The implications of oil price volatility: a tempest in a teapot
Lori Siegel is a senior modeler for Climate Interactive. She uses system dynamics analyses to gain insight into the complex systems involved in global climate change and to facilitate international dialogue regarding policies to mitigate climate change.
They say the only thing constant about the weather is change. The same can be said for the price of crude oil. Curiously, however, projections for the energy/climate system often gloss over this volatility.
Oil industry players, financial experts and organizations such as the U.S. Energy Information Administration (EIA) regularly publish their projections of crude prices. Likewise, using its En-ROADS tool to demonstrate the energy drivers of climate change, Climate Interactive explicitly models the price of extracted fuels, including that of crude oil.
As a commodity, fuel exhibits capacity that expands with greater profits and contracts with lesser profits. Notwithstanding OPEC and other pressures, oil prices are a function of consumer utilization of that capacity, so they tend to follow a cyclical pattern: Low prices undermine the desirability of extracting more oil. Lack of supply sends prices back up again, encouraging more drilling — until high rates at the fuel pumps propel consumers away from gas-guzzlers, which pushes prices and then capacity down again. Adding to this inherent volatility is the fact that prices are also a function of the costs of extraction, which increase as resources become constrained, and of substitutability with other fuels.
Compound these oscillating prices with geopolitical dynamics, and it’s easy to see why predicting with any confidence the exact frequency, amplitude, and mean change of the pattern is less likely than, say, predicting where a tornado will land or lightning will strike.
Nevertheless what does this volatility mean for the oil industry and the race against climate change?
Although financial analysts lack that same crystal ball meteorologists would give their right arm for, we can isolate the effects of oil prices on projected measures of future energy and climate systems. To assess the potential implications of uncertain crude oil prices, we forced Entelligent’s modeling based on Climate Interactive’s En-ROADS to override the endogenously modeled price of extracted oil with exogenously specified price trajectories. The price projections are determined by a sinusoidal wave with varying frequency, amplitude, and mean increase. Bottom line, we performed sensitivity analyses of the effects of varying inputs on oil prices.
Figure 1 shows the variability that we forced for crude oil prices. Figures 2 through 7 present the implications of those specified crude oil prices on the energy system, while figures 8 and 9 present the implications on the climate system.
Figure 1 - Specified Price of Extracted Oil
Figure 2 - Range of Price of Other Extracted Fuels with Specified Crude Oil Prices
Figure 3 - Range of Price of Delivered Fuels with Specified Crude Oil Prices
Figure 4 - Range of Price of Electricity with Specified Crude Oil Prices
The prices of extracted coal, gas, and biofuels adjust with the crude oil price changes, but to a far lesser extent than the prices of extracted oil do. Likewise, the price of each delivered fuel varies, but the delivered oil price does so most notably.
These variations in both extracted and delivered prices are a result of several factors: One is the effect of substitutions at the extraction stage. Another is each fuel’s short- and long-term supply-demand-price dynamics at the delivered fuel stage, which determine the blueprint for that fuel’s extraction capacity and, by association, its extraction price. Although oil use for electricity is currently negligible, variations in crude oil prices influence the price of electricity through their impact on other fuel prices.
It comes as no surprise that demand for each resource varies, including for those not requiring coal, oil, gas or biofuels; again, however, oil’s fluctuation is most notable. Table 1 quantifies the range in demand in EJ/year for the year 2100, shown in figures 5 through 7. Depending on the carbon intensity of each source, the resulting energy mix drives the emissions trajectory and resulting climate impacts.
Figure 5 - Range of Primary Energy Equivalent Demand of Fuels with Specified Crude Oil Prices
Figure 6 - Range of Primary Energy Equivalent Demand of Other Sources with Specified Crude Oil Prices
Figure 7 - Range of Primary Energy Equivalent Demand of Fuels with CCS with Specified Crude Oil Prices
Figure 8 - Range of CO2 Emissions with Specified Crude Oil Prices
Figure 9 - Range of Temperature Change with Specified Crude Oil Prices
With the large range in specified crude oil prices, the energy industry’s 2100 CO2 emissions range from 99 GtonsCO22/year to 132 GtonsCO2/year, with a mean of 113 GtonsCO2/year. The temperature change in 2100 ranges between 4.2 and 4.4 degrees C, with a mean of 4.3 degrees C — minimal progress relative to the target goal of 2 degrees C.
No doubt, crude oil prices will continue to fluctuate. These analyses teach us that it is the oil industry itself that will likely experience the most significant consequences of oil’s price volatility: the changing demand for oil. These fluctuations will be felt throughout the energy industry, and minimally impact the demand for other fuel sources, including renewables. despite having only a slight impact on our climate.
The upshot: Changing oil prices alone are not nearly enough to address climate change but should not dissuade investors from looking at alternative paths to our energy future.