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The High Price of Cheap Oil

When fuel costs plummet, Americans tend to buy bigger cars and drive them more. Could this time be different?

The same barrel of crude that sold for more than $110 a year ago is down to $87—at the time of this writing. That disclaimer is necessary because oil prices are falling so fast, the price of a barrel could well be into the $70s if you’re reading this just a few days from now.

Oil prices have dropped more than 25 percent since June, driven down by diminished demand from Europe, a flood of new supply from fracked oil fields in the United States, and other factors referred to as “God only knows” (that term was popularized by energy economists).

Most news outlets have focused on what plummeting prices mean for geopolitical hotspots like Russia or Iraq. But there could be significant environmental consequences as well—although it’s tough to tease out exactly what they’ll be. The relationship between oil prices and carbon emissions is a complicated one.

Cheap Oil = More Consumption

When the price of something goes down, people generally consume more of it. That’s Economics 101. (Actually, you’re probably supposed to know that before starting Econ 101 these days.) When gas gets cheaper, families are more likely to drive to Wally World, and commuters are less likely to take the bus or bike to work when it’s chilly. Temporary price changes, however, don’t tend to have huge impacts on consumption all at once.

“The demand for oil is fairly inelastic,” says Adam Millard-Ball, an assistant professor of environmental studies at the University of California at Santa Cruz. In other words, people change their consumption only a little, even when price changes significantly. “At least in the short run,” he says, “the effect [of falling gas prices] will be fairly modest, especially in the transportation sector.”

If oil stays inexpensive for several months, though—which it very likely will do, given the rapid expansion of supply—then you might need to start worrying. Between 2000 and 2008, average miles per gallon moved in almost perfect lockstep with the price of gasoline. As pump prices rose steadily, U.S. consumers demanded more fuel-efficient cars, and manufacturers responded. (Well, some responded. Toyota overtook GM’s dominant position in car sales, and the federal government bailed out the auto industry in part because of its failure to react to changing demand.)

Photo: Busse et al

If gas prices stay low, history suggests that the opposite could happen. People might replace their sedans with Hummers or move farther away from where they work. These sorts of changes build long-term increases into oil consumption.

How much of an increase? It’s difficult to say. A 10 percent change in the price of oil can shift global demand between 2 percent and 7 percent over the course of 20 years, depending on which economists you choose to listen to.

This does not mean the recent 27 percent decline in oil prices will result in a 15 percent increase in oil combustion. (That would be a disaster for the climate, since oil accounts for about 42 percent of global carbon emissions.) A few months isn’t enough to make a long-term difference of that magnitude, and there are many factors beyond price affecting oil consumption.

In recent years, in fact, the use of oil has fallen dramatically in wealthy countries, largely due to changes in driving habits. “There seems to be a natural saturation in how much we want to drive,” says Millard-Ball. “Young people are less likely to obtain a driver’s license today in countries like the States, Germany, and the U.K. Some of our efforts to develop mass transit and promote walking and biking may be paying off. We may also have simply run out of places to drive to. If there is a Wal-Mart within 5 miles, why drive to one 10 miles away?”

Photo: Adviser Perspectives, Inc.

As oil prices fall, there could be a driving rebound, but it probably won’t reverse the overall downward trend, which has been going on for a decade. (Former Wall Street Journal environment editor Jeffrey Ball also makes this point in a recent column at The New Republic.) According to research that UC Santa Cruz's Millard-Ball conducted with Adam Brandt of Stanford, we could see a global peak in oil demand sometime in the 2030s, when the same factors that have slowed oil consumption in the West take hold in the developing world. Lower long-term prices, however, would likely shift that date back, putting millions more tons of carbon dioxide into the atmosphere.

Low Prices = Less New Drilling

Now for the good news. Oil companies care primarily about money. So when oil is cheap, they’re less likely to risk their capital going after oil in remote locations like the bottom of the sea or Canada's far northern reaches. It just so happens that the most environmentally damaging oil exploration occurs in the most expensive areas.

Tar sands, for example, are the world’s most carbon-intensive fossil fuel. Extracting and processing the sludge requires about four times as much energy as is used to make conventional crude, and that’s not including the energy used transporting it from northern Alberta, Canada. By some calculations, producing tar sands oil is energy negative. It’s also hugely expensive. The break-even price for a new tar sands oil project is currently well below the market price for the product, causing oil companies to flee the dirty energy source (as I explain here).

Cheap oil isn’t just inhibiting tar sands exploration. If the price drops any further, energy producers will have to rethink their plans to develop offshore oil projects, which break even at around $70 to $80 per barrel. Even the U.S. shale oil boom isn’t fully insulated. Some shale drilling projects need prices to stay above $60 per barrel to be economically feasible.

The postponement or cancellation of oil exploration projects—some of which would produce oil for several decades once greenlit—could give renewable energy sources more time to mature. Of course, if energy stays cheap, the right financial incentives to encourage renewables have to be put in place. That leads us to one more way to think about cheap oil from an environmental perspective….

An Opportunity

The federal gasoline tax, which helps fund highway improvements (and, incidentally, provides a mild disincentive to burning fossil fuels), has been an issue in every presidential election I can remember. Bill Clinton criticized the tax in his race against George H. W. Bush. Bob Dole demanded it be lowered during the 1996 race. George W. Bush did the same while running against Al Gore. You get the idea—politicians promise to lower the federal gas tax to appeal to drivers.

For the first time in many election cycles, politicians from both parties this year are openly talking about raising the gas tax. At 18.4 cents per gallon, the fuel tax hasn’t increased a penny in more than 20 years, but the recent dramatic fall in gas prices has offered political and economic cover for such a bold move. As USA Today pointed out, we could tack 12 cents per gallon onto the tax, and gas would still be cheaper than it was on Labor Day. The Highway Trust Fund, which relies on the tax to pay for road improvements, is nearly empty, so the government has an immediate need for cash. The increase could even (shhh) represent a step toward a broader carbon tax.

So give your member of Congress a call today, and demand more expensive gasoline. You’ll have to wait through the stunned silence.

onEarth provides reporting and analysis about environmental science, policy, and culture. All opinions expressed are those of the authors and do not necessarily reflect the policies or positions of NRDC. Learn more or follow us on Facebook and Twitter.

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