Energy Price Volatility Dampens Growth; Can Renewables Help?

The New York Times today reported that recent extreme volatility in oil markets has “is puzzling government officials and policy analysts…” It is also “hobbling businesses and consumers … as they try in vain to guess where prices will be a year from now–or even next month.”

Random Reasons for Volatility

Oil is a complex market, and analysts struggle to explain its gyrations. Supply is affected by many things, including reserves, politics, and possibly financial speculation in recent years. John Lipsky of the IMF concluded in a recent speech at the 4th OPEC International Seminar, however, that  “financial market dynamics and flows have not been a major driver of recent oil price trends.”

What is behind oil price volatility? A 2005 study by Hui Guo and Kevin L. Kliesen, economists at the Federal Reserve Bank of St. Louis, concluded that “crude oil price volatility is mainly driven by exogenous (random) events such as significant terrorist attacks and military conflicts in the Middle East.”

Impact of Volatility: Dampening Growth (Except for Oil Companies)

A common sense suggests that low oil prices help drive economic growth while high oil prices tend to dampen growth. But the St. Louis Fed study demonstrated that volatility itself–whether yielding price increases or declines–can put a brake on economic growth. The study found that ” sharp oil price changes—either increases or decreases—may reduce aggregate output temporarily because they delay business investment by raising uncertainty or induce costly sectoral resource reallocation.” In order words, “an increase in the price of crude oil from, say, $40 to $50 per barrel generally matters less than increased uncertainty about the future direction of prices.”

Similarly, a report published last month by Amanda Logan and Christian E. Weller at the Center for American Progress (which describes itself as a “progressive” think tank) cites data from the Bureau of Economic Analysis to show that consumers and businesses curtail spending following periods of energy price volatility. The Logan/Weller report also found that, while energy price volatility may dampen economic growth, the energy companies themselves can benefit from it. The study found that “the profit rate of oil—and coal—companies increased on average by 0.8 percentage points during periods of high energy price volatility and that there is a 63.0 percent chance that the profit rate will increase during periods of extraordinary price volatility.”

Can Renewable Energy Help?

There are a variety of policy options for trying to smooth out energy prices, but they all have their limitations. (Wonks may want to refer to a 2008 report on this topic by the International Bank for Reconstruction and Development.)

But I was wondering: Does renewable energy suffer from the pricing volatility of fossil fuels? After all:

  • The energy sources (wind, water, sun, geothermal) are basically eternally free, and
  • The supplies are more broadly distributed than fossil fuels

According to a 2008 report by the government-sponsored National Renewable Energy Laboratory, “whether a utility owns its renewable generation or purchases renewable energy through a power purchase agreement, the price is known and essentially fixed over time.”

So while stocks of renewable energy companies may be volatile (it is, after all, a very young industry), renewable energy itself may exhibit substantially more price stability than fossil-fuel based energy. This could end up being a significant, but less-noted, benefit of the uptake of renewable energy.

And price stability is worth money.  (Hence the flourishing markets for insurance and options and futures.) So isn’t possible that higher costs for some forms of renewable energy may be at least partly justified by the promise of stabler prices?

Your Thoughts?

I would love to hear your thoughts: Will renewable energy prices be less volatile, and will energy consumers pay for that benefit?

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