Food & energy price shocks from Ukraine war may last for years

For policymakers, a short-term priority is to provide targeted support to poorer households facing higher food and energy prices. Over the longer term, they can encourage energy efficiency improvements, facilitate investment in new sources of zero-carbon energy, and promote more efficient food production. Recently, however, policy responses have tended to favour trade restrictions, price controls, and subsidies, which are likely to exacerbate shortages

Mumbai: The war in Ukraine has dealt a major shock to commodity markets, altering global patterns of trade, production, and consumption in ways that will keep prices at historically high levels through the end of 2024, according to the World Bank's latest Commodity Markets Outlook report.

"Commodity markets are under tremendous pressure, with some commodity prices reaching all-time highs in nominal terms," said John Baffes, Senior Economist in the World Bank's Prospects Group. "This will have lasting knock-on effects. The sharp rise in input prices, such as energy and fertilizers, could lead to a reduction in food production particularly in developing economies. Lower input use will weigh on food production and quality, affecting food availability, rural incomes, and the livelihoods of the poor."

Baffes, who heads the World Bank's Commodities Unit, was addressing an event which was held by Misra Centre for Financial Markets and Economy (MCFME) at IIM (A) in virtual mode recently.

The increase in energy prices over the past two years has been the largest since the 1973 oil crisis. Price increases for food commodities - of which Russia and Ukraine are large producers - and fertilizers, which rely on natural gas as a production input, have been the largest since 2008.

The war in Ukraine has caused major supply disruptions and led to historically higher prices for a number of commodities. For most commodities, prices are expected to be significantly higher in 2022 than in 2021 and to remain high in the medium term. The price of Brent crude oil is projected to average $100/bbl in 2022, a 42 per cent increase from 2021 and its highest level since 2013.

Non-energy prices are expected to rise by about 20 per cent in 2022, with the largest increases in commodities where Russia or Ukraine are key exporters. Wheat prices, in particular, are forecast to increase by more than 40 percent this year, reaching an all-time high in nominal terms.

Baffes said, "While prices generally are expected to peak in 2022, they are to remain much higher than previously forecast. The outlook for commodity markets depends heavily on the duration of the war in Ukraine and the severity of disruptions to commodity flows, with a key risk that commodity prices could be higher for longer."

A special focus section of the recently released Commodity Markets Outlook of The World Bank investigates the impact of the war on commodity markets and compares the current episode with previous price hikes. It finds that previous oil price hikes led to the emergence of new sources of supply and reduced demand through efficiency improvements and substitution of other commodities.

In the case of food price hikes, additional land came into use for production. For policymakers, a short-term priority is to provide targeted support to poorer households facing higher food and energy prices. Over the longer term, they can encourage energy efficiency improvements, facilitate investment in new sources of zero-carbon energy, and promote more efficient food production. Recently, however, policy responses have tended to favour trade restrictions, price controls, and subsidies, which are likely to exacerbate shortages.

Energy prices are expected to rise more than 50 percent in 2022 before easing in 2023 and 2024. Non-energy prices, including agriculture and metals, are projected to increase almost 20 percent in 2022 and will also moderate in the following years. Nevertheless, commodity prices are expected to remain well above the most recent five-year average. In the event of a prolonged war, or additional sanctions on Russia, prices could be even higher and more volatile than currently projected.

Because of war-related trade and production disruptions, the price of Brent crude oil is expected to average $100 a barrel in 2022, its highest level since 2013 and an increase of more than 40 percent compared to 2021. Prices are expected to moderate to $92 in 2023 - well above the five-year average of $60 a barrel. Natural-gas prices (European) are expected to be twice as high in 2022 as they were in 2021, while coal prices are expected to be 80 percent higher, with both prices at all-time highs.

Wheat prices are forecast to increase more than 40 percent, reaching an all-time high in nominal terms this year. That will put pressure on developing economies that rely on wheat imports, especially from Russia and Ukraine. Metal prices are projected to increase by 16 per cent in 2022 before easing in 2023 but will remain at elevated levels.

The report offers an in-depth exploration of the war's impact on commodity markets. It also examines how commodity markets responded to similar shocks in the past. The analysis finds that the war's impact could be longer-lasting than previous shocks for at least two reasons.

First, there is less room now to substitute the most affected energy commodities for other fossil fuels—because price increases have been broad-based across all fuels. Second, the increase in prices of some commodities is also driving up prices of other commodities—high natural-gas prices have raised fertilizer prices, putting upward pressure on agricultural prices. In addition, policy responses so far have focused more on tax cuts and subsidies—which often exacerbate supply shortfalls and price pressures—than on long-term measures to reduce demand and encourage alternative sources of supply.

The war is also leading to more costly patterns of trade that could result in longer-lasting inflation. It is expected to cause a major diversion of trade in energy. For example, some countries are now seeking coal supplies from more remote locations. At the same time, some major coal importers could step up imports from Russia while reducing demand from other large exporters. This diversion will likely be more costly, the report notes, because it involves greater transportation distances—and coal is bulky and expensive to transport. Similar diversions are occurring with natural gas and oil.

In the near-term, higher prices threaten to disrupt or delay the transition to cleaner forms of energy. Several countries have announced plans to increase production of fossil fuels. High metal prices are also driving up the cost of renewable energy, which depends on metals such as aluminium and battery-grade nickel.

The report urges policymakers to act promptly to minimize harm to their citizens - and to the global economy. It calls for targeted safety-net programs such as cash transfers, school feeding programs, and public work programs - rather than food and fuel subsidies. A key priority should be to invest in energy efficiency, including weatherization of buildings. It also calls on countries to accelerate the development of zero-carbon sources of energy such as renewables.

Talking to Bizz Buzz, Prof Sanket Mohapatra, MCFME Chairperson said: "The global as well as the Indian economy have experienced significant upheavals in recent years. It is important to develop a sound understanding of these trends to aid policy formulation. At the Misra Centre for Financial Markets and Economy at IIM Ahmedabad, our aim is to bring together research, policy, and practice."

The talk by Dr John Baffes of the World Bank is one such initiative to gain insights into recent developments in global commodity markets, he added.