In two years, oil has gone from negative prices to huge highs – part of a rising inflationary shock not seen since the 1970s. By Claire Connelly.

How will oil shock affect the Australian economy?

The Gazprom Neft oil refinery in Omsk, Russia.
The Gazprom Neft oil refinery in Omsk, Russia.
Credit: Reuters / Alexey Malgavko

Ben Goodwin refers to Vladimir Putin as “the arc”. The Merlon Capital Partners analyst says the Russian president is the link between the ultra-low oil and gas prices of early 2020 and the ultra-high prices we’re seeing today.

Goodwin is one of the analysts warning that the disruption to rising oil and gas prices caused by the war in Ukraine has increased to levels “outside the bounds of normality”. They warn of volatility so extreme as to make gas an unreliable source of energy for Europe and potentially other parts of the world.

The wild fluctuations in energy prices during the past 24 months are part of a rising inflationary shock on a scale not experienced since the 1970s, demonstrating the inexplicable link between energy security and national security. Some economists are calling for a temporary tax on Australian fossil fuel producers to fund an urgent transition to renewable energy and penalise war profiteering.

Just two years ago, in April 2020, United States oil prices plunged into negative territory for the first time after producers ran out of storage for the oversupply of crude triggered by the Covid-19 crisis and the preceding short-lived production war between Russia and Saudi Arabia, causing a historic market collapse.

About 160 million barrels of oil were stored in “supergiant” floating tankers, levels of offshore storage not seen since 2008, while other companies sold their excess for pennies on the dollar.

Two years later oil is trading between $US110 and $US120 a barrel, doubling in price since December 2019, and a 30 per cent increase on the already high prices seen before Russia’s invasion.

As Goodwin says: “Then Russia invaded Ukraine and the Plus part of OPEC Plus put oil and gas prices on steroids.”

European liquefied natural gas hit record highs on Monday, compounding an already tenfold price increase over the past year. Spot prices spiked by 79 per cent to €345 per megawatt-hour, equal to $US100 per million British thermal units (MMBtu), Bloomberg reported, the equivalent of $US575 for a barrel of oil.

Asian spot LNG was at $US47.30 per MMBtu on Tuesday, according to the latest Platt’s assessment, up from $US7.02 in March 2021. Put another way, prices have increased by five-and-a-half times over the past year. Ordinarily long-term contract gas trades at 12.5 per cent of Brent crude prices, or $10-$15 per MMBtu.

“Russia was as much a part of that,” Goodwin says, “as it is a part of prices being at the extreme highs that we’re seeing today.”

The volatility is so acute that by the time you read this, the figures will probably be out of date.

Bruce Robertson, energy finance analyst at the Institute for Energy Economics and Financial Analysis, says the volatility is so “insane” gas has essentially become an unreliable fuel in Europe. The analyst fears it could lead to a long, cold, hungry European winter due to food and energy price inflation.

“This is a commodity people rely on to heat their homes, cook with and produce industrial commodities,” he says. “To be reliable, you’ve got to have some sort of price certainty.”

Europe’s almost complete reliance on Russian fuel makes it difficult for the international community to respond. Imposing direct sanctions on Russian exports would only exacerbate energy price pain on consumers, a fact unlikely to have been lost on Putin.

“The longer this war sticks around, the more inflationary it’s going to become,” Robertson says.

Economist Frances Coppola says previous discussions about interest rate rises have been put on the backburner, “because wars are inflationary”.

“The disruption to rising oil prices, commodity markets, and the natural resources that Russia controls, in effect mean Western countries now face a much larger inflationary shock on the scale of the 1979 Iran–Iraq War, or the oil embargo of 1973 during the Yom Kippur War,” she says.

However, Richard Denniss, chief economist of The Australia Institute, says Australia has not had any “big outbreak of inflation” caused by volatile energy prices, and that profit growth, not oil, gas or wages, is the major cause of inflation.

“If oil prices really were a threat to inflation and our economy, we’d have been busting our guts to get onto electric vehicles,” he says. “The government can’t have it both ways. You can’t say, ‘Oh my god, oil prices are the biggest problem in the world and in Australia, that’s why we’re doing nothing to transition away from oil and gas.’ ”

The irony is the war will likely be a short-term boon for the Australian fossil fuel industry.

Denniss says the government should impose a temporary levy to ensure Australian energy producers do not unintentionally benefit from Putin’s invasion, a proposal supported by economist John Quiggin.

“The Australian gas industry is about to make windfall profits from Russia’s aggression,” Denniss says. “Surely they could pay a temporary tax. Why should Australian energy producers be the beneficiaries of the war in Ukraine?”

Professor Quiggin says Australia urgently needs to transition away from fossil fuels and, while he favours a comprehensive carbon tax, “if a temporary levy is more politically feasible, I’d support that”.

A levy would also address shortages highlighted in the 2010 Henry Tax Review and 2017 Petroleum Resource Rent Tax Review, which found revenues are declining.

“Australia overtook Qatar to become the world’s largest exporter of LNG two years ago,” Denniss says. “Qatar collects 20 times more tax than we do from oil and gas.”

Neither party supports this proposal. However, Shadow Minister for Climate Change and Energy Chris Bowen says Labor supports cutting taxes on electric vehicles to make them cheaper for families.

Denniss says the volatility of oil and gas prices proves that energy security and national security are “inextricably linked”.

“For decades, many countries have been determined to treat climate policy as an environmental issue, even while institutions as radical and progressive as the US Pentagon have been saying climate change is a national security risk,” he says.

Robertson agrees. He says Europe has become addicted to Putin’s gas and that the war highlights how vulnerable Australia’s energy security is to disruption.

“If Australia went to war now, we’d run out of bloody fuel in two weeks,” he says. “The place would grind to a halt before you could say boo-hoo. Our strategic oil reserves are located in the US. I mean, seriously? We need energy independence here, now.”

Given its lack of oil-refining capacity, Australia is incredibly reliant on global trade routes to keep the economy going.

“I don’t think people fully understand how geopolitically tenuous Australia’s energy situation is,” Robertson says. “Our energy security hangs on by a thread. It’s literally a thread of cotton and no thicker. It’s incredibly tenuous.”

Robertson says Australia, like Europe, must immediately diversify its energy supply, roll out emergency renewable schemes, and follow China’s example on energy diversification by not relying on a single form of energy, either by type or source.

“Otherwise, we’ll find ourselves in a position like Germany, which is almost entirely reliant on Putin’s gas,” he says.

Reports by the CSIRO, Lazard’s and the International Energy Agency all confirm that wind and solar are indisputably the world’s cheapest forms of energy, even with firming and network augmentation costs.

“We’re seeing continued cost price deflation in wind and solar,” Robertson says. “It falls in price every year. That trend won’t change.”

Abel Polese, senior research fellow at the Dublin City University Institute for International Conflict Resolution and Reconstruction, with 20 years of specialisation on Ukraine, says the current crisis should be taken as a lesson about the importance of long-term energy and security planning.

“If we had started [transitioning to renewables] in 2014, or even 2008, we’d be in a completely different situation right now,” he says.

“It may have been difficult to anticipate a war, but it was not difficult to understand that dependency on Russia would mean you could not really cut ties without being in trouble.”

Commodity prices have always been volatile. Historically, there was no substitute for oil and gas. Now there is. Denniss says the question is who will defend the old or embrace the new.

“Australia is stuck defending the old,” he says. “In the long run, that’ll be bad for us. But in the short run, it’s happy days for gas exporters.”

This article was first published in the print edition of The Saturday Paper on March 12, 2022 as "Zero to one hundred".

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