COMMENT: Why low oil prices are good news for the environment, but not for the reasons you may think

Published 17:29 on May 15, 2020  /  Last updated at 19:48 on May 16, 2020  /  Conversations, Views  /  No Comments

Low oil and gas prices are no boon for the climate in the short term, but they give us a window into a future of ever-decreasing fossil fuel demand that may deter expansion an opportunity to put in place policies that get us paying to decarbonise the fossil fuels we dig up, argues Eli Mitchell-Larson of Oxford University's Environmental Change Institute.

By Eli Michell-Larson

On the same day that the University of Oxford made the historic decision to divest from fossil fuel companies, oil prices went negative for the first time in the US. The two events were of course unrelated—the divestment decision was years in the making, and the price shock had more to do with expiring futures contracts than some watershed transition away from fossil fuels—but the historically-low oil prices sparked conversations in climate-engaged circles. If low oil prices persist, as they have in the ensuing weeks, what does that mean for the climate? One temptation would be to draw parallels between crashing oil stocks and an increase in divestment activity, accusing investors of cynical motivations for divestment rather than a genuine environmental awakening. Another dominant emotion is schadenfreude—a sense of justice being served to fossil fuel companies that have long resisted climate action and are now suffering an existential crisis.

Both reactions are misplaced. Cheaper oil is as bad for the planet as it is for oil companies; the cost to pollute the atmosphere with CO2 has never been lower, and any fossil fuels that aren’t extracted can bide their time underground until demand, and prices, rebound. In some extreme cases, producers may burn oil that’s too cheap to sell rather than shut down production. The simple economics of substitution create a quandary for those who are sympathetic to the climate battle, but will quietly switch to a cheaper energy source if low oil and gas prices stick.

Furthermore, low-priced fossil fuel stocks haven’t become the financially toxic asset proponents of divestment might have hoped. Instead, they offer a bargain buying opportunity for those who foresee a return to business-as-usual after the pandemic subsides, as evidenced by Saudi Arabia’s unprecedented $1 billion share purchase following the April crash. They know that when the pandemic recedes and economic engines reignite, those engines will still be burning oil, and all the better for them if their US shale competitors go bankrupt in the meantime. Slumped demand doesn’t mean our underlying economic machine has fundamentally changed, nor should we rest our hopes on investors voluntarily fleeing oil and gas stocks.

However, if we’re serious about stopping climate change, low oil prices signal a massive opportunity for two reasons.

First, today’s demand drop offers a window into our not-too-distant future. As the global lockdown drags on, the IEA forecasted that liquid fuel consumption would be 30% lower for April, and 9% lower for 2020, compared to the 2019 average of around 100 million barrels per day. These same levels of demand, considered extraordinary at the moment, could become the norm in the near future if we take the steps needed to begin decarbonising the economy in earnest. The Intergovernmental Panel on Climate Change (IPCC) report on 1.5°C forecasts equivalent levels of fossil fuel consumption arriving between 2030 and 2050, depending on the rate of investment in energy efficiency, renewables, and carbon capture and storage. For example, in a 1.5°C-compatible emissions pathway described as “middle-of-the-road”, oil demand is 14% lower in 2030 than 2018, despite GDP and overall energy consumption increasing [1]. Even oil giant Shell broadly agrees—their Sky Scenario forecasts an 8% drop in primary energy from oil by 2040 relative to the pre-Covid 2019 peak [2]. Both forecasts are within the 15 to 30 year average lifespan of an oil well. This gives climate activists an excellent argument to discourage further investment in new oil and gas production: not because of black-swan oil prices, but because today’s low demand could become the norm sooner rather than later. In other words, the average human in 2030 could lead a better-than-2019 life using 2020 volumes of fossil fuels.

Second, low oil prices offer an unprecedented opportunity to put in place new climate and energy policies to curb warming and put us on a path to net zero. That’s because until recently, the world was happily planning to buy oil for $60 a barrel for the foreseeable future. Prices bottomed out due to a confluence of grounded planes, geopolitical spats, and structural issues in the US oil industry, not because consumers are fundamentally unwilling or unable to buy energy at higher prices. The effect of oil price on the downstream energy costs for businesses is also muted—less than 35% of the price of gasoline in most countries is attributable to the cost of oil (the rest is a mixture of taxes, distribution, and marketing costs). The swing in fuel prices resulting from a $40 drop or rise in oil prices is less severe than intuition would dictate.

What if we harnessed the delta between today’s record-low oil prices, and the prices we were paying in 2019, to pay to clean up the carbon pollution generated by these fuels? If, after adding on the costs of such cleanup, fossil fuels couldn’t compete with renewables, that would signal their demise. Policymakers have been so focused on trying to make renewables cheap that they’ve so far missed out on an alternative, complementary goal: “decarbonising” oil and gas such that it has the same, carbon-free property of renewables. How? By requiring carbon extractors to store enough CO2 to counterbalance the carbon embedded in their products. This is at the heart of the Carbon Takeback Obligation, a proposal requiring oil and gas companies to take responsibility for the emissions their products generate. It’s also present to varying degrees in commitments from oil and gas companies like Repsol, Occidental, BP, Shell, and Total, who claim they will increasingly account for and offset the carbon contained in their products. If the cost of storing enough CO2 such that it offsets the carbon content in a barrel of oil is on the order of $40 or less (roughly the difference in the oil price from its 2020 peak in January to today), that’s a price we can afford and one we should be willing to pay to save the climate.

A Carbon Takeback Obligation would effectively increase the cost of production of oil and gas, making sure that fewer marginal, high-risk fossil fuel projects pencil out, and thereby reducing systemic risk. It’s good for oil producers and investors because it reduces the degree to which demand for oil drops – liquid fuels can still be a useful means of providing energy, provided the carbon pollution they cause has been cleaned up in advance through commensurate storage. It’s good for the climate because it stops fossil fuels from causing climate damage thanks to the permanent storage of equivalent volumes of CO2 from other industrial sources.

Low oil and gas prices are no boon for the climate in the short term, but they give us a window into a future of ever-decreasing fossil fuel demand that may deter expansion. The silver lining is the opportunity to put in place policies that get us paying to decarbonise the fossil fuels we dig up, still at a discount to yesterday’s prices.

[1] The “P3” pathway in the IPCC’s special report on 1.5°C is described as “a middle-of-the-road scenario in which societal as well as technological development follows historical patterns”, and forecasts 2030 final energy demand as 5% higher than today, with the primary energy from oil to meet that demand dropping 14% (other energy sources pick up the slack). The IPCC uses 2010 as a baseline, so calculations relative to 2018 are based on Our World in Data.

[2] See Shell’s Sky Scenario

Eli Mitchell-Larson is a researcher at the Environmental Change Institute at the University of Oxford.

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