Energy Blog: It’s Time to Break with the Past

May 5, 2020

by Michael E. Webber

Booms and busts are just part of life for oil, as they are for any other important commodity. Prices go up and they go down. It’s a simultaneously thrilling yet ho-hum part of the yo-yo life in the oil patch. In that long view, the latest price crash is just one more paragraph in the long story about black gold.

Despite how common price spikes and collapses are, the one this year is different. It has different causes and will have different impacts.

Crude oil prices crashed because demand is decreasing quickly from the pandemic, while at the same time supply increased because of the oil price war between Saudi Arabia and Russia. One or the other is enough to send the markets into a tailspin, but together they are a wicked combination for oil producers in other countries. Those actions, overlaid on limited storage capacity worldwide, caused the price for West Texas Intermediate, one of the world’s benchmark crudes, to go dramatically negative for the first time in history.

Economic models couldn't handle this situation: instead of forking over $25 to $75 for the right to own a barrel of crude, producers would pay you handsomely—up to $37—to take a barrel away.
These are unusual times.

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Normally a price drop triggers demand for oil. But this time the demand is dropping for other structural reasons that won’t end quickly: not only the COVID-19 pandemic and the rise of videoconferencing capabilities as an alternative to travel, but also new policies that prohibit diesel vehicles and promote electric ones leading to investment by major manufacturers such as Volkswagen into the development of electric drivetrains.

New car designs are executed over multi-year product development cycles, so oil price volatility doesn’t really change decision-making for the long run. That means oil demand might not snap right back to where it was before.

Amazingly, President Trump took the unprecedented maneuver to intervene with the Russians and Saudis to cut oil production and raise oil prices. Think about that: A U.S. president actively sought to use foreign policy as a lever to raise energy prices on American consumers. Why would he do such a thing? While cheap energy is an accelerant for the economy, as a major employer and driver of capital investments, energy production is also important to the economy. Pushing for higher prices protects producers in West Texas at the expense of consumers, but those consumers weren’t driving anyway.

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Another break from tradition is how oil prices will affect the fate of renewables. According to conventional wisdom, low fossil fuel prices are bad for renewables. The thinking is that higher-priced renewable energy would not be able to compete with the lower-priced fossil options as consumers would choose the more affordable option.

That thinking is getting turned on its head: The oil price collapse might make renewable energy even more attractive. It does from the investor side, not the consumer side.

The renewable energy supply chain has matured a lot in the last few decades, so it’s more competitive than ever. Furthermore, while staying at home might cause the demand for transportation fuels to plummet, electricity demand has only dropped a little bit as we consume electrons for our telework, homeschooling and streaming on devices at home.

Perhaps most importantly, low oil prices mean investments in oil and gas are less likely to generate an attractive return. By contrast, renewables look like a safe haven investment with fixed prices and guaranteed returns that last two to three decades while sparing exposure to price volatility. Whether consumers want renewables or not, that’s what investors want to build, so that’s what we’ll get.

What do we do now? It is time to put a tax on carbon—adjustable to minimize the downward effects of price fluctuations. And invest in efficiency, to reduce consumers’ exposure to volatility. And invest in R&D, so that the oil & gas sector remains competitive—our oil is the cleanest and most environment-friendly to produce, so we want to keep it going, but to serve export markets. Lastly, we should support the transition of workers from oil and gas to other industries, including advanced geothermal energy and carbon management. This price crash is an opportunity: Let’s seize it. 
 
MICHAEL E. WEBBER is the Josey Centennial Professor of Energy Resources at the University of Texas in Austin and chief science and technology officer at ENGIE, a global energy company headquartered in Paris. His television series, Power Trip: The Story of Energy, is available on Apple TV, Amazon Prime Video, and local PBS stations.
 

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