by Marshall Auerback
Monday, 27
June 2022
Analysis
16:15

Low energy prices won’t stop a recession

A collapse could herald tough economic times across the world
by Marshall Auerback
Oils well that ends well.

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. 

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Arkadian X
Arkadian X
3 months ago

Not quite clear what the author’s point is. If energy prices keep going up (and in the UK gas and electricity should go up by another 50% in October, plus petrol prices never seem to stop increasing) for sure there is going to be a recession.
If they go down… There is going to be a recession.
So I would probably rephrase it saying that there will indeed be a recession, but at least energy prices will go down.

Marshall Auerback
Marshall Auerback
3 months ago
Reply to  Arkadian X

No the point is that rising energy prices have been a contributing factor to rapidly decelerating consumption all across the US, UK and EU, which will likely contribute to a recession (so we’ll get the lower oil prices, but only as a “consolation prize” for more economic dislocation). What’s very striking as one looks at the latest data (everywhere in fact) is how quickly things are slowing down. We could have a real problem on our hands by the autumn.

J Bryant
J Bryant
3 months ago

Thank you for clarifying your article, Mr. Auerback.
My question (should you choose to answer) is what can we do about our current economic situation? Is a crash inevitable and necessary?
More generally, how can we build a sustainable economic future? I see so many clever articles describing the problems, but few articles proposing specific, workable solutions. Where can I find such articles? Perhaps you would consider writing one.

Arkadian X
Arkadian X
3 months ago

I see. Thank you.
I have to say, I have not seen a decline in traffic… It looks all the same where I am. Personally I am currently hunting for cheap/er smokeless coal to try and use less gas come the winter, not sure what others are doing.

Pete Williams
Pete Williams
3 months ago
Reply to  Arkadian X

I’m hard at work cutting down my local rainforest. Plenty of firewood to cook my Orangutang stew.

Ian Miller
Ian Miller
3 months ago
Reply to  Arkadian X

The simplest answer is to stop digging ever deeper into this Climate Change hole we have apparently dug for ourselves, and wake up to the fact that India, China and others are reaping the benefits of Cheap Reliable Energy. When the West is Virtue-Signalling its way to Obscurity it needs to – STOP DIGGING !!

Last edited 3 months ago by Ian Miller
Nicky Samengo-Turner
Nicky Samengo-Turner
3 months ago

I predict a crash at the beginning of Q4 ’22, when crypo vapourisation and tech stock plunge will allow index and tracker funds to plummet equity markets, and a switch into cash/ bonds will cause bond prices to rise, bond yields to drop, completely out of synch with by then raised interest rates….

Brendan O'Leary
Brendan O'Leary
3 months ago

The oil price fall in late 2008 was merely a blip in the 2004-14 oil price boom and could be seen as a mere correction to the sharply-rising price in the months from late 2007. The slump since KSA opened the taps in late 2014, and the collapse during pandemic shutdowns seem far more significant.
https://www.macrotrends.net/1369/crude-oil-price-history-chart

I guess there are two somewhat opposing trends:
A drop in demand due to coming recession and a squeeze in supply due to war and sanctions. They may see-saw for a while but eventually low price discourages investment and supplies reduce further until price goes up and investment resumes.

FacRecte NilTime
FacRecte NilTime
3 months ago

Exactly. I said something similar in a comment that seems to have been parked out pending approval (despite no obvious trigger words)

Hardee Hodges
Hardee Hodges
3 months ago

One issue that’s different is the ESG push has restrained investment. That started ~ 3 years ago by Blackrock, etc. That shows up later as exploration slows and risky funds for drilling are not there. But a balance will arrive perhaps after considerable economic damage. (As if the pandemic hadn’t already placed the world on tilt).

FacRecte NilTime
FacRecte NilTime
3 months ago
Reply to  Hardee Hodges

Good point. Although UAE has been investing to increase short term production precisely to monetise their reserves before they become stranded assets as a result of energy transition. Saudi Arabia takes a more cautious approach as it also wants a sustainably high oil price to finance its economic diversification, which is less advanced. Refineries in consumer markets rather than production are however a specific choke point for capacity, and this shortfall does seem to have been influenced by the ESG bandwagon.

Eddie S
Eddie S
3 months ago

The article makes sense but the headline doesn’t. Cheaper energy prices per se might well save us. However the article argues any cheaper prices would mean we’d already gone into recession, in which case they would be a symptom of us already not having been saved. Thus the headline is somewhat circular in its logic.

Andrew McDonald
Andrew McDonald
3 months ago

The bit we never seem to get to is any discussion of when we stop using (and wasting) quite so much energy, rather than when its price will go up, and when it will go down. Like, say, food prices in an economy where up to a quarter of all food produced is never consumed. The coming recession may make that a less desirable luxury.

Matt M
Matt M
3 months ago

The bit we never seem to get to is any discussion of when we stop using (and wasting) quite so much energy

This seems to be discussed pretty frequently to me. Aren’t those people who keep blocking roads doing it in the name of better insulation?
I suspect the problem of insulation and energy wastage is more difficult than they will admit given there have been grants to get your loft insulated for two decades.

FacRecte NilTime
FacRecte NilTime
3 months ago

So it’s cyclical, who knew? Well, for a start, Saudi Arabia and the other major oil producers – much of whose surpluses are invested in western markets and who therefore have an interest in prices that are sustainably strong without provoking a recession that crashes stockmarkets, or energy demand, or drives faster transition away from hydrocarbons.

Current crude oil prices reflect high demand as the covid pandemic (crude dropped to low $20s in early 2020 after several years in the range $40-60) and broader supply chain crisis unwinds. Inflation today is price-led not wage led. This is not the seventies.

Demand will adapt and the price will ease. It will be a market correction, albeit probably with a degree of overshooting. It will not be a full blown recession unless Ukraine or some other external shock supravenes.

FacRecte NilTime
FacRecte NilTime
3 months ago

So it’s cyclical, who knew? Well, for a start, Saudi Arabia and the other major oil producers – much of whose surpluses are invested in western markets and who therefore have an interest in prices that are sustainably strong without provoking a recession that crashes stockmarkets, or energy demand, or drives faster transition away from hydrocarbons.
Current crude oil prices reflect high demand as the covid pandemic (crude dropped to low $20s in early 2020 after several years in the range $40-60) and broader supply chain crisis unwinds. Inflation today is price-led not wage led. This is not the seventies.
Demand will adapt and the price will ease. It will be a market correction, albeit probably with a degree of overshooting. It will not be a full blown recession unless Ukraine or some other external shock supravenes.