Resources | Market Trends | April 4, 2022

Inflation Update: Growing Energy Costs Continue to Drive Higher Prices

As inflation has soared in recent months, the skyrocketing cost of energy has consistently been one of its biggest causes.

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As inflation has soared in recent months, the skyrocketing cost of energy has consistently been one of its biggest causes.

Energy prices had already been ramping up as the world economy gradually emerged from the COVID pandemic, but the Russia-Ukraine war has heightened the impact.

“You can’t understand the inflation story if you aren’t looking at what’s happening in the energy sector,” said Aditya Devurkar, C2FO’s senior vice president of data science. “Part of the problem is related to the crisis in Ukraine, and part of it’s being caused by a resurgence in global demand. And some of it’s related to larger structural issues in this industry.”  

Using its proprietary data model, which harnesses more than 900 million invoices on its platform, C2FO can estimate changes to the consumer price index and the producer price index, two key measures of inflation, more than a week before the US Bureau of Labor Statistics.

  • The producer price index is projected to have grown by 10.31% year-over-year (YOY) in March, compared to February’s 10% increase, as measured by the US Bureau of Labor Statistics. 

  • The consumer price index is expected to have increased by 8.45% YoY in March, compared to the 7.9% increase recorded by the BLS in February. About one-third of February’s monthly increase in the cost of all goods could be traced back to higher gas prices.

The Bureau of Labor Statistics will release its official update on the March consumer price index on April 12 and the March producer price index on April 13.

How we got here

Russia is the world’s largest exporter of natural gas and one of the world’s top exporters of oil, but when sanctions were put into place after its invasion of Ukraine, many buyers declined to buy Russian oil because of trouble accessing shipping, insurance or lending. At one point, the International Energy Forum (IEF) estimated that up to 70% of Russian oil had trouble finding a buyer.  

“Energy markets were already tight prior to the Ukraine conflict, and additional supply losses from any source will only exacerbate price spikes and volatility,” said Joseph McMonigle, the IEF’s secretary general.

The rise in prices has been particularly steep in Europe. In March, energy costs surged by 44.7% YOY in the euro zone, following a 32% increase in February, according to Eurostat, the European Union’s statistics office. 

Europe has greater exposure to the disruption in the market: According to the International Energy Agency (IEA), around 60% of Russia’s oil exports are normally sent to Europe. Last year, 45% of Europe’s natural gas imports came from Russia. 

The United States hasn’t been hit quite as hard, but it is still seeing significant increases. Energy costs were up 25.7% YOY in February, according to the US Bureau of Economic Analysis’ personal consumption expenditures index.  

One of the most visible impacts has been at the gas pump. Nationally, the cost of a gallon of gas was $4.189 on April 4, compared to $2.873 a year earlier, AAA reported.

Diesel costs put greater pressure on businesses

As bad as fuel costs are for consumers, the rising price of diesel is even worse for businesses. 

On March 28, a gallon of diesel cost $5.185 in the US, up 156% from a year earlier. That’s a huge expense for the farmers, shipping companies, construction crews and others that use diesel in their trucks and heavy machinery. Those costs eventually make their way into the prices that consumers pay.

Some of the higher costs can be traced back to the situation in Ukraine, but it’s also true that refinery capacity has declined in recent years — down 5% in the US and 6% in the EU since 2019, consulting firm Turner, Mason & Co. told The New York Times. 

What’s being done to solve the problem

To push back against rising costs, the US has decided to release 180 million barrels of oil from the Strategic Petroleum Reserve, or roughly 1 million barrels of oil each day for the next six months. 

Other countries are planning similar moves. The 31 member countries of the International Energy Agency have agreed to a release of an unspecified number of barrels from their reserves. 

The news has already had some effect — the price of Brent crude dropped 4.88% immediately following the US announcement — but industry analysts say it won’t be enough to resolve the long-term need if the war or the sanctions against Russia drag on.

The US said its release is designed to be a “wartime bridge” until domestic producers are able to step up production later this year. Even though consumer demand is strong, oil production can’t ramp up immediately. It can take months for an oil well to get up and running.

Several countries are dipping into their strategic energy reserves.

What will the coming months look like? 

It’s still not clear exactly how higher energy prices will play out this spring. On the one hand, higher energy costs could help reduce inflationary pressures for other goods, though that also raises the risk of lower growth. Factories in Europe and Asia are reporting slowing demand

There are a few reasons why consumers might be able to weather higher energy costs, at least temporarily. In Europe, several countries have announced direct assistance or tax relief to help consumers ride out energy inflation. 

Many US households have strong savings in reserve or are earning more, Moody’s Analytics noted in a recent report. 

“In fact, retail gasoline prices as a share of average hourly earnings for private workers is 11.7%,” the report noted. “Between 2011 and 2014, retail gasoline prices accounted for 15% of average hourly earnings.”

What businesses can do 

“Companies need to be focusing on this problem now and preparing for prolonged higher prices as well as future volatility,” said Mark Thomas, C2FO’s COO for the EMEA region. 

“There should be a senior executive focusing on this, ideally a CFO. What is the level of potential impact and risk for your specific business? Depending on energy intensity and profit margins, for some this will be unpleasant but manageable, but for others this is about survival.”

Reducing energy use is a first step, but may have limited applicability for many operations. Companies might need to consult professionals to understand their options for hedging future energy costs. Shopping around for other energy providers might be a possibility.

And businesses may need to review pricing models to determine how much of the extra cost can be passed on to customers sustainably.  

Maximizing working capital can help companies either pay higher energy costs or invest in long-term strategies that reduce energy costs over the long term. 

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