December 2, 2015/iMFdirect
By Rabah Arezki and Maurice Obstfeld
“The human influence on the climate system is clear and is evident from the increasing greenhouse gas concentrations in the atmosphere, positive radiative forcing, observed warming, and understanding of the climate system.” —Intergovernmental Panel on Climate Change, Fifth Assessment Report
Fossil fuel prices are likely to stay “low for long.” Notwithstanding important recent progress in developing renewable fuel sources, low fossil fuel prices could discourage further innovation in and adoption of cleaner energy technologies. The result would be higher emissions of carbon dioxide and other greenhouse gases.
Policymakers should not allow low energy prices to derail the clean energy transition. Action to restore appropriate price incentives, notably through corrective carbon pricing, is urgently needed to lower the risk of irreversible and potentially devastating effects of climate change. That approach also offers fiscal benefits.
Low for long
Oil prices have dropped by over 60 percent since June 2014 (see Chart 1). A commonly held view in the oil industry is that “the best cure for low oil prices is low oil prices.” The reasoning behind this adage is that low oil prices discourage investment in new production capacity, eventually shifting the oil supply curve backward and bringing prices back up as existing oil fields—which can be tapped at relatively low marginal cost— are depleted. In fact, in line with past experience, capital expenditure in the oil sector has dropped sharply in many producing countries, including the United States. The dynamic adjustment to low oil prices may, however, be different this time around.
