Over the past two and a half years, world oil and gas prices have been subject to demand shocks and supply shocks – and sometimes both simultaneously. The resulting volatility in energy markets is a reflection and a microcosm of a careening global economy.
The price of Brent crude oil declined from a “normal” $68 a barrel at the end of 2019 to $14 a barrel in April 2020 as the Covid-19 pandemic spread worldwide. Two years later, in March 2022, the price soared to $133 a barrel after Russia invaded Ukraine. Now it is falling again amid growing fears of a recession in the US. But the price could rise sharply if the Chinese economy bounces back from the stupor induced by its zero-Covid policies.
What will happen next, and how can policymakers keep their eye on environmental sustainability in the face of this market turmoil?
One reason why oil and gas prices are so volatile is that short-term demand for energy responds much faster to changes in growth than to price changes. So, when there is an energy shock, it can take a huge price change to clear the market.
And the pandemic was the mother of all shocks, bringing about the biggest sustained shift in demand since the second world war. Before Covid-19, global oil demand was about 100m barrels a day but lockdowns (and fear) sent demand plummeting to 75m barrels a day. Suppliers could not collectively turn off the spigot fast enough (slowing down a gushing oilwell is not a trivial task). On 20 April 2020, the oil price fell briefly to minus $37 a barrel, as storage facilities became overwhelmed and suppliers sought to avoid dumping penalties.
Investment in new oil and gas production had already been weak prior to the pandemic, partly in response to worldwide initiatives to steer economic development away from fossil fuels. The World Bank, for example, no longer finances fossil fuel exploration, including projects involving natural gas, a relatively clean energy source. Environmental, social, and governance investing and regulations are reducing oil and gas projects’ access to financing, which of course is the point. That is perfectly fine if policymakers have laid out a feasible transition plan to reduce reliance on fossil fuels but this has been a challenge, especially in the US and Asia.
Oil, coal, and natural gas still account for 80% of global energy consumption, roughly the same share as at the end of 2015 when the Paris climate agreement was adopted. Policymakers in Europe and now the US (under President Joe Biden) have laudable ambitions to fast-track green energy during this decade. But there was really no plan to cope with the V-shaped recovery in oil demand that came with the post-pandemic rebound, much less the energy-supply dislocations resulting from the western-led sanctions on Russia.
The ideal solution would be a global carbon price (or a carbon credit trading scheme if a tax proves impossible). In the US, however, the inflation-panicked Biden administration is seriously considering going in the opposite direction, and has called on Congress to suspend the federal gasoline tax – $0.18 a gallon – for three months. The recently announced G7 plan to cap Russian oil prices makes sense as a sanction but Russia is already selling to India and China at a steep discount, so this is unlikely to have a big impact on the global price.
Only a short while ago, the Biden administration was using its executive powers to stunt the growth of US fossil fuel production. Now it is championing higher output from foreign suppliers, even those – notably Saudi Arabia – that it had previously shunned on human rights grounds. Unfortunately, being virtuous by limiting US oil production while at the same time soaking up output from other countries does not really do much for the environment. Europe, at least, had a semi-coherent plan until the Ukraine war brought home just how far the continent – especially countries such as Germany that have taken nuclear power out of the equation – is from achieving a clean-energy transition.
As with all kinds of innovation and investment, strong growth in green energy requires decades of consistent, stable policies to help de-risk the massive long-term capital commitments that are needed. And until alternative energy sources can start to substitute more fully for fossil fuels, it is unrealistic to think that rich-country voters will re-elect leaders who allow energy costs to blow up overnight.
It is notable that the protesters who have successfully pressed some universities to divest from fossil fuels do not seem to be lobbying nearly as hard to turn down heating and air conditioning. The energy transition needs to take place but it will not be painless. The best way to encourage long-term producer and consumer investments in green energy is to have a reliably high carbon price; gimmicks such as divestment initiatives are far less efficient and far less effective. (I also advocate establishing a World Carbon Bank to provide developing economies with funding and technical assistance so that they, too, can cope with the transition.)
For the moment, oil and gas prices seem likely to remain elevated, despite fears of a recession in the US and Europe. As the Northern Hemisphere’s summer driving season gets under way, and with the Chinese economy potentially rebounding from zero-Covid lockdowns, it is not difficult to imagine energy prices continuing to rise, even if the Federal Reserve’s interest rate increases sharply curtail US growth.
In the longer term, energy prices look set to rise unless investment picks up sharply, which seems unlikely given current policy guidance. Supply and demand shocks will most likely continue to roil the energy market and the global economy. Policymakers will need strong nerves to manage them.
Kenneth Rogoff is professor of economics and public policy at Harvard University and was the chief economist of the International Monetary Fund from 2001 to 2003