High commodity prices a major driver of inflation

Basic industrial inputs, especially energy, increase the costs of almost everything

Costs for energy such as natural gas are leading an overall spike in commodity prices | phototropic/E+/Getty Images

If you were to glance at a real-time commodity price chart recently, you could be forgiven for thinking you were looking at the vital signs of someone who just finished a one-mile sprint.

Almost all industrial commodities have risen at a crazy clip in recent weeks. The exceptions are lumber, which hit record highs six months ago, but has since dipped, and iron ore, which has dipped mainly due to China’s policies of reducing pollution by cutting back on iron and steel production in the lead-up to the 2022 Beijing Winter Olympic Games.

The Canadian Consumer Price Index has risen 4.1% since August 2020 – an annual inflation rate not seen since the 1980s. Typically, central banks aim for a 2% annual increase in inflation. By August, gasoline prices were up 32.5% compared with one year ago.

“This year it’s pretty clear that certain categories are being driven by commodity prices,” said Marc Desormeaux, commodities analyst for Scotiabank (TSX:BNS).  

“Fuel oil is up 30% year over year. Natural gas is up about 20% as of last month. Commodities like oil and like natural gas, the fact they are up so high, that’s impacting home heating costs, transportation costs, gasoline and ultimately flowing through into consumer prices.”

Commodity prices can be expected to rise in a global economic recovery. But a combination of supply chain problems and a profound supply-to-demand mismatch have pushed many key commodity prices – notably energy – through the roof. 

“We’ve just gone through – we’re still going through – one of the most significant economic global events in decades,” Desormeaux said.

“What we’re seeing now is that demand is recovering very strongly across many parts of the world. Supply chains, for various reasons related to the pandemic, haven’t been able to keep up with that demand, and that is driving scarcity. It’s driving price increases. And that’s something that will take some time to work through.

“Our latest forecasts, we projected that inflation would remain above that target level of 2% for a few quarters and start to ease back towards the 2% target in the coming years as reopening continues, as we start to work through supply chain issues and supply and demand align more closely.”

There are a lot of moving parts in the global economy – some of which are still gummed up – that contribute to inflation, both here and abroad. High commodity prices for basic industrial inputs are one contributing factor.

It’s not all bad news for Canada, because it is a resource-exporting country that produces many key industrial inputs such as lumber, oil, metallurgical coal, copper and many agricultural staples. What’s bad for Canadian consumers – higher costs for pretty much everything – is good for Canadian industries and governments that receive tax and royalty revenue from them. As of last week, the S&P TSX Composite Index was up by 23% compared with last year, and the Canadian dollar has risen on the back of strong commodity prices.

“Obviously, we do benefit from stronger global demand and stronger global pricing,” said Jock Finlayson, economist and senior policy adviser for the Business Council of British Columbia (BCBC). “And the proof in the pudding on that is the Canadian dollar, trading now above US$0.80.”

But ultimately, Canadians will pay more for the imported goods they buy, due to higher input and transportation costs.

Six months ago, the big commodity story was lumber, which hit record highs of about US$1,600 per thousand board feet. That increased the cost of construction.

At the beginning of October, the price for Western spruce-pine-fir was down to US$540 per thousand board feet, which is still well above average. 

“In terms of our forecast, we see [lumber prices] remaining quite strong,” Desormeaux said. “That reflects expectation that supply will remain constrained to an extent.”

High lumber and other wood products prices are reflected in higher furniture prices and new home construction or renovation costs.

Today, the hot commodity story is anything energy related: thermal coal, natural gas, oil, gasoline and electricity.

Responding to soaring demand in Europe and Asia, American liquefied natural gas (LNG) exports increased by 42% in 2021’s first half, with a knock-on effect of American Henry Hub natural gas prices nearly tripling in one year.

China has scrambled to buy thermal coal from whomever it can, at any cost, pushing up prices for all other coal-importing countries. So desperate is China for coal that it recently reversed its ban on Australian coal imports.

How long exorbitant energy prices will last depends largely on weather. It, after all, was responsible for a steep decline in European wind power and a hurricane that shut down U.S. oil refineries in the Gulf of Mexico. Also, winter temperatures will determine how much demand there will be for natural gas and heating oil.

As for metals, higher prices for copper, aluminum, steel and battery metals (lithium and cobalt) add to the cost of cars, appliances and electronics.

Finlayson worries that inflation may not be as “transitory” as central bankers predict.

“We are looking at an increasingly concerning situation with respect to inflation,” Finlayson said. “We could be looking at a longer-lasting spike in inflation and part of that is definitely coming from the producer side of the economy. And energy and industrial materials are an important part of that.”

Some year-to-date commodity prices for October 2021, according to Trading Economics, as of last week: 

•U.S. thermal coal, up 203% 

•European TTF natural gas, up 345%

•U.K. natural gas, up 284% 

•American natural gas, up 113% 

•U.S. crude oil, up 66% 

•Copper, up 23% 

•Steel, up 40% 

•Lithium, up 255% 

•Cobalt, up 65% 

•Aluminum, up 55% •