What is the ideal oil price for the energy transition?

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Photo: Flora Cyclam

Photo: Flora Cyclam

Does the energy transition benefit from low or high oil prices? Proponents of a swift energy transition have debated this question for a long time. Most believe high oil prices are beneficial, because they make alternatives more competitive. But high oil prices also lead to huge profits for fossil fuel businesses, while low prices make the more costly (and often dirtiest) projects unprofitable. According to Rick Bosman and Derk Loorbach of the Dutch Research Institute for Transitions at Erasmus University in Rotterdam, the ‘best’ oil price is neither high nor low, but fluctuating and unpredictable. That’s why the current oil price collapse may be good news for the transition: it seems symptomatic of the growing destabilisation of the fossil fuel regime.

Six years ago, with the world economy going at full throttle and concerns over the available reserves of easy oil, the oil price climbed to an all-time high of over $140 a barrel (see figure 1). Those hoping for a swift transition to a sustainable energy system, among whom we count ourselves, thought that such a high oil price would accelerate the search for alternatives, people switching to electric vehicles, the development of renewable sources of energy, etcetera.

Figure 1 Oil price over the last decades. Source: Macrotrends.org

Figure 1 Oil price over the last decades. Source: Macrotrends.org

This did happen to some extent, but oil showed very little elasticity of demand: consumption was not impacted very much. At the same time, oil firms were amongst the most profitable businesses on the planet, which gave them considerable economic and political influence as well as the means to expand their business.

Then the economic crisis hit and oil prices plunged. Some observers even saw a causal relationship between the very high oil prices and the world economy coming to a halt. However that may be, most people believed that when the economy would pick up, oil prices would also climb up again and everything would return to ‘normal’. But in the last couple of months the oil price imploded again to around $50 a barrel, with no clear explanation in the state of the world economy.

The United States has cranked up output in recent years leading to a glut in supply. OPEC and its main constituent Saudi-Arabia were expected to lower output to stabilise global oil prices, but apparently they have no intent to do so at the moment.

A recent article in the Economist with the apt title Sheiks v Shale, analyses the consequences of this battle of oil powers. The most interesting result of the current low oil prices, at least from an energy transition perspective, is that it pushes out the more costly endeavours. In a stunning analysis published before Christmas, investment bank Goldman Sachs found almost $1 trillion (a one with 12 zero’s) in investments in future oil projects at risk (see figure 2). These often happen to be also the dirtier kind. Good news for the transition, one would think.

Figure 2 How profitable is $70 oil? Source: Goldman Sachs Global Investment Research. Annotated Tom Randall/Bloomberg

Figure 2 How profitable is $70 oil? Source: Goldman Sachs Global Investment Research. Annotated Tom Randall/Bloomberg

That’s one side of the story. Unfortunately there is a downside as well. Low prices also stimulate demand for oil, make alternatives relatively more costly and the search for better alternatives less urgent. This is not what the proponents of a swift transition like to see.

If both high and low oil prices are not very helpful for the transition, then what would be a better outcome? For one, recent fluctuations in oil prices may be an indicator of a destabilisation of the fossil fuels regime. Such a destabilisation is a necessary precondition for a fundamental transition. Together with fluctuating prices, the tensions over access to fossil energy, geopolitical stresses, the carbon bubble debate, the (resistance to) shale gas developments and the climate negotiations are all putting the heat on fossil fuels. It seems that, combined with the accelerating pace of the spread of renewables, all ingredients are there to create long term instability in the fossil based markets. The recent call from IEA’s Executive Director Maria van der Hoeven to use low oil prices to raise the carbon price fits this picture.

The main lesson we can draw from the fluctuations in the oil price, is that they are very difficult to predict and probably will continue to be. And this is actually the best news for the transition. Renewable energies, although often still more costly than its fossil counterparts, have one characteristic that makes them very attractive in a world of highly volatile fuel prices: their costs are known. When you install a wind turbine or solar panel, you know what it will cost you and although the output is variable, you know roughly how much energy it will produce over a period of years. Therefore, these sources are more reliable price wise. They can even be used to hedge for fluctuations in fossil fuel prices.

The more oil prices will fluctuate the more this benefit of renewables will get the attention of consumers and investors. Therefore, the best oil price for the energy transition is a heavily fluctuating one.

Editor’s Note

Rick Bosman is PhD-student at the Dutch Research Institute for Transitions. His research focusses on the energy transition and specifically the destabilisation of the fossil energy regime. Follow Rick on twitter @r_bosman  

Derk Loorbach is full professor socio-economic transitions at the Erasmus University in Rotterdam and director of the Dutch Research Institute for Transitions. Follow Derk on twitter @drk75

Rick Bosman and Daniel Scholten in November 2013 published a highly original, groundbreaking article on Energy Post: How renewables will transform commercial and (geo)political relations. This has been one of our best-read articles. Recommended!

Comments

  1. Lukas Hermwille says

    Thanks for that very interesting article. I agree with most of it. What we actually need is not one but two fuel prices: low prices at the well, high prices at the pump. The strong fluctuations kind of emulate this situation. But that is certainly not enough and that is why I agree with Maria van der Hoeven. An adequate carbon price will also create this price difference and thus contribute to further destabilize the unsustainable energy regime.

  2. Math Geurts says

    “When you install a wind turbine or solar panel, you know what it will cost you and although the output is variable, you know roughly how much energy it will produce over a period of years”

    Although the relation between of oil and the price of power are not that straight anymore nowadays it is obvious that small and big investers prefer power plants which get strong guarantees from governments for their financial revenues indepently of the market value of their output. This will be more true as the fluctuations of the value of power would become bigger. For that conclusion no “scientific” analysis is needed.

  3. Dennis Bevington says

    This latest oil price fluctuation seems to have its basis a demand reduction worldwide, without any dramatic downturn in the world economy. This must speak volumes to oil importing regions, reducing demand can reduce the cost of oil. Building economies that avoid utilizing oil mean lower prices for what oil is requires.

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