The Fall of Oil and the Environment
Bane or Blessing?
The recent rapid decline of the price of oil, from around $115 per barrel in mid-2014 to below $50 per barrel by August 2015 (Brent Crude), has prompted widespread concerns about negative impacts of cheap oil on the environment.
These concerns can be roughly divided into three major categories:
(1) By standard economic logic, low oil prices, and thereby low prices of oil derivatives such as gasoline and diesel, are expected to spur higher demand for internal combustion engine (ICE) powered vehicles. This in turn could undermine the development and diffusion of environmentally friendlier alternatives, first and foremost electric vehicles (EVs), which don’t emit carbon emissions. Higher conventional car travel in turn would cause even more emissions.
(2) Falling oil prices are feared to put downward pressure not only on gas(oline) prices, but also on natural gas prices. This could potentially divert crucial investments from environmentally sustainable renewable energy technologies to more gas-fired power plants for electricity generation. The much-needed transition of the world’s energy systems away from fossil fuels and towards low-carbon alternatives could thus be severely stalled.
(3) In a general low-oil-price context, international efforts to reach vital diplomatic accords on the protection of the health of our planet, such as the United Nations (UN) Climate Change Conference (COP21) and the UN Sustainable Development Summit, could be undermined by the correspondingly higher opportunity costs nations will face in divesting from fossil fuels.
This article will examine each of these three categories of concern in turn.
Electric Vehicles
Falling and low oil prices are often expected to lead to lower prices of gasoline and diesel at the pump. This, many fear could hurt a nascent industry of zero-emission vehicles (ZEVs), such as EVs using lithium-ion battery or fuel-cell technology, which is viewed by some as already struggling to compete with an incumbent and well-connected oil- and ICE-based industrial complex.
The first caveat to this argument however, is the simple reality that a lower price per barrel of crude oil does not necessarily always translate into (equivalent) price reductions at the pump. According to the Energy Information Agency (EIA), less than half of retail prices for gasoline and diesel in the U.S. come from the price of crude oil. The remainder is owed to refining, distribution, marketing, and taxes. In fact, while crude oil prices have fallen roughly 57% since mid-2014, regular conventional retail prices of gasoline in the U.S. have fallen by “only” 36% over the same time period.
Even with significantly falling prices at the pump, it is far from certain to what extent, and if at all, EV manufactures will actually be hurt substantially. Take one of the currently most important and definitely most well-known players in battery-based EVs, Tesla: by targeting the premium car market with its signature Model S, directly competing with the likes of BMW and other premium car manufacturers, its most important customer base is likely to care much less about the opportunity costs of going electric due to fuel prices, rather than the environmental benefits and prestige that come with owning a Tesla.
Still, even when doing the price comparison at current national averages for retail gasoline prices of $2.337 per gallon and residential electricity prices of ¢12.93 per kWh (as per September and June 2015 respectively, according to the EIA) EVs still come out on top. For a 100-mile charge, the necessary 33kWh for the Model S cost roughly $4.29 using a 240V charger. Even the most fuel efficient of comparable premium cars cannot compete with that. With the Lexus ES 300h for example, an extremely fuel-efficient hybrid (!!) that achieves 40-miles-per-gallon, a 100-mile drive would currently cost $5.84 in regular gasoline.
A last crucial point that should be considered concerns the economic concept of the price elasticity of demand. When the fall or rise of the price of a certain good by 1% leads to a rise or fall of the demand for that good by more than 1%, we speak of (price-)elastic demand – small changes in the price have large impacts on demand. If the opposite is true, we speak of inelastic demand.
Gasoline prices have been shown to have little effect on the overall demand for car travel, which implies that the demand for car travel is actually quite inelastic. This can be explained by the inconvenient truth of our current transport system being still so exceedingly dependent on oil that economists call gas a necessity good. People need to get around, go to work, drive their kids to school, and buy groceries. Especially in the U.S., the vanguard of individual motorized transport, for most people the ICE vehicle is still the only viable option for their personal mobility. They tend to buy and use gas almost regardless of its price and even their personal income, because gas is simply a necessity. Therefore falling oil and gasolines prices can reasonably be expected to have only moderate effects in terms of increased car travel and emissions.
Renewable Energy
Although the causal relationship between oil and natural gas prices is an issue of continuous debate, the casually observed positive correlation between the two (meaning that they tend to move in the same direction) seems to at least hold for the most recent price drop. While oil prices (i.e. Brent Crude) have fallen by roughly 57% since mid-2014, natural gas prices decreased by approximately 43% since, or from about $4.7 per MMBtu. (Million British Thermal Units) to $2.7 per MMBtu. (Nymex). One possible explanation for this connection is the substitutability of oil and natural gas in many applications, such as in heating and increasingly also in transportation. Thus when the price of one fuel decreases, consumers tend to switch over and substitute it for the other, which in turn decreases demand for the now comparatively more expensive alternative and puts downward pressure on its price.
While the world economy is tremendously reliant on oil in many sectors (especially in transportation), when it comes to electricity generation oil plays only a marginal role. In 2014, petroleum (i.e. oil) contributed to only around 1% of overall electricity generation in the U.S., while natural gas made up 27% of the electricity mix. Yet if the continuous decline in oil prices will indeed lead to correspondingly further falling natural gas prices, competitors such as renewable energy technologies will indeed face strong competitive pressures.
So far however, renewable energy is growing impressively worldwide, in terms of both investment volumes and capacity installations. Global investment in renewable energy in fact increased in 2014 for the first time since 2011, reaching an astounding $270.2 billion – the second highest recorded amount of investment in renewables in history. Worldwide renewable electric power capacity increased from 1,578 GW in 2013 to 1,712 GW in 2014, with the share of renewable energy in global electricity generation amounting to almost 23% by the end of 2014. These developments have largely been owed to continuous cost reductions, especially in solar photovoltaic (PV). The levelized cost of electricity (LCOE, i.e. the present value of the cost of electricity generation per kWh over the lifetime of the generating asset) for solar PV has halved between 2010 and 2014.
Despite historically low oil and gas prices, renewable energy technologies today are already largely cost-competitive with fossil fuel based power generation in many areas. For some applications, such as off-grid solutions, they are unquestionably superior. Solar PV is already becoming increasingly cost-competitive at the utility-scale, while for residential (rooftop) applications, expected further advancements and cost reductions in battery technology could, in combination with the widespread deployment of smart grid technologies, lead to an outright revolution in the way we use and produce energy.
Even so, the threat further declining oil and natural gas prices pose to a swift low-carbon transition should not be discounted easily, as the full effect on renewable energy investments and installations may simply not have been felt just yet. Furthermore, it is difficult to establish the proper counterfactual of how much would have been invested in renewables in the absence of the latest price drop in oil and thus to appreciate how much damage falling oil and gas prices may have actually done.
Yet it has also been suggested that recently low natural gas prices have stalled investment in new pipeline and shale exploration projects, because many are simply not economically viable at current prices. This illustrates that low oil and natural gas prices can behave as a double-edged sword – while potentially spurring demand for oil and natural gas and thereby diluting economic incentives for transitioning to low-carbon alternatives, they can also curb the supply side by making new investments economically unviable – at least temporarily. Thus while renewable energy has continued and even accelerated its growth over the past year, the full effects of further falling oil and natural gas prices remain to be seen.
Environmental Diplomacy
At COP21 in December this year, the world will come together to face the Herculean task of finally reaching a meaningful and binding universal agreement to curb global man-made greenhouse gas (GHG) emissions responsible for climate change. In order to mitigate anthropogenic (human-induced) climate change and its potentially catastrophic consequences for the entire planet (in terms of extreme weather events, sea-level rise, biodiversity, and vital ecosystem services) decisive global action will be crucial.
The most important and most challenging part of this action will be the waning off of the world’s carbon-based energy system from GHG spouting fossil fuels and the transition towards a new, low-carbon energy system. The cheaper the fossil fuels at the heart of the current system however, the higher will be the opportunity costs of switching to cleaner alternatives that, in the short term, may then appear more expensive. Of course when factoring in the costs of the environmental and human calamities that can be expected to follow from unmitigated climate change, any reasonable observer should conclude that any short term losses will be greatly outweighed by the long term benefits of changing our ways and averting disaster.
Yet when it comes to so-called collective action problems, of which multilateral (climate) diplomacy is a particularly vexing variant, reason is often times overshadowed by other, less noble deliberations of free riding and of deciding who is the bear the short-term costs. In climate diplomacy this is exacerbated by the fact that long-term benefits of averting disaster, while probably enormous, are distant, uncertain, and difficult to measure.
The future benefits of a potentially painful coming off of fossil fuels cold turkey today will not accrue until years or decades down the road and even then will be difficult to measure – how would a heroin addict put an economic price tag on substantially reducing (but not eliminating) her risk of a premature death in the future by quitting the needle today? The benefits seem obvious and large enough to warrant action, but if action depends on the (costly) collaboration of not a single individual but of many different actors with differing interests, then measuring and eventually dividing the pieces of the gained pie will be crucial to induce their action. Even worse, when it comes to global climate change, not only is the magnitude of the benefits uncertain but whether they will be accrued at all also depends not on any single country’s individual but on all of their collective action. Therefore even the most enthusiastic of nations in mitigating climate change cannot be sure of the success of their own actions, unless virtually everybody else follows suit.
Hence lower oil and natural gas prices are feared to adversely alter the cost-benefit calculations of crucial actors tasked with hammering out an already highly complex and extraordinarily difficult agreement in December. Luckily there have been many positive signs over the past year leading up to Paris, such as bilateral action on climate change between China and the U.S., India and the U.S., and Brazil and the U.S., the encyclical letter of Pope Francis “On Care for our Common Home”, and even an unexpected call for carbon-pricing from six major oil companies in an open letter to the UN and governments around the world. Last but not least the UN will also convene this month in New York in order to adopt a new set of Sustainable Development Goals (SDGs), which are to take the place of the Millennium Development Goals. The SDGs are designed to put the world on a sustainable development path, eradicating poverty and ensuring health and prosperity for all, while paying equal attention to economic, social, and finally environmental objectives, such as the respect for our planetary boundaries, including those related to the climate system.
These positive developments all have been taking place despite (or at least in the case of the oil major perhaps partly because of) historically low oil prices. There finally seems to be reason for hope, or dare I say cautious optimism, for reaching a long overdue meaningful and universal agreement on climate change mitigation by the end of this year. Yet of course, as my friend and colleague Joaquin Vallejo recently pointed out, the current progress and commitments are still falling far short of what will be necessary to avert climate disaster and many vexing obstacles still have to be overcome in the pursuit of that goal.
Despite the tremendous decline of oil prices over the past year, the direct and indirect impacts on the environment through the above discussed channels seem to have been limited so far, if even altogether negative. In transportation, the price pressures from cheap oil still seem to be insufficiently strong to change the economic fundamentals of the sector or severely undermine the EV industry. Renewable energy is still growing strong and in 2014 has even accelerated its growth, mostly owed to continuous large cost reductions, especially in solar PV. Even the problem child climate change diplomacy has shown some important vital signs over the past year.
Yet low oil, gasoline, and natural gas prices continue to loom menacingly, hanging like the sword of Damocles above the entire planet. The fall of oil and fossil fuels and the transition of the world’s energy system, in both transportation and electricity generation, away from fossil fuels and towards low-carbon alternatives, are far from being a done deal. While the world looks in anticipation to COP21 in Paris, it will require nothing short of the combined efforts of diplomats, world leaders, private business owners, civil servants, NGOs, consumers, and each and every citizen to wane the world off of fossil fuels, protect the climate and biodiversity, respect planetary boundaries, and eventually ensure a healthy and happy life for all.
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