Tuesday’s 180-page World Economic Outlook from the International Monetary Fund is a gloomy portrait of a global economy heading into slower growth due to the war in Ukraine, pandemic lockdowns, monetary risks, fiscal extravaganzas and other products of interventionist policy-making. It makes for unsettling reading. No less grim is the second IMF report of the day, a 100-page Global Financial Stability Report, which warned that inflation, private debt, sovereign debt and other risks have risen in the wake of Vladimir Putin’s war.
Readers interested in enjoying the peace and quiet of the coming summer months are advised to find other reading material. The list of anxiety-inducing situations is endless, including the following few words from the stability report’s forward: “The geopolitics of energy security may put climate transition at risk. Capital markets might become more fragmented, with possible implications for the role of the U.S. dollar. And the fragmentation of payment systems could be associated with the rise of central bank digital currency blocs. In addition, more widespread use of crypto assets in emerging markets could undermine domestic policy objectives.”
One small section of the Outlook report, however, caught my attention — a short six-page special feature on the global oil and gas industry that highlights a steady decline in investment in fossil fuels, a decline that threatens market stability and points to the need for careful policy co-ordination to avoid a new energy crisis.
That’s my reading of the section, titled “Market Developments and the Pace of Fossil Fuel Divestment.” The main point of the feature is that there is a grave risk created when the two central but different carbon policies clash to create a major economic confrontation. The two conflicting economic forces are 1) policies that aim to reduce demand for oil and gas and drive prices lower and 2) policies that aim to reduce the supply and production of oil and gas and drive prices higher.
The IMF feature uses the example of oil to illustrate the contradictory and clashing forces behind the global Paris Agreement net zero emissions scenario. If policies were to focus solely on reducing demand for oil, the price of oil would fall dramatically, heading to as low as $20 a barrel by 2030. Investment would fall and oil production would decline.
On the other side of the face-off, policies that only focused on reducing the supply of oil would have the effect of driving up the price to $190 a barrel by 2030. Oil would then become more profitable, with investment continuing to stimulate production.
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The IMF report notes that “it is typically assumed that the energy transition would work as a negative demand shock.” Subsidies for electric cars, for example, or carbon taxes would lead to reduced demand for fossil fuels. At the same time, it is assumed, restricting investment flows into oil and gas will coincide with falling demand.
The challenge is to get the two sides of the great net zero policy machine to operate in some kind of synchronized equilibrium, something that seems to be missing from current policy. Oil and gas divestment declined by between 20 and 25 per cent between 2014 and 2019, a decline driven at least in part by the clean energy investment crusade. The IMF report observes, however, that the decline has been excessive. “The clean energy transition requires a substantial reduction in fossil fuel investment. The recent energy crisis, however, has raised concerns that, relative to the speed of adoption of renewable energy, the pace of divestment from fossil fuels is too fast, especially for oil and gas.”
The balancing act between reducing demand for fossil fuels and reducing the supply of fossil fuels in the pursuit of net zero is a global central planning exercise that is massive in scope and filled with risk. The six-page IMF feature concludes with a seemingly modest but likely impossible suggestion: “A co-ordinated climate effort among fossil fuel consumer and producer countries and divestment from fossil fuels at a pace commensurate with the speed of adoption of renewable energy would help reduce the risk of high and volatile energy prices.” Good luck with that.
“Anticipation of lower fossil fuel demand and — possibly, but to a lesser extent — supply-side climate policies (including shifting public preferences for sustainable investing) have sapped capital expenditures in oil and gas globally over the past three to four years — especially for publicly traded companies, whose investment may have shrunk 20 per cent during that time. This can put persistent upward pressure on oil and other fossil fuel prices, move production to less regulated producers, and add substantial uncertainty to the outlook for oil and gas prices. A co-ordinated climate effort among fossil fuel consumer and producer countries and divestment from fossil fuels at a pace commensurate with the speed of adoption of renewable energy would help reduce the risk of high and volatile energy prices. And less policy uncertainty would help countries make necessary adjustments.”