Oil: why higher prices will complicate the energy transition

Oil and trouble. Pix One

Jorge Guira, University of Reading

The oil price is on a rollercoaster. Having crashed into negative territory just last April, the price of Brent crude climbed all the way to US$70 (£50) earlier in March. It has since slid below US$64. So where is it heading and what are the implications?

There are several reasons why oil prices surged from their 2020 lows. One is a common belief in an imminent “commodity supercycle”, in which an explosion in economic activity after the pandemic creates soaring oil demand.

Supply has been limited since Saudi Arabia and Russia cut production in spring 2020. The suspicion then and consensus now is that this sought to force down prices to drive less efficient US shale oil producers out of the market. It has substantially had that effect, with less shale entering the market as a result.

The price of oil (Brent crude, US$)

Price graph for Brent crude, 2015-2021
TradingView

Prices have eased in the past couple of days amid fears that Europe’s vaccine difficulties will slow global recovery, and thanks to a stronger dollar after the US Federal Reserve declined to curb rising Treasury bond yields at its most recent policy meeting on March 17.

Nonetheless, the direction of oil prices looks like it will be broadly upwards: most oil majors are signalling reductions in capital expenditure. Meanwhile, Opec, the 13-country cartel of oil nations, has a vested interest in continuing to restrain production to keep prices higher, while the whole framework of the Paris climate agreement aims to make oil production more expensive. This will be passed on to consumers in the form of higher prices.

As for oil demand, it is still expected to climb for many years, despite the rise of renewables. A recent study by BloombergNEF forecasts that the green agenda will only push oil into structural decline from 2035.

Admittedly, carbon taxes may soften demand by increasingly penalising companies for using fossil fuels – whether through the EU Emissions Trading Scheme, the new China scheme, or the proposed London Voluntary Scheme or US scheme. But it will depend on how the rules develop. The EU scheme is the most advanced but includes lots of exceptions that currently minimise the requirements on numerous sectors.

Oil and the wider economy

The oil price and its relationship with the economic recovery, bond prices and inflation is going to be vital to the post-COVID world order. Oil prices are closely linked to inflation. This is because oil has a multiplier effect as it circulates through markets: for example, it is an unavoidable cost for companies that run vehicles, who then pass it on to consumers by increasing the price of their goods and services.

In the US, there are already substantial concerns about the inflationary impact of the US$1.9 trillion stimulus package, particularly when the Federal Reserve has signalled that it will tolerate more inflation than previously. Rising oil prices feed into these concerns.

Long-term interest rates rise with inflation worries, and have duly been climbing sharply recently. If this continues, it could limit what the US government can borrow to spend on infrastructure. At the same time, inflation is liable to make the infrastructure more expensive.

The Fed therefore has an incentive to keep interest rates as low as possible, and there has been much speculation about whether it will do this by buying more long-term Treasury bonds. But that could further stoke inflation, which could end up pushing oil prices up further, so it’s a question of striking the right balance between over-stimulating and under-stimulating the economy. If inflation is held at bay, lower or at least stable oil prices may result, just like after the global financial crisis of 2007-09.

In the UK, the situation is a bit different. Inflation has remained low as oil prices have dropped. COVID-19 reduced demand for UK oil drastically and drilling activity has been negatively affected. Higher prices should help reverse this, depending on the oil demand from abroad – including from Europe.

In developing countries that depend on exporting oil and other natural resources, higher prices are definitely welcome. Many low to middle-income countries, including Nigeria and Indonesia, have seen government budgets taking a hit from the fall-off in demand during the pandemic.

In Nigeria, the government has been forced to devalue the naira to stimulate the economy. In such circumstances, rising oil prices can be a reliefincluding for exporters of other commodities such as industrial metals, whose prices are linked to oil.

Meanwhile, other developing countries lose out as oil prices rise – especially oil importers such as Thailand and Turkey. The Turkish central bank has just raised interest rates by two percentage points, partly to curb inflation.

The net zero threat

The oil price has implications for the ability of nations to meet the net zero emissions targets required under the Paris Agreement.

More expensive oil should hasten the tipping point where renewables become the cheapest way of generating electricity and powering transport. The lower cost of renewables compared to fossil fuels has already been helping to make them more attractive.

EV charging space
Renewable infrastructure does not grow on trees. Dana Kenedy

Yet paradoxically, higher oil prices also provide incentives to oil companies to spend more on exploration and production – a potential step in the wrong direction for achieving net zero emissions. And in developing countries that depend heavily on oil exports, higher prices mean more money for spending on society, which boosts government popularity. So they too may prioritise greater oil exploration and production, potentially at the expense of developing renewables and meeting nationally defined carbon targets.

This is not to say that higher oil prices will negatively affect the scope or pace of renewables spending overall. But they have to be further developed and built, so higher oil prices certainly risk progress in developing countries. This means that being able to keep oil prices from getting too high will play a key role in the pace and scope of the energy transition.

Jorge Guira, Associate Professor of Law and Finance, University of Reading

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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Tom in Toronto
March 20, 2021 6:17 pm

Oil prices will get back to $100+ barrel. Banks are getting eco-shamed for even lending to upstream (E&P) at this point, so existing producers have a valuable monopoly. Last year’s crash led to many bankruptcies and massive underinvestment. By 2023 all of OPEC+ production will be restored and there will still be a structural deficit in the market that will take 2-3 years of $100+ barrel oil to bring back into balance.
We saw back in 2007-08 how high prices can get before demand is reduced; back then it was around $140/bbl; and it might be north of $200/bbl in 2023-2025.
Policy-makers are dreaming if they think we have hit peak oil demand in 2019. 2022 will exceed 2019’s demand, and it will continue higher from there at least until 2030 (barring economic catastrophes like COVID in the meantime).

Last edited 4 months ago by Tom in Toronto
RelPerm
Reply to  Tom in Toronto
March 20, 2021 10:27 pm

Well, that was a realistic vision until technologies of multi-lateral directional drilling and fracture stimulation opened up tremendous oil and gas potential in the USA which is economically viable at $50-60/bbl. That means global energy prices can be stable and moderately low for a very long time. That is unless Biden squashes domestic USA production like a bug.

Tom in Toronto
Reply to  RelPerm
March 21, 2021 9:58 am

That’s my assumption – US, Canadian, and European production is held down by morons like griff, greta, etc.
Obviously if the shackles (and devil horns) are taken off of oil production in these areas, prices will stay moderate.

bigoilbob
Reply to  RelPerm
March 21, 2021 12:05 pm

“…. which is economically viable at $50-60/bbl.”

Which is where we are now. Please show me the company that claims to be engaging in these practices:

  1. That is spending CAPEX at a rate of any more than a fraction of that a few years ago.
  2. Has a stock price any more than a fraction of that a few years ago.
  3. Has a debt load lower than that of a few years ago.
  4. Uses service companies that are not also losing their ***es, and will not increase their money losing rates as soon as they smell a whiff of a comeback.

Not rhetorical. The company please…..

Pat from kerbob
Reply to  bigoilbob
March 21, 2021 5:20 pm

Personally I know of none expanding, I imagine they are in watch and wait mode to see if Biden really is as stupid as he seems, then the flood will unleash.
Strictly my opinion, such as you enjoy lathering around here Bob

bigoilbob
Reply to  Pat from kerbob
March 21, 2021 5:31 pm

Personally I know of none expanding”

Nor do I.

“I imagine they are in watch and wait mode to see if Biden really is as stupid as he seems, then the flood will unleash.”

They have been “in watch” for years now. Please expand on what they will “unleash”, beyond another round of Bk’s, and more shirking of the Trumpian YUGE asset retirement obligations they have incurred over the past 15 years.

Strictly my opinion, such as you enjoy lathering around here Bob.”

We’re all opinionated. But thanks for saying so, without claiming it’s truth with no backup. I clearly state IMO, and aks for any counter documentation. I get VERY little.

MarkW
March 20, 2021 6:36 pm

The lower cost of renewables compared to fossil fuels has already been helping to make them more attractive.

The claim that renewables are cheaper than fossil fuels is not and never has been true.

davidmhoffer
Reply to  MarkW
March 20, 2021 8:58 pm

Of course it is true. Just because the price of electricity rises everywhere that they are heavily used…oh? there aren’t any of those? ok medium used…. oh? there aren’t any of those? ok used just a little bit… the fact that using just a little bit increases the price of electricity doesn’t change the fact that they are cheaper.

This is the New Math. The Old Math got Cancelled.

Reply to  davidmhoffer
March 21, 2021 6:51 pm

davidmhoffer
But in the US the greater the penetration of solar & wind, the more likely the state has an average kWh cost higher than the US average (~$0.12).
From a Manhattan Inst 3/2019 article:
The EIA.org estimates of LCOE (levelized costs of energy) do NOT include:
backup generation
transmission costs
property taxes
utility profits.
And the EIA uses a 30 year depreciation schedule which is 10 years longer than its life expectancy (ditto for solar. But 30 yrs is 10-30 yrs too short for coal, gas or nuclear).

Bottom line: most cost comparisons in the MSM are apples-to-oranges, ie bogus.
The New Math is just like The New Economy (internet bubble) or more currently Modern Monetary Theory: aka magical thinking.

Anon
Reply to  MarkW
March 20, 2021 9:28 pm

And if renewables were indeed cheaper, then you have this to contend with:

Jevons’ Paradox

In 1865, the English economist William Stanley Jevons observed that technological improvements that increased the efficiency of coal-use led to the increased consumption of coal in a wide range of industries. He argued that, contrary to common intuition, technological progress could not be relied upon to reduce fuel consumption.

https://en.wikipedia.org/wiki/Jevons_paradox

markl
March 20, 2021 7:10 pm

So when the Marxists take complete control of Venezuela will they use the oil/reserves as cudgel to crash the Arab fossil fuel dominance? Conspiracy theorists want to know.

Juan Slayton
Reply to  markl
March 21, 2021 5:47 am

Marxists already have complete control of Venezuela. I think the Arabs are not worried.

Drake
Reply to  Juan Slayton
March 21, 2021 4:27 pm

The Saudis run their oil companies efficiently unlike Venezuela. They are not elected, they are a hereditary monarchy and their leaders are smart enough to put businessmen in charge, not cronies.

ResourceGuy
March 20, 2021 8:03 pm

Given the current rate of blindness in the Climate Crusades, they won’t even notice that the increased oil investments will be in the Arctic and Middle East while all the headlines are about the U.S. and North Sea.

michael hart
Reply to  ResourceGuy
March 21, 2021 4:01 pm

And in a prime example of Western-media onanism, they also ignore which companies are doing the producing. Many of them are national state-owned companies. In 2019 Exxon only came in at number six in the rankings.

Countries who’s main source of income is oil/gas will chew off their own legs before they join the green crusade.

n.n
March 20, 2021 9:10 pm

From [reliable] energy to transenergy (i..e. a state or process of divergence from normal). One step forward, two steps backward.

StephenP
Reply to  n.n
March 21, 2021 1:41 am

Looking at http://www.gridwatch.templar.co.uk for the past month it looks as if a significant proportion of the electricity generated in the windy periods would have been needed to recharge the batteries, if we had them.
Just because we can do something doesn’t mean it is necessary or economic to do so.
But, but, but we are saving the world, even if the CO2 emitted in the manufacture of windmills and batteries offsets much of the CO2 from gas power stations.
Also the costs and emissions incurred by renewables will recur on a 10 to 16 year cycle.

Redge
Reply to  n.n
March 21, 2021 4:01 am

From [reliable] energy to transenergy

When I first read that I thought energy was self-identifying as “trans”.

My mistake 😉

Dennis
March 20, 2021 9:45 pm

As the price of oil rises that price will soon reach and exceed the point at which oil resources such as shale oil and oil bearing sand deposits become commercially viable.

In Australia there are many capped oil wells in remote areas that were drilled by the government owned Commonwealth Oil Refineries in the early 1900s but Middle East oil was cheaper to extract and deliver to market.

And then there is fuel produced from coal to consider.

Geoff Sherrington
Reply to  Dennis
March 21, 2021 4:32 am

Dennis,
We operated the Mount Morgan Mine in the 1970-80 era. In evenings, I would read the library books in the Directors Quarters, so learning how Mt Morgan’s profits led to oil discovery in Persia, to the C.O.R. company that BP took over in 1952. And so on.
I am puzzled by your reference to C.O.R. discovering oil in Australia, for I was unaware of this. BP after 1952, yes, and we now have particularly the WA gas fields.
.
Might you please reference the oil discoveries that you mention? Geoff S

Dennis
March 20, 2021 9:50 pm

As or if fossil fuel demand decreases governments will lose tax revenue, to replace that revenue will be a priority and accordingly electric vehicles will be charged a road use tax to replace fuel tax/excise.

However, it would be interesting to observe how the electricity suppliers/grids would cope with EV demand if EV replaced ICEV.

More wind and solar? Located at which suitable locations of land areas needed?

RelPerm
March 20, 2021 10:01 pm

“Yet paradoxically, higher oil prices also provide incentives to oil companies to spend more on exploration and production – a potential step in the wrong direction for achieving net zero emissions.”

That may be if higher price profit flows to oil companies instead of governments and mineral owners. In 1980, good old Jimmy Carter implemented “Crude Oil Windfall Profit Tax” which confiscated much of the profit when prices got above a fairly low base price. Many current international contracts are Production (or Profit) Sharing, where again, after costs are recovered, much of the profit goes back to the government. Gasoline and Carbon Taxes have impact of increasing prices, but all is captured by the government.

The Greenies like to talk about how oil and gas companies are “subsidized”. In reality, O&G companies have an exceedingly high tax/royalty/profit sharing burden in upstream, midstream, and downstream operations. As shift moves from oil and gas to wind/solar/bio/hydro/or even nuclear, local governments will start to ask “who’s going to pay for schools and roads and…”. New Mexico is already asking that with the slowdown of O&G activity on federal lands. NM is losing out on state/county severance and ad valorem taxes on the lower federal production.

In the mean time, I’m going to have fun driving around in my high $ tax subsidized electric Hummer and pay no $ for road construction/maintenance or schools or… I feel sorry for the poor schmucks buying gasoline as they will get stuck with more of these costs.

Editor
March 20, 2021 10:48 pm

Typically of The Conversation, they talk about oil price movement as something that they can control to get a desired effect – the problem being that they can’t work out which way to move it.

The answer for them is very simple: ignore the oil price, and concentrate on getting their favoured renewable energy competitive with fossil fuels. Once they have done that, people will happily buy their energy in preference to fossil fuels.

This free-market idea doesn’t seem to go down too well with them. It seems that winning on merit is too difficult a path, or maybe even too difficult for them to understand, and only winning by manipulation and fiat is acceptable.

Drake
Reply to  Mike Jonas
March 21, 2021 4:38 pm

But Mike, renewables can only “win” by manipulation and fiat, they are expensive, inefficient and not dispatchable so they can win no other way.

very old white guy
March 21, 2021 3:01 am

Everytime I read the words “net zero” I want to throw something at someone. There is not now, nor ever will be anything such as net zero, no matter what kind of idiotic math is used.

Redge
Reply to  very old white guy
March 21, 2021 4:04 am

Agreed.

“Net zero” is a bullshit term allowing wealthy greens (and countries) to pretend they are not emitting CO2 (not that CO2 emissions matter – unless you dine on CO2)

RLu
Reply to  very old white guy
March 21, 2021 6:19 am

Yep.
By the time all your neighbors also use weather dependent energy … who will absorb your surplus.
And utility scale power plants are like fire trucks. They cost about the same, whether you use them 300 days per year or once in 3 years.

Steve Reddish
Reply to  RLu
March 21, 2021 8:32 am

The neighboring states to California and Oregon are profiting from those states’ move toward renewables. Why would neighbors make the same mistakes?
Neighbors receive low cost or even no cost electricity when CA has excess, and sell high priced electricity back when renewables drop off.

Bruce Cobb
March 21, 2021 3:19 am

“why higher prices will complicate the energy transition”. You misspelled “energy disaster”. Common error.

Last edited 4 months ago by Bruce Cobb
LdB
Reply to  Bruce Cobb
March 21, 2021 6:16 am

They also left the part where riots break out and many green supporters end up against the wall.

ThinkingScientist
March 21, 2021 3:41 am

The article states:

Supply has been limited since Saudi Arabia and Russia cut production in spring 2020. The suspicion then and consensus now is that this sought to force down prices to drive less efficient US shale oil producers out of the market”

Wrong way around. It is increasing supply, thereby lowering prices, which is what puts US shale oil and gas under pressure. With a low price they cannot make money, whereas Saudi Aramco can still make money at very low oil prices (although Saudi Arabia would likely struggle with balance of payments then).

Barnes Moore
March 21, 2021 7:09 am

I love these types of statements “More expensive oil should hasten the tipping point where renewables become the cheapest way of generating electricity and powering transport. The lower cost of renewables compared to fossil fuels has already been helping to make them more attractive”. Like virtually everyone else making this claim, what they fail to understand is that unreliables are dependent on fossil fuels from cradle to grave – from powering the machinery needed to mine the enormous amount of raw materials required, to the transport, manufacturing, site prep, ongoing maintenance, and ultimate decommissioning. Like everything else, increased costs of fossil fuels means increased costs of pretty much everything, including unreliables, except that with unreliables, the cost may be hidden due to subsidies.

Mickey Reno
March 21, 2021 7:18 am

How cute, a lefty assistant professor finally read a book on supply side economics and thinks he now understands incentives. And he STILL wants to control them and the entire consumer market for fossil fuels via central planning, but has to admit he doesn’t know how.

John the Econ
March 21, 2021 7:43 am

Not mentioned is the degree to which fossil fuels will be required to build this new green infrastructure; Higher oil prices mean an even higher cost of bulding all this new green infrastructure for this supposedly cheaper green energy.

Coach Springer
March 21, 2021 8:19 am

The Biden administration (not Biden) are practicing supply side economics to fossil fuels. Restrict supply, raise prices, push demand to mandated alternatives. And yes, OPEC is happy to see Democrats do their job in restricting US production while their prices rise.

Mickey Reno
Reply to  Coach Springer
March 23, 2021 3:08 am

No, the Biden Administration is practicing central planning of what would otherwise be a more free market that was free to respond to all natural market forces, with less of a heavy touch of government’s thumb on the scale. To be sure, the incentives that Biden’s and the lefties are creating will exact their punishment, and cannot be ignored. The “free” market thus becomes less free, and the politics of this political economy are more partisan and surreptitious and presumptuous, as is typical of all Leftist/Marxist/Socialist planning..

James F. Evans
March 21, 2021 9:02 am

 “…net zero emissions…”

A recipe for rationing.

A higher oil price… makes the shale oil business financially viable.

Steve Z
March 21, 2021 11:06 am

As oil prices rise, frackers in Texas and North Dakota (who might have temporarily shut in their wells during the COVID downturn) who operate on private land will increase production, in order to take advantage of increased profit margin. This will tend to keep a lid on oil prices, while governments who try to force renewables on the market will have to subsidize them even more, which could cause a taxpayer revolt.

ResourceGuy
March 21, 2021 5:03 pm

Remember to look the other way when China adds to its investment in the Russian Arctic oil development and large diameter pipelines are added between Russia and China, and China becomes the world’s largest oil refiner, and China buys more crude oil from Iran and Venezuela. In fact you need to get climate religion not to see these things. There will b a blessing of the EVs next week and sainthood for Al Gore and Obama. Bless the children for they shall inherit this Potemkin village.

aaron
March 22, 2021 12:56 pm

https://www.facebook.com/aaron.chmielewski.3/posts/260553140734515

Whenever people start talking about OPEC, I like to point out this Paul Krugman paper from 2001, http://web.mit.edu/krugman/www/opec.html.

When people say that the US cannot affect the price of oil, I like to point out several things: 1.) That’s a good thing because every bit we produce goes to our GDP. 2.) That’s a good thing because every bit we don’t import adds to our GDP. 3.) That’s a good thing because every bit we don’t import reduces our trade deficit. 4.) That’s a good thing because it means lots of tax revenue (see 1 and 2). 5.) Don’t be so sure about that, a little competition could spur production in lots of other places.

Many producers produce inefficiently (and messily) because they believe price rises will keep them wealthy. E.g. Venezuela, Russia in the 1990s… They don’t keep their equipment maintained and they waste/spill a lot.

US hoarding sends a signal to oil producing nations with two implications: 1). Alternative Energy is nowhere near ready, otherwise the US would be extracting its oil before prices fall; the US likely doesn’t expect alternatives to ever be better than fossil fuels (I’d like to get into this, but I’ll save it for another time). 2). Current producers can make money by keeping production low.

If the US told the world it believes alternative energy R&D would pay off within the next 50 it would mean nothing, unless they back it up with extraction for the medium term. I believe that if the US said that there was no future in oil, and backed it up by pumping full-tilt to take advantage of the current high prices, we’d see both alternative research take off as well as exploration, extraction, and productivity throughout the world.

Reagan wasn’t the Great Communicator because of how he talked. Actions speak far louder than words.
Cheers,

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