How the ‘Energy Shock’ Has Upended the Global Economy

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Just as the world was getting serious about a green-energy future, its dependence on fossil fuels struck home with a force not seen since the 1970s. Russia’s invasion of Ukraine combined with pressures unleashed by the pandemic to send the price of all forms of energy rocketing, with oil climbing more than 50% in the first half of 2022. That energy shock was at the heart of a surge in inflation 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 plunged briefly below zero as the pandemic sank the global economy. A year later, the price had rebounded to pre-pandemic levels and kept on rising as revived demand outstripped growth in crude supplies. Then came a wild series of jolts from the 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 fertilizer to nickel). More than half of Russia’s oil exports go to the countries in the European Union, but markets for energy are global, so changes in supply and demand are felt worldwide.

Consumers were hit particularly hard, since spending on energy is difficult to cut. In the UK, regulators warned that the surge in global natural gas prices was set to drive the average household energy bill up another 42% in October when a price cap is adjusted higher, producing the biggest hit to living standards since the 1950s. In much of the world, retail fuel prices rose even faster than crude. Gasoline topped an average of $5 a gallon (3.79 liters) in the US for the first time in June, the start of the summer driving season there. The end result was a surge in inflation that the world hadn’t seen in decades, with energy making up more than half of the jump in major advanced economies. Beyond price concerns, there were worries that global power grids already strained by climate change could prove even more fragile, leading to blackouts that could put lives at risk.

There was a scramble to increase supplies and reroute fuels to where they were needed — efforts that met with limited success. The EU phased in a partial ban on Russian oil and bought more liquified natural gas on world markets to wean itself off of Russian gas pipelines, which accounted for 40% of supply. By mid-June, Russia, for its part, had cut off gas flows to four EU countries. US President Joe Biden’s administration asked oil refineries about the feasibility of bringing back mothballed capacity. There were other responses as well: To cool the surge in inflation the US Federal Reserve and its counterparts were expected to crank up interest rates in the most aggressive monetary policy tightening cycle in decades (China and Japan were exceptions). That won’t bring energy costs down right away, but the aim is to slow economic growth to such an extent that inflation fizzles out.

By early June, there was no sign of an end to what had become a grinding, bloody war in Ukraine and little hope for big boosts in energy production, with the oil-rich OPEC nations agreeing to only a modest increase in oil output. The price of the West Texas Intermediate oil futures contract climbed above $120 a barrel, and a potential post-pandemic resurgence in consumption in China, the world’s biggest crude importer, threatened to add even more upward pressure. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said that oil had the potential to hit $150 or $175 a barrel and that the bank was bracing itself for an economic “hurricane.”

5. How does this compare with previous shocks?

The vault in prices is comparable to history’s two most famous oil shocks: the 1973 Arab-Israeli war, which led many crude producers to refuse to sell to countries that supported Israel, and the revolution in Iran six years later that for a time cut out about 7% of global crude supply. But there are differences: Economic growth isn’t as closely linked with oil as it was in the 1970s — output is much less energy-intensive than it was back then. Fracking shale has made the US the world’s biggest producer of oil and gas, bringing America much closer to the energy independence it pursued after gasoline shortages hit home in the 1970s. Still, the crisis was a reminder that the world remains reliant on fossil fuels for more than three-quarters of its energy, a state of affairs that’s likely to endure for decades, even as some countries speed up their investment in renewables.

• A Bloomberg Economics report on what’s driving faster inflation around the world

• How Russia’s war in Ukraine is choking commodities exports.

• A blog post from the International Monetary Fund on how the world now gets more mileage from each barrel of oil.

• Bloomberg Opinion’s John Authers on comparisons with the oil shocks of the 1970s.

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