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Back to 2023_06_15_ECO_precios
Álvaro Bañón Irujo
Professor of Financial and Investment Management
Following the Russian invasion of Ukraine in February 2022, the prices of almost all raw materials skyrocketed. The price of natural gas doubled between January and May, and with it, the price of electricity. The price of oil rose by 50 % and that of raw materials such as wheat by another 50 %.
In the summer of last year, gasoline in Spain reached prices of up to 2.1 euros per liter and some predicted that it would reach 3 euros. Today gas is - and has been this winter - practically at the same price as before the invasion, electricity has been cheaper than before for months and a liter of gasoline is around 1.5 euros. Wheat is almost 50% cheaper than a year ago.
What has happened? Unfortunately, it is not that the invasion has ended. What has happened is that the markets have worked and supply and demand have adjusted to the new scenario, bringing prices back to equilibrium in the commodity markets.
On the demand side, companies and households have sought energy efficiency in order to spend less. In homes and neighborhood communities, heating has been turned on later, investments have been made in insulation and consumption is being monitored more closely. Companies have also become aware of the importance of energy costs and have taken measures. The result of all this is a drop in gas consumption of more than 17% in Europe (10.8% in Spain).
Would these measures have been taken if there had not been a brutal rise in prices? Most probably not. As strange as it sounds, this price hike has been healthy because it has driven consumers to efficiency.
On the supply side, and especially in the case of gas, the market has worked: as prices have risen so much, gas sellers have appeared from under the rocks and Europe is even having difficulties to store it. There is oversupply and the price of gas has plummeted. There have even been traffic jams of methane tankers for download liquefied natural gas in Spanish ports.
It is supply and demand
We could make the same reflection with wheat, corn or oil. As prices have risen, more supply has appeared. This has been the case for 2,000 years. This brings us to something difficult to understand, even for scholars. Prices are not about costs, they are about supply and demand. The market is not interested in costs but in finding the price at which the seller is interested in selling and the buyer is interested in buying.
A year ago the cost of extracting a barrel of oil was practically the same as today, yet today it costs about 40% less. The reason? Supply and demand. The cost of a hotel room in Pamplona on November 7 and July 7 is similar (for the hotel itself). And yet, on July 7, with the Sanfermines, the price is multiplied by four. Why? Because of supply and demand.
Now, if markets are adjusting, why isn't the shopping basket leave? The answer is twofold:
Because demand remains strong. We need to buy food and demand is quite inelastic (does not vary much in the face of price changes) for basic commodities such as milk, oil and eggs.
Because, in order to lower prices, there needs to be skill more producers offering their products on the market.
It is not necessary to trust that prices will go down when product costs go down, because they will not. They will go down when skill increases and when there is more product in the market.
On the other hand, there are goods that are already falling. Why? Because their consumption has adjusted to prices.
For example, if the price of veal rises sharply, we will consume less veal and buy more chicken. What will happen then? As demand decreases, producers will find themselves with calves that they will have to sell and this will lower prices.
In conclusion, and now that there is so much talk of intervening in the markets, a committee for the public authorities: let the markets adjust. Price is an indicator of excess supply or demand and any imbalance will be corrected by the market itself. If the price rises too much, new sellers will appear, demand will be reduced and the price will adjust.
Any attempt to fix a price not based on supply and demand leads to shortages or black markets. If you want to lower the price of a good or a service, or to improve that service, you must encourage the emergence of new competitors. This is the only way for those who are already in the market to get their act together. There is nothing worse than feeling like a captive customer.