The United States has weathered energy shocks before. Broad price swings for a barrel of crude are nothing new.
But we have never seen an energy crunch like 2022: Reeling from a pandemic, confronting climate change, with oil and gas embargoes weaponized in a foreign war. The resulting shortage of optimism and confidence spoke volumes as the Dallas Fed and Minneapolis Fed gathered academic, industry, and political leaders for a recent summit on “Energy Inflation: Drivers and Solutions.”
Energy investments require major up-front expense for a distant payoff. U.S. producers are, by some measures, well positioned to gear up and bring more supplies online. But participants cited a list of headwinds in the near term, not least a shortage of labor and investor interest.
With the world poised midstream in a massive transition to renewable energy, CEOs say they and their investors lack a clear sense of the balance between today’s energy needs and tomorrow’s climate goals. Crucial components for solar and wind power are affected by tariffs, shortages, and clogged supply chains. It is also hard to launch new investments without knowing if Russian oil and gas are off the menu for months, years, or decades.
The foggy outlook heightens the challenge for the Federal Reserve, whose monetary policy levers target only one side of the forces driving inflation. “Our tools don't really work on supply shocks. Our tools work on demand,” said Fed Chair Jerome Powell following the recent decision to increase interest rates by the most in more than 20 years. “We can't affect, really, oil prices or other commodity prices.”
Hearing about the supply outlook directly from industry and elected decision-makers helps Fed officials gauge how long and how deeply to apply demand-side tightening in the Fed’s commitment to bring inflation back to its long-term 2 percent target.
No template for this oil shock
The past offers limited help in understanding today’s challenges, said Dallas Fed Senior Economic Policy Advisor Lutz Kilian—at least when it comes to crude oil.
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Economic history does offer some reassurance. Despite the conventional narrative about 1970s and ’80s inflation, Kilian said, oil supply shocks “historically have never caused persistent inflation.” Jumps in crude oil prices tend to cause “a one-time blip in the inflation rate.” Nor is there evidence that rising oil prices trigger wage-price spirals or monetary policy responses that worsen inflation, Kilian said.
The prices consumers experience at the pump are less volatile than the price of crude itself. At more than $4.00 per gallon, U.S. gas prices are at a new nominal high in the spring of 2022. Adjusted for inflation, however, crude and gasoline prices remain well below their peak in the summer of 2008, when gas topped $5.00 in today’s dollars (Figure 1).
Another reassuring fact: U.S. consumers’ expectations of future inflation—which, like a self-fulfilling prophecy, can spur inflation higher—do not seem closely tied to the price of gas. For now, Kilian says this trend seems to hold in the latest consumer surveys, with “no evidence that gasoline price shocks are moving long-run inflation expectations.”
However, there are reasons to see 2022 as a different beast from previous oil crises. One factor is the lingering damage to supply chains from the pandemic. The other is Russia. In fact, Kilian said, our current situation is not fundamentally an oil supply shock at all, but rather “a negative shock to the demand for Russian oil.” And that shock has yet to unfold.
“We’re going to see growth of more than a million barrels a day in U.S. oil supply this year,” said Columbia University’s Jason Bordoff. “There’s just too much money to make at these oil prices.”
Should a full-scale European embargo come to pass, Kilian says it might lower Russian oil production by 3 million barrels a day—almost one-third of Russia’s total output, roughly 3 percent of global supply. In that scenario, “it becomes very difficult for Russia to restart production, especially without foreign technical assistance,” Kilian said. “We could be looking at an extended period of lower Russian production if that happens.”
And in the face of higher prices, the world’s demand for oil shows no sign of weakening. All of this suggests to Kilian that “we have only seen the beginning” of the current oil shock. “The reason is that this isn’t just about oil, it is also about natural gas in Europe,” Kilian said. “It is about other industrial and food commodities that affect the economy, and it is about global supply chain disruptions on top of the supply chain disruptions we have already seen.”
U.S. shale to the rescue?
Rising use of renewable sources and new technologies to tap shale oil deposits—such as North Dakota’s Bakken Shale and Texas’ Barnett Shale—helped the U.S. become a net exporter of petroleum in 2020 and 2021. With global markets disrupted, can U.S. oil and gas supplies rise to the challenge?
“U.S. shale is ‘short-cycle’ supply, and it responds very quickly to changes in price,” said Jason Bordoff, co-founding dean of the Columbia Climate School and founding director of the Center on Global Energy Policy. “It is going to respond. We’re going to see growth of more than a million barrels a day in U.S. oil supply this year.”
Oil and gas investors “want us to buy back shares and they want us to increase the dividend. They don’t want us to grow right now,” said Vicki Hollub of Occidental Petroleum.
Bordoff expects oil and gas investors to overcome their recent hesitancy. “I think that so-called ‘capital discipline’ is going to ease,” he said. “There’s just too much money to make at these oil prices.”
That view met some skepticism from industry representatives.
“We’re headed for an environment where we just can’t amp up supply very quickly,” said Vicki Hollub, president and CEO of Occidental Petroleum. “We will see incremental production from the U.S. this year, but it’s going to be insufficient to meet the demand.”
The collapse of energy demand during the pandemic led energy companies to ramp down their production as they reached their storage capacity. “We need to respect the fact that the supply chains have been disrupted for the oil and gas industry in a very significant way,” Hollub said. “We’re increasing production, but we cannot go too aggressively because the materials would not be there.”
Nor will the people, said Cindy Taylor, president and CEO of Oil States International, which provides back-end products and services to the drilling industry. Taylor estimates as many as half of oil rig workers were furloughed or laid off when COVID-19 hit.
“[As] we shut down the coal plants, which is absolutely the right thing to do as an industry … you remove some of that ability” to absorb surging natural gas prices, said Xcel Energy’s Brian Van Abel.
“This is shift work, hard work, hourly work,” Taylor said. “We have, I think, permanently lost a lot of workers who go out to the well site. These are highly technical, highly demanding jobs. A lot of industries out there today are facing retention issues, loss of workers. [This challenge] is on steroids for us.”
Exploring and extracting oil and gas also require large capital expenditures on the front-end—for which investors still have little appetite, says Hollub of Occidental Petroleum.
“Even before the pandemic, we were starting to see pressure from the investment community because of … the lack of return on capital to the investors,” she said. “We have to make up ground now. We have to return value to our shareholders. All of our investors in our stock want us to buy back shares and they want us to increase the dividend. They don’t want us to grow right now.”
Summit participants noted foreign policy options for boosting near-term global supply, including reviving the multiparty Iran nuclear agreement and strengthening foreign relations with Persian Gulf States.
They also reinforced the need to subsidize energy for low-income U.S. households, doing so in a targeted way that assists the most vulnerable without significantly stoking demand and thus making the overall situation worse.
It’s not easy going green
Multiple participants cited the challenge of a transition from fossil fuels to renewable energy sources, which is still a work in progress. One example: the move away from coal.
Xcel Energy is on track to become coal free by 2034, said Xcel Chief Financial Officer Brian Van Abel, who also leads Xcel’s Innovation and Transformation Office. However, this removes the utility’s flexibility to fall back on coal to generate electricity as natural gas prices rise.
“As we go through this transition and we shut down the coal plants, which is absolutely the right thing to do as an industry … you remove some of that ability to destroy [natural] gas demand,” Van Abel said. “What we really need to do is accelerate solar buildup, accelerate wind buildup, accelerate storage buildup to really replace some of the capacity that we’re losing.”
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Van Abel said Xcel has invested over the past five years to become one of the country’s largest generators of wind power, and plans another 10 gigawatts of renewable capacity in the coming decade to replace coal. The utility recently received regulatory approval to extend the operation of its Monticello nuclear plant until at least 2040, and is exploring the long-term potential of smaller, “modular” nuclear reactors to diversify its power sources.
While this diversification will transform our electricity sources, however, there is no clear alternative for the nearly half of American homes that rely on natural gas for heat. Natural gas prices this winter hit their highest levels in a decade, although they are well below their recent inflation-adjusted peak in 2011 (Figure 2).
And after a pre-pandemic boom for the solar industry, supply chain and production issues have set in, compounded by an investigation into whether major suppliers are circumventing U.S. tariffs on solar panels from China. These challenges, Van Abel said, “have really slowed down the solar buildup in the next couple of years.”
“We were used to solar costs and battery costs just falling year after year after year, and now the last two years we’ve started to see those costs rise again,” said Columbia University’s Jason Bordoff. “It’s going to take time for markets to respond and for the supply chains to catch up. And the mining: You need to do a lot of mining if you want to have a clean energy transition. It takes a long time for that to come online.”
Policymakers weigh in
The tension between immediate energy needs and future aspirations shaped the conversation at the summit between Sens. Kevin Cramer (R-N.D.) and John Hickenlooper (D-Colo.).
“We can see that climate change is real and there’s a sense of urgency around this transition,” said Colorado Sen. John Hickenlooper. What we’re really lacking is a plan, a long-term plan, so we can have some guardrails on what the price of oil is going to be.”
“I think oil and gas is in a tough situation,” said Hickenlooper. “They need long-term infrastructure, and yet we can see that climate change is real and there’s a sense of urgency around this transition. What we’re really lacking is a plan, a long-term plan, so we can have some guardrails on what the price of oil is going to be.”
“We have a 2050 aspiration—nothing wrong with that,” said Cramer. “We have a 2022 reality. The urgency of the two are clashing. The lack of a plan—the lack of a short-term, mid-term, a long-term plan—that investors and innovators can count on, really is a problem.”
Cramer dismissed suggestions that price-gouging plays a role in current energy prices. He called for relaxing government regulation on fossil fuel production, as well as on the mining of elements important for renewable technologies. Investments in carbon-capture technology, he said, hold the promise of “carbon-negative” oil. “We should be more fuel-neutral in our aspirations and just focus on emissions,” Cramer said. “If reduced emissions are the goal, let’s set that goal and find the incentives that turn the innovators loose.”
“We should be more fuel-neutral in our aspirations and just focus on emissions,” said North Dakota Sen. Kevin Cramer. “If reduced emissions are the goal, let’s set that goal and find the incentives that turn the innovators loose.”
Hickenlooper’s angle was somewhat different. “If you want to look at the most deflationary energy sources, it is the renewables,” he said. “As we went through this inflationary period, people who have gotten their power from wind and solar have seen no stress at all.”
Hickenlooper highlighted the need to invest in transmission alongside production. “We have to figure out ways to simplify not just pipelines, but transmission lines,” he said. “People are optimistic that we’re going to be able to efficiently harvest the renewable energy that’s sprouting up all around us. But if we can’t get those transmission lines permitted, we’re suddenly going to find we have gaps in where we’re producing energy and where we need energy.”
Both senators referenced bipartisan efforts to lower near-term barriers that prevent U.S. oil and gas from reaching countries affected directly by disruption of supplies from Russia.
“Our allies in Europe need what we have, they want what we have, they’re willing to build the infrastructure to take what we have, particularly in natural gas but also in oil,” Cramer said. “If they buy it from us, it has the additional benefit beyond national security of being cleaner and more climate-friendly.”
A bigger challenge for the Fed
Although Federal Reserve monetary policy tools influence the demand-related pressures driving inflation higher, Minneapolis Fed President Neel Kashkari underscored the importance of understanding the forces shaping energy supply.
“It doesn’t appear that there are any short-term fixes to bring energy prices back down on their own on the supply side,” said Minneapolis Fed President Neel Kashkari. “Which means we will probably have to carry more of the load through monetary policy in bringing demand down.”
“I’m confident that my colleagues and I have the conviction to do what we need to do to bring inflation back down,” Kashkari said. “But I’ll be honest with you: I hope we have to do less. And we’ll only be able to do less if more supply comes online.”
The summit conversation was rich with specific insights into the challenges facing the industry. It was not rich with answers.
“What I heard today from the experts is that it doesn’t appear that there are any short-term fixes to bring energy prices back down on their own on the supply side,” Kashkari said. “Which means we will probably have to carry more of the load through monetary policy in bringing demand down. But we are going to keep looking at the data—keep assessing what happens on supply, what happens on demand, what happens on workforce—and try to make the best decisions we can.”