Week Ending March 25, 2016

In Address at U.S. Energy Association, University of Chicago Economist Contends Market Forces Alone Can’t Drive Sufficient CO2 Reductions

This Article Appears as Published in Foster Report No 3092
In Address at U.S. Energy Association, University of Chicago Economist Contends Market Forces Alone Can’t Drive Sufficient CO2 Reductions

In a March 21 address to the U.S. Energy Association (USEA) in Washington, D.C., Thomas Covert, an assistant professor of microeconomics at University of Chicago’s Booth School of Business, maintained that the play of market forces alone will fall short of achieving significant long-term reductions in greenhouse gas emissions (GHG).  Based on his analysis of historical trends and projections, he argues that it would be unwise for policymakers to pin their hopes on natural market forces causing enough of a drop in conventional fossil fuel-burning to reach the carbon-cutting goals embraced by many climate scientists.  In short, neither a tightening of oil and gas supplies or increasing cost of extraction (“supply side” forces), nor the advent of substantially cheaper, non-GHG-emitting alternatives (“demand-side” forces) can be expected to rescue the planet from serious global warming, the professor insists.

Covert’s talk was based on a paper he co-authored – entitled, “Will We Ever Stop Using Fossil Fuels?” –published in the Journal of Economic Perspectives (winter 2016 edition). [1]  The paper concludes that truly “drastic” reductions in GHG emissions will only come about as a result of an “activist” policy response.  Moreover, Covert observes that getting broad, multi-national action is especially challenging because the costs and benefits of GHG emission restrictions are not generally confined within a region.  He contrasts this with the “first wave” of regulatory restrictions, experienced in the U.S. from the 1970s into the early ‘90s, which addressed “conventional” fossil fuel pollutants – i.e., particulates, SO2, and nitrous oxide.[2]  In that era, localized actions generally translated into local or regional benefits.

But greenhouse gasses, Covert notes, affect the global climate and require a global response, not just self-imposed restrictions by the more prosperous nations.

Conventional Pollutants.  Pollution control technologies and cost-effective fuel diversification (e.g., increasing nuclear power) were favored policy levers, Covert points out, during the “first wave” of regulations to reduce fossil fuel emissions (later complemented by emissions credit trading schemes).  But he does not believe these tools can sufficiently control GHG.  He submits that a “large contingent” of science and technology people, as well as regulators and business executives, have concluded that materially less “combustion and consumption” of fossil fuels is critical to combatting climate change.

A central premise of Covert’s analysis is that carbon dioxide emissions have not as yet been effectively tackled by regulatory initiatives.  He recounts that Congress did not pass the Waxman-Markey bill[3] when it had the opportunity in the late 2000s; that the U.S. does not yet have a “Clean Power Plan”; and that Europe’s carbon trading scheme has been crimped by “fairly inexpensive permit prices” for CO2 emissions.   His one “caveat” is that, in developed countries today, there are fairly widespread public subsidies for renewable resource technologies.  But Covert rates this policy “second, third, or fourth best” compared to the kinds of regulatory approaches adopted in the first wave of emissions restrictions during 1970s-90s.

Misplaced Reliance on Market Forces to Shrink Supply.  Much of Covert’s talk was aimed at discrediting suppositions that, in the near to medium future, fossil fuel consumption will decline significantly due to natural market forces.  He separates these “natural decline” theories into two categories:

  • The “supply theory” – that the world “will run out of inexpensive fossil fuels”;
  • The “demand theory” – that “scientific advances will improve the energy efficiency of existing technologies and develop newer, cheaper carbon-free technologies” that will shoulder aside carbon-emitting fuels in the marketplace.

Although the argument that fossil fuels will decline in availability (since they are “finite” by definition) and/or rise to uncompetitive prices has had traction at times, Covert rejects the “supply theory” based on the historical record.  He presented a chart depicting that, for many decades, the ratio of proven oil and gas reserves to annual consumption has remained remarkably constant – around a 50-year supply – despite steady growth in demand and spurts of price volatility, reflecting the resiliency of the industry through many economic cycles.  (Coal, by contrast, has seen a steady decline in its ratio of reserves to consumption, though it is still pegged at a lofty 100-plus years.)

The “stability of the reserve-to-consumption ratio,” Covert suggests, is the “first piece of evidence against the idea that the supply of or demand for fossil fuels are likely to ‘run out’ in the medium term.”

Covert then focuses on the record of technological advancement and “exploration success” that helps explain how the reserve-to-consumption ratio has held up in spite of increasing world consumption and greater reliance on harder-to-access oil and gas deposits.

By way of illustration, he notes that oil from the Canadian “tar” sands and both oil and gas from the North American shale deposits were not even classified as “reserves” until relatively recently.  For the Canadian sands, the first small-scale production only began in 1967, and it wasn’t until 1999 that Canadian authorities recognized this growing resource as a “reserve.”  That decision added 130 billion barrels to Canadian oil reserves and boosted world reserves by 10%.  The experience with U.S.-based shale deposits tells a similar story:  with the refinement of hydrofracturing and horizontal drilling techniques, U.S. oil and gas reserves expanded by 59% and 94%, respectively, between 2000 and 2014.

Fossil-Fuel-Reserves-to-Production-Ratio

This history of developing new or improved technologies to access deposits previously regarded as uneconomic correlates with a long-term uptrend in drilling successful wells.

A second chart presented by Covert depicted a gradual but significant improvement in the U.S. success ratio of developmental wells, and an even greater surge in the success probability of exploratory wells.  These steady improvements in technologies resulted in the “large-scale development” of new oil and gas from Alaska and the North Sea beginning in the 1970s, from deepwater prospects like the Gulf of Mexico in the 80s and 90s, and from onshore shale deposits beginning in the 2000s, Covert emphasizes.

Fraction-of-Successful-Exploratory-and-Development-Wells-in-US

Covert also underscores that other large deposits of fossil fuel deposits currently viewed as technically unrecoverable could become economical in future years.  He cited “oil shale” (which is fundamentally different from “shale oil and gas”) [4]  as a potential source of 2.8 trillion Bbls of oil and  methane hydrates, estimated to contain 10-100 Tcf of natural gas, as prime examples of tomorrow’s possible breakthroughs.   Moreover, the rapid development of shale oil and gas in North America could eventually be emulated around the world; over 90% of the world’s shale oil and gas deposits, Covert notes, are outside the U.S.

To Covert, the “policy implications” of the steady expansion of fossil fuel extraction are “profound.”  Even if countries enact policies like carbon taxes and cap-and-trade systems to curb the use of fossil fuels, the historical track record is that technology will work “in the opposite direction” to make their extraction more feasible, even from resources previously regarded as unreachable.

Potential for Greener Alternative Fuels.   Having shown scant hope of diminishing supplies of affordable fossil fuels, Covert then pivoted to the demand side.  Focusing on the electricity generation and transportation sectors as major consumers of fossil fuels, he questions how likely it is that progress in the efficiency of renewable resource power generation and battery power storage will, by lowering their market prices, lead to shrinkage in the demand for fossil fuels.

Covert submits that, at least in the U.S., “We are running out of demand for coal.”  But comparing natural gas as a generation fuel to the main non-carbon-emitting power options – new nuclear, wind, and solar[5] – his analysis (based on levelized costs under a 5-10 year forecast)[6] showed that none of these alternatives have become more economical than gas.  This is true even though the capital costs of wind and especially solar have fallen in recent years, and the variable cost of these renewables is close to zero.[7]

Moreover, notes Covert, the additional cost of compensating for the natural intermittency of wind and solar adds to their effective total cost, though the extent varies depending on the region and the benefits of site diversification.  A variety of factors, Covert concludes, make wind and solar generation “ill-suited” for baseload generation in the absence of “economical storage technologies.”

When it comes to transportation fuel, again Covert finds that fossil fuels (mainly oil) will continue to have a long-term advantage over battery-powered electric vehicles (EVs).  Relying on a graph that shows what the “indifference point” is between internal combustion cars versus EVs – that is, what the cost of oil would have to be to make EVs just as affordable across a wide range of theoretical battery costs – his analysis shows that oil would have to cost many multiples of its present cost (e.g., $300-400/Bbl) based on present battery costs.[8]  And even if battery costs are brought down to the U.S. Department of Energy’s target (which would require great progress in battery efficiency), oil would still have to be priced above $115/Bbl to make car purchasers indifferent.[9]

He concluded that, with oil prices where they are, “unfortunately” battery costs must be “substantially cheaper” than they are today for a reduction in demand for transportation fossil fuels to take place.

Covert also looked at the price outlook for biofuels as an alternative to gasoline for internal combustion vehicles, but similarly found these fuels less cost-effective than fossil fuels based on current technologies.

Policy Implications.  Contrary to “peak oil” theorists, Covert suggests the world is not going to run short of affordable fossil fuels in the near or medium future, nor are “greener” alternatives going to make deep inroads into the prevalence of fossil fuels, assuming market forces are largely allowed to run their course.

Covert’s USEA address did not extrapolate the implications of continued heavy reliance on fossil fuels, but his paper does.  It offers what it terms some “back of the envelope calculations” on the warming effect of “using all available fossil fuels.”  Based on such a future, the article projects “an increase in global average temperatures by 10-15 degrees F.”  The paper states:  “Such scenarios imply difficult to imagine changes in the planet and dramatic threats to human well being.”

The article connects this “dystopian future” to two “market failures” – the underpricing of GHG emissions in carbon trading systems and the underfunding of “basic or appropriate research and development.”  But even if these two problems were addressed, a more intractable political problem is that the poorest countries are expected to experience the greatest growth in energy consumption in the coming decades, and are unlikely to turn to less carbon-intensive but more expensive fuels absent “direct compensation.”

Covert and his fellow authors do see a ray of hope from the December 2015 Paris climate conference accords, which etched “broad outlines of what could constitute dramatic change in global climate policy.” While they see this as a promising blueprint for “dramatic change,” whether this “high-level voluntary agreement” will actually be implemented “will be determined in the coming years.

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[1]   Although Covert is listed as the lead author of the published paper, Michael Greenstone and Christopher Knittel are listed as co-authors.  Greenstone is a professor of economics at the University of Chicago as well as director of the Energy Policy Institute, also part of the University of Chicago; Knittel is a professor of energy economics at the Sloan School of Management and director of the Center for Energy and Environmental Policy Research, both at the Massachusetts Institute of Technology.

[2]   Covert remarked that the U.S., as well as other developed Western nations, have made a great deal of progress in treating this class of pollutants; although not for a number of developing nations.

[3]   This bill, which passed in the House in 2009 but died in the Senate, would have imposed a cap-and-trade scheme for GHG.

[4]   Its extraction would be more similar to techniques used to mine Canadian oil sands.

[5]   Hydroelectricity is obviously non-carbon emitting too, but the potential for growth in capacity is site-limited.

[6]   This data was drawn from the U.S. Energy Information Agency’s projections.

[7]   Covert did point out, however, that wind and solar energy costs are lower in some geographical areas than others.  His analysis was based on broad national averages.  In the southwestern U.S., he noted, recent utility-scale solar projects have been priced in the $40-50/MWh range; and, while these benefit from federal tax credits, the “implied real” costs are “near or below” the levelized cost estimates for natural gas-fired projects.

[8]   Covert cited a 2015 study suggesting that the battery costs, which have come down significantly over the past 10 years, are predicted to “level off between $150-300 per kWh over the next 15 years.”  The U.S. DOE target for 2022 is a battery cost of $125 per kWh.

[9]   Covert’s study also notes that total life-cycle carbon emissions from cars do not go down if the fleet of vehicles is converted to battery power unless the fleets of generation stations are also converted to lower-carbon-emitting technologies.

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Copyright © 2016 by Concentric Energy Publications, Inc.  All rights reserved.

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