Crude Oil Prices, Climate Change, and Global Welfare

06/03/2015 05:02 pm ET | Updated Jun 03, 2016

A few weeks ago I participated in a panel session titled "The Remarkable Transformation of the Energy Sector: Does It Also Transform Our World?" The motivating question was: "Is the dramatic decline in oil prices a complete gift to the West because of the enormous funds being saved, or is it an unintended Trojan horse because development of renewable energy as well as new fossil-fuel sources will decline in the West, posing longer new challenges?"

The other members of the panel — from private industry — had vastly more expertise (and relevant insights) on fossil-fuel markets, but here's what I had to say. This is hardly at the sweet spot of my professional competence, so I welcome your comments and corrections! In general, how would you answer that question?


I start (and started) from the premise that the dramatic decline in crude oil prices that took place from August 2014 ($96 per barrel) to March 2015 ($44 per barrel), was due — on the one hand — to decreased demand (a function of slow economic growth in Asia, Europe, and elsewhere; endogenous, price-driven technological change leading to greater fuel efficiency; and policy-driven technological change that also has been leading to greater fuel efficiency, such as more stringent Corporate Average Fuel Economy, or CAFE, standards in the United States) and — on the other hand — to increased supply (partly a function of the growth of unconventional, or tight, U.S. oil production , in turn a product of the combination of two technologies: horizontal drilling and hydraulic fracturing). And, in the presence of all of this, Saudi Arabia decided not to restrict its output to prop up prices.

(Before proceeding, I should note that since May of this year, crude oil prices have increased by about 30 percent from their March low but, at $60 per barrel as of May, are still far below their August 2014 level.)


When one examines virtually any significant price change from an economic perspective, there inevitably seems to be both good news and bad news. So it is with the fall in crude oil prices.

The Bad News

First of all, I assume that low crude oil prices are problematic for the economic and political stability of some of the oil-producing/exporting countries, including Saudi Arabia, Russia, Venezuela, and Nigeria.

Second, it's frequently been asserted that low oil prices are bad news for the development of alternative forms of energy, including renewable sources. Of course, in the United States, there isn't much effect on electricity generation from renewable (wind and solar), because in the U.S. electricity sector, renewable supplies compete with coal and natural gas, not with fuel oil (but in other countries, which use more fuel oil for electricity generation than we do, there can be a disincentive for renewable dispatch — and hence development).

Third, there can be — indeed, there has been — a major impact in the U.S. motor fuels sector, where the market for biofuels (mainly ethanol) is negatively affected by low conventional gasoline prices. However, these impacts must be somewhat muted by public policies that directly or indirectly subsidize (or, in fact, require) the use of biofuels.

Fourth, low gasoline prices have resulted in decreased demand by consumers for motor vehicles with high fuel efficiency, and SUV and pickup truck sales have rebounded from previous lows. But these effects are also muted, to some degree, by public policies, including U.S. CAFE standards. Finally, low gasoline prices also have short-term effects in the form of more driving and fuel use by the existing fleet of motor vehicles, which is bad news in terms of emissions (and congestion).

Differences Across Sectors

Before turning to the "good news" about low crude oil prices (and there surely is good news), it's worth noting that whether individual businesses find these low prices to be good or bad depends largely upon the economic sector in which they operate. For example, whereas commercial airlines are finally making profits, due to the low price of jet fuel (their most important variable operating cost), manufacturers of commercial aircraft will see lower demand for new planes if low jet fuel prices become the long-term norm. The primary factor driving the larger airlines to replace aircraft in their fleets is the lower operating costs due to the much greater fuel efficiency of new models.

The Good News

Finally, here is the upside of these significant changes in crude oil markets.

Low oil prices are unambiguously good for aggregate global welfare. This includes consumers in the United States, Europe, Japan, and South Korea. And, at least temporarily, OPEC seems to have lost its ability to set a price floor.

Turning to the environmental realm, there is also good news, or at least the possibility of good news. An opportunity for new, sensible energy and climate change policies has emerged with these low oil prices.

First, now is the time to reduce — or, better yet, phase out — costly and inefficient fuel subsidies that exist in many parts of the world, particularly in developing countries.

Second, with gasoline prices relatively low — and natural gas supplies holding down electricity prices, at least in the United States — there has never been a better time to introduce progressive climate policies in the form of carbon pricing, whether via carbon taxes or through carbon cap and trade. Unfortunately, none of us should hold our breath waiting for that to happen.