What’s Behind the Rise in Energy Prices?

0

 

Year-over-year inflation, as measured by the Consumer Price Index (CPI), hit 7% in December. The US is now clearly experiencing its most serious bout of sustained inflation since the 1970s. There is ongoing debate about how much of the increase in CPI (which is constructed from the prices of a “basket” of common goods across many sectors) is broad-based, or mostly driven by a small number of important sectors that are dealing with special circumstances. But what isn’t in doubt is that a surge in energy prices is one of the most important factors. According to the White House Council of Economic Advisors, about half of the increase in CPI has been due to just energy and cars.

So what is going on with energy markets? It’s a complex question, and there are both short-term and long-term factors at play. Investment in new oil and gas projects have been flagging ever since 2014, when oil prices dropped from a peak of about $115 per barrel to less than $45 per barrel over the course of just seven months. Energy was the worst-performing sector in the S&P 500 in the decade prior to the pandemic.

However, this depressed investment in new energy supplies met a massive and unexpected spike in demand starting in 2020. The recovery from the COVID recession, fueled by unprecedented fiscal stimulus, was faster and bigger than anyone anticipated. Further, people shifted much of their consumption from services to goods, increasing demand for oil used for shipping and contributing to the ongoing supply chain bottlenecks.

And as always with energy, events around the world impacted energy prices in the US. The OPEC-Russia agreement to restrict oil production has maintained upward pressure on oil prices. Chinese imports of liquefied natural gas (LNG) have been surging since 2020, as the government has been trying to reduce its dependence on coal (among other reasons). European Union LNG imports have also increased dramatically as it attempts to reduce its dependence on piped-in Russian gas. These twin global demand shocks for LNG have caused US gas companies to increase LNG exports, raising gas prices at home.

So a long-run decline in investment in new oil and gas projects has met a sudden and dramatic rise in demand driven by several different factors. Economic theory predicts that the resulting high prices should encourage increased investment, eventually bringing more supply and reduced prices. This may be happening, but new energy projects are complex and have long lead times, so price relief might be some time away.

Americans are upset about high gas prices and electricity bills, and this is contributing to President Biden’s falling approval rating. But energy markets are global and there is very little US presidents can do to influence them. Biden could try pressuring Saudi Arabia (the de facto leader of OPEC) to lift OPEC’s production caps, but it’s unclear what leverage the US has to do that. There have been calls for the US to accelerate withdrawals from its Strategic Oil Reserve, but the oil market is too large for that to have much of any impact.

Predicting energy price movements is always a mug’s game. Continued economic recovery and supply chain bottlenecks could keep prices high, or the surge in demand could prove transitory, returning prices closer to pre-COVID levels. But as long as we are reliant on fossil fuels for energy, US energy prices will move according to the whims of a complex global market.

Share.

About Author

Brock Smith is an Assistant Professor in the Department of Agricultural Economics and Economics at Montana State University. He received a PhD from UC-Davis in 2013 and spent three years as a Research Fellow at the Oxford Centre for Analysis of Resource Rich Economies. He mainly studies effects of oil and natural gas shocks in both an international and domestic US setting.

Leave A Reply