History shows high energy prices could drive us into recession
Compared to the tremendous suffering of the Ukrainian people, Americans paying more at the pump is a minor inconvenience. But the recent energy price spike hits many families and industries hard and may have much larger implications for the American and global economies. In efforts to help try to avoid another recession, U.S. lawmakers should implement policies that increase the supply of fossil fuels.
Although the Great Recession of 2007-2009 is understandably blamed on a massive housing price bubble and financial industry malpractice, energy prices were also a contributing factor. Crude oil prices more than doubled between the beginning of 2007 and summer 2008 — peaking at more than $145 per barrel. Regular gas prices reached $4.06 per gallon in July 2008 — a level that was not surpassed until March 2022.
Higher fuel prices raise the cost of agricultural commodities, which require energy to be harvested, and of finished goods, which are usually shipped by truck. For consumers, the increased price of driving to the store and buying products, reduced buying capacity.
Demand for gas-guzzling light trucks and sport-utility vehicles cratered. Reduced sales of these big, high-margin vehicles hammered the big three U.S. automakers, which had become dependent on truck and SUV sales. By 2009, General Motors and Chrysler had entered bankruptcy, along with numerous automotive suppliers. Although federal bailouts cushioned the blow, the industry still shed tens of thousands of jobs.
2008 was not the first time that energy price spikes laid the U.S. economy low. In 1973, an OPEC oil embargo triggered a sharp recession which lasted into 1975. A few years later, the Iranian Revolution and the Iran-Iraq War crimped Middle Eastern oil supplies, driving up gas prices and contributing to recessions in 1980 and 1981-82.
Issues with Iran also exacerbated the oil price spike in 2008. During the spring and early summer, markets priced in the risk of a U.S.-sanctioned attack on Iran’s nuclear program by the Israeli air force. Once it became clear that President George W. Bush had rejected neoconservative calls for military confrontation with Iran, oil prices rapidly receded (although the drop was likely the result of numerous factors, including reduced oil demand caused by the recession).
Today, amidst Russia’s invasion of Ukraine, high inflation in the U.S., and ongoing pandemic measures, high energy prices are contributing to worries about a new recession, just two years after the economy bounced off its coronavirus trough. Treasury yield curves have recently approached an inversion point under which longer-term yields fall below shorter-term yields — widely regarded as a harbinger for recession. Meanwhile, the Atlanta Fed’s GDPNow forecast recently estimated first quarter 2022 GDP growth of less than 1 percent.
Since energy price spikes typically correlate with economic downturns, policymakers should avoid actions that might result in sharp oil price increases. That starts by reducing conflict in the former Soviet Union, Middle East and other oil producing regions.
While no one seems to know what Russian President Vladimir Putin is thinking, offering Russia an off-ramp from recent sanctions could increase the odds of peace in the Ukraine while also stabilizing international energy markets. Now would also be a great time to return to the Iran nuclear deal abrogated by former President Donald Trump since Iran has enormous oil reserves. As good investors know, diversification is a great way to reduce risk: Diversity among international oil supply sources reduces the risk of sudden oil price increases.
Of course, U.S. policy can’t guarantee that all foreign oil suppliers will remain on line. In Venezuela, poor management by the socialist government is crimping that country’s oil output.
The best way to ward off foreign energy instability is to encourage low cost energy production at home.
A major contributor to the reduction in oil prices in the 2010s was the spread of hydraulic fracturing in the United States. The amount of oil produced from fracking in the U.S. increased from less than 1 million barrels per day in 2010 to over 4 million barrels by 2015. According to the Independent Petroleum Association of America, fracking has produced a total of 7 billion barrels of oil and 600 trillion feet of natural gas since 1947.
Unfortunately, fracking has proven controversial due to environmental concerns. Maryland, New York, Vermont and Washington have imposed fracking bans, and other states have implemented strict regulations. To the extent that fracking or drilling fouls water supplies or causes other environmental damage, limits on fracking — ideally achieved by affected property owners defending their rights in court — are appropriate. But blanket restrictions, driven by a general hostility to fossil fuel production, are problematic.
At the same time, efforts to diversify the U.S. away from fossil fuels can also help protect the American economy from price spikes. To the extent that electric vehicles obtain their energy from solar, wind, hydro and nuclear power sources, they reduce our dependence on potentially unreliable oil sources. Energy storage technology helps solve the intermittency issues with some renewable forms, further loosening reliance from fossil fuel sources. Similarly, voluntary measures to conserve energy should also be welcomed.
Although we can debate the extent of anthropogenic global warming, we shouldn’t pass up cost-effective opportunities to reduce our dependence on energy sources that generate carbon pollution. For example, the U.S. should welcome imports of low-cost solar panels overseas — rather than imposing tariffs on them as the Trump administration did.
President Obama’s “All-of-the-Above Energy Policy” largely struck the right tone. Although it included far too many unwelcome subsidies to politically connected clean energy producers and others, the approach of facilitating all types of energy production is the one most likely to help ward off energy price spikes. By further opening the door to an array of domestic energy alternatives and helping de-escalate international conflicts that threaten overseas energy supplies, U.S. policymakers could play a role in reducing the risk of another Great Recession.
Marc Joffe is a policy analyst at Reason Foundation, former senior director at Moody’s Analytics, and author of the new study “Unfinished Business: Despite Dodd-Frank, Credit Rating Agencies Remain the Financial System’s Weakest Link.”
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