by Dominic Hogg5 minute read
How should you feel about primary commodity prices? It might sound like a strange question, but imagine you were being interviewed by a journalist, and after asking about which film you preferred – the Godfather, or Star Wars – their next question was ‘do you prefer commodity prices to be high or low?’. What answer do you give?
In the midst of the COVID-19 crisis, oil prices plummeted to historically low levels. The media reported this with some surprise, especially as, in the US, prices turned negative in April. Producers – their storage facilities apparently full – were prepared to pay buyers to take oil off their hands. But there was also some noticeable concern: oil prices have played the role of a bellwether for the health of the global economy, so precipitously falling prices were seen as an indicator of deep economic calamity.
When oil-producing nations then agreed a record-breaking cut in production to shore up prices, the way in which it was reported ought to astonish us. There can’t be too many markets where the anti-competitive actions of a cartel are reported in such glowing tones. In most market situations, the coordinated actions of suppliers to constrain supply and increase prices is frowned upon, and in the UK there are numerous examples of it resulting in hefty fines.
On April 11, however, the Financial Times reported that the US and G20 gave “international backing to deep oil production cuts pledged by Opec and Russia.” You might have been forgiven for thinking that the cartel were the saviours of the planet. Yet the reality is clearly somewhat different: if we are serious about dealing with climate change, then we can’t afford to burn fossil fuels with the same abandon as we do today.
The fall in oil prices was occasioned principally by a fall in demand for oil, which was triggered by the travel restrictions and other effects of the coronavirus pandemic. But this fall will need to be massively exceeded by any credible approach to addressing climate change. While this future fall might not be so sudden, dramatic or unexpected as the changes occasioned by the pandemic, a faster, rather than slower, reduction in demand is clearly to be welcomed. How, then, are governments going to react to this necessary future reduction in demand – let alone, take the necessary actions to bring it about – when during the pandemic, they seem to have backed collusive action to shore up the profitability of an industry whose demise is somewhat overdue?
I couldn’t help but think how this episode demonstrated a complete lack of preparedness for what needs to happen in future. We should be seeking to engineer exactly the drop in demand that we have just witnessed, which ought to result in a substantial drop in prices. I’m talking here about the basic commodity price, prior to the impact of any measures, such as a higher price on carbon, that might intentionally constrain demand by increasing the price paid by consumers. A price on carbon that is commensurate with the reductions in greenhouse gas emissions which are needed globally ought to squeeze out profits, and reduce the price paid for oil, excluding the effect of those carbon pricing instruments.
This recent pandemic-inspired episode should give oil producers a glimpse of the future that needs to be set out for them, but with one major difference: policy makers should not support coordinated action to constrain supply, but should accept that some producers will go out of business – or at least, out of the oil business. In the interim, policy makers – including those in the G20, who more than a decade ago committed to “Rationalize and phase out over the medium term inefficient fossil fuel subsidies that encourage wasteful consumption” – should stop putting our money where our future cannot afford it to be.
It is becoming ever clearer that oil producers are aware that the future is not one where oil continues to be burned. Part of their strategic response is to seek to shift more into the production of plastics. If this is considered as an attempt to refocus on a more sustainable area of business, then perhaps the industry needs to think again. Continued reliance on fossil-derived plastics for an ever-growing share of consumption would be one thing if all plastics were kept within closed loops, and the need for virgin materials was declining over time. After all, recycled plastics utilise only around 10-15% of the energy used to make primary resins, and the associated climate change emissions are also much reduced. But globally, the reality is so radically different as to make this fanciful.
Because plastics are so abysmally managed at the end of their life, there are no reliable numbers on what becomes of them – despite many attempts to produce meaningful data. Yet we know that vast swathes of the global population are consuming plastics with little hope of much of the resulting waste ever being collected. An enormous quantity find their way into rivers and seas. If the salvation of the oil industry is based on perpetuating this state of affairs, then we should consider this to be one more reason to hasten its demise.
With this in mind, we should look forward to a future of low oil prices: not because we want to use more fuel, but because taxes and other measures have brought about changes that mean we no longer seek to consume oil, leaving the more expensive sources of oil priced out of both the market, both for powering transport and, to a considerable degree, for producing packaging materials.
We should no longer step in to shore up an industry whose continued existence seems increasingly predicated upon our failing to do what we know we must. Instead, the G20 needs to pull the plug on subsidies and ensure that carbon pricing applies to all forms of consumption of oil.
So, back to the question at the top of this article: do you prefer high, or low, prices? The answer should probably be, ‘it depends on the cause’. In future, we have to hope that all pre-carbon-policy fossil fuel prices will fall to low levels, even under normal circumstances. A low oil price – if it reflects plummeting demand – should become a sign that we’re successfully addressing a global emergency.
Featured image: Paul Glazzard (CC BY-SA 2.0), via Wikimedia Commons