Oil and trouble. Pix One
Jorge Guira, Reading University
The price of oil is on a roller coaster. After falling into negative territory for Brent crude only last April, it rose to $ 70 (GBP 50) in early March. It has since fallen below $ 64. So where is it going and what are the effects?
There are several reasons why oil prices have risen from their 2020 lows. One of these is the widespread belief that a “commodity super-cycle” is imminent, with a post-pandemic explosion in economic activity leading to soaring demand for oil.
Supply has been limited since Saudi Arabia and Russia stopped production in spring 2020. Then and now there is a suspicion that this was intended to reduce prices in order to drive less efficient US shale oil producers out of the market. This has essentially resulted in less slate entering the market.
The price of oil (Brent crude oil, US $)
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Prices have been falling in the past few days amid fears that vaccine troubles in Europe will slow global recovery and rising yields thanks to a stronger dollar after the US Federal Reserve rejected its last meeting on March 17 Curb government bonds.
However, the direction of oil prices appears to be largely up: most of the major oil companies are signaling a reduction in capital spending. Meanwhile, Opec, the 13-country cartel of oil nations, has a vested interest in further curtailing production in order to keep prices higher, while the entire framework of the Paris Climate Agreement aims to make oil production more expensive. This is passed on to consumers in the form of higher prices.
Demand for oil is likely to rise for many years to come despite the surge in renewable energies. A recent study by BloombergNEF predicts that the green agenda will not drive oil into structural decline until 2035.
Admittedly, carbon taxes can dampen demand by increasingly penalizing companies for using fossil fuels – be it through the EU emissions trading system, the new China system or the proposed London volunteer program or the US system. But it will depend on how the rules develop. The EU system is the most advanced but contains many exceptions that currently minimize the requirements in many sectors.
Oil and the economy as a whole
The price of oil and its relationship to economic recovery, bond prices and inflation will be critical to the post-COVID world order. Oil prices are closely related to inflation. This is because oil has a multiplier effect as it circulates through markets: for example, it is an inevitable cost to companies that operate vehicles, which then pass it on to consumers by increasing the price of their goods and services.
The US already has significant concerns about the inflationary impact of the $ 1.9 trillion stimulus package, especially if the Federal Reserve has signaled that it will tolerate more inflation than before. Rising oil prices add to these concerns.
Long-term interest rates are rising with inflation worries and have been duly rising lately. If this continues, it could cut US government spending on infrastructure. At the same time, inflation can make infrastructure more expensive.
The Fed therefore has an incentive to keep interest rates as low as possible, and there has been much speculation as to whether it will do so by buying longer-term government bonds. However, this could further boost inflation and drive oil prices higher. So it’s about finding the right balance between the over- and under-stimulating economy. Keeping inflation in check can lead to lower or at least stable oil prices, just like after the 2007-09 global financial crisis.
In the UK the situation is a little different. Inflation has remained low as oil prices have fallen. COVID-19 drastically reduced the demand for UK oil and adversely affected drilling activities. Higher prices should help reverse this, depending on demand for oil from abroad – including from Europe.
In developing countries that rely on the export of oil and other natural resources, higher prices are definitely welcome. Many low- to middle-income countries, including Nigeria and Indonesia, have suffered government budgets from falling demand during the pandemic.
In Nigeria, the government was forced to devalue the naira in order to stimulate the economy. Under such circumstances, rising oil prices can be a relief – also for exporters of other commodities such as industrial metals, whose prices are linked to oil.
Meanwhile other developing countries are losing with rising oil prices – especially oil importers like Thailand and Turkey. The Turkish central bank has just hiked interest rates by two percentage points, in part to contain inflation.
The net zero threat
The price of oil has an impact on the ability of nations to meet the net zero emissions targets required by the Paris Agreement.
More expensive oil should accelerate the tipping point when renewables are the cheapest way to generate electricity and power traffic. The lower cost of renewable energy compared to fossil fuels has already helped make it more attractive.
Renewable infrastructure doesn’t grow on trees. Dana Kenedy
Paradoxically, higher oil prices also provide incentives for oil companies to spend more on exploration and production – a potential step in the wrong direction to achieve net zero emissions. And in developing countries, which are heavily dependent on oil exports, higher prices mean more money to spend on society, which increases the popularity of the government. Hence, they too can give priority to increased oil production and production, possibly at the expense of developing renewable energies and meeting nationally set carbon targets.
This does not mean that higher oil prices will adversely affect the overall size or pace of spending on renewable energy. However, they need to be developed and built, so higher oil prices will certainly risk advances in developing countries. This means that the ability 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 by The Conversation under a Creative Commons license. Read the original article.
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