Europe’s Energy Crisis Can Speed Transition

Copyright © 2021 Energy Intelligence Group

Western Europe is experiencing a serious energy crisis. Natural gas prices have increased 500% in the UK from year-earlier levels. Electricity and gas prices have jumped by large amounts in France, Spain, Italy, Greece and the UK. Government officials in these and other countries are scrambling to find solutions. In most cases, they are finding they can do little. Neither government nor company officials can boost natural gas supply or find alternatives to lower prices. Instead, governments should embrace the higher prices to accelerate the transition to a low-carbon or no carbon world, while increasing payments to consumers to offset the impact of higher prices.  Such measures will match the steps taken over the last 18 months, where increased government expenditures during the Covid-19 crisis moderated the economic slowdown and prevented economic depression. The expenditures can be financed by taxes on the profits of energy producers.

The European situation is not new. In February, Texas residents experienced even more dramatic electricity price increases when frigid weather shut down much of the state’s power system. Natural gas curtailments forced consumers to suffer through cold nights with little heat. Those who were lucky enough to have power were later shocked by huge electric bills.

The European and Texas episodes are just two of the myriad energy crises various countries have seen over the last 50 years. In every case, politicians rushed to address the issue. And in every case, the political solutions proved disastrous.

Secretary of State Henry Kissinger convened the Washington Energy Conference following the 1973 Arab oil embargo. His hope was to address the petroleum shortages and associated drastically higher prices during the crisis. The countries attending created the International Energy Agency (IEA). The signatories to the International Energy Program (IEP) Agreement intended that they and other countries joining the IEA would share supplies during shortages. The members also agreed to invest in strategic energy stocks, from which they could draw to help alleviate or moderate future crises.

Kissinger’s energy-supply sharing concept turned out to be a pipe dream. In the years since the IEA’s creation, countries and companies have shown they would rather hoard than help during shortages. Furthermore, rising prices have seldom been moderated by draws from strategic stocks, especially in Europe and the US.

Instead, strategic reserves have proven to be welfare supplies for Big Oil. For example, Exxon and two other refiners tapped the US Strategic Petroleum Reserve to keep operating after Hurricane Ida struck in late August of this year. As Williams and Wright wrote in 1982, strategic stocks substitute for commercial stocks. Their research and 40 years of experience reveal that private companies hold lower stocks when governments build strategic stocks.

In other cases where governments mandate stock levels — as in Europe — we observe that companies are reluctant to sell from inventories when asked to do so by the IEA. In 2011, for example, European stocks did not drop when governments tried to address the Libyan shortage. The actions should not have surprised, because company officials recognized they would need to rebuild inventories to meet requirements using higher priced crude.

After the 1979 Iranian Revolution, President Jimmy Carter and his advisers introduced measures to address surging oil prices and respond to the public outcry over gasoline shortages. The result was a windfall profit tax on crude oil and billions spent on a synthetic fuels program. The tax generated little revenue because prices collapsed in a few years, while the ill-conceived Synthetic Fuels Corp. produced little fuel even as it devoured huge sums of money.

In 2006, President George W. Bush proposed a so-called renewable fuel program, which required the blending of increased volumes of biofuels such as ethanol into gasoline and diesel to address America’s “addiction to oil.” The policy was advanced as oil prices surged, eventually reaching $130 per barrel. Its proponents said that introducing renewables would lower fuel prices and promote energy independence. Fuel prices did not fall. Instead, food prices increased, and critical water supplies were depleted, as corn and soybean production skyrocketed.

Fighting High Prices

One can list hundreds of actions by governments in the US and almost every nation to address energy crises. Many countries invested heavily in coal-fired facilities. As an alternative to costly oil, Japan built 60 nuclear reactors, which provided 30% of its electricity needs in 2010, just prior to the accident at Fukushima. France became even more nuclear-reliant. Everywhere nations focused on substituting other energy forms — often fossil fuels — for oil to reduce their exposure to volatile prices and cartel pressures.

Digging though the reams of policy papers published over the decades, one finds reference after reference to the need to moderate the economic impact of rising energy prices. That moderation has been the goal of policymakers past and present. Many see sudden energy price increases as a significant cause of economic recessions, which policymakers everywhere want to avoid.

A rational observer, looking back over the last 50 years, must conclude that their efforts have failed. Today, most economies in the world remain exposed to energy price surges that precipitate slowdowns or recessions despite the best efforts of brilliant individuals. The monies spent have bought large, inefficient and incompetent bureaucracies such as the IEA and the US Department of Energy rather than tempering energy price fluctuations.

The explanation for policy debacles seems obvious in retrospect. Most energy crises, which I define as very large price increases, are tied to supply disruptions. With few exceptions, these interruptions cannot be offset quickly, given the time lags and large investments needs that characterize the energy industry. Hence, a supply loss will, per force, lead to substantial price increases.

Embracing High Prices

We now know, however, that such increases need not lead to recessions or macroeconomic chaos. After Covid-19 broke out in March 2020, the world’s central bankers showed everyone that the economic impact of global catastrophes can be dealt with successfully if prompt action is taken.

The solution to energy crises is the same as the Covid-19 solution. When prices surge, as they are today in Europe, governments should help consumers financially. The funds for this aid can be collected from company windfall profits or borrowed, as the central banks did in response to the havoc wreaked by the coronavirus.

This policy of tolerating or even embracing higher prices, while stopping price increases from causing recessions by making consumers whole, may be the optimal energy and/or environmental policy because it allows the proper market signals to be transmitted to consumers, while not harming the individuals or businesses affected by the high prices. Economic experience shows that consumers will respond to the higher prices by consuming less and/or seeking alternatives to preserve their lifestyles.

Rational consumer behavior will, for example, accelerate the transition from fossil fuels if the prices of those fuels or the electricity produced from them remain high and volatile. High gasoline prices are a much greater incentive to purchase automobiles with good fuel economy, or electric vehicles, than are fuel economy standards. High prices have also been shown to encourage consumers to reduce their home electricity use through installing solar panels and other measures. Business, large and small, are even more responsive.

If policymakers truly want to see large reductions in greenhouse gas emissions, they should embrace market disruptions such as the one in Texas last February or in Europe today, while at the same time getting out their checkbooks to support consumers and avoid the economic slowdowns that have traditionally accompanied energy interruptions.

Governments should also be willing to tax the windfall profits earned during the price disruptions. While private companies will assert this leads to reduced investment, there is no evidence that the investment will come quickly, if at all. High prices, not high profits provide the best incentive for more investment

Rahm Emanuel, the former adviser to President Barack Obama and Chicago mayor, offered us the best advice when he said, “You never let a serious crisis go to waste. And what I mean by that it’s an opportunity to do things you think you could not do before.”

The energy crisis in Europe provides a golden opportunity to move more rapidly toward achieving net-zero emissions. Governments should welcome this chance, while making sure to offset any financial damage to consumers.

Philip Verleger is an economist who has written about energy markets for over 40 years. A graduate of MIT, he has served two presidents, taught at Yale and helped develop energy commodity markets since 1980. Kim Pederson is editorial director of PKVerleger LLC.

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