Why energy prices will remain high despite the global economic downturn

And the pandemic is the mother of all surprises, bringing about the biggest sustained change in demand since World War II. Prior to COVID-19, global oil demand was around 100 million bpd, but lockdowns (and fears) sent demand plummeting to 75 million bpd. Suppliers cannot collectively turn off the taps fast enough (slowing down flowing oil wells is no trivial task). On April 20, 2020, the price of oil fell to reduced $US37 per barrel, as storage facilities become overwhelmed and suppliers try to avoid dumping penalties.

Investment in new oil and gas production had been weak before the pandemic, in part in response to global 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.

Investment and environmental, social, and governance regulations reduce oil and gas projects’ access to finance, which is, of course, the point. It would be fine if policymakers had devised a viable transition plan to reduce dependence on fossil fuels, but it has been a challenge, especially in the US and Asia.

US shifts position

Oil, coal and natural gas still account for 80 percent of global energy consumption; about the same part 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 accelerate the green energy path over the course of the decade. But there are really no plans to tackle the V-shaped recovery in oil demand that comes with the post-pandemic rebound, let alone the dislocation of energy supplies due to Western-led sanctions on Russia.

The ideal solution is a global carbon price (or a carbon credit trading scheme if taxes prove impossible). In the US, however, the inflation-ridden Biden administration is seriously considering going in the opposite direction, and has asked Congress to suspend the federal gasoline tax — $0.18 a gallon — for three months. The recently announced G7 plan to cap Russia’s oil prices makes sense as a sanction, but Russia is already selling to India and China at heavy discounts, so this is unlikely to have a major impact on global prices.

Just moments ago, the Biden administration used its executive powers to stifle the growth of US fossil fuel production. Now he is fighting for higher output from foreign suppliers, even those – especially Saudi Arabia – who were previously shunned on human rights grounds.

Unfortunately, being virtuous by limiting US oil production while at the same time absorbing output from other countries doesn’t really do much for the environment. Europe, at least, has a semi-coherent plan until the Ukraine war takes home how far the continent – ​​especially countries like Germany, which has taken nuclear power out of the equation – from achieving a clean energy transition.

As with all types of innovation and investment, strong growth in green energy requires consistent and stable policies over decades to help mitigate the risk of the enormous long-term capital commitments required. And until alternative energy sources can begin to completely replace fossil fuels, it is unrealistic to think that rich country voters will re-elect leaders who let energy costs swell overnight.

The best way to encourage green investment is to have a reliable high carbon price; gimmicks like divestment are far less effective.

It is noteworthy that the protesters who have succeeded in pressuring some universities to ditch fossil fuels do not appear to be lobbying as hard as they could to turn down heating and air conditioning. An energy transition is necessary, but it won’t be painful.

The best way to encourage long-term producer and consumer investment in green energy is to have a reliable high carbon price; gimmicks like divestment initiatives are both far less efficient and far less effective. (I also advocate the creation of a World Carbon Bank to provide funding and technical assistance to developing countries so that they too can cope with the transition.)

For now, oil and gas prices are likely to remain high, despite fears of a recession in the US and Europe. As the northern hemisphere summer driving season gets under way, and with China’s economy potentially recovering from a zero-COVID lockdown, it’s not hard to imagine energy prices continuing to rise, even if the Federal Reserve’s sharp rise in interest rates limits US growth.

In the longer term, energy prices are likely to rise unless investment picks up sharply, which seems unlikely with current policy guidance. Supply and demand shocks are likely to continue to rock energy markets and the global economy. Policymakers will need strong courage to manage them.

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