June 27, 2022 - 4:15pm

Be careful what you wish for: energy prices look set to plunge, which will alleviate inflation, but the fall will likely be the result of a debilitating recession, as opposed to any of the cosmetic measures now being proposed by global policymakers. A global constellation of collapsing economic activity points to an eventual collapse in energy prices as well.

As things stand, governments around the world are in a collective state of panic over rising energy prices. Last week, President Biden called on Congress to suspend the federal gas tax as he tries to quell the rapid surge in prices at the pump, which are contributing to his plunging approval ratings.

Similarly, Germany’s new coalition government is contemplating gas rationing after a drastic drop in supplies from Russia, saying Moscow’s decision to weaponise its energy exports had plunged Europe’s largest economy into a “gas crisis”. Scholz’s Government, along with the Netherlands and Austria, are all restarting coal power plants, in effect swapping climate change aspirations for energy security, as they seek to cope with the greatest inflationary pressures in decades.

All of this comes against the backdrop of newly released data from the International Energy Agency (IEA), which is predicting 1.7% growth in global petroleum liquids demand this year. That is considerably higher than the 1.36% annual average liquids growth rate since the beginning of 2000. And it may prove to be an overly optimistic forecast, given mounting signs of global economic distress (in part brought about by the surge in energy and food prices). In fact, according to the IEA’s own numbers, the oil market is likely to be in surplus by the end of this year, which would imply falling energy prices. 

On the surface, this should be good news for highly stressed consumers, buffeted by inflationary pressures and rising personal debt levels. But it comes with a catch: the price rises that have occurred over the past 12 months have created significant economic hardship for millions of consumers across the West, and enhanced the likelihood of a severe recession, given prevailing high levels of private indebtedness. Much like the tale of “The Monkey’s Paw”, the wish for relief in rising energy costs could well come with an enormous price — namely a renewed global recession.

The historical record shows that even during a small recession like between 2000-2002, global oil demand growth can go to zero for several quarters, which clearly has adverse price implications. Of course, the falls can be more dramatic in a severe recession.

We saw a dramatic fall in the price of crude oil in the wake of the Great Financial Recession of 2008 with West Texas Intermediate (WTI) collapsing in a mere five months from early July to December, from $147 to $29. But that price fall came against a backdrop of the greatest economic crisis since the Great Depression. 

While things are not yet as bad as they were in 2008, both Europe and the US are almost certain to experience significant recessions over the next few months even with a big fall in energy prices. Private debt levels remain high and unemployment is also likely to rise. Consumption is declining rapidly across the US and Europe, as the latest retail sales data indicates.

Sadly, despite the tightest labour market conditions in decades, very few workers have been able to benefit via significantly enhanced wage rises, as any gains have been largely swallowed up in real terms by rising inflation, which in turn has curbed consumer spending power.

Ironically, then, just as policymakers are reaching peak panic levels about rising energy prices (and therefore encouraging massive increases in energy infrastructure and fossil fuel production), the world may find itself facing an unexpected glut of energy over the next six months. While that would represent a welcome respite from some current inflationary pressures, the sting in the tail could well be much slower economic growth brought about by those much higher energy prices in the first place. 

Marshall Auerback is a market commentator and a research associate for the Levy Institute at Bard College.