Low oil price could be a boon for net zero

By Dr Jonathan Marshall, Head of Analysis

Published:21 April 2020

Historically, sustained low fossil fuel prices have not been great news for proponents of a low carbon transition. Why, for example, would investors take an interest in renewable energy when the costs of – and therefore returns on offer from – oil and gas are skewed against clean alternatives?

But since the last time energy commodities faced such a dilemma, just four years ago, structural changes in both markets and society mean that cut-price carbon is no longer necessarily a threat to climate action. On the contrary, it could further cement enthusiasm towards a net zero world.

Timeline

Back in 2016, when major oil benchmarks plummeted from $100+/bbl to around $30, the world was a very different place. Ink on the Paris Agreement was still drying, the concept of ‘net zero’ was yet to break into the public limelight, and the UK was run by an administration rumoured to be less keen on comprehensive climate action than that currently holding the reins.

Concern, justifiably, back then was that cheap oil and gas would undermine the case for clean energy to move us around, keep us warm and power our lives.

And while the 2016 crash heralded a new era in global commodity markets, cementing the role of US shale outfits as swing producers and undermining the long-held grasp OPEC had on a market that ultimately affects all of our lives, now we find ourselves in a radically different position.

Dependent

UK oil fields have high extraction costs
UK oil fields have high extraction costs

The collapse, and rebuilding of, global supply chains is likely to be a defining feature of national responses to the coronavirus crisis. Some political leaders are already asking if the degree to which nations are dependent on other countries for essential supplies is sustainable, while others are pushing for more global trade to kick-start dormant economies.

And while there is no shortage of questions on how the oil price plunge will pan out, one thing is unquestionable. High priced suppliers will be squeezed out, with just the lowest-cost (usually state-backed) operations continuing.

This will cripple the economics of North Sea suppliers, as well as producers in most countries outside of Russia and the Middle East. The consolidation of global oil and gas supplies into the hands of a few powerful figures capable of weathering the storm – either through low production costs or state support seems certain.

At a time of growing international tensions, this may be too much to bear.

In the UK and across Europe as a whole, there have been rising concerns about rising fuel import dependence. Output from British oilfields is now just a third of what it was 20 years ago, while import dependency is forecast to surge from 28% today to upwards of 65% by 2035.

Not only this, but a new era of market volatility makes it much harder to incorporate oil and gas into the long-term policies needed to achieve a growing number of net zero targets around the world. Planning measure to move homes off gas heating, or to lock in supplies of cheap and clean fuels for key industries will be a lot easier without markets vulnerable to movements seen this month.

Underpinning an economic recovery on measures based on clean energy with costs that are only getting cheaper, rather than those at risk of spiking both high and low, will allow mandarins to lock in certainty for years to come.

When back in 2016 it was low carbon energy sources that seemed the riskier option, it is now fairly safe to say that this is no longer the case.

Cashflow

The UK's renewable sector is booming as oil and gas output declines. Image by David Dixon

Before the latest market woes, there were warnings that the continental shelf would be a net drain on UK finances for the second time in just five years. Having struggled through the ‘lower for longer’ period of oil prices, this new era looks even more daunting for domestic supplies.

The oil price curve – based on the value of contracts for delivery of a barrel of oil months or years into the future – doesn’t offer much in the way of good news either, with prices struggling for years to come.

At well below the costs of extracting oil from the UK Continental Shelf, the resultant drying up of investment will inevitably hasten the long-term decline of UK hydrocarbon production, as well as that for countless other projects around the world.

Changes

Just four years ago renewables were more expensive than dirty power, electric vehicles were prohibitively costly, and notions of school strikes, flight shame and protesters shutting down bridges in central London were far-fetched.

Now, with even oil majors setting net zero targets and publicly talking about diversifying, it is hard to see arguments around supporting high carbon energy production holding weight, and even harder to see them garnering support from the public.

A striking poll this week showed just 9% of Brits want life to return to how it was before, a clear mandate for policymakers to try and shape things for the better. With concerns around climate high before lockdown began, and the Conservatives reportedly keen to make net zero a defining feature of the Johnson premiership, it would be expected to feature highly when a response does come.

Putting a rocket under the UK’s low carbon transition, as well as pulling the plug on industries that have been on life support for years, could be one of the ways of giving the public what it wants.

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