A mixture of a post-lockdown resurgence in demand and struggling supply has been sending energy prices soaring in the last few months. And with the Russian-Ukrainian conflict threatening energy supplies even more, we could increasingly be looking at a scenario where energy prices remain high for years to come. And if that’s the case, the impact is bound to be felt across economies, businesses, and your investments alike.

What’s the impact on the global economy?

Despite a surge of investments into renewable energy over the past decade, the world is still very dependent on fossil fuels: oil, coal, and natural gas provide more than 80% of the global economy’s energy today. And according to consultancy Gavekal Research, the cost of a typical basket of those fuels was up more than 50% from a year ago even before Russia’s invasion of Ukraine and the resulting spike in energy prices.

Those higher energy prices will lead to higher inflation, at a time when it’s already at multi-decade highs in large parts of the world. What’s more, economic growth will take a hit as companies and consumers find their bills rising and spending power squeezed by costlier electricity, transportation, heating, and more. Taken together, we could enter a new era of stagflation, where economies simultaneously experience rising inflation and falling economic growth.

What’s the impact on central bank policy?

It’s very hard for central banks to simultaneously tackle rising inflation and falling economic growth. So the key question is: which of the two will they prioritize?

My view is that they’ll prioritize tackling inflation. After all, it’s currently running 2-3x higher than the US’s, UK’s, and Europe’s central banks’ official targets, and it’s only set to get worse given the invasion. Economic growth might dip in the meantime, sure, but that doesn’t mean we’re looking at a recession, where the economy shrinks and central banks really do need to get involved.

So in a bid to bring inflation back under control, expect central banks to bring forward interest rates hikes, increase them more aggressively, or both.

What’s the impact on markets?

Investment firm Schroders has calculated the average real (inflation-adjusted) annual total return of major asset classes since 1973 during different economic phases. The top performers during periods of stagflation have been gold, commodities, and real estate investment trusts (REITs), while stocks have tended to struggle.

Asset class performance during different economic phases. Source: Schroders

This makes sense. Gold is often seen as a safe-haven asset that tends to do well in times of economic uncertainty. Real interest rates also tend to fall in periods of stagflation, which reduces the opportunity cost of owning a zero-yielding asset like gold, boosting its appeal to investors. Commodities are a source of input costs for companies, as well as a key component of inflation indexes. So they typically perform well when inflation rises, often because they’re the reason inflation is rising in the first place. Similarly, REITs offer a partial inflation hedge via the pass-through of price increases in rental contracts and property prices.

On the other hand, stocks perform poorly because falling economic growth leads to lower corporate profits. What’s more, if interest rates are rising, then the present value of companies’ future (and now lower) profits goes down, since the interest rates used to discount those profits have gone up.

As for bonds, the impact is more mixed. For one thing, bonds tend to fare poorly if inflation is increasing, as the fixed amount of cash they offer investors becomes worth less. But government bonds are often seen as a safe-haven asset that tends to do well in times of economic uncertainty – not to mention the rising geopolitical tensions we’re witnessing today.

What’s the impact on exporters and importers?

To state the obvious, the biggest winners are energy-exporting countries – like Russia, Saudi Arabia, Qatar, and the UAE – and the biggest losers are energy-importing countries – like Korea, India, and Japan. Of course, Russia is a caveat in the sense that the West’s sanctions on the country will make it difficult for it to reap the windfalls of higher energy prices.

You can see the winners and losers more granularly in the chart below, where economists at Bloomberg have quantified the impact of rising commodity prices on individual countries’ GDPs (the size of their economies). While they factored in all commodities (energy, metals, agriculture, and so on), the impacts are mainly driven by energy exports and imports.

Countries’ expected 2022 gain/loss (as a % of GDP) using forecasted changes in commodity prices. Source: Bloomberg

What’s the impact on energy companies?

The most obvious beneficiaries of higher energy prices are the big oil and gas producers of the world like Royal Dutch Shell, BP, ExxonMobil, Chevron, TotalEnergies, ConocoPhillips, and Eni. But there are three additional sub-sectors of the wider energy complex that are worth mentioning in light of the current geopolitical situation.

See, most of Europe’s energy needs are currently met by imports of Russian natural gas. The continent has always wanted to wean off its dependence on Russia, and that goal’s only been expedited since the conflict broke out – not least because Russia might retaliate against the West’s sanctions by cutting off Europe from its key source of gas.

Over the short term, electricity producers could be forced to burn coal instead – something they’ve already been doing recently due to a shortage of natural gas in the continent. That could push up the price of coal even more and provide a profit windfall to coal mining companies like Arch Resources and Peabody Energy in the US, Glencore in Europe, and China Shenhua Energy, China Coal Energy, Adaro Energy, Whitehaven Coal, and Coal India in Asia.

Over the long term, Europe will be looking for alternative sources of natural gas (specifically) and energy (more generally). On the former, Europe will likely move away from Russian gas transported by pipelines to natural gas carried by liquified natural gas (LNG) tanker ships from big LNG-exporting nations like Australia, Qatar, and the US. So firms well-positioned in the booming LNG market – like Royal Dutch Shell and Cheniere Energy – are set to benefit.

On the latter, renewable energy will likely be a big winner amid expectations that energy supply disruptions from the Ukraine turmoil will cement the political will to accelerate the full transition to clean power once and for all. That’ll benefit European renewable energy companies like Vestas, Orsted, EDP Renovaveis, and Siemens Gamesa.