Why cheap oil is an opportunity for fossil fuel price reform

Burning oil already contributes to about one fifth of greenhouse gases causing climate change, according to data published in a report by the Intergovernmental Panel on Climate Change and the International Energy Agency, while oil extraction has local environmental impacts such as water and air pollution.

Citigroup’s suggestion that oil could fall to $20 per barrel and that its chances of returning to $100 were slim could be read as catastrophic news for the planet.

Impacts of low oil prices

If people choose what’s cheaper, one might expect a fuel feeding frenzy that will push back a transition to cleaner transport and efficiency while pushing up carbon dioxide emissions.

Investment analysts have tended to assume that the high oil prices of the last decade drove an energy revolution, stimulating investment in electric vehicles, cleaner energy and ‘smart’ technologies that could help to radically reduce emissions. But of course, they also drove investment in new supplies of oil (and gas) – particularly American shale oil – that have helped send the market price back down.

Immediate impacts of low oil prices depend on whether people and industries will actually use significantly more oil when it’s ‘cheap’ and choose to buy less efficient vehicles in which to burn it. While traders may be filling up supertankers in anticipation of a higher future price, drivers face a different price reality. With the exception of the United States, pump prices for petrol and diesel have not dropped as much in other rich countries due to duties and taxation – 16 per cent in Japan and 18 per cent in the UK.

This is why the real trend to watch is fossil fuel price reform. Several large developing country governments that currently subsidize fuel for their populations are seizing the opportunity that cheaper oil offers to reduce subsidies or add taxes and duties with little initial impact on consumers.

Oil importers, Indonesia, India and China are doing this. Here, as has already happened in Europe, taxation will drive a widening wedge between crude oil and end-user fuel prices.

Effects on coal and gas

Oil doesn’t generally compete with the main fuels used to produce electricity – coal and gas. But it does affect their price in various ways. This is important because the future outlook for gas and coal prices is a key factor in the business case for renewable energy and buildings efficiency. Decisions that governments and investors take now on electricity provision will lock in fuel choices – and emissions – for at least 40 years.

For example, gas to European and Asian markets is expected to fall by up to a third over the next year and the question is whether politicians continue to back a long-term future of solar, wind, insulation and smart grids for example, over the prospect of lowering people’s energy bills in the short term.

As for coal – that king of culprits in terms of carbon dioxide emissions – the oil price has given ailing mining companies in countries like Australia and Indonesia a leg up. Cheaper oil is a bonus to them as it cuts costs in both mining and shipping.

This may be temporary, but if it allows coal to stay cheap for longer and thus spurs more coal-fired power stations, it is bad news for climate and for public health. Burning coal – still the main source of power generation in Asia – is estimated to cause the early death of more than half a million people in China alone from strokes, lung cancer and respiratory diseases, according to a report in the South China Morning Post.

Time for price reform

Basing our economies on burning stuff – including oil, gas and coal – remains an extremely expensive policy whether the fuel itself is bought cheap or not. Mass layoffs in the energy industry and devastating currency devaluations in oil exporting countries such as Russia and Venezuela underscore the vulnerability of economies and jobs dependent on volatile fossil fuel revenues.

If governments want to promote healthy societies and livelihoods, they need to enforce regulation over air quality, buildings efficiency and environmental protection.

Incorporating the real costs of health, carbon and resource degradation into fuel pricing is essential. This will not only provide a buffer against oil price volatility, but also enable clean energy and efficiency to prosper.

This article is published in collaboration with Chatham House. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Glada Lahn is a Senior Research Fellow at Chatham House working on Energy, Environment and Resources.