Is the Energy Price Surge “Transitory” or a Longer-Lasting Trend?

Energy prices have surged to multi-year highs amid the global economic recovery from COVID-19, contributing to larger-than-anticipated jumps in measures of headline inflation. While some policymakers had suggested inflationary forces would prove “transitory,” today many are questioning that thesis. Franklin Equity Group Portfolio Manager Frederick Fromm outlines what has been impacting energy prices, whether he sees the recent price rise as sustainable, and where he is finding investment opportunities within the sector.

Rapidly rising energy costs have been making headlines this month after building steadily throughout the summer. Crude oil and natural gas prices have reached multi-year highs, with US benchmark West Texas Intermediate crude trading above US$80 a barrel for the first time since 2014 (up from the 2020 pandemic low of US$19.33 a barrel), while natural gas futures rose to their highest level since 2013.1

In Europe, even faster-rising natural gas and power prices have raised the specter of an energy crisis heading into winter. Natural gas prices in some parts of the continent reached more than US$30 per million British thermal units (BTUs) as several European countries began to compete more aggressively to secure supplies, including bidding against China for liquified natural gas (LNG) cargoes. In addition to impacting industries that use natural gas as a feedstock—including fertilizer, chemicals and plastics manufacturing—the rally has elicited a rise in switching from natural gas to petroleum and even coal for power generation, which could meaningfully increase demand for oil and provide further support for oil prices.

While Europe has been grappling with a supply crunch, Brazil and other South American countries were contending with a different cause with a similar effect, having recently grown more dependent on natural gas-fired electricity generation as a drought crimped hydroelectric output. The region’s LNG demand has almost doubled in the past year.2 Booming demand has been met with lower supply of LNG while small disruptions—some caused by maintenance, others unplanned—have nibbled away at global output. The combined effect has been to cut global LNG supply by roughly 5% in 2021.3

A global natural-gas production deficit, dwindling inventories and a concerted regulatory effort by the Chinese government to slash emissions—substituting lower-carbon fuels such as LNG for coal—all play a role in the current energy supply/demand imbalance. With US stockpiles already running below their five-year seasonal average, growing US natural gas exports could trigger additional price spikes as power plants and factories are forced to compete with rising home and business heating demand as the Northern Hemisphere winter heating season gets underway.