In early January, a barrel of crude oil fetched $76.08 on the New York Mercantile Exchange. At the time, American consumers were hitting the road again after their COVID-19 confinement and the industrial economy was awakening from a tough disruption. Demand for energy was on the rise, as was the price of gasoline at the pump.
While analysts recognized the recovery of the energy economy, hardly anyone predicted that crude oil’s price would hit $118.87 in early June, up more than 50 percent in just six months — let alone that Russia would invade Ukraine and simultaneously disrupt petroleum and natural gas flows to the western world. In the United States, the average price of a gallon of regular gas rose from $3.16 in January to $4.87 in early June.
We may not have seen such a big price increase coming, but everyone, it seems, knew it when it happened. Politicians scrambled, fussed at oil companies and called for patience. Their voices certainly mattered but were weak compared to the clear signals being delivered straight to every consumer and producer by the always-badgering price system. Enough time has now passed to look at how effective our response has been.
The price system unrelentingly and continuously delivered a scarcity alert worldwide. Whether it was motorized-rickshaw operators in Dhaka, Bangladesh, Uber drivers in Baltimore, mothers picking up children after school in Savannah, Ga., operators of truck fleets and police departments or managers of large manufacturing plants, the signal was the same. It said to consumers, “Energy has gotten scarcer; it is time to conserve.” And to suppliers, it said, “This stuff has gotten a lot more profitable to produce; see if you can find ways to provide more.”
That’s why, though it may sound cruel, some have said that the cure for high prices is high prices. Has this made a difference? And how could it?
Let’s look at the latest prices. During the first week of August, the price of crude oil hovered at $88.54, higher than the $76.08 price in January, but a lot lower than June’s $118.87. The average price of a gallon of regular gas rested at $4.19. Yes, lower prices had arrived, at least for oil, but not so much for gasoline.
Consumers responded in almost countless ways to bring the demand for energy down somewhat. With price-pressured budgets across Europe, national governments made the decision to darken lighted national monuments. In France, all air-conditioned shops were ordered to keep their doors closed; air-conditioned sidewalk cafes were banned. In some countries, illuminated billboards were ordered to darken during late-night hours. As for individual consumers, common sense prevails. People reluctantly adjusted thermostats, started working more from home to eliminate commuting and generally reduced their driving.
What about the supply side of the story? These adjustments didn’t come as quickly, but some important things happened. Germany postponed a decision to close its few remaining nuclear power stations. The Netherlands and Germany announced a joint effort to produce natural gas from a newly found field in the North Sea. Qatar reported a large increase in liquefied natural gas production for world markets. The United States appropriated funding to accelerate nuclear power production, and some support for oil extraction was included in the final version of the Inflation Reduction Act of 2022.
Naturally, most readers are still wondering about that sticky gasoline price that just doesn’t want to fall very much. There are multiple issues to consider, but refining capacity is the big one. Refiners reduced capacity when COVID led to a sharp decline in travel. Shuttered plants cannot be reopened quickly. Federal actions favoring electric cars and a general anti-fossil fuel ethic have made it clear to carbon fuel producers that they should not necessarily replace and enlarge aging fuel production capacity. Reversing the actions they’ve taken cannot happen quickly, and given the volatility of the matter, perhaps would not make economic sense.
Are higher prices a solution to high prices? Yes, they surely help. Incentives like these get people to act, and prices communicate scarcity when it matters most.
Bruce Yandle is a distinguished adjunct fellow with the Mercatus Center at George Mason University and dean emeritus of the Clemson College of Business and Behavioral Sciences.