With U.S. inflation standing at a 40-year high of 7.9%, the Federal Reserve has finally begun to tighten monetary policy, with a small initial increase in interest rates and the promise of more to come. Getting inflation back under control won’t be easy — and the Fed shouldn’t be asked to do it all alone.
The soaring price of energy is compounding the problem. President Joe Biden’s recent announcement of a ban on imports of Russian oil, gas and coal helped push the benchmark price of oil to well over $100 a barrel at one point — and the effects of this most recent spike aren’t yet reflected in the inflation rate. As the war in Ukraine drags on, there might be worse to come. What can be done to mitigate the short-term inflationary pressure from mounting energy costs?
Truthfully, less than one might wish. Even so, the Biden administration isn’t helpless.
Governments shouldn’t pretend consumers can be sheltered from the economic consequences of Vladimir Putin’s war. Some of the measures under consideration, such as a gas-tax holiday, would be cosmetic at best. Accusing U.S. oil producers of gouging their customers is downright counterproductive; the administration needs these firms as partners, not enemies. On the other hand, poorly designed subsidies for energy production might yield little in the short term and could jeopardize longer-term efforts to fight climate change.
Markets for energy are forward-looking. Forward prices rose much less than spot prices after the energy sanctions on Russia were announced. What producers expect to be paid in the future, not today, guides their production planning. Short-term supply is relatively inflexible, and fresh investment is required to bring new and existing wells online. The challenge is to moderate the upward pressure on short-term prices, and hence on inflation, without making fossil fuels more attractive in the long term. Ideally, planned supplies would be delivered sooner, not persistently raised.
The Strategic Petroleum Reserve is one way to do this. On March 1, the U.S. announced it would release 30 million barrels of crude oil from its stock of 580 million. (Other governments announced releases of their own, bringing the total to 60 million barrels.) Releasing stocks into the economy alleviates the short-term disruption. This can and should be combined with advance commitments to restock later, which would take supplies off the market and reassure producers that, until the reserves are replenished and preferably enlarged, there’ll be sufficient demand to justify a temporary increase in output.
The use of so-called exchange agreements with the SPR is well established. After Hurricane Katrina in 2005, for instance, the SPR lent refiners roughly 10 million barrels of oil, and another 11 million were sold into the market. The borrowed oil was paid back by 2007. Such arrangements help to stabilize both prices and production. The stresses caused by the Russia sanctions will likely be longer-lasting and more difficult to manage, but a more ambitious use of the SPR could make a difference.
The administration should also explore other ways of boosting short-term supply. Officials have been in talks with Venezuela. Negotiations with Iran over the terms of a revived nuclear agreement could bring new supplies back to the market. Improving U.S. relations with Saudi Arabia offers another avenue to do the same. All such initiatives involve downsides, and a balance will have to be struck between the pressing need to stabilize the global energy market and the risk of jeopardizing other vital goals.
Note, however, that none of these initiatives need deflect the U.S. and its allies from their efforts to fight climate change. The goal, after all, is not to make fossil fuels cheaper than they would’ve been if not for the assault on Ukraine; it’s merely to keep the rise in short-term costs within bounds. Efforts to stabilize the market with additional short-term supplies are consistent with higher fossil-fuel costs in the medium and longer term, which in turn will accelerate the shift to energy efficiency and low- or zero-carbon alternatives.
The SPR and its counterparts in other countries are finite and, in relation to the market as whole, small. Who knows whether the disruptions due to Russia’s aggression will get worse, or how long they’ll persist. Reserves can’t solve the problem. But they can help for the time being — and this is exactly the kind of emergency they were designed for.
— Bloomberg Opinion (TNS)
