemic economic rebound relied heavily on energy-intensive industrial production and property construction, creating sizable demand for electricity over the past year. Faced with increasing demand, the power outages started in May in Guangdong province, when high coal prices led to power companies winding down their inventory in hopes that prices would revert back down shortly, according to initial remarks by policymakers⁴. They did not, leading to shortages at coal-fired plants across the country and electricity shortages spreading from industrial producers to residential users.   

Policymakers have recently accelerated new mining approvals instructed miners to produce more coal supply⁵ and the National Development and Reform Commission (NDRC) recently announced a raft of measures to liberalize electricity prices⁶. These measures should better incentivize power companies to produce more electricity though it doesn’t address the shortage of coal, caused by recent floods and mine accidents⁷. Recent coal prices in China are close to RMB 2,400 / ton vs the average of the past 3 years of around RMB 600. 

It’s possible that the government will step in with more measures, though it’s likely prices will remain elevated for a while. Energy-intensive sectors such as building materials, chemicals and the metals sectors will continue to face supply-cost headwinds, pushing up China’s near-term PPI. That said, China’s economic growth is slowing, and the construction sector’s activity has already and should continue to cool in the coming months – all of which should reduce electricity demand. It’s logical to think that the worst of the crisis is behind us.  

An increase in coal mining and coal-fired electricity demand may seem at odds with China’s pledge to achieve peak carbon neutrality by 2030. Even though carbon emissions are likely to creep up even further in the near-term, the government’s decision to liberalize its power pricing policy should raise electricity prices, which in turn should dampen demand and lead to better conservation from the country’s energy-intensive industries.    

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.

Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.

1  https://www.eia.gov/energyexplained/us-energy-facts/imports-and-exports.php
2  https://fred.stlouisfed.org/series/IPG3361T3S
3  US Department of Commerce
4  https://www.sohu.com/a/474583261_121123911
5  http://www.gov.cn/premier/2021-10/08/content_5641406.html
6  https://www.ndrc.gov.cn/xxgk/zcfb/tz/202110/t20211012_1299461.html?code=&state=123
7  https://baijiahao.baidu.com/s?id=1702243076448438265&wfr=spider&for=pc

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