Rising energy costs are highly visible and therefore not politically advantageous for politicians with constituencies comprising large numbers of energy consumers. And in politics, as the old saying goes, when you’re explaining you’re losing, a reality that drives most such public officials away from analytics — even if we assume that they understand them — and toward blame-shifting, in particular with respect to the fossil-fuel industry.
In reality upward and downward fluctuations in fossil energy prices are wholly consistent with fully competitive conditions and the market behavior driven by them. Increasing demand conditions, such as those attendant upon the global economic recovery from the Covid downturn, have the obvious effect of driving prices up. Short-term supply shifts can stem from a large number of causes: unexpected interruptions in production due to natural and manmade phenomena, actual and threatened military action, terrorist activities, transport accidents, pipeline ruptures, refinery outages, production decisions by governments and/or multinational organizations, and on and on.
The weather affects both demand and supply conditions in ways difficult to forecast very far in advance. More generally, many influences on energy prices are subtle. Because international crude oil prices usually are denominated in dollars, increases and decreases in the exchange value of the dollar yield declines and increases in crude oil prices, respectively, other factors held constant. Shifts in interest rates have effects that are crucial, however opaque to many public officials: An increase in interest rates will end to drive crude oil prices up in part because the fossil energy industry is highly capital intensive and higher interest rates make both investment and inventories more expensive.
Moreover, rising interest rates increase the expected rate of energy price increases over time for a reason more fundamental. The production of fossil fuels — crude oil and natural gas — is “substitutable” over time. Unlike perishables that must be sold and consumed immediately, fossil fuels can be produced either during the current time period or stored (in the ground) until a future one. If crude oil prices are expected to rise at x percent over the ensuing year, an increase in interest rates to a level above x percent means that it is profitable to produce more now and to put the sales revenues in the bank. This means that an increase in interest rates induces the market to increase production of fossil fuels during the current time period. Prices will fall now but rise faster over time, so that the expected price path rises at the (higher) market rate of interest.
In a word, the world is complex, which illustrates the profound unseriousness of the usual conspiracy mongering. What are serious are the public policies — in substantial part driven by the Biden administration — that have the effect of driving energy costs upward, a reality that receives far too little attention.
Consider first the investment and price effects of the ideological and policy environment deeply opposed to the use of fossil fuels. These impacts are far more profound than the obvious immediate price effects of pipeline denials, increased leasing constraints, and the like. As noted above, the expected price path for fossil fuels rises at the market rate of interest. The ideological and policy attack on fossil fuels must result in a decline in investment, a decline over time in production, and therefore upward pressure on both future prices and current ones, as higher future prices would create incentives to produce less now. This means that the adverse price effect from an expected decline in future investment would be reflected in prices almost immediately.
There are the effects of tax policies implemented as punishments rather than tools with which to allocate the costs of public spending efficiently. A good example is the legal exclusion of the major integrated oil companies from the use of the percentage depletion allowance, which is just a form of depreciation that all extractive industries are allowed to use. (The common “fossil subsidies” argument is profoundly incorrect.) Even given the formal exclusion of the major integrated oil companies, the allowance is limited as a practical matter to small producers, as it is allowed for only the first 1,000 barrels per day of production and is limited to 65 percent of net income.
There are the longer-term effects of massive subsidies for unconventional energy, that is, competitors to fossil fuels. The Congressional Research Service analysis shows that fossil fuels are about 78 percent of energy output and about 26 percent of the “subsidies”; renewables (including hydropower), respectively, 13 percent and 65 percent; and nuclear, respectively 9.5 percent and 1.7 percent. These subsidies often have the effect of allowing the producers of unconventional energy to underprice their output — the subsidies compensate fully or more than fully for narrow operating losses — and thus create an artificial competitive advantage, particularly in the electricity sector.
The Jones Act — the requirement that limits waterborne transport of goods between U.S. ports to vessels built and flagged in the U.S. and at least 75 percent U.S.-owned and crewed — increases transport costsmassively and distorts the geographic movement of crude oil among refineries. An example: Because transport of domestic crude oil on U.S. tankers is so much more expensive, it often proves cheaper to import crude oil for processing in domestic refineries.
The renewable fuel standard — the requirement that gasoline be blended with ethanol — is enforced with minimum blending requirements for refiners combined with a system of credits (“RINs”) that refiners failing to blend in the required minimum amount of ethanol in their gasoline outputs are required to purchase. This has been a particularly significant cost for smaller refiners. The costs of the ethanol and the credits are reflected in market prices, in particular because the demand for gasoline is less “elastic” (responsive to price changes) than the supply of gasoline. Moreover, ethanol has only about two-thirds of the energy content of gasoline, a real cost that has not received as much attention as it deserves.
Back to the ideological attack on fossil fuels: A reduction in current fossil investment in the U.S. and other western economies would be likely to yield an investment increase in economies with weaker property rights. The net effect of such a geographic shift in investment would be an overall reduction in global investment, and prices higher in the future and therefore now.
So ignore the conspiracy theories, the “greed” and “price gouging” accusations, and the other descents into silliness so common in the Beltway. Focus instead on the competitive market processes driving price dynamics in conventional energy sectors, and the ways that policy reforms might yield large benefits for consumers and the economy writ large.
