Amy Myers Jaffe, Boston - Feb 28, 2022

Oil and gas price spikes, amplified by geopolitical risks surrounding Russian military action, have raised questions about whether markets are moving into a structural commodities supercycle based on a lack of investment in future supplies, or whether this is a brief anomaly. It is perhaps premature to conclude the energy “transition” has created undue price volatility, and I would argue that it is still not firmly ensconced enough to negatively influence new supplies in 2022. Rather, Covid-19 has stimulated a bust-boom supercycle. The ultimate impact of high prices is still an unknown given the extreme geopolitical risks facing international oil and gas markets today. But if history is any teacher, high oil prices and any war-related supply disruptions are also likely to hasten the long-term trend toward the declining oil intensity of the global economy. 

For decades, the oil patch has suffered from an extrapolation problem. Typically, the coterie of analysts, executives and government officials that comment publicly on oil prices have had difficulty not drawing a straight line from whatever trend is dominating the market’s immediate present-day reality. During oil price rallies of 2008-09 and again in 2012-14, dire tales of running out of oil, so-called peak oil supply, dominated prognostications about how expensive $100 oil was here to stay forever. On the flip side, notable market collapses (post-2009 financial crisis, 2020 Covid-19 crisis) produced headlines predicting the ultimate end to the oil era.

What we know from experience is that oil and gas prices remain cyclical, connected to the global secular business cycle and amplified the relatively lengthy time scale that it takes to bring on incremental oil and gas production capacity and export facilities. As just took place in 2021, periods of strong global economic growth lead to increased oil and gas demand. As the world waits for new investment, oil and gas prices tend to push higher, leaving the global economy more susceptible to price shocks, which geopolitics often delivers. The latter can then plant the seeds for recession, which, in turn, lowers demand and brings prices down again. In addition, high prices drive a shift to alternative fuels. It is a cycle that has repeated itself many times since the mid-1900s, sadly often against the backdrop of wars involving major oil exporting countries.

Lately, there appears to have been even more confusion than usual about whether oil and gas has moved into a structural commodities supercycle based on a lack of investment in future supplies or a brief anomaly on the way to the permanent replacement of carbon-laden oil and gas for cleaner energy sources. But sometimes the simpler explanation can be the more accurate one. I believe that the Covid-19 pandemic created a one-time, unprecedented oil and gas boom and bust supercycle that was sudden, fierce and sui generis. It has been amplified by the rising geopolitical risk of the Russia-Ukraine conflict. Historically, military conflicts involving oil exporters often are punctuated by prolonged sanctions against energy exports. This risk, as well as other kinds of disruptions to energy flows, is rising.

Lockdowns and Stimulus

When Covid-19 lockdowns came in early 2020, oil demand collapsed overnight. Oil exporters struggled to find sufficient storage for the unprecedented volume of unwanted barrels, and in many locations, production had to be throttled back and new drilling put on hold. The economic hit of Covid-19 was so severe, that governments around the world injected massive amounts of cash into their economies. Fast forward to 2021, economic stimulus and vaccines bring a return to GDP growth, in some cases, like the US, at a very fast clip. US GDP averaged gains of 5.7% last year, the fastest rate in decades. Global GDP gained 5.5%

The sudden return of demand, as quickly as it had disappeared, left oil exporters scrambling to restore production but many experienced technical and financial setbacks that slowed rapid restoration of production capacity. The lag in restoring output, which would be a common aspect of the bust-boom cycle, leaves some unanswered questions this time around, however. Might the energy transition be discouraging capital spending in oil and gas development? Did the sudden shutdown of production in the spring of 2020 damage reservoirs inside Opec-plus countries and contribute to a shrinkage of spare capacity that is supporting tighter markets? Or are Opec-plus' largest members simply grabbing the opportunity to hold back volumes to goose up prices for geopolitical or financial reasons?

I would argue that the energy transition is not firmly ensconced enough to negatively influence new supplies in 2022. This year’s production is the result of capital investment made in the 2010s when industry had not embraced the possibility of lower future demand. And US shale drilling that tends to be shorter cycled is now responding positively to rising prices, as would be expected in the normal pattern of bust to boom.

Lessons From History 

Analysts disagree about how much new oil will come on line in the next six to eight months. Still US production will likely reach record levels again this year and new oil production is expected from Canada, Brazil, Guyana, Argentina, Colombia and Suriname, among other places. It seems clear that supply is not standing still. But history would suggest that as these new barrels come on line, they might not actually be met with the forecasted strong rise in demand. Instead, high oil prices and geopolitical conflict might slow global economic growth and leave markets just as suddenly oversupplied.

Not only is evidence emerging that inflation could slow US growth, but high fuel prices are crippling the recovery in low- and middle-income countries whose debt levels had already reached burdensome levels. A freeze on debt payments in 2020-21 has also now ended and the world’s poorest nations face $35 billion in debt service payments in 2022, calling into question whether their economic recovery can be robust. Supply-chain problems could also wind up as a drag on optimistic scenarios for economic growth in export-oriented economies.

The ultimate impact of high prices is still an unknown. Still, if history is any teacher, high oil prices and geopolitical conflict involving a major oil-exporting country are also likely to hasten the long-term trend toward the declining oil intensity of the global economy. It now takes 92% less oil to fuel one unit of GDP in the US, compared with 1972. China has also been proactively working to lower the oil intensity of its economy, which is currently only 26% as oil intensive as it was in 2000.

Digital Accelerator

While it is true that Covid-19 has been a mixed bag for oil demand, it has also been an accelerator of the digital economy. Telecommuting is now an accepted alternative to commuting to an office in many economies. Jobs that can be done remotely, for example, potentially constitute 40% of employment in the US and Europe. Prior to Covid-19, telecommuting represented under 5% to 10% of jobs. Moreover, physical commuting was a large driver of oil use and congestion. In the US for example, commuting constituted 16% of US oil demand. As economic activity gets back to normal, travelers might return to public transit, but some level of telecommuting is likely to remain.

E-commerce is also on the rise, up 44% in the US in 2020 and up 54% in Mexico, for example. With tech giants like Amazon, Microsoft and Google all committing to net-zero targets and clean energy for delivery vehicles, data centers, and more, increases in the digital footprint of major economies could eventually lower oil intensity further.

The juxtaposition of the pandemic and the digital revolution have clearly made itself felt in the oil world. But it is likely premature to conclude the energy “transition” has created undue price volatility. Rather, Covid-19 has stimulated a bust-boom supercycle the end of which — another crash in prices — has yet to arrive.

Predictions that such a crash can never come again seem premature, especially in light of a major war in Europe. Governments and companies have many tools at their disposal to lower dependence on oil, maybe not in one week but certainly over many months. They are likely to use them.

Amy Myers Jaffe is research professor and managing director at the Climate Policy Lab at Tuft University's Fletcher School, and the author of "Energy's Digital Future."