This commentary was provoked
by recent reports that Norway’s sovereign wealth fund is to sell off its
investments in companies that explore for oil and natural gas. This has been
welcomed by some environmentalists campaigning for disinvestment from the
hydrocarbon-based economy. In fact the Norwegian move is not really a signal of
environmental virtue or ethical investing, and is best interpreted simply as a
prudent rebalancing of their investment portfolio, a point made forcefully by
Nick Butler in a recent FT article (18 March 2019). Butler regrets that this disinvestment is
not balanced by “positive” investment in low carbon alternatives.
Butler goes on to claim, again
correctly, that environmentalists may also be disappointed because, as he says,
the evidence is that the oil companies are anticipating a continuing demand for
their product, with few forecasts anticipating a peak before the mid-2030s. If
these forecasts are correct and we are unable to prevent continuing growth in
production and consumption, then it is bad news for hopes that the ambitious aspirations
of the Paris agreement can be met, and that global warming can be limited to
the 1.5o C. This is regarded by many climate scientists as the upper
limit consistent with avoiding the most dangerous environmental and climate
outcomes.
There are however some related
factors that should concern us in relation to oil industry incentives for
investment. One is the so-called Green Paradox[1]. This argues, very
logically, that if fossil fuel producers perceive that they face increasingly
hostile restrictions on output, and gradually increasing carbon taxes, then
they have a strong incentive to accelerate production and accelerate the
depletion of their reserves. Implicitly the same argument would apply to many
of the main sources of demand for oil, where the product depends on oil
consumption either in the production stage
And yet that is more or less
exactly the future carbon scenario that is most often presented in policy
forums, that of a gradually increasing carbon tax. Needless to say, there is
little evidence yet of the sort of collapsing investment that would seriously
reduce supplies, nor of the much higher oil prices that could result, at least
temporarily, from serious disincentives to production. The oil price seems to
be stuck somewhere around the $60/ bbl mark, near the bottom of the $60 - $120
“credible range” recognised by many industry analysts.
In consequence it should be no
surprise that production and consumption continue to rise. A rational policy to
reverse this, and to overcome the Green Paradox, would be to recognise that, if
anything, immediate near-term emissions, given that CO2 is cumulative, do more
damage per tonne than future emissions[2] and have a significantly
higher social cost. Rational policy towards climate should therefore include a
policy for a price/tax on emissions that starts high rather than climbs
gradually. This would make fossil fuel extraction and investment less profitable, and also provide an additional non-distorting incentive for low carbon investment of all kinds, an objective that many of us share.
Of course, it will be argued
that this may have redistributive consequences, but green taxes offer their own
answer in this respect. Revenues from taxing emissions offset the need for
other taxes, or can be used for redistributive agendas.
………..
From an economic analysis
perspective, the Green/ Sinn Paradox may not seem very surprising. It simply represents
a potential consequence of policies that are poorly thought out (at least from
a climate perspective). There are of course other factors that lead some oil
rich states to favour accelerated exploitation, notably the desire for an
immediate boost to the domestic economy, even at the expense of longer term
considerations. But the Sinn paradox provides an additional incentive.
The source of the disconnection,
between the science led climate imperative and the current economics of fossil
fuel industries, is explored in more depth on another page: CUMULATIVE CARBON. HAS THE ECONOMICS LOST CONTACT WITH
THE PHYSICS?