What will Covid-19 mean for carbon?

If the 2003 SARS outbreak had been as severe as the current pandemic, a broken economy, a glut of oil and a lack of alternatives would have meant doom for the climate. But this is 2020, and the transition to clean energy may now be our cheapest option. The game is on.

Peak oil just happened

The first thing to note is that the recent reduction in fossil fuel demand has been monumental.  30m barrels of oil consumption per day (about 30%) has been erased as business and industry slow down and people stay at home.  Hyper-oversupply is creating an ocean of surplus oil as global storage facilities reach capacity.  Whilst demand will recover as people gradually go back to work and air travel resumes, 2019 may well go down in history as the year oil consumption peaked.  

The slow down in fossil fuel use has already led to a welcome drop in CO2 emissions in the short-term, the question is whether a struggling global economy and sustained lower oil prices (which generally lead to lower gas and electricity prices) could hinder long-term efforts to eliminate carbon emissions? 

Green grids

A significant drop in electricity demand is having a profound effect on where our power is coming from.  Having zero marginal cost of production, power from wind and solar projects will generally be used first whilst utilisation rates of fossil-fuel power stations suffer.  We have already seen some of the highest ever levels of renewable penetration across Europe in the past few weeks; in the UK, wind and solar were the two largest sources of power on several recent days leading to negative wholesale prices. 

Whilst this situation may not endure, it may play an important role in demonstrating to electricity system operators that grids can cope with high proportions of renewable energy.  

Price collapse or price fixing?

Over the next few years it’s likely the global oil market will oscillate between periods of market oversupply with very low prices, and periods of coordinated supply reduction with slightly higher prices.  

In the first scenario, many oil and gas producers will be loss making as they require prices above $40/barrel to break even and we are tracking at below $30 today.  Large swathes of the industry will be burning cash, resulting in consolidation, bankruptcies and reduced investment in oil exploration, with the backdrop of capital markets increasingly hostile to carbon-intensive industries.  Once closed, some oil production facilities may never re-open. Of course lower fossil-fuel energy prices will also reduce the economic competitiveness of zero-carbon technologies which may cause a slow down in their deployment.

In the second scenario, collaboration between oil producing nations to reduce supply may allow prices to rebound slightly, but these agreements are unlikely to be sufficiently large or stable enough to raise prices significantly for very long.  OPEC+’s most recent announcement over the Easter weekend to reduce production by 9m barrels a day has done little to lift prices above historic lows.  Lost revenue during these periods will hurt many state owned and private producers whilst higher prices will only improve the investment case for non-fossil based solutions. 

In both scenarios profits across the energy industry will be wafer thin at best, the test will be who can survive these conditions for longest.  Clean technologies may have the tailwind of public opinion and benefit from a growing number of socially responsible investors, however the balance sheet and influence of the fossil fuel industry will make this a long fight.

How will this play out?

The biggest area of uncertainty in all of this is of course politics.  A simplistic view is that given the global economic pain and crippling government debts, solving climate change will be seen as a luxury we sadly just cannot afford.  If this were 2003, this would very likely have been the case. Whilst SARS was happening however, an innovative energy policy in Germany called a Feed-in Tariff was about to give rise to the modern renewable energy industry as we know it. We are now in 2020, and two decades of exponential cost reductions mean that the common assumption that zero-carbon technologies require subsidies is no longer valid.  As power plants and car fleets need replacing, zero carbon alternatives are looking increasingly cost-effective. This means that even without policy intervention progress will continue, and many key measures that are already in place, such as the UK's ban on new petrol car sales from 2040, seem unlikely to be rolled back.  

We should not forget also that the vast majority of energy subsidies globally are still lavished on fossil fuels.  With a renewed need for fiscal conservatism, these subsidies may need to be reviewed.    

On the flip side, fossil-fuel groups still represent very large employers and tax payers. Some of these organisations may even see the Covid-19 crisis as an opportunity to push for climate change policies to be relaxed.

A key factor will be how policy makers and the public view the pricing of externalities going forward.  The devastating impact of Covid-19 highlights all too well that seemingly intangible yet well known-risks can and do have a real cost.  True, Covid’s immediate impact on everyday life helps to focus minds in contrast to the slow burn of climate change. A heightened sense of fragility however may make us more attuned to the warnings of scientists and, even more optimistically, may alert policy makers and the public to the greatest subsidy of them all - the socialization of the costs of climate change.