The recent tightening of energy markets and ensuing price spikes are being felt globally. These conditions are driven by a multitude of factors related to fossil fuel demand and supply. Fingers are being pointed at producers, at the transition to clean energy sources, and at government.
The blame game is overly simplistic, and helps no one.
Demand has returned more forcefully than expected in 2021 following Covid-induced declines – industry analysts also believe prices reflect the risk of a cold winter that could drive demand still higher. The supply side issues include meager stockpiling of coal in Asia, outages from hurricane Ida, and, more structurally, less refining capacity for diesel and other fuels worldwide.
In the United States, the Biden administration has been accused of “beating up” the oil and natural gas industry while asking OPEC to produce more oil to help ease the pressure on gasoline prices. In trying to balance its climate aspirations and the realities of the economy, a somewhat tumultuous picture emerges. On balance, though, the administration’s actions have not been as detrimental as the oil and gas industry associations claim, nor as bad as the environmental community seems to think.
We highlight three important lessons from the ongoing energy crisis.
The first is the importance of storage, diversity, and redundancy of supply. In other words, this isn’t primarily a production problem, but a more complex picture including closely-linked markets, new trading maps, changing geopolitics, a confluence of unexpected demand issues, and not enough focus on reliability and resilience.
Second, as it relates to the transition away from fossil fuels, the crisis is serving as a reminder that government needs to establish and clearly communicate strategies that result in declines in demand as well as supply. Focusing on one without the other threatens to hurt either consumers (if supply is short) or the industry (if demand is cut too quickly). This requires thoughtful policy and regulation that can help manage and “steer” the transition over various timeframes effectively – not an easy task.
Third, natural gas will likely play a key role over the next two decades as low-carbon industries develop and grow. This is a controversial point, as some insist that any fossil-fuel development hurts the planet. And it is true that methane emissions associated with oil and gas development must be severely limited, and soon. Yet with the need to retire higher carbon-emitting fossil fuels (such as coal) as a priority, there is no viable substitute at scale.
It is true that the new U.S. administration brought with it rhetoric about America’s need to wean itself off of fossil fuels in order to address climate change, and their early actions included a pause of leasing on federal lands. Still, their actions did not cause any substantive constraint on activity.
For example, despite the review of federal land practices, the number of drilling permit approvals on federal lands in 2021 will exceed those issued annually during the first three years of the prior administration. These recently issued permits have bolstered what for many companies was already years of drilling inventory.
While U.S. oil production remains about 12% below the highs set before the pandemic, this is not due to the Biden administration. Instead, the U.S. is producing less oil because the industry has spent less to extract it from the ground – and it has spent less because that is what investors and lenders demanded.
These financial actors have chosen to rein in the U.S. oil and gas industry not primarily due to climate change or the tone of the Biden administration (or even the risk of additional regulation), but rather because of the industry’s own behavior. Years of bloated capital expenditure budgets, fueled by debt, had delivered disappointing financial returns.
Senior management of the publicly-traded companies acknowledge this and all have, over the course of the last year, adjusted their business models to spend less of the cash they bring in, and instead to pay down debt and return cash to shareholders. In so doing, they have positioned their companies to grow production more slowly.
The current energy crisis creates an opportunity for the oil and gas industry to highlight how it can be a positive part of the solution set for decades to come (which several international oil company representatives are in fact doing). It is also a good time to vastly improve data transparency around greenhouse gases and local emissions.
Misrepresenting the current crunch as a production problem, blaming renewables, and trying to suggest U.S. government culpability squanders that opportunity. Meanwhile, governments in attempting to work towards both economic and environmental goals, must heed the lessons from the current crunch and focus in earnest on fostering energy security and sustainability.
Morgan Bazilian, of Golden, is director of the Payne Institute for Public Policy at the Colorado School of Mines. Brad Handler, of Pleasantville, N.Y., is senior fellow at the institute.
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