Houston: Oil Has a Problem

The energy crisis of 2022, clearly the worst market upheaval since World War II, did not cause a recession. Simply put, the oil weapon had been neutralized — and based on developments since the oil shock of 1973 and especially since 2010, it is now clear that society can accelerate its move away from fossil fuels without suffering recession or depression. This has huge implications for the energy industry. One immediate one is that we can probably ignore warnings about inadequate investment in hydrocarbons from oil company executives, oil-exporting nations and other fossil fuel proponents at CERAWeek by S&P Global in Houston, and elsewhere.

The roots for neutralization lie in central banks’ greater understanding of the global economy’s interrelationships and the willingness of governments to spend during a crisis. In 1973, the role of energy and oil was not understood. By 2022, however, these banks were well aware of the impact of higher oil prices and developed tools to address it. The actions of entrepreneurs on the level of Steve Jobs and Elon Musk have also removed the venom from the Opec sting administered by Sheikh Yamani in 1973. Western and especially US intellectual might has nullified the need for the Middle East’s and Russia’s vast hydrocarbon reserves.

Then and Now

After the 1973 and 1979 energy crises, higher energy prices panicked government policymakers and economists, prompting them to alter policies. Their focus then was on boosting long-term fossil fuel supplies independent of oil-exporting nations. The US Congress passed laws mandating greater coal use and poured billions into a synthetic fuels program. The policy response in 2022 was very different. Temporary releases from strategic oil reserves were made in Europe and the US, and ambitious programs to phase out oil were enacted.

Monetary policy officials have altered their response as well. Central bank authorities in the US, Japan and various European countries did not act in 1973, worried that the large sums flowing to oil-exporting countries might destabilize financial markets just recovering from the US shift to flexible exchange rates. Policies adopted since then have focused on moderating the impact of energy shocks. In 2022, they succeeded in quashing these effects.

The lessons learned from, and applied after, the energy crises from 1973 to 2022 have made the large, developed nations far less vulnerable to sudden price increases or decreases. The oil market’s future, then, is tied to the developing nations, which account for perhaps half of global consumption. These countries have implemented strategies to neutralize price fluctuations. To borrow a famous phrase from the Apollo 13 film, “Houston, oil has a problem.”

Lessons for the Transition

Higher oil prices were also once seen as a threat to economic growth, but that danger and the perception of it seem to have declined since 2010. Government responses also helped moderate the 2022 energy crisis. Fiscal and monetary intervention, combined with the strategic reserve oil releases, neutralized the impact of rising gasoline prices in the US. Europe’s even greater fiscal stimuli and monetary easing offset the impact of rising natural gas, coal and oil prices there. The success of these interventions demonstrates that energy supply disruptions no longer pose a risk to economic activity when policymakers take proactive action.

The success of the economic policies in 2021 and 2022 in defusing the impacts of energy price rises should guide thinking now regarding the transition to net-zero emissions. The evidence shows that the transition can be accelerated despite protestations from major fossil fuel producers, particularly oil companies, which continue to counsel taking it slow. They argue that modernization of the electricity grid and construction of renewables is going too slowly, and that consumers will not embrace the lifestyle changes inherent in the energy transition.

That may sound reasonable, but one can also point to past occasions where proponents of the status quo ignored the impacts of innovation. Telecoms is a prime example of a capital-intensive industry turned on its head in fewer than 40 years by the cell phone’s advent. Cell phones and then smartphones displaced the established landline industry at breakneck speed when the cost of cellular communications dropped.

Today, similar trends can be seen in the energy space. Tesla was founded in 2003. At the time, few gave the company any chance of survival because no one other than Chinese entrepreneurs operating in a protected market had created a new auto firm for years. How wrong they were. On Mar. 2, Tesla announced plans to produce 20 million cars per year while cutting production costs in half.

The two key lessons of the last 10 years, then, are these: Economic impacts of energy market disruptions can be neutralized or avoided by prudent, well-designed economic interventions in deregulated, competitive economies led by officials who understand the key linkages and are willing to take bold steps; and transitions from one dominant technology to another can come rapidly despite large amounts of invested capital in the old or legacy technology.

Writing on the Wall

The probability of a more rapid transition will increase, too, if investors prove unwilling to support additional spending by the oil industry. This looks increasingly likely amid growing concern that demand for fossil fuels will peak as soon as 2030.

A lack of investment funds will limit increases in crude production. Oil prices will likely climb, as industry officers assert. But looking at the transition from wired to cell phones and railroads to other transport modes, one can see the obvious consequence of higher prices: a faster energy transition.

The clear message, then, is that the energy transition can be accelerated without a serious economic disruption if economic policymakers implement properly designed fiscal and monetary measures. A second message is that fossil fuel producers, particularly oil producers, will fade away because they have lost the support of investors — who now demand a return of their capital — and have shed the labor force they need to expand.

Some readers will note that this argument contains an uncertainty because fiscal support measures will increase government debt or require new taxes. Here, it seems that investors are being particularly astute in recognizing that it will be the fossil fuel producers that pay. Windfall taxes or other measures will be introduced across the world.

To conclude with a data note. In 1981, I co-wrote a paper on The Windfall Profit Tax: Origins, Development Implications with Dennis Drapkin, which appeared in the Boston College Law Review. For years, the paper lay dormant. Recently, however, a service has sent notification almost daily that someone has read it. Most of the readers have email addresses that suggest they are with governments. A check of the Boston College website shows that there have been 1,292 downloads. That appears to be an increase of more than one thousand views in a year.

The conclusion is that much higher taxes on oil producers will come. They will help pay the costs of the energy transition.

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. The views expressed in this article are those of the author.