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Just as the world was getting serious about a green energy future, its reliance on fossil fuels struck with a force not seen since the 1970s. Russia’s invasion of Ukraine, coupled with the pressures created by the pandemic, sent prices of all forms of energy skyrocketing, with the price of oil surging by more than 50% in the first half of 2022. This energy shock was at the heart of an inflationary spurt that caused hardship and political headaches around the globe.
1. Why do we have an energy shock?
Just two years ago, the price of the benchmark US oil futures contract briefly plunged below zero as the pandemic battered the global economy. A year later, the price had recovered to pre-pandemic levels and continued to rise as revived demand outpaced growth in crude oil inventories. Then came a wild series of convulsions from waves of sanctions by the US and its allies to shut out Russia, the source of 10% of the world’s oil (along with other key commodities from wheat to fertilizers to nickel). More than half of Russia’s oil exports go to European Union countries, but energy markets are global, so changes in supply and demand are felt around the world.
Consumers have been particularly hard hit, as spending on energy is difficult to cut. In the UK, regulators have warned that the rise in global natural gas prices will push up average household energy bills by a further 42% in October if a price cap is adjusted higher, resulting in the biggest fall in living standards since the 1950s. In much of the world, retail fuel prices have risen even faster than crude oil prices. Gasoline averaged $5 a gallon (3.79 liters) for the first time in the United States in June, the start of the country’s summer driving season. The end result was a surge in inflation the world hadn’t seen in decades, with energy accounting for more than half of the increase in the major advanced economies. Price concerns aside, there were concerns that global power grids, already strained by climate change, could prove even more vulnerable and lead to power outages that could endanger lives.
There was a scramble to increase supplies and redirect fuel to where it was needed – efforts that met with limited success. The EU gradually implemented a partial ban on Russian oil and bought more LNG on world markets to wean itself off of Russian gas pipelines, which accounted for 40% of supply. By mid-June, Russia had stopped supplying gas to four EU countries. US President Joe Biden’s administration has asked oil refiners about the feasibility of bringing back mothballed capacity. There were other reactions as well: To stem the rise in inflation, the US Federal Reserve and its counterparts were expected to hike rates in the most aggressive monetary tightening cycle in decades (China and Japan were exceptions). That won’t bring down energy costs immediately, but the goal is to slow economic growth enough that inflation fizzles out.
By early June there was no sign of an end to Ukraine’s grueling, bloody war and little hope for large increases in energy production as oil-rich OPEC nations agreed to only modest increases in oil production. The price of the West Texas Intermediate oil futures contract surged above $120 a barrel and a potential resurgence in post-pandemic consumption in China, the world’s largest importer of crude oil, threatened to add further upward pressure. Jamie Dimon, chief executive officer of JPMorgan Chase & Co., said oil has the potential to hit $150 or $175 a barrel and the bank is bracing for an economic “hurricane.”
5. How does this compare to previous shocks?
The price vault is comparable to the two most famous oil shocks in history: the 1973 Arab-Israeli War, which resulted in many crude oil producers refusing to sell to pro-Israel countries, and Iran’s revolution six years later, the one About 7% of the global crude oil supply failed for a while. But there are differences: Economic growth isn’t as closely linked to oil as it was in the 1970s — extraction is much less energy-intensive than it was then. Shale fracking has made the US the world’s largest oil and gas producer and has brought America much closer to the energy independence it aspired to after the gasoline shortages of the 1970s. Still, the crisis was a reminder that the world still depends on fossil fuels for more than three-quarters of its energy, a state of affairs likely to persist for decades to come, even as some countries accelerate investment in renewable energy.
• A Bloomberg Economics report on what’s driving faster inflation around the world
• How Russia’s war in Ukraine is stifling commodity exports.
• A blog post from the International Monetary Fund on how the world is now getting more miles out of every barrel of oil.
• John Authers of Bloomberg Opinion on comparisons to the 1970s oil crises.
For more stories like this, visit bloomberg.com
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