How to Get Off the Energy Price Roller Coaster

After three years of above-target inflation, core PCE (Personal Consumption Expenditures)—the Fed’s preferred inflation metric—slowed to 2.6 percent last quarter, prompting the Fed to cut rates last week for the first time since March 2020. This move is likely the first in a cutting cycle, designed to return rates to their long-run neutral.

By some accounts, including Fed Chair Jay Powell’s, the Fed’s extended rate hike was a policy success—an orchestrated soft landing in which the Fed accomplished its goal of bringing down inflation without crashing the economy.

We’re a bit more skeptical. Soft landing, sure. But orchestrated, not really. The extreme energy price growth and volatility we’ve seen even amid 11 rate hikes capture the limitations of US monetary policy and our existing tool kit.

There have been two major revelations for the macroeconomic community over the last several years, which we would be silly to forget now that we’re on the other side of the Fed’s hiking cycle. First, we witnessed the undeniable role of supply-side disruptions in driving overall inflation. When price volatility is the result of closed factories, disrupted shipping routes, and coordinated reductions in energy supply, demand-focused inflation policies, such as raising interest rates, have limited utility.

Second, we saw the role of corporate profiteering in driving inflation. Companies used the pretext of legitimate supply constraints to boost—not just maintain—profit margins in the wake of higher input costs and overall inflation. In some cases, corporations participated in outright collusion.

Both of these dynamics contributed to extreme energy prices.

When overall inflation reached its peak of 9.1 percent in June of 2022, four months after Russia’s invasion of Ukraine, energy prices were responsible for one-third of price acceleration. The war in Ukraine constrained the global supply of oil and gas, creating a spike in prices that US monetary policy tools could not remedy.

Furthermore, energy supply was further constrained when US oil companies used the cover of geopolitical shocks to illegally coordinate output reductions, keeping prices high for their own profit gain. Earlier this year, an FTC investigation into the acquisition of Pioneer Natural Resources by ExxonMobil revealed that US oil companies played a significant role in driving recent record-breaking increases in the price of necessities. The investigation found that Scott Sheffield, the former CEO of Pioneer, colluded with domestic oil companies and OPEC to reduce output and keep oil prices high.

We need better tools to manage fossil fuel–driven inflation.

Monetary policy tools, like interest rates and the Fed’s balance sheet, aren’t particularly effective at addressing energy price inflation driven by supply-side constraints—especially intentional ones. Instead, domestic antitrust enforcement and federal commodity storage units are the primary tools in the federal government’s limited tool kit.

Colluding to fix prices is illegal, violating bedrock US antitrust law designed to protect consumers. To be sure, the FTC should be applauded for discovering evidence of Pioneer Natural Resources collusion with OPEC and for prohibiting Sheffield from serving on the ExxonMobil board following the merger. The Senate Budget Committee has also taken action and launched an investigation into 18 major US oil producers to determine if they too colluded with OPEC to keep prices high. But despite the crocodile tears from Big Oil and its sympathizers, these are mere slaps on the wrist. Importantly, the merger was allowed to go through, contributing to even more consolidation in the oil and gas industry. There’s more work to be done to root out the extent of this illegal, anticompetitive activity. In particular, the Department of Justice must investigate Sheffield and his alleged co-conspirators for criminal wrongdoing.

But all of those would still be short-term fixes at best. Fossil fuels are unlike other industries, where the goal of improved or perfect competition in their respective markets may be sufficient to protect consumers and firms. Even if we crack down on domestic oil and gas supply manipulation and corporate consolidation, fossil fuel prices are set by an international cartel, OPEC, over which we have no legal control. A perfectly competitive fossil fuel industry is a fantasy.

Moreover, if we take seriously the need to drastically curtail our fossil fuel production and reliance, a perfectly competitive fossil fuel market is not an appropriate North Star. Even as we advocate for more stringent antitrust enforcement, such measures will be insufficient to achieve energy security and price stability as we actively shift an entire sector out of the center of the economy.

The only tool the US government has to directly influence domestic fossil fuel supply, and thus prices, is the strategic petroleum reserve (SPR). The SPR, created in 1975 to diminish vulnerability to short-term supply interruptions in petroleum products, is the world’s largest stockpile of crude oil. By releasing stores of oil into the market from the stockpile, the federal government aims to drive down prices by increasing available supply. In March 2022, when oil prices reached their then-high, President Biden sold over 160 million barrels of oil from the SPR.

The direct impact of reserve sales on prices is difficult to pin down; the Treasury Department estimated that these SPR releases brought gasoline prices down by only $0.38 per gallon in 2022. When average gas prices reached $5.01 a gallon at their peak in 2022, this is hardly a home run.

More importantly, using the SPR in a moment of crisis to attempt to bring energy prices down is not a lasting solution if we care about decarbonization. It is a problem that our only tool to stabilize energy prices rewards the sector that drives their volatility and moves us farther away from our net-zero emissions goals.

The answer, then, is expanded monetary and fiscal policy tools.

To fully integrate the cost of fossil fuel dependence to consumers and the broader economy, the Fed must incorporate the impact of energy price volatility more fully in its policy-setting. Instead of attempting to stabilize prices through subsidies to fossil fuel firms, fiscal policymakers should force the industry to pick up the tab by taxing excess profits and setting price controls. And most essentially, we need a coordinated wind-down of the fossil fuel sector to end the havoc the industry has wreaked on the economy and the planet.

The Fed should internalize the price stability risks the fossil fuel sector poses.

A mounting volume of research shows that the inherent volatility of fossil fuels and our reliance on the sector pose severe economic risks—and central banks around the world are paying attention. As we’ve argued before, the Fed needs to catch up on its reading to better understand how energy prices drive overall inflation and instability. Price shocks to the fossil fuel sector not only translate to higher prices at the pump or in heating bills; they force other prices up across the economy as a ubiquitous input for virtually every supply chain. This has macroeconomic impacts: Oil shocks have precipitated 10 of the past 12 recessions. But the Fed has decided its price stability mandate does not extend to energy markets.

So Powell can’t take the soft landing victory lap for tamping down oil and gas prices. The Fed’s interest rate regime can’t address inadequate supply, and is a blunt tool to tame excess aggregate demand—never mind that demand for baseline energy usage is inelastic in the short-run, unchanging despite the price. High energy prices don’t alleviate the need for people to drive to work or heat their homes. They just cause more economic pain along the way. Low-income Americans who are closest to tipping into energy insecurity suffered the most as a result of the price hikes and suffer doubly from contractionary Fed policy that was aimed at suppressing wage growth and increasing unemployment.

The federal government should stop subsidizing fossil fuels.

In 2023, US fossil fuel companies received $757 billion in explicit and implicit subsidies in the form of increased lease royalties for oil and gas, research and development funding, tax incentives, and of course the health and environmental cost borne by the public. Not only do taxpayers foot the bill for new oil wells; they pay for their cleanup if they’re abandoned. Last year, the US set a new world record for oil production, producing 13 billion barrels of output per day—more than any country, at any time in history. Yet despite all of the public financial support these companies reap, there is no requirement they meet domestic oil needs first; if they can make more of a profit exporting a barrel of oil, they have no trouble forgetting who helped foot the bill to extract it.

The fossil fuel industry is no stranger to turning to the federal government for financial assistance. During the COVID-19 pandemic, fossil fuel firms received a disproportionate share of the relief. According to research from Bailout Watch and Public Citizen, in seeking help from the Paycheck Protection Program, “fossil fuel companies were likelier to seek help, tended to receive larger loans, and reported saving fewer jobs compared with those in other industries.”

We need to repeal regulatory loopholes afforded to fossil fuels, repeal subsidies for fossil fuels designated by the federal tax code, and plan for the next fossil fuel bailout by attaching strings on any federal aid they receive. Propping up corrupt fossil fuel companies with subsidies and legal leeway is not a lasting solution to ensure energy price stability.

Price stabilization policies should shift the burden to fossil fuel companies.

While the SPR attempts to stabilize markets by increasing supply, taxes and controls placed on fossil fuel firms can stabilize prices without giving handouts to the industry. For example, a windfall profits tax for oil and gas companies, like the one proposed by Senator Sheldon Whitehouse and Congressman Ro Khanna, would limit the amount of profit large firms are able to take home and repurpose revenues as rebates to consumers.

Price caps on energy could be reintegrated into the federal policy tool kit, though it’s critical that they are designed in a way that discourages production expansion. To prepare for the next energy shock, Congress should give the president authority to direct US oil producers to cap prices on domestic sales and limit sales abroad to ensure domestic demand is met without expanding oil and gas production.

Even as we transition away from fossil fuels to renewables, future price shocks are likely and have motivated arguments for bringing new fossil fuel capacity online to smooth the transition. Instead, we should focus on policy that reins in the distortionary and unfettered power our current domestic fossil fuel sector has over the economy.

Ultimately, the only way to get off the roller coaster of volatile energy prices is to transition to renewable, electrified energy as soon as possible. Since the enactment of the Inflation Reduction Act two years ago, we’ve made considerable progress on the transition. Solar capacity has increased by 36 percent, we’ve increased the share of electric vehicles on the road by 31 percent, and the law has catalyzed nearly $300 billion in clean energy and manufacturing investments. But while more renewable energy capacity is coming online, there are not commensurate decreases in fossil fuel consumption. The share of energy consumption from renewable sources has more than doubled over the past 20 years, but it still makes up just 9 percent of total consumption, and fossil fuel use has barely declined. Our current clean energy transition incentives were intended to expand renewable capacity but will not effectively wind down fossil fuel reliance.

To meet our emissions reduction goals and secure long-term energy price stability, we need to completely transition away from fossil fuels. The only way to achieve this equitably, effectively, and in time is to leverage public capacity. As Kate Aronoff argues in a recent Roosevelt report: We need a publicly managed and led wind-down of the fossil fuel sector. Each policy action we take, even during extreme price shocks, must lead in that direction.