A new inflation age, part one: commodities

By Nadir Tekarli

After a decade of low inflation, the COVID-19 pandemic and recovery have upended what had become settled expectations of inflation. In this unique confluence of events, inflation is being pushed from both sides: supply shortages in key industries and increased demand due to shifted spending patterns.

Difficult predictions have been a theme of the pandemic years, but some trends have materialized with experts in industry warning of more inflation and supply issues to come.

In this first article of a series on inflation trends, we will explore supply issues driving inflation at the commodities level. Ramping up production of these essential components is complex and requires billions of dollars in investment and years to come online. Other trends such as increased demand for electric vehicles and green energy are creating a sustained surge in demand for relevant raw materials.

Some of the most dramatic price increases have been in metals, with aluminum reaching a 13-year high, copper rising due to supply concerns in Chile, and nickel at an 11-year high.

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Aluminum production is highly susceptible to energy prices and supply, resulting in 3.8 million metric tons of output lost in China and Europe in 2021 due to high electricity prices and at-capacity electrical grids. A key gauge of raw materials, the Bloomberg Commodity Spot Index, rose to record highs in February, spotlighting the economy-wide commodity shortage. Nickel and lithium, key components of batteries used in electric vehicles, are also likely to rise as EV adoption grows in China, Europe and the U.S., with China set to have 30 percent of its vehicle market electrified by 2026.

Energy prices rose sharply in 2021 and early 2022 as production struggled to accelerate after demand cratered in 2020, with oil prices climbing past $100 a barrel for the first time since 2014 as the OPEC countries and Russia struggle to pump more out of their fields and war in Eastern Europe with the Russian invasion of Ukraine have played a role in increasing costs amidst sweeping sanctions and supply cutoffs. Domestic suppliers are aiming to increase production as higher prices make shale extraction economically viable again, but energy prices should remain volatile due to production challenges and geopolitical uncertainty.

Lumber has seen a spectacular rise since the pandemic, while supply problems years in the making have exacerbated the issue. On the supply side, Canadian forests that supply most American lumber have struggled over the past decade or so, with pests and wildfires hampering logging. With the COVID-19 pandemic, construction demand soared, supplanted by strong DIY demand. Before the pandemic, lumber futures traded between $300-400 per 1,000 board feet. In 2021 prices soared to above $1,600 and remain high due to labor shortages at sawmills and increased tariffs. As housing construction accelerates, these costs are being passed on to homebuyers at a rate of more than $18,000 per home in a market already facing record price increases. Unless the labor shortage or tariffs can be mitigated, lumber prices are unlikely to return to pre-pandemic levels for some time.

Though consumers rarely think about the prices of commodities, the prices of these materials ripple through the economy as they cause snowballing price increases or supply problems in finished goods ranging from a new house to a can of beer. For many sectors, relief is farther away than we would hope.

Part two of this series will explore intermediate goods with a special focus on semiconductors.

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About Author

Nadir Tekarli is an economic research associate at ABA.