## The Scramble for Energy

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### Overview
- The world shifted from "plentiful cheap energy" to scarcity amid low investment and war.
- European gas prices reached unprecedented levels in the third quarter of 2022, increasing roughly 14-fold from the third quarter of 2019.
- US gas prices have tripled and global oil prices have increased by about 40 percent (as of third quarter of 2022).
- High energy prices are a major driver of high inflation and a major drag on economic growth.

### Investment dynamics and the boom-bust cycle
- Investment in oil and gas surged beginning around the turn of the century and peaked in 2014.
- Drivers of the investment boom:
  - High prices from buoyant demand in emerging markets.
  - The U.S. shale oil and gas revolution enabled by fracking of unconventional deposits.
- Consequences of the 2014 price collapse:
  - Global oil and gas investment was cut drastically after the collapse.
  - Producers slashed investment and began divesting from fossil fuels rapidly.
- Renewable energy investment shortfall:
  - Investment in renewable energy lagged the United Nations’ target of net zero emissions by 2050 by about $1 trillion a year (according to the IEA).
- Net effect: a shortfall in total global energy investment.

### Rising role of natural gas and electrification
- As electrification rates rose, many economies increased dependence on natural gas to buffer interruptions in renewable energy and to replace coal-fired plants.
- Global share of gas in total primary energy production:
  - 16 percent in 2010
  - 22 percent in 2021
- In OECD countries, share of gas in power generation:
  - 23 percent in 2010
  - 30 percent in 2021 (IEA)

### War in Ukraine: timing and pre-existing vulnerabilities
- In 2021, before Russia’s invasion of Ukraine, gas markets were already imbalanced:
  - A cold winter and weather-driven low power generation from renewables in Europe and Brazil.
  - Global gas consumption rebounded faster than expected after the pandemic.
  - Russia reduced gas flows to Europe starting in mid-2021 before the start of the war; Gazprom decided not to fill central European storage facilities.
- Price movements before and after:
  - European and Asian gas prices increased almost sevenfold to $33 per million British thermal units in the fourth quarter of 2021 from $4.90 in the fourth quarter of 2019.
  - In contrast, oil prices stood at $78 per barrel in the fourth quarter of 2021, only $18 higher than eight quarters earlier.
  - Coal more than doubled to $182 a ton from $73 over the same period.
- After the invasion:
  - European gas prices in the third quarter of 2022 climbed another 75 percent after six months of war.
  - Oil prices were up only 15 percent since the invasion.

### Fragmented natural gas markets vs. integrated oil markets
- Fragmentation of gas markets:
  - Currently, only a quarter of global gas markets are integrated.
  - Natural gas relies mostly on pipeline infrastructure that prevents arbitrage across regions.
  - European pipeline gas markets connect to the LNG market via liquefaction and re-gasification terminals that allow intercontinental transport by tanker.
  - Russia lacks sufficient pipelines or gas liquefaction terminals to reroute a large fraction of its European pipeline exports elsewhere; the decline in Russian gas flows is equivalent to about 17 percent of European gas consumption and non-European LNG imports combined evaporating off the market.
  - To incentivize market adjustments, gas prices need to increase by several times because demand and supply elasticities are low.
  - Policies that shield consumers by distorting price signals (e.g., price subsidies) are not helpful; if market forces are not allowed to induce adjustment, rationing becomes the only option.
  - Governments can protect vulnerable households through lump sum payments and other mechanisms while keeping price signals working.
- Integrated oil markets:
  - Transportation and processing infrastructure allow for arbitrage across borders; only a temporary impact on prices from shocks compared with gas.
  - Supply and demand price elasticities are higher because they can adjust at larger scale.
  - Russian oil exports remained steady in 2022; sanctions and reduced business caused market dislocations partly absorbed by a widening Brent–Russian oil spread.
  - Brent prices rose while Russian oil sold at a discount, creating incentives to reroute Russian oil to India, China, and elsewhere.
  - Strategic oil reserves were released to tame higher prices.
  - The slowdown of economic activity in China and around the world exerted downward pressure on oil prices.

### Fallout for electricity markets
- Wholesale electricity prices in Europe move in tandem with gas prices because electricity prices are set by the highest marginal cost of production, and gas-powered plants are currently the highest-cost producers.
- Electricity prices have been extremely volatile and recently peaked at seven times what they were in early 2021.
- Even in countries with a relatively small share of natural gas in power generation (e.g., Spain and Portugal), electricity prices spiked.
- Differences across European countries in the electricity price impact are driven by:
  - Infrastructure bottlenecks.
  - Differences in the mix of power generation sources.
  - Diverging policies regarding subsidies or price caps.
- Greater integration and investment can buffer shocks:
  - Comparison of gas/electricity markets versus oil markets shows risks of fragmentation and benefits of integrated markets.
  - Governments should foster integration of global natural gas markets and regional electricity markets.
  - In addition to support for renewables, governments should assist in building gas liquefaction and trade infrastructure as well as denser electricity transmission networks.
  - Expedited action will help replace Russian energy supplies and deal with the intermittence of renewable energy.

*Andrea Pescatori is chief of the Commodities Unit in the IMF’s Research Department, where Martin Stuermer is an economist.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/december/pescatori.pdf_