Energy Price Stability: The Peril of Fossil Fuels and the Promise of Renewables

By Lauren Melodia and Kristina Karlsson

Energy is a Macroeconomic Issue

Energy is a Macroeconomic Issue

• Because energy prices are so volatile, they are excluded from core CPI measure that the Federal Reserve monitors. But energy prices impact the health and stability of the economy as a whole.
• Energy constitutes a large part of household budgets, price fluctuations will have a significant impact on consumers.

Energy is a Macroeconomic Issue

• Energy price volatility contributes significantly to overall inflation.
• Gasoline prices specifically accounted for 75% of energy inflation over the last year.

Energy is a Macroeconomic Issue

If there had been no price changes for energy and cars over the past year, annual inflation as of March 2022 would have been only 4.4 percent, roughly half of the annual inflation rate

​

Fossil Fuels are Inherently Volatile

The Nature of Production

• Hydraulic fracking requires shooting large quantities of water, sand, and chemicals into “tight” rock formations to crack them open and release trapped gas (Denchak 2019). Fracking requires higher initial production costs and has a higher depletion rate, so it can be necessary to repeat the costly fracking process to keep up with demand (Taylor 2021). This can lead to more frequent cost spikes and greater potential for price volatility.

Geopolitics and International Conflict

• Fossil fuel prices have been both implicated and used as a tool for international conflict. Supply and price of oil and gas are at the mercy of volatile markets.
• When supply and demand are tight, the leaders of fossil fuel-producing countries like Russia and Saudi Arabia can become more aggressive, knowing that their fossil fuel exports give them a shield against Western sanctions (Sahay 2022).
• In other instances, fossil fuel-rich countries manipulate the price of oil intentionally to further their geopolitical positions, as was the case in 1973 when the Arab members of OPEC imposed an oil embargo on countries perceived to be in support of Israel (Hamilton 2011)

Boosting Domestic Production Does Little to Influence Prices

• Oil prices are determined at the international level through OPEC, and increases in domestic oil production, even if intended to be consumed in the US, will impact the global aggregate supply and price.
• Domestic producers are heavy exporters, the profit incentive to sell domestic oil and gas abroad will always prevail over price pressures in the US. LNG provides a compelling example.
• Exports now outrun the rate of production, we are drawing down inventories to meet international demand while domestic consumers are paying extreme prices at the pump.

Speculation

• International fossil fuel markets are subject to significant speculation which further amplifies price fluctuations. Speculators thrive on and promote volatility, as every price change is a profit opportunity. During times of elevated demand - ie. natural disasters, or supply shortages - speculators can increase prices significantly.
• This was the case during the Texas winter storm of 2021, during which wholesale power costs rose by 400 times the normal amount and consumers faced energy bills in the thousands of dollars, some reaching over $15,000 (Nieto del Rio et al. 2021).
• The top private commodity trading houses doubled their profits in 2021.

Vulnerability to Climate Change

• Extracting, producing, consuming fossil fuel contributes significantly to climate change. Pipelines, oil sands, fracking sites, are all vulnerable to episodes of extreme weather or disasters.
• Trans-Alaska Pipeline System is currently suffering from thawing permafrost that will jeopardize the supports holding up elevated portions of one of the world’s largest pipelines (Hasemyer 2021).
• Russian environmental minister, Alexander Kozlov reported that permafrost degradation led to roughly 23 percent of technical failures and 29 percent of losses in fossil fuel extraction (Lee 2021; Moscow Times 2021).
• In 2016, wildfires in Alberta threatened oil-sands mining complexes, causing a 40 percent reduction in Canadian daily oil production—or over 1 million barrels a day (Lee 2021).

Fossil Fuel Volatility is a Persistent Threat to Our Economic Stability

Risks of Volatility

• Energy price volatility is a major factor in overall price stability
• Energy is the fourth largest category of expenses for the average US household (11% of all expenditures)
• Energy is often the most visible indication of price increases (Gas Prices, Energy bills)
• Fossil fuel price shocks hit businesses and consumers, dragging down economic activity and often triggering recessions
• Energy consumption is inelastic, so people are forced to pay higher energy prices and decrease spending in other sectors
• Many business operations rely on gasoline and energy as factors in the production and distribution of goods and services

Energy Is a Macroeconomic Issue

10 out of the past 12 recessions have been preceded by a shock to oil prices.

Transitioning to Renewable Energy Will Bolster Price Stability

Consistent, Infinite & Universal

• While petroleum must constantly be discovered and extracted, renewable energy is, by definition, naturally replenishing—the sun shines and the wind blows every day.
• This prevents the type of major disruptions that plague the fossil fuel industry and provide price uncertainty.
• Each country has access to some renewable energy sources and, with equitable distribution of these necessary components for the upfront costs of renewable energy technology, production can be relatively free of the geopolitical dynamics that cause much of the volatility of fossil fuels.

Affordable

• The cost of producing renewable energy is rapidly declining due to technological advances and increases in economies of scale.
• Estimates indicate the costs for solar and wind technologies will fall to 60 percent and 70 percent, respectively, below the long-run marginal cost for natural gas by 2030.

No Fuel Costs

• Once capital is invested in the infrastructure to capture renewable energy and convert it to electricity or heat, there are no fuel costs—that is, no specific volume of gasoline manufactured elsewhere that must be input to generate power.
• Without fuel costs, the most volatile component of fossil fuel prices, renewable energy production can have long-term, fixed-price contracts—something that is not possible in fossil fuel production.

Delivered via the stable electricity sector

Fighting Climate Change

• A rapid transition to renewable energy will slow and minimize further warming of the climate, translating to fewer energy system disruptions that result in price volatility due to a mismatch between supply and demand or speculation.

​

What Does This All Mean?

Lower, More Stable Prices

• A rapid transition to wind and solar energy production today, followed by more technological advancements in subsequent years, will save consumers $26 trillion in energy costs in the coming decades.
• These savings are particularly crucial for low- and middle-income households, as energy prices typically comprise larger shares of their household budgets.
• Without the persistent volatility caused by fossil fuels, consumers and businesses will enjoy more consistent

Promoting Equity

• Energy inflation can be the tipping point into energy insecurity for many low-income, Black, and Latinx households who face a higher energy burden and have limited disposable income
• Electrifying the grid and transitioning to renewable energy sources will deliver more stable and affordable energy prices in the long term, reducing the energy burden for all households in addition to decreasing the disproportionate impact on low-income, Black, and Latinx households and minimizing their risk of energy insecurity due to fossil fuel volatility.

Stronger, More Inclusive Growth

• In addition to creating millions of jobs in research, development, and deployment of renewables, a green transition will yield savings in energy prices that will flow to other sectors and drive inclusive growth across the economy.
• Avoiding consistent price shocks will also prevent persistent economic contractions and support long-term sustainable investments.

Unlocking Greater Levels of Employment

• Policymakers try to balance the goals of price stability and employment
• With greater stability in energy prices, we can achieve higher levels of employment with reduced inflationary risks and subsequent austerity and backlash.

Q + A