Climate change, exhibited as global warming and frequent extreme weather events, has a great impact on our world, including the U.S. fuel Industry. Recently, there has been a debate between the energy industry and public about whether or not we should price the risk from climate change in the energy production industry.
According to a report from The New York Times, “Efforts are now afoot to set industry-specific standards for disclosing climate change risks, most notably by the Sustainability Accounting Standards Board, a nonprofit group whose chairman is Michael R. Bloomberg, the former New York mayor. The board estimates that there are significant climate risks for most companies it tracks, which represent $27.5 trillion, or 93 percent, of United States stocks as measured by market value.”
However, most of the energy production companies oppose that, for example, Exxon Mobil has argued that, “projections are difficult without knowing what future climate-change regulations will entail, or how new technologies might help curtail greenhouse gas emissions.” It appears that they highly doubt the necessity or even possibility to put a price tag on climate change.
Regardless of the debate’s outcome, or whether it is technically viable to evaluate the risks of climate change on the energy industry, the existence of risk is indisputable. On one hand, the decrease in the fuel price during the past few years could be considered as a signal of these risks. On the other hand, peoples’ negative expectations that the fuel price may keep going down in the coming few years is another reflection of the potential risk in the fuel industry.
Here we analyze the relationship between the fuel price and the environmental risks that the fuel industry is facing.
Supply side (The main cause of current price decrease)
In the past few years, North America has gone through a shale gas boom. There is a surge in the amount of shale gas being produced and the proportion of that shale gas in the whole energy consumption, showed in graph below. The sudden and mass increase in fossil fuel supply leads to a comparable decrease in energy price.
In figure 1, the supply curve moves from S to S’, the price goes down from P0 to P1.
Demand side (The reasons that might leads to further price decrease in the future)
- Decrease of market demand.
The impact of climate change on the economy is huge. According to a peer-reviewed study published earlier this year in Nature, even under the objectives of the Paris Climate Accords, which seeks to mitigate the rising temperature change within 2 degrees, there will be $1.7 trillion loss in financial assets. Given this loss, it is expected that there will be a negative effect on people’s willingness to consume and invest. As an input in many kinds of production and for goods people used in daily life, the demand for fuel will decrease significantly.
2. Increase in demand for substitute energy
Global warming, a major element of climate change, has a different impact on traditional fuel industry and renewable power industry. On one hand, because fuel is usually used for heating, the demand for it will decrease. On the other hand, demand for electricity, which powers hundreds of millions of air conditioning units and cooling appliances, will greatly increase because of the weather is going to be warmer. Such change is expected to change consumer behavior and lead to more consumption of electricity from all sources, including renewables.
In conclusion, demand for renewables goes up, while demand for fuel could go either way, depends on both the decrease from less heating demand and increase from electricity demand.
Besides, technological improvements in nuclear, solar, and wind energy, industries are incentivized by climate change, thereby encouraging investment in these industries and increasing power supply from fossil fuels’ competitors. As the substitute goods’ price goes down, the quantity demanded for fossil fuels simultaneously falls. As the demand decreases, the demand curve moved from D to D’, and as the result, the price decrease from P0 to P1.
Through the analysis of the reasons that lead fuel price goes down, in the present and future, we can broaden an understanding about the risks that American energy industry is facing.
- Lack of demand
Climate change puts people’s lives at risk, besides the direct economy loss from extreme weather events, the incentive for investment and consumption has been greatly impaired. In addition to the growing demand for wind power, nuclear power and solar power, the demand for fossil fuel is expected to decrease, or grow at a much slower rate as the alternative industry expands.
2. Oversupply with increasing production cost
The energy industry, as a whole, may earn high revenue from the sale of energy at such a large scale, despite the presence of low prices. However, the demand for fossil fuel is likely not to be as large as many energy industries expect. Therefore, one might expect a surplus in fossil fuel, forcing the industry to store excess product.
Moreover, climate change is expected to exacerbate this situation. The marginal cost of fuel production increased because of climate change. Extreme weather events occur more and more frequently, requiring more maintenance expenditure than before. Additionally, global warming makes energy production require more water for cooling, because the water temperature raises.
Due to low price and increased production costs, the energy industry is facing a great risk. First, some companies may choose to reduce their production. But it takes time to make that happen, thus they may have to proceed with their production in a period when their marginal cost is higher than marginal revenue. In addition, some companies may not able to produce under the high marginal cost, so they will quit the energy industry, which means some smaller firms without deep pockets may be forced into bankruptcy.
TABUCHI, H., & CLIFFORD KRAUSS, C. (2016, September 26). A New Debate Over Pricing the Risks of Climate Change. Retrieved from http://www.nytimes.com/2016/09/27/business/energy-environment/a-new-debate-over-pricing-the-risks-of-climate-change.html
DeHaan, P., & Laskoski, G. (n.d.). Fuel Price Outlook 2016 (p. 11, Rep.).
Comstock, O. (2016, May 17). EIA’s Annual Energy Outlook is a projection, not a prediction. Retrieved from http://www.eia.gov/todayinenergy/detail.php?id=26272
Climate Impacts on Energy. (n.d.). Retrieved from https://www.epa.gov/climate-impacts/climate-impacts-energy#Renewable