Aguilera & Radetzki: Climate Policy With Low Oil Prices

  • Date: 10/09/15
  • Roberto F. Aguilera and Marian Radetzki

From Roberto F. Aguilera and Marian Radetzki’s new book The Price of Oil, Forthcoming, Cambridge University Press, November 2015

The Price of Oil

In our forthcoming book, The Price of Oil, we argue that although oil has experienced an extraordinary price increase over the past few decades, a turning point has now been reached where scarcity, uncertain supply and high prices will be replaced by abundance, undisturbed availability and suppressed price levels in the decades to come. We also examine the implications of this turnaround for the world economy, as well as for politics, diplomacy, military interventions and the efforts to stabilize climate. 

Using simplistic methodologies, we conclude that the shale revolution will yield an increased output of oil in the world (outside the US) totaling 19.5 mbd in the 20 years between 2015 and 2035. We also assert that the conventional oil revolution – the application of horizontal drilling and fracking to conventional oil formations in the world outside the US – will yield a further addition of 19.7 mbd in the same period, summing up to a spectacular total rise of over 39 mbd by 2035. This is nearly twice as much as the global increase in all oil production in the 20-year period 1994–2014.

As the revolutions develop and expand internationally, they are bound to have a strong price-depressing impact, either by preventing price rises from the levels observed in 2015 or by pushing them back to these levels if an early upward reaction takes place. Our conclusion on prices envisages a level of about $60/bl in 2035, while a more optimistic scenario which appears increasingly likely, sees a price of $40 by then. The price implications of the revolutions will in turn influence many other conditions that shape human life, be they economic, political, diplomatic or military.

Though concerns about global warming are not the main focus of our book, we take a look in one of the chapters, and in this Guest Editorial, at the relationship between climate policies and the projected greater availability and lower long-term oil prices due to the two revolutions. Without policy reactions, the use of oil will grow and extend its life expectancy in the global energy system.

An inherent conflict

A deep climate policy was defined as one assuring that CO2 concentrations in the atmosphere did not exceed a doubling throughout the twenty-first century – believed to involve a warming of some 2 degrees Celsius. Such a policy is seen to require global emission cuts of some 30 percent already by 2035 (and no less than 50 percent by 2050) compared with 2011 levels (IEA, 2013). There is little doubt that implementation of a climate policy at this level of ambition would imply the end of most of the oil revolutions. There have also been widespread claims that such policy would result in massive stranded assets in unconventional oil sources in general, far from just shale oil.  

Would sizable proved reserves remaining in the ground due to a deep climate policy constitute a serious problem? We do not think so, and present the content of Table 1 in support of our view. The table is based on IEA’s New Policies Scenario, which assumes that current and planned climate policies will be implemented, but that no new and more severe ones will be introduced – so that the climate policy burden on the economy will remain quite light. The output growth anticipated by the IEA in this scenario permits us to calculate the aggregate 2014-2040 output as a multiple of output in 2013, and so to assess the remaining proved reserves in 2041 (also expressed in years of 2013 output). It emerges that colossal proved reserves will remain in 2041 even in the absence of deep climate policy. But unused reserves apparently do not cause any serious problem to the fossil fuel industries, or else, they would never have been created on the prevalent scale. The reason may be that investment in reserve creation is relatively small in relation to total production cost, and worth the companies’ while to assure reasonable peace of mind about future production potential. Of course, reserves remaining in 2041 would be even larger if a deep climate policy were implemented.

The stranded asset problem could raise far more serious problems if climate policy resulted in unused production installations, whose development has involved heavy investments. Applying the rough and simplified assumption that oil output would be reduced in line with the overall emission cuts referred to earlier of 30 percent in coming decades, we see oil production reduced from 87 mbd in 2013 to around 60 mbd in 2035. This would be a remarkable change, but even here we believe that serious stranded asset problems are unlikely to occur. Producing wells worldwide experience, on average, decline rates of 7 percent per annum, so stable production requires investments either in enhanced recovery, or in the development of completely new fields. No more than five years of absent investments would then be required to reduce current production capacity to the maximum 2035 level imposed by climate action. In the absence of dramatic and sudden measures imposed without warning, there is little likelihood that installations capable of continued production would be left idle in consequence of interventions to arrest climate change.

These considerations raise the question about the realism of the stranded asset fears. Some studies warn about the risks to the oil industry of launching expensive, marginal projects – a “carbon bubble”. However, it would appear that the industry and its investors are generally assuming that climate agreements will not be pursued with sufficient seriousness to jeopardize their future investments. We are inclined to share this view.

Another point to consider in this context is that a vast majority of the world’s oil reserves are in the hands of state owned enterprises in developing countries. These organizations have goals like social and economic development, which are likely to be higher priorities than cutting emissions. Moreover, the oil consumers in most oil producing developing countries receive significant public subsidies. These subsidies are politically hard to discontinue. They also encourage domestic usage, and, by implication, the level of production.

Climate policy: costs

The cost of a rational, deep policy, using the most efficient instruments and assuming that economic adjustment to the policy effects will be ideally flexible, has been assessed to amount to perhaps 1–2 percent of annual global GDP. Political dilemmas will obviously arise, as these costs will ultimately have to be borne by unwilling tax payers or energy users.

These dilemmas will become much more profound since the less developed countries are now the largest emitters, and virtually all of the energy demand growth in the future will come from these countries. Yet it is reasonable for them to express an unwillingness to go along with a global emissions deal, where everybody is equally charged for each emission unit. Given the developed world’s history of intensive oil, coal and gas use, it is clearly a politically and morally sensitive issue to deny the less developed countries the use of fossil fuels to achieve reduced emissions at the expense of similar prosperity. Income transfers from the rich countries would be of essence to get the poorer countries aboard a global scheme.

Against this background, it may be appropriate to present some results showing the order of magnitude of the required dollar flows if the world is to attain the emissions goal referred to earlier, with the non-OECD world’s participation paid for in full by financial transfers (Jacoby et al., 2009). By 2020, the net annual transfers are assessed at $500 billion, of which $200 billion are from the US. By 2050, the required annual transfers would exceed $3 trillion, with the US contribution rising to $1 trillion. To put these sums in perspective, the rich countries have to date pledged around $10 billion in compensation to the rest of the world – but even these meager commitments are not definitive as they are facing political resistance in several of the countries making them. Given the relative size of these numbers, it is easy to understand the failure to come to an agreement at the 2009 climate change conference in Copenhagen, Denmark – a failure that clearly perseveres in the preparations for the Paris meeting in December 2015. The gulf between the climate rhetoric and the political preparedness to incur costs appears difficult to bridge.

Climate policy: prospects in a 20-year perspective, and implications

We note that practically all energy forecasting organizations are predicting an expanding fossil fuel future for decades to come, with oil continuing to play a key part in satisfying the world’s energy needs. Moreover, as stated earlier, the oil industry’s investment behavior exhibits unbelief in deep climate policy within the foreseeable future. The stranded asset phenomenon may come to apply in the main to expensive, subsidized renewables if these attitudes prevail and become instrumental in policy evolution. 

Despite the difficulties in predicting what might transpire, history and current behavior point to no more than a superficial climate policy in the foreseeable future, with our projected revolutions proceeding by and large unhampered. We deem that the great ambitions of the Paris climate meeting in December 2015 are very unlikely to be fulfilled.

References 

BP (annual), BP Statistical Review of World Energy, British Petroleum, London. 

IEA (2013), Redrawing the Energy-climate Map, International Energy Agency, Paris. 

IEA (2014), World Energy Outlook, International Energy Agency, Paris. 

Jacoby HD et.al. (2009), “Sharing the Burden of GHG Reductions”, in Aldy J and R Stavins, editors, Post-Kyoto International Climate Policy, Cambridge University Press, Cambridge, UK. 

  • Roberto F. Aguilera, Adjunct Research Fellow, Curtin University, Australia
  • Marian Radetzki, Professor of Economics, Luleå University of Technology, Sweden
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