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By Paul Homewood

This item appeared in the Wall Street Journal’s daily 10-point guide to the top stories yesterday.

It goes to the heart of the energy crisis:

Large swings in energy markets are nothing new. Because demand is so inelastic, even small changes in either supply or demand can cause big price changes.

We saw similar price spikes in the oil and gas markets in the years leading up to the 2008 financial crash. Indeed, it was arguably those price rises which triggered the crash. The cause of these rises was the increased demand from Asia, as China and other economies there began their rapid growth, thus increasing demand for energy.

Normally the energy market reacts by increasing capital spending to increase output. After 2008, it did just that, and, as tends to happen, the market swung the other way with surplus production and prices falling to economically unviable levels a few years ago.

However, this time around energy companies appear to be more reluctant to commit to new investment, as the WSJ notes, thanks to a combination of shareholder and government pressure, share buybacks and the easy money to be had from heavily subsidised renewable energy.

We have a similar situation in the UK and Europe, with companies like Shell keen to move away from oil and gas, along with political pressure to block North Sea oil development.

It is absolutely clear that, despite climate policies and renewable energy, global demand for fossil fuels will remain high, and probably increase, for at least the next decade. But if new investment does not come forward to maintain output levels, energy markets will become tighter still, driving up prices to crisis levels.

The knock on effect this will have on the world’s economy could be frightening.

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October 14, 2021