Oil Prices and Clean Energy

Today NYMEX Crude Oil Futures closed at $96/barrel, meaning that the world price of oil has risen almost seven-fold since it hit a nadir of $14/barrel in 1998. It is tempting to conclude that by raising the threshold per-kilowatt hour price that alternatives to oil must meet in order to be competitive, the surge oil prices will increase production of low-carbon energy sources (wind, biomass, etc.). Thus, one might argue that in the long-run rising oil prices promote de-carbonization of the world's energy supply and reduction of greenhouse gas emissions.

Be wary of this conclusion. Energy producers indeed respond to oil's price signals, but as a discussant on today's NPR Science Friday points out, in the near-term higher oil prices will serve mainly to stimulate production of coal, earth's most carbon-intensive energy source. For most activities dependent on oil, coal is the cheapest and most plentiful alternative - on a kilowatt hour basis much cheaper than wind, solar, or any of the bio-fuels examined in National Geographic's excellent survey of the subject. As these graphs show, recent gains in the price of coal have lagged far behind those in the price of oil.

Higher oil-prices make low-carbon energy sources more attractive relative to oil, but do nothing to improve their economic viability viz. coal (except insofar as oil is a minor input into coal production). Coal's low price makes it the substitute energy source of choice for almost all users of oil and natural gas; its abundance throughout the world (particularly in China) means that its favored status is unlikely to dissipate anytime soon. To achieve market share, the per unit price of any low-carbon energy source must be able to compete with coal (as Stephen Chu of Berkeley often points out). Incentivizing production of low-carbon energy thus requires raising the price of all carbon-intensive energy sources (oil, coal, natural gas, etc.) - a rise in the price of oil alone will not do it.

The Royal Commission on Environmental Pollution calculates that a carbon tax of $40/metric ton would make low-carbon sources competitive with coal on an industrial scale. Gilbert Metcalf of Tufts recommends $15/metric ton. Whatever your preferred amount, the influence of coal-producing states in the U.S. Senate (Byrd and Rockefeller of West Virginia; Specter of Pennsylvania) makes any American carbon tax unlikely in the near future. Note that the Lieberman-Warner climate bill forgoes a carbon tax completely in favor of the far inferior cap-and-trade approach.