Over the past few weeks, oil prices have declined from over $100 a barrel to under $50 a barrel. Should environmentalists be worried that this will cause people to turn away from clean energy and fail to meet climate pollution goals?
In my judgment, no. On balance, the break from high oil prices can be good for the environment. I believe we should celebrate our good fortune if we are entering a period of lower energy prices. But we must make sure that we do not squander the (short term) benefits by weakening our resolve to transition to efficiency and clean energy supply. We must instead expand our efforts to provide a suite of carrots and sticks, new regulations in some areas and reduced regulation in others, to encourage more efficient transportation systems, which account for the lion’s share of oil use.
Over the past few weeks, oil prices have declined from over $100 a barrel to under $50 a barrel. Should environmentalists be worried that this will cause people to turn away from clean energy and fail to meet climate pollution goals?
In my judgment, no. On balance, the break from high oil prices can be good for the environment. I believe we should celebrate our good fortune if we are entering a period of lower energy prices. But we must make sure that we do not squander the (short term) benefits by weakening our resolve to transition to efficiency and clean energy supply. We must instead expand our efforts to provide a suite of carrots and sticks, new regulations in some areas and reduced regulation in others, to encourage more efficient transportation systems, which account for the lion’s share of oil use.
Low prices do not mean that oil is “cheap”, since the true costs of oil include the damage to our health, to the world’s climate, to American national security, to economic stability, and to the environments where oil drilling takes place. These costs are usually invisible to the consumer. But they are real, and they represent an irresponsible if unintended policy to shift costs from producers and consumers of oil to the general public.
Some of these invisible costs are saved as low oil prices make some of the worst projects financially infeasible.
Today’s low oil prices, and the market expectation that they will remain low for almost a decade– futures markets expect them not to recover to much above $70 until 2023 –will cause some oil production plans to be cancelled, which is a good thing from an environmental perspective. (I expect that oil prices will not remain low that long, which I will discuss later, and others agree(http://www.reuters.com/...)). We must instead expand our efforts to provide a suite of carrots and sticks, new regulations in some areas and reduced regulation in others, to encourage more efficient transportation systems, which account for the lion’s share of oil use.
The risk of low prices is that they will divert people’s attention from the policies needed to improve efficiency: policies that require continually improving fuel economy in cars and other vehicles, that provide incentives for vehicles cleaner than the minimum requirements, and that promote compact, walkable, communities that require less driving.
Low Oil Prices Stop Some of the Dirtiest Energy
Many of the dirtiest oil resources are expensive. They only make sense when oil prices are high. If oil prices remain low for a few years it will reduce or eliminate the threat of oil drilling in the Arctic and the Canadian tar sands.
At current oil prices, infrastructure projects like the Keystone XL tar sands pipeline stop being viable investments. At slightly higher prices, pipeline projects like Keystone XL become even more of a threat to the environment: they would enable economically marginal tar sands projects that otherwise would not be economical to move forward by providing cheap transportation capacity. Stopping tar sands production is important for the environment because the tar sands have a higher carbon footprint than other sources of oil, and because production is especially damaging to the local environment.
Already, major oil companies are announcing the cancellation of environmentally damaging drilling projects, and I anticipate more to come.
Low oil prices do not stop all environmentally damaging oil drilling. Some environments where drilling has adverse effects on health, the local economy, the livability of a community, or the local ecology, can be drilled at a low price, and still require careful regulation to prevent or minimize impacts. Environmentalists cannot slacken in our vigilance to stop inappropriate oil production schemes.
High Prices Do Not Promote Efficiency
The bulk of clean energy resources are energy efficiency, and all the evidence I have seen shows that efficiency is only minimally affected by price. This evidence is pretty clear in the utility sector. For the transportation sector, which is most relevant to oil use and price, some would question this assertion, but every study I have seen leads me to believe that the outcome is the same: price has only a minimal effect on efficiency, and a larger but still modest effect on usage.
Efficiency—the provision of the same level of service, for example the same level of transportation access, the same size and performance of cars—must be distinguished from conservation, which is exemplified by using smaller or slower cars. (See Invisible Energy for a more detailed discussion of efficiency compared to conservation.) America has not made much progress at conservation, especially policy-directed conservation, but we have made dramatic improvements over the years in the efficiency of cars, airplanes, refrigerators, air conditioners, and lighting, all as a result of policy, with almost no effect from energy price.
Simple economic theory may hold that high energy prices lead to higher levels of efficiency, but more realistic models, both theoretical and empirical, show that energy price has little effect on efficiency. In a mass production economy, the efficiency options available to consumers are limited to what is produced, and what is produced is determined primarily by the efficiency standards and incentives available.
For example, the halogen technology used in current incandescent lamps saves 28% compared to the old technologies. It has been available in principle for decades, but only became available in the marketplace when required by federal standards. This is not just me asserting that the technology only became available due to standards, this is also the judgment of Philips Lighting.
This technology makes economic sense at current electricity prices, but would also make sense if electricity prices were less than what they are today. And the more advanced technology—LED lighting—is expected to take off when the cost of a bulb drops below some threshold, say $5, regardless of the value of the savings (which are already greater than $100).
Most consumers do not invest in efficiency even when the investment returns 40% annually. If lower prices caused the return to drop to 30% it would not make much difference; similarly if the return increased to 50% due to higher energy prices, it would not mean that everyone would rush to invest. Recall that businesses and consumers who own homes can usually raise capital at a cost of 4%, and even credit card interest rates of 18% are far lower than the return on efficiency.
I first noticed the lack of relationship between efficiency and energy price in the 1970s when we were able to obtain information on the efficiency of commercial lighting and of home air conditioners. New York electricity prices were more than ten times higher than those in Seattle, yet a square foot of office space used more energy for lighting in New York. Air conditioner efficiency was not higher in Florida, where they operated long hours, than the national average.
More corroboration came soon afterward, when an international study showed that fuel efficiency of cars in Europe was only minimally higher than in the United States, even in the face of gasoline prices much more than double those here. European cars were smaller, so overall gas mileage was better, but for a car of the same size and performance, fuel economy was hardly different.
Arguments have also been made that North Americans drive more than other countries of comparable incomes as a result of lower gasoline prices, but more recent studies have shown that variations in neighborhood characteristics explain the levels of car ownership and usage much better than price.
When California accidentally tried to raise electricity prices—by a 40% increase in electricity costs in 2001 that was a consequence of its experiment with electricity deregulation—the effect on consumption was so small as to be unobservable.
More broadly, the conditions economic theory assumes, and that are needed to make price elasticity work are broadly missing in the real world. Saving Energy Growing Jobs lists over a dozen of the assumptions needed for theory to predict strong price response that are violated in the real world.
I recognize that the fact that energy price doesn’t really affect efficiency violates deeply held beliefs of many people. I encourage them to look at the theory and the evidence in detail, as I do in this book. (A book provides the opportunity to cite references and address contrary arguments in detail not feasible in a blog.) Economics is not a religion; it is a science. Observing that price does not explain everything is not a heresy, but is a scientific conclusion based on evidence.
Energy price does affect behavior—people are likely to keep their houses warmer if heating fuel costs less. But conservation—accepting a lower level of comfort or convenience--is not a significant part of climate pollution plans in America or anywhere else in the world. And it is a relatively minor contributor to emissions reductions, as well as being one that can be motivated by other tools than price.
In sum, any increase in climate pollution is likely to be small and temporary. In contrast, the setbacks to ill-advised oil production schemes will be large and long-lasting.
What if you are not convinced that low prices have such a benign (if still directionally bad) influence on oil consumption?
Then you should be supporting a pollution fee. If $100 a barrel for the consumer is an appropriate price for oil, we should charge producers a fee of somewhere around $40 a barrel. Notwithstanding the arguments I make here, I think that such a fee is a good idea. It is fair, in that it makes those who benefit from oil consumption compensate those who are hurt by it. And even if it doesn’t have a large effect on consumption it still moves the nation in the right direction.
And think of what it could do to the government deficit! A $40 a barrel fee would cut the deficit by some $250 billion annually. That’s a 50% reduction.
Note that I am not arguing that the correct amount of the fee is $40 a barrel. Lower amounts may make more sense. Nor am I arguing that deficit reduction is the best use of the money: investments in clean energy transportation alternatives would be far better for both the economy and the environment.
Low oil prices do not affect most renewable energy sources
Renewable resources are mainly used in the electricity system, and electricity prices are almost entirely independent of oil prices. Oil is missing from the list of generation fuels in the U.S. Renewables compete against gas and coal, and the prices of these fuels are only minimally affected by oil prices.
Clean energy is driven largely by policy, not price
Oil and gas prices fluctuate dramatically, especially over 5 or 10 year time frames. We have, notwithstanding this, successfully produced large investments in both efficiency and in renewable energy sources in times of low prices as well as high prices. We have done this through policies such as financial incentives for clean energy investment, by reformed regulatory policies that allow utilities to profit from clean energy, by regulations on product efficiency and renewables portfolio standards and low carbon fuel standards, by reductions in regulations that prevent developers from building smart-growth neighborhoods or that require parking spaces that they do not want to build, and by providing transparency on the energy costs of cars, buildings, and appliances.
States and countries that have more consistently adopted and maintained these policies have much lower carbon footprints (and lower energy bills) than those that have not. They also tend to have more robust economies.
Profiting from Today’s Lower Oil Prices
Lower prices for oil and for gasoline save consumers money, and this is good for the economy in the short term. We celebrate these consumer and business savings. Amory Lovins has noted that energy price is a race between efficiency and depletion (actually a race between efficiency plus renewables and depletion). We rejoice that the market in late 2014 is telling us that clean energy is pulling ahead.
But we do so with the memory that price cuts (or spikes) are not permanent. At some point, perhaps next year, more likely in 5 years, and possibly not for 10 years, oil prices will go up again. We want to approach that time prepared, with a drastically reduced dependence on volatile-priced fossil fuels.
Yes, I noted above that futures markets expect oil to remain well below $75 for ten years. But we’ve seen this movie before—especially in the early 1980s and the late 1990s. Futures markets are thin and volatile, and often fail dramatically to predict the future.
While lower oil prices may help the economy in the short term, in the long term the states and countries with strong policies supporting clean energy do better economically than those that are less active, and spend less on energy even in those cases when energy prices are higher. (They spend less because diminished consumption due to efficiency means bills are lower, even when unit costs are higher.)
We need to take a long term planning perspective. The more effective we are at transitioning to a clean energy economy, the less vulnerable we will be to the next uptick in oil prices (or gas prices). And the more competitive our economy will be when that happens. Those who think that price is more influential than I do should be supporting a pollution fee on oil (and other polluting energy forms).
The risk to lower oil prices is if we get complacent and lazy. If we slack off on policies to reduce automobile efficiency/carbon pollution reduction or on encouraging smart growth, if we start to think that renewable energy is not so important, then low oil prices will have been a snare, not a benefit.