In markets characterized by tight capacity, risks of further disruptions abound
In response to high commodity prices and the likelihood of further price increases for some inputs, firms should continue to prioritize efforts to manage costs and protect margins. Strategies include: reducing supply chain inefficiencies, such as packaging optimization to lower shipping costs; utilizing hedging strategies, including commodities options and longer-term contracts; making input substitutions; and shifting product offerings toward higher-margin goods. Companies should approach decisions to pass costs through to customers carefully, accounting for strong inflationary pressures around the world and customers’ increasing price sensitivity. Our global demand destruction risk index can aid in pricing decisions.
Overview
A variety of input costs have hit multi-year highs or even all-time highs in the weeks since Russia’s invasion of Ukraine. Many cost categories were already at historically high levels in 2021. As suppliers of the world’s energy, metals, and food commodities and notable players in global shipping networks, Russia, Ukraine, and Belarus are now in major recessions, which will contribute to falling production of these inputs and drive higher costs in 2022. Sanctions and self-sanctioning on the part of commodity traders and shippers have further reduced global supply and exerted additional upward pressure on prices. Based on our outlook for the war in Ukraine, these costs are likely to remain elevated through much of 2023. Although additional supply will eventually come online, years of underinvestment in extraction and production will make for a slow supply response. Costs are unlikely to ease considerably until 2024, although the rate of cost increases is likely to slow later this year.
Our View
Cost pressures will continue this year across shipping, energy, metals, and food commodities, but market dynamics vary.
Shipping: The war in Ukraine has prompted a major increase in air freight costs, particularly between Europe and Asia. The impact on container shipping has been more limited, although prices are nonetheless close to all-time highs. Despite expectations of a gradual increase in shipping and air freight capacity over the course of the year, risks of further disruptions abound in a tight market. Two notable risks are China’s lockdowns, which are already forcing delays in China’s trucking freight market and will likely add to ocean shipping bottlenecks. Another risk surrounds the likelihood of a labor strike at US West Coast ports this summer, which would throw a massive disruption to US inbound and outbound shipping.
Oil: Sanctions on Russia are already causing notable disruptions to Russian energy production, even as Russian oil continues to be traded. We expect Russian production to fall by at least 1.5 million barrels per day this year, a shortfall that will be partially offset by supply responses from OPEC, the US, and releases from strategic petroleum reserves. Price risks are to the upside due to the reasonable likelihood of further sanctions on Russia’s energy sector, which would drive down production faster.
Natural gas: The persistent threat of disruption to gas flows from Russia to Europe, and the immense challenges of pivoting away from Russian gas imports, will keep gas costs in Europe elevated through next year. Increased global competition for LNG as Europe shifts away from Russian pipeline gas will also keep gas costs elevated in Asia. In the US, relative abundance of natural gas will keep costs significantly lower than in other regions; however, rising LNG exports will gradually drive domestic costs higher as prices come into line with the rest of the world.
Metals: Copper supply is experiencing a moderate disruption from the war in Ukraine, as the region supplies 7% of global supply. Elevated costs stem mostly from a global, secular increase in demand for copper associated with energy. Price risks are to the upside in 2022 due to temporary supply disruptions in Chile and Peru. Pressures on iron ore should remain low in 2022 as China struggles to push forward with infrastructure investment under virus lockdowns. A potential exit from Zero Covid in 2023 raises the possibility of a price surge as China pushes stimulus measures.
Food commodities: Prices for grains and vegetable oils have surged since the invasion because of Russia and Ukraine’s outsized share of global supply. A combination of export bans by Ukraine and several other countries, disrupted planting and harvest seasons in Ukraine, and surging global fertilizer costs virtually guarantee further price increases later this year and in 2023.
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