This Time Is Different — Potential Energy Recession

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The world confronts an unprecedented energy crisis, potentially causing far more damage than any energy price upheaval since the 1970s. Today’s crisis is not merely an oil crisis, it affects all fossil fuels. If natural gas and coal prices remain at current levels for another six months, the consequences would be worse than those from $100 oil — sparking the most severe global economic recession in five decades. The rise in fossil fuel prices has come so quickly that neither the OECD nor the International Monetary Fund considered it in their global economic forecasts for 2022, published this month. However, the fallout will be long-lasting because the economic slowdown will lead to further reductions in spending on oil and gas exploration. It could even hasten the end of the hydrocarbon era.

The last few weeks have seen unprecedented rises in coal and gas prices along with higher oil prices. China’s aggressive buying seems to be a major factor behind the increases. The problem is inadequate coal and gas supplies and low inventories. Oil-exporting countries have exacerbated the situation by limiting crude production.

The table below provides a rough estimate of global oil, gas and coal expenditures in 2020 and 2022, assuming prices do not decline. Indeed, several analysts who focus on energy expect coal and natural gas prices to keep rising, given the supply-demand imbalance. They see oil prices increasing further, as well, given the unwillingness of oil-exporting nations to raise output.

One can observe from the differences in the 2020 and 2022 expenditures shown in the table below that “this time is different.” Past energy crises have been driven by rising oil prices, which, as economists have described, act as a tax. In this case, it is coal and gas prices that inflict the most damage.

Fried and Schultze explain the economic impact of an earlier bout of higher oil prices: “In essence, the initial impact of the oil price increase can be compared to the imposition by the producer of oil of a large excise tax, the proceeds of which were not immediately used to buy goods or services. Consumers in the importing nation paid more for energy and therefore had less to spend for other products.”

This phenomenon is precisely what is occurring today except the “tax” comes in the form of higher oil, gas and coal prices combined. For example, UK gas consumers may see their heating oil bills quadruple from last winter. The annual cost for some could rise by £1,000 ($1,366). Across the UK and Europe, gas and electricity price increases are reducing what consumers can spend on other items, just as a boost to the VAT would. Through economic multiplier effects, demand for non-energy goods and services will decline, bringing down non-energy GDP.

Similar spending reductions will occur in Asia and, to a smaller extent, the US. This economic response should come as no surprise. Past oil price shocks — in 1974, 1979, and 2008 — had the same effect. This time, though, coal and gas are the primary drivers behind the “tax increase” and oil is secondary.

Price controls on electricity in countries such as India and China will exacerbate, rather than mitigate, the economic disruption, because artificially low prices give consumers less incentive to reduce consumption. The US maintenance of oil price controls in 1979 illustrated how price crises are exacerbated if supply cannot increase when consumers fail to cut use. In that year, the US offered subsidies for distillate fuel oil imports in the spring. The Department of Energy's $5 per barrel bounty for imports drove up the global price of distillate and crude oil.

In this episode, expenditures on oil will increase by 140% from 2020 if oil prices remain at current levels. Natural gas expenditures will rise by 435% (yes, 435), and coal expenditures by 236%. At these prices, the total rise in spending on energy — and related decrease in spending on other things — will almost certainly exceed any likely increase in global nominal GDP. Unless governments in Asia and Europe step in and increase deficit spending, as they did in 2020 after the Covid-19 shutdowns, GDP must decline in 2022. I estimate the decrease will be 3%- 5%.

The GDP impacts will be harshest in Europe and Asia. In particular, the “through-the-roof” gas prices will hammer China and India. High coal prices would even more severely impact these countries if domestic producers were allowed to charge their residential, commercial and industrial consumers at world rates. The exorbitant cost of imported gas will have similar effects on European consumers.

The US, Canada and Mexico will fare better initially because the gas price rise in these producing countries will be constrained by their limited capacity to export gas. Over time, though, North America will likely experience reduced economic growth as Asian and European demand for exports declines. Globalization spreads any recessionary or expansionary impacts across all regions. A strengthening US dollar may speed the recession’s incursion as US manufacturers get priced out of European and Asian markets.

When Prices Retreat

Eventually, the global slowdown will curb or depress energy prices as consumption declines, but not before serious damage has been inflicted. Investment in fossil fuels will be depressed yet again by the lower prices.

The table and figure illustrate the point. The figure shows the fluctuation in energy’s share of GDP over the decades. The graph presents natural gas, coal and oil expenditures as a percentage of OECD GDP. The shaded areas mark periods of sharp oil price increases and recession. Note how big increases in the energy share of GDP correlate with price shocks and recessions.

The table shows rough estimates of world oil, gas and coal expenditures for 2020. The gas and coal expenditures were calculated using price and quantity data from BP’s Statistical Review of World Energy. The global GDP data come from the World Bank. The 2022 projections are based on International Energy Agency forecasts and assume the continuation of end-September 2021 prices of around $15 per million Btu for gas in Europe, $90/bbl for oil, and $125 per ton for coal.

With these assumptions, note that energy would account for approximately 9% of global GDP in 2022, up from 3% of global GDP in 2020, which was down from 4.2% in 2019. That means consumers in 2022 would pay an “energy tax” of almost $6 trillion.

Basic macroeconomic multiplier analyses suggest that a $1 tax increase would cut GDP by around $1.50, implying that global GDP will be reduced by approximately $9 trillion in 2022 due to the higher energy prices. For context, world GDP declined by $3 trillion from 2019 to 2020. The 2022 shock will be three times larger.

Rough Estimates of World Expenditures on Oil, Gas and Coal: 2020 vs. 2022
($ billion)OilNatural GasCoalTotalGlobal GDPEnergy as a % of Global GDP

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.

Macroeconomics , Oil Supply, Oil Prices
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