The USA is currently experiencing a little energy revolution. In 2011, it imported just 45% of its liquid fuel requirements, down from 60% in 2005. Domestic production of oil and gas has been booming, driven by higher prices and technological improvements such as fracking. High prices, changing behaviors, much improved vehicle fuel efficiency standards adopted by the Obama administration, and the weak economic situation have driven down consumption of liquid fuels by about 9% since only 2007.
What are the implications of this revolution for climate policy, the economy and geopolitics? Firstly, oil prices remain an economic threat. Few people realize the important role that oil prices played in the 2007/8 subprime mortgage crisis, which ignited the global financial crisis. When the oil price rose from roughly $30 in 2003/4 to $145 in 2008, household budgets were severely constrained. Interest rates rose fivefold in response to the price increase, further increasing the mortgage repayment burden. In their study, Kaufman et al conclude: “…increasing energy expenditures are among the most important drivers of the post 2005 increase in mortgage delinquency rates.” And in 2011, when the recovery was just taking hold, oil prices jumped on the back of the Libyan war. That price increase dragged significantly on the recovery in the US and EU. Now, the threat of an Israeli/American attack on Iran is again driving up oil prices, helped by political instability in Syria, Yemen, Sudan, etc.
Obama too might be forgiven for saying “what energy revolution?” High gas prices are one of the central issues in the upcoming elections. Indeed, gas prices may be the kingmaker come November. Trevor Houser’s fascinating analysis shows the state-by-state fallout of higher gas prices in the US election. Neither Obama, nor the Republicans, nor the US can cut themselves off from global markets, still less from a global economy vulnerable to highly volatile energy prices.
Secondly, the USA’s reduction in oil dependency should be welcomed, insofar as it is based on a sustainable shift in energy policy (which it is mostly not). There is no way that the US would dare push sanctions on Iran to the extent they have, if they had not succeeded in reducing their energy dependence. A nuclear armed Iran would be a catastrophe; the US’s ability to conduct a strong policy here shows already the geopolitical benefits of reducing energy dependency. However, the big risk now is a false sense of security. The US cannot risk worsening its lock-in into oil and fossil fuel intensive infrastructure and behavior. The catastrophic economic impact of high oil prices in 2007/8 shows the risks.
Thirdly, what does this mean for climate policy? For some time, the argument of “energy security” has been central in driving the climate agenda in the US, but also elsewhere. The current situation shows the risks of this focus. Essentially, there are enough commercially accessible fossil fuels to fry the planet. Energy security can motivate some climate action, but not enough. The graph below shows the forward price curve for oil futures (contracts for delivery at a future date). The decline shows that market participants expect oil prices to decline, as higher prices motivate investment in new production, energy efficiency and behavior change. This suggests that oil prices will moderate at least for the coming decade, which is crucial for climate action. Alongside is a graph showing the cost of new oil wells in the US. It shows that oil extraction has grown more and more expensive, as geological and technological frontiers are pushed, and materials such as steel grow more expensive due to booming global demand. It shows how new production is growing more intensive, in monetary, resource (steel/energy/water) and environmental terms.
Forward curve for oil futures (left) and cost per well (right).
Source: HSCB left, EIA right.
These two graphs may seem to present a contradictory picture. Here is my sense of the complex debate:
- There are enough commercially available fossil fuels to fry the planet. Energy security will never be a sufficient motivation for taking sufficient climate action. We need to worry more about peak carbon than peak oil.
- Nonetheless, the global economy is highly exposed to resource prices, in particular oil. Recent reductions in US energy dependence show the benefits of taking action. The current US pressure on Iran would be unthinkable with an energy dependence of 60%, as in 2005.
- This opportunity must be used to reduce structural dependence by investing in energy efficiency and fossil fuel alternatives. Prolonging the dependence on this fuel will only increase the lock-in of infrastructure and behavior, and worsen the environmental and economic risks. The amount and cost of remaining oil is uncertain; we have control over the factors to reduce global exposure to this uncertainty, such as efficiency and fossil fuel alternatives.
- Oil prices will likely remain high (above $100) and volatile in the coming 5 or so years. The increased cost of new production and growing demand from emerging countries will put a floor on oil prices. However, structural factors, i.e. real physical scarcity or a demand/supply gap, are unlikely to drive real prices to levels of above $150 in the next 5 or so years years. Geopolitical events could do this quickly at any time. Again, it makes sense to reduce our exposure to this risk as much as we can.