Economist explains the link between gas reserves and consumer price rise?

Although Latvia is once again under tight curfew due to Covid-19, which, according to many, has taken away the colours from the already grey autumn, it is possible people may conclude this year was «blessed». In the near future residents and companies in Latvia will feel the consequences from the considerable climb of natural resource prices. The price rise will impact some sectors directly, such as the energy sector, and some indirectly, says Citadele Bank senior economist Mārtiņš Āboliņš.
Transport and logistics costs will increase, as will all tariffs on production, postage and other services.
Economic recovery after the drop caused by the pandemic will be very rapid, but it will not benefit residents’ wallets, says Āboliņš.
«If we look at the economy as a whole, it continues recovering from the pandemic. The process is unexpectedly rapid and at the same time dynamic in most of the world.»
«Latvia’s GDP indexes have returned to their pre-pandemic level. Registered unemployment is below 6%. Yes, the shocks were considerable, and recovery continues at the expense of state support, budget deficit and state debt increase. At the same time, inflation is more rapid than what we have seen since 2008. It is close to 5%. The increase of production costs is even more considerable and already exceeds 20%,» says the economist.
Natural resources, oil, natural gas, food, metals, lumber and electricity in Europe in the last one and a half months. All of this makes goods and services more expensive.
There are multiple reasons for that.
Harsh inflation – elementary reasons
First of all, at the start of the pandemic consumption drop outlooks were similar to the financial crisis observed in 2008 and 2009. However, the decline was followed up by an unexpected and unpredictably rapid increase of demand, which production and logistics could not keep up with. People want to have everything now, there is a shortage of goods and problems with deliveries at reasonable prices. Even Latvia experiences an increase of energy, fuel and electricity prices.
While the tight curfew is making the situation on the labour market more complicated, sectors that are not impacted by Covid-19 – industrial production, IT, etc. – are experiencing stable 6-7% wage growth.
However, aside from wage increase we can see increased transport, energy resource and labour costs. This means pressure increases for domestic service prices, which has so far been stable, keeping service price inflation at 2%. This will change, however. In September Latvia’s inflation was slightly below 5%. By the end of the year, however, it will likely reach 6%.
If winter turns out harsh and natural resource prices continue increasing, consumer price inflation may reach upwards of 10%.
Natural resource price increase is the second reason behind the inflation, and it is caused by low resource reserve level in multiple regions of the world. One may think where the problem is – there was oil, gas and coals in the ground before the pandemic and they still are. However, demand has returned more rapidly than expected. Last year people’s mobility reduced by the pandemic. Demand dropped as well. Russia, USA and OPEC countries also decided to reduce oil production.
Currently demand is high, but OPEC countries are not in a hurry to increase production.
All this has an effect on fuel prices, which, in turn, affect everyone who needs transportation of goods or services.
India and China have reduced coal mining due to the push towards green energy and problems caused by climate change: the cold winter had increased demand for energy and windless summer had reduced energy production in Europe, which, in turn, has caused demand for fossil fuels to increase. However, it is not possible to increase resource mining rapidly enough to satisfy demand on the same day. This is why low stores of coal increase natural gas prices, which then increase prices of other goods, because side-products from natural gas production are also widely used in chemistry, mineral fertilizers, plastic, synthetic clothes, packaging and other product manufacturing, explains Citadele economist.
If we produce electricity in Latvia, why do prices increase anyway?
Latvia is one of few countries that produces electricity using renewable energy resources. In Latvia’s case this is water, for Lithuania and Estonia this is wind energy. However, this does not mean Latvia is protected from external price fluctuations.
During the spring floods Latvia exports electricity. In August and September, when the period of drought steps in and water levels drop, Latvia instead imports electricity.
However, electricity wholesale trade price is dictated by the last produced unit of natural gas, which makes up the fluctuating portion of the price – the energy not possible to be produced using water or wind energy. If the gas price goes up, so does the electricity price.
What is the link between natural gas reserves and the increase of service prices? For all the aforementioned reasons the increase of production prices is more rapid than consumer price rise. The longer prices remain high, the clearer it becomes that the abilities of different businesses to cover the price increase are limited. This is why next year will become a year of strong inflation, which is expected to be at 4%, says Āboliņš.
He adds the good news is that the price rise will not continue the whole year. At the same time, the price level will not drop to its previous level. This means service providers will needs to adjust prices in accordance with price changes.
Then what?
It is likely the effect of the tight curfew on the economy will turn out much more dangerous in the long run than the immediate future. GDP will not shake too much, because Latvia will borrow money again to compensate losses.
Nevertheless, there is multiple problems that will appear after the pandemic: reduced foreign investor activity in Latvia, lasting distance teaching regime will have an impact on children’s knowledge and competitiveness on the labour market.
It is possible after several years the countries that do not fall into curfew regime again will get ahead of Latvia development-wise.
But the picture is not all grim. Yes, like it or not, people will have to pay more, but inflation will be compensated by wage growth. At the same time, the economy will continue developing and will not cause much headache in the near future. Nevertheless, Latvia will need to think more carefully about the issues that went mostly unresolved during the pandemic – demography, EU green goals, etc., stresses the senior economist.