Energy Price Stability

According to this briefing from economists at the Roosevelt Institute, energy price inflation is a persistent driver of overall inflation and recessions in the US. For the Federal Reserve to fulfil its primary mandate, they argue that it must facilitate a rapid and orderly transition away from inherently volatile fossil-fuel markets, towards more stable electrical and renewable sectors.

The paper explores how rising hydrocarbon costs are dragging down economic activity and claims it is “nearly impossible” to manage prices while still dependent on fossil fuels. As inflation hits a 40-year high, the price of energy commodities rose more than any other item on the consumer price index in the year preceding March 2022. Notably, petrol price rises accounted for 75% of energy inflation during that time period.

As the brief also notes, fossil fuel price spikes have historically been a tipping point for recessions. Indeed, every recession from the last half century (excluding the Covid-19 pandemic) was preceded by a crude oil price spike. As businesses and consumers cannot forgo energy use, price changes have major macroeconomic implications, yet the Fed does not include energy pricing in core inflation metrics.

In contrast to hydrocarbon volatility, the electricity and renewables sectors have historically produced stable prices and low average inflation. The authors explain that grid electricity has “never had the extreme price volatility” of fossil fuels and is more resilient to supply disruptions by drawing on diverse sources. In order to increase price stability and improve its ability to effectively mitigate inflation, they argue the Fed must prioritise an orderly green transition.

Renewables rely on naturally replenishing inputs and have low ongoing fuel costs, making them amenable to long-term fixed price contracts. By contrast, the authors note, the constant process of discovery and extraction required for hydrocarbons leads to inflating prices and significant marginal costs. As supply is always in flux, fuel costs are inherently unpredictable.

The authors also say that every nation has access to some form of renewable energy input, providing greater price insulation from geo-political conflict. If distribution of the financial and mineral resources needed for initial infrastructure is done equitably, then universal access would increase long-term energy market stability and resilience.

The paper argues that, with sufficient public investment, renewables will result in sustained downward pressure on electricity prices, securing greater energy independence for the US. Increased domestic oil production has failed to reduce prices as it has largely been exported. However, renewable energy incentivises domestic consumption and is already contributing to declines in wholesale prices, according to data from the Energy Information Administration.

The authors also estimate that for each 1% increase in use of solar and wind, a decrease in wholesale prices of $0.14 per megawatt hour can be expected.

With public investment, equitable design, government-led action, and support from central banks and financial regulators, the authors say that renewable energy has the power to reduce climate risks, stabilise prices, drive inclusive growth and save trillions of dollars per year on fossil fuel costs.