If you want to understand what has been happening in world oil markets over the past six years, this paper from @HansWernerSinn is essential reading. (HT @BayouTerrier, who was tweeting about Sinn and "the green policy paradox" earlier today.) https://www.ifo.de/DocDL/cesifo1_wp2087.pdf
The argument is essentially a variation on the well-known Jevons paradox: if technology or policy increase the efficiency of using a resource, then consumption of that resource can actually increase
Sinn's argument is that climate policies risk being similarly counter-productive, for two reasons. 1) If some countries curb demand for fossil fuels, world prices will fall, leading to increased consumption in other countries that do not have such restrictions
And 2) If fossil fuel producers see demand restrictions and lower prices coming in the future, they have an incentive to produce more now, to maximise their total revenues
So when the leading economies develop renewable energy and EVs, and increase fuel efficiency, they can drive down their own fossil fuel demand, but "one country’s green policies just help the other country buy energy at lower prices, and the speed of global warming is unchanged."
That these effects occur is undeniable. Whether they are significant or not depends on the market. In coal, world consumption has been on a plateau since the 2013-14, and it is hard to see any fall in prices that could put the market back on a sustained growth path
In oil, though, Sinn's analysis seems like an important part of the explanation for what we have been seeing over the past decade. US oil consumption hit a plateau in 2005-07 at ~21m b/d, and although it will rebound post-Covid, it is unlikely to exceed that level ever again
Global consumption has been growing strongly over that period: from 85m b/d in 2005 to 99m b/d last year. China alone grew~6.5m b/d, from 6.8m to 13.3m. China's emergence as the world's largest refiner shows the shift that has been under way. https://twitter.com/JavierBlas/status/1330417848418775040?s=20
But China's oil demand is not going to keep growing at that pace forever. For industrial policy and energy security as much as for environmental reasons, the government is making a big bet on EVs. https://www.ft.com/content/f414839d-b7e0-43ea-bba2-dc8966d64a11
So if you are an oil producer with a lot of reserves looking at this prospect, what should you do? Well, the news from Abu Dhabi today suggests they are doing exactly what Sinn says is rational for them to do: they are planning to increase production
Abu Dhabi today added 22bn barrels to its reported recoverable oil reserves, raising the total to 107bn barrels. At maximum output, that is more than 70 years of production. But if China's car sales are already 50% EVs by 2035, what is oil demand going to look like in the 2090s?
In Hotelling's theory, resource owners assess a tradeoff between future price appreciation and what they could do with the money if they sold today. If climate policies make it look less likely that prices will rise in the long term, they increase the incentive to produce today
And that is what Abu Dhabi is doing. In today's announcement, the annual rate of capital spending was cut slightly from previous plans. But the emirate is sticking with its plan to raise production capacity 25%, from 4m to 5m b/d, by 2030
Bottom line: curbs on demand and incentives to increase supply mean long-term equilibrium oil prices will be lower. Good news for consumers; bad news for producers who need high prices to be viable
Now, that is the long-term equilibrium, and there will of course be cycles around that. Most immediately, the recent weakness of oil investment and exploration, exacerbated by the pandemic, is setting us up for tighter markets and higher prices some time this decade
But on average, prices will be lower than they would otherwise have been. And as Sinn says, that will create additional consumption. It is like squeezing a balloon: if you push down on oil demand in one place, it will pop up in another. That doesn't make these policies useless...
Sinn's suggested solutions include decoupling energy use from emissions through carbon capture and the use of carbon sinks such as forests
Some of his proposals seem highly impractical: a global tax on fossil fuel production or a super-OPEC of all energy producers, linked by a shared emissions trading system. Don't hold your breath
But his work is an important reminder that energy markets are global, and climate change is a global problem. And the law of unintended consequences is particularly powerful when it operates on a global scale. (ENDS) https://www.ifo.de/DocDL/cesifo1_wp2087.pdf
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