Chances are you’ve heard something about oil prices recently. They’ve been dropping like a stone for months but reached harrowing lows in the first weeks of 2016.
The benchmark West Texas Intermediate oil prices sank to nearly $26 a barrel on Wednesday; for comparison, back in 2014, when oil was at $100 a barrel, the notion that it could drop below $75 was hard for experts to fathom. Today’s sub-$30 prices haven’t been seen since May 2003. What’s scary is that no particular crisis precipitated the current decline, just the collective action of oil producers trying to maintain revenue by pumping out more oil than the world needed. With so many responsible parties, who’s supposed to fix the situation?
Those of us who don’t trade in commodities markets are going to feel the effects of cheap oil in two major areas: low-cost fuel for the short-term but added complexity for longer-term planning. Urban and suburban commuters, local governments, and businesses reliant on transportation costs have a lot to celebrate. But for cities trying to move away from fossil fuels, the sudden shift in oil price makes it harder to calculate the costs and benefits of energy-saving improvements.
“These collapsing oil prices, while enjoyable in the short run for consumers, are a sign that we’ve entered a period of boom-bust, more volatile oil prices, and that is no fun,” says Robert McNally, founder and president of the global energy markets analysis firm the Rapidan Group.
How did we get here?
The world has been producing a lot more oil in recent years, largely driven by new technologies that made previously inaccessible reserves suddenly viable. The U.S. shale oil boom was a big player, but deepwater drilling contributed, as did those dirty dirty tar sands that the Keystone XL pipeline was meant to carry. In 2014, a global economic slowdown lowered demand, but producers kept chugging along, which built up extra supply. Normally, that’s when the Organization of the Petroleum Exporting Countries would step up its cartel game and arrange a production cut to keep profits high for members. This time, for various reasons, they didn’t.
You might ask, recalling your Econ 101 lessons, shouldn’t the market adjust to lower demand and bring supply down? That’s how an ideal market would work, but the players in the oil industry had trouble heeding that principle.
On the supply side, says McNally, producers can’t turn an oil well on or off like a spigot. It takes years of labor to get an oilfield up and running, and once it’s in motion, halting production can be expensive. On top of that, producers have to front-load installation costs to get started, paying them off with the subsequent flow of oil. Even if they’re not getting a great price for it, they’re better off bringing in some money to pay back their investors than none at all. The fact that their competitors also operate this way only exacerbates the oversupply and reduces everyone’s profits: there’s no point in being the one producer who cuts back to prevent a global surplus.
The demand side isn’t particularly responsive either. “When the price of gas goes down by a third,” McNally says, “are you going to go to the parking lot and drive around in circles and just burn gasoline? Are you going to go out and buy a Hummer right away? No.” People do drive more when gas is cheap, and drivers will feel less guilty filling up their tank. But most people won’t be pumping gas into buckets and barrels to store for when it’s more expensive. That means demand won’t shoot up to consume the surplus oil anytime soon.
The good and the bad
A cheaper gas tank will be the main benefit for anyone who relies on cars to get around. That will cheer up car-reliant suburbanites and people with longer commutes, but it’ll be felt in city centers, too. City governments operate fleets of vehicles for a host of tasks, and they can save a little money on refueling.
On the other hand, tax revenue will suffer in cities and states where the economy rests on the oil industry. American producers decommissioned 60 percent of their rigs last year, The New York Times reported, and domestic production has started to fall. That means jobs getting cut and incomes dropping in oil-rich regions. (It’s even worse in Russian, where the government derives an astounding half of its revenue from oil and gas.)
Environmentalists are right to be worried about an increase in fossil fuel consumption due to low prices, but they can take heart in another result of the situation. Oil has gotten cheap enough to make investment in lot of new oil exploration uneconomical, says David Goldstein, co-director of the Natural Resources Defense Council’s energy program. That’s especially true for the environmentally damaging extraction of tar sands oil, which is also more expensive than conventional drilling.
But sustainability advocates shouldn’t find too much solace in this slowdown of new drilling, says McNally. For one thing, the freeze on new projects will eventually constrict supply so that, when demand catches up again, the industry won’t have enough projects in motion to ramp up production adequately. That will slingshot prices back up, making it once more profitable to invest in new drilling projects.
Furthermore, the volatility also makes it harder to invest in cleaner alternatives to oil, McNally notes. If a car company is deciding how many electric cars to manufacture, but they don’t know what fuel prices are going to look like for the next couple of years, they may be more cautious about going in on the new technology. It’s harder to calculate return on investment. “When you’ve got the world’s most vital commodity whipping around like this, it scrambles decision-making,” he says.
Cheap oil also complicates a city’s argument for decarbonizing its infrastructure, says Johanna Partin, director of the Carbon Neutral Cities Alliance. An energy-saving improvement, like switching a fleet of cars to electric vehicles, for instance, won’t save as much money with oil this cheap. But, Partin says, this problem predates the current trends: the market doesn’t price the social and environmental costs of fossil fuels. “Not having that true price definitely makes it much harder to talk to folks in a way that really conveys the message of how important it is to decarbonize,” she says.
Now might be the ideal time to push for social pricing of carbon—consumers are enjoying a 70 percent price cut over the last year and a half, so an increase won’t be as painful as when gas was already expensive. Climate advocates had better act fast, though, because the next surge in the crazy oil price rollercoaster won’t be too far down the road.