Oil prices, the Paris Agreement and the endgame for fossil fuels
03 April 2018
Energy policies across Europe have been based upon a simplistic and beguiling narrative. They grew out of the consensus in the last decade that matured into the European Climate Change Package, adopted in 2008. The basic story was that fossil fuels were going to get scarcer, prices were going to rise, and hence it made perfect economic sense to switch to renewables rapidly. Any subsidies would be temporary, quickly rendered unnecessary by the rise in oil and gas prices.
This was the logic behind the energiewende in Germany, a giant industrial policy to give Germany and German companies competitive advantage. It was aped to a lesser degree in most other European countries, all were given hard targets in the renewables directive.
Done at great costs
A decade later and it is obvious that the basic assumption is wrong, badly wrong. Worse in the process, German emissions started rising again, backed by 13GWs of new coal and, globally, the European effort if anything sucked in carbon intensive products which it once produced. If the question was how to give Europe competitive advantage, and how to reduce global carbon emissions, the results have not been encouraging. All of this has been done at great costs.
It took until late 2014 for the great commodity super-cycle to bust, and it took another two years for both the great oil countries and producing countries, and the renewables lobby to admit that it was not just a short-term bust. Oil prices fell back to about $50 a barrel and have stubbornly refused to go back up again, despite the efforts of OPEC and the Russians.
It may take longer for the prospect that oil prices will probably go on falling through to a gradual endgame for fossil fuels. A price of $50 is still a high price against a marginal cost of less than $10 in core Middle Eastern countries, and less than $20 in Russia. Even marginal shale production in the US can be in the money at $50, as the Saudis and the Russians are painfully finding out.
Their relatively feeble efforts to rig the market by declaring that they are going to reduce output just creates more gaps for the US producers to fill. Quite soon the US might be exporting two million barrels a day (mbd), whereas just a few years ago the expectation was that they would be importing ever-larger volumes. It is a similar story for gas, with perhaps an even greater abundance of US supplies.
If this is indeed the new world of gradually falling oil and gas prices, then it is now time for the world to wake up and smell the coffee. Falling fossil fuel prices mean the gap between the costs of renewables and the subsidies required to bring them on is going to keep getting bigger. It is true that the costs of renewables are falling too, but there is also some dangerous and naïve talk about ‘subsidy free renewables’. What the falling oil and gas prices mean is that the subsidies to renewables are not going to be temporary and wither away any time soon. They are more likely to be around for quite a long time.
Renewables escape the serious costs they impose upon electricity systems
Subsidy free makes sense only when the full costs of renewables are compared with the full costs of fossil fuels. Almost everywhere, renewables escape the serious costs they impose upon electricity systems. They typically are at the periphery of electricity systems, yet they don’t pay for the geographical location costs of transmission and distribution.
Contrary to all the press releases that claim new installations are enough to power x number of homes, this is only true for part of the time. An electricity system needs much more total capacity when some of it is intermittent. Some of this extra generation can be very expensive, and the impact on wholesale prices when renewables do generate imposes lots of costs on existing conventional generation.
A host of new technologies coming down the track
All is not, however, hopeless in the new lower fossil fuel world. The reason is technical change. At last the world is waking up to the need to move on from the early, and quite primitive technologies embedded in wind farms and current vintage solar, and look through to a host of new technologies coming down the track.
The main ones are digital, and the economies are fast digitalising. Robots, 3D printing and Artificial Intelligence are becoming normal. Electric transport is moving from the fringes towards serious investment across the board. Battery technology is coming on in leaps and bounds.
Then there are basic scientific advances, opening up the light spectrum and new materials like graphene, and new ways of applying solar film. It would be very rash to believe that next generation solar is going to be anything other than a great success.
The paradox in all this is that as the economies digitalise, everything digital is electric, and as the energy mix shifts to electricity, the demand for fossil fuels is going to fall. Indeed it must fall, if we are to decarbonise. Falling demand and lots of supplies force the oil and gas prices down even further, helping to hold on to competitive advantages. It is a race between technological progress and falling fossil fuel prices.
New technologies will revolutionise electricity markets and hence energy markets
The implications are radical, in that the new technologies will revolutionise electricity markets and hence energy markets. Most of the new electricity generation technologies are zero marginal costs. As they increase, down will go the wholesale price, further depressed by falling fossil fuel prices.
Put these together and the basis of the electricity industry shifts from the wholesale markets that have dominated for the last century, to a new world of capacity. Buying electricity will be about buying capacity, not energy. This is the economics of broadband, not the economics of energy, as we know it.
With these changes will come big impacts on transmission and distribution systems, and the architecture of energy systems. It is too early to tell where this will end up in any detail. Indeed in the context of rapid technical change it would be foolish to try to predict. But the broad stakes already in the ground are plain to see. The electricity and energy world will be very different, and faster than you think.
Professor Dieter Helm is an economist specialising in utilities, infrastructure, regulation and the environment, and concentrating on the energy, water, communications and transport sectors primarily in Britain and Europe. He is a professor at the University of Oxford and fellow of New College, Oxford. During 2011, Prof Helm assisted the European Commission in preparing the Energy Roadmap 2050, serving both as a special adviser to the European Commissioner for Energy and as chairman of the Ad Hoc Advisory Group on the Roadmap. He is the author of ‘Burn Out – the endgame for fossil fuels‘, published by Yale University Press in 2017https://www.engineersjournal.ie/2018/04/03/oil-prices-paris-agreement-endgame-fossil-fuels/https://www.engineersjournal.ie/wp-content/uploads/2018/04/a-dieter-1024x608.jpghttps://www.engineersjournal.ie/wp-content/uploads/2018/04/a-dieter-300x300.jpgElecclimate change,fossil fuel,oil