Thursday, February 12, 2015

Oil's Price Volatility is Bad for the Economy and the Environment

No matter how you slice it, oil's price volatility is bad for business and bad for the economy. At the start of this decade headlines were commenting about the high cost of oil now they are awash with remarks about price declines.

Unpredictable oil prices hurt everyone. The problem of oil's price volatility was made apparent during the OPEC oil embargo of 1974. Since then we have seen a number of radical fluctuations including a sudden price spike in the summer of 2008 when a barrel of crude hit more than $130 only to fall to $40 per barrel a few months later.

This radical swing contributed to the worst recession since the great depression. Further, it is hard to make capital allocation decisions in the context of such volatility.

Recently we have seen even more price volatility. In February 2011 the price of oil was again almost $130 per barrel only to fall to $90 per barrel in 2012 and then climb back up to almost $120 in 2013. Then starting at the end of July 2014 oil began to free fall to under $50 per barrel.

This volatility is being driven by uncertainty about the future of oil. There is massive speculation going on in the oil futures market and in both the up and down directions. However, the reasons that oil is so volatile goes far beyond speculators. The future of the fossil fuel industry itself is being impacted by concerns about carbon bubbles, stranded assets and carbon pricing.

The Saudi's are undeniably playing with oil markets for their own advantage. In 2011 they hyped peak oil which drove up prices. We now know that the concern is not peak oil but peak carbon (It has been said that at least half of all known oil reserves will have to be left in the ground if we are to stay within our carbon buget). We will have to bring down global emissions and this means we will have to wean ourselves off of fossil fuels. The Saudi's understand this fact so they are now flooding the market with "spare capacity." This cheap oil serves two purposes, first it kills their competition and second it is part of their plan to bring as much oil to market as they can before global markets dry up.

Volatile oil prices create economic instability which undermines efforts to invest in a low carbon economy. Further, the rush to bring as much fossil fuels to market as possible is bad for the economy and even worse for efforts to reduce emissions and combat climate change.

No comments: