Markets may be over-reacting to changes in gas prices
Do the stunning gains made by the Ukrainian armed forces over the last few days mean that peace is nearer than we’ve dared hope? Or will a desperate Vladimir Putin escalate the conflict? At this stage it’s still anyone’s guess, but some of those guesses have consequences — for instance, on the cost of heating our homes.
You may surprised to learn that the movement in gas prices in recent weeks has been sharply downwards. Just take a look at the following chart tweeted out by the German financial journalist, Holger Zschaepitz:
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The extreme spike in gas prices we’ve seen since the invasion of Ukraine appears to be subsiding. Zschaepitz declares that the “Kremlin strategy of weaponizing energy [is] falling flat”. European demand for gas is already down significantly on previous years. Alternative sources of supply are making themselves felt. As for Putin imposing further restrictions on the supply of Russian gas, current export levels are so low that he’s hasn’t got that much more room for manoeuvre. We’ll see this week how the markets react to the rapidly changing war situation, but Putin may have come close to doing his worst — at least in terms of gas prices.
Of course, even if this is his worst, it’s quite bad enough. The energy crisis is real and a free marketeer like Liz Truss wouldn’t be getting ready to spend £150 billion on a price freeze if she had any other choice.
And yet we still need to ask whether the energy markets are over-reacting. While the long-term increase in prices does reflect real world conditions, there’s no ignoring the series of insane price spikes that punctuates the trend. These look like evidence of panic on the part of energy buyers and speculative frenzy by sellers and traders.
Such convulsions go well beyond the normal up-and-downs of a properly functioning market. For millions of households and businesses the resulting instability is unmanageable.
In normal circumstances the market does what it’s meant to do — i.e. send price signals to even out imbalances in supply and demand. But when this mechanism goes crazy it does more harm than good. There’s a useful analogy that can be made with the body’s immune system. Most of time, we couldn’t do without it. However, there are life-threatening conditions, such as sepsis, in which the immune response massively over-reacts to infection — to the extent of damaging the body’s own tissues and organs. A particular kind of over-reaction, called a cytokine storm, is thought to explain why so many young adults died during the Spanish Flu epidemic.
When an immune system goes haywire, medical intervention is required to save the patient. Similarly when vital markets go haywire, the only way forward is state intervention. As a matter of urgency, western governments need to coordinate a more effective response to energy market meltdowns. As in a banking crisis, chaotic trading should be suspended. Governments should also form a buyers’ cartel to secure necessary supplies at non-insane prices.
Obviously, this would be an emergency measure only — the economic equivalent of declaring martial law. Furthermore, it would come with its own major costs and consequences. But don’t forget that right now western governments are planning to spend hundreds of billions on subsiding prices. This too is a massive, and very expensive, market intervention.
So we’re already in the field of extreme medicine. Rather than being forced into action as a last-ditch measure, governments need to develop a wider range of possible interventions. There is no cost-free response here, but that is precisely why we need a least-worst option.