Renewable and Sustainable Energy Reviews 68 (2017) 609–622

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Renewable and Sustainable Energy Reviews

journal homepage: www.elsevier.com/locate/rser

2014 oil plunge: Causes and impacts on renewable energy

a,⁎ b,c c d
crossmark
Muhammad Imran Khan , Tabassam Yasmeen , Abdul Shakoor , Niaz Bahadur Khan ,
Riaz Muhammade
a
Institute of Petroleum Engineering, Heriot Watt University, Edinburgh, UK
b
Department of Mechanical Engineering, Imperial College London, London, UK
c
Department of Mechanical Engineering, University of Engineering & Technology, Peshawar, Pakistan
d
Faculty of Engineering, University of Malaya, Kuala Lumpur, Malaysia
e
Department of Mechanical Engineering, CECOS University of IT and Emerging Sciences, Peshawar, Pakistan

A R T I C L E I N F O A BS T RAC T

Keywords: Following four years of relative stability at around $106 per barrel (bbl), oil prices have declined sharply since
Oil price June 2014 and are expected to remain low for a considerable period of time. There are multiple factors which
Shale oil are being considered behind the plunge in the price of oil since June 2014. Most observers have conjectured that
OPEC domestic oil boom in the United States and Iraq is the major cause for the falling oil prices. Some have
Renewable energy
suggested that a major shock to oil price expectations occurred after the November 2014 meeting of OPEC,
when they did not cut production despite the steady increase in non-OPEC oil production.
In this paper, first we analyzed the effect of various factors on the oil prices and then we studied impacts of
the falling oil prices on non-hydro renewable energy. We compare the recent decline in oil prices with previous
episodes up to 1996. We show that the demand and supply formula cannot be implemented to the current oil
plunge.
The study shows that so far the recent plunge in oil prices has produced no major impact on renewable
energy sector. We found that renewable energies, such as solar and wind, are increasingly becoming cost
competitive with fossil fuel energy. However the oil price crash could hurt the short-term outlook for certain
specific clean energy technologies such as bio-fuel and electric vehicles that do compete with oil-based
transportation. While long term low oil prices may threaten renewable energies, climate policies have the
potential to act as a counterweight, encouraging long-term, low carbon, investment.

1. Introduction
Global oil prices have fallen sharply over the past two years,
resulting in one of the most dramatic declines in the price of oil in
recent history. The collapse of oil prices from around $114 in June
2014 to $28 in February 2016, has led to a large body of literature
analyzing the causes of this steep oil price drop and its macroeconomic
implications. However, most of this literature is mainly written by
international organizations (see, for instance, the IMF blog by Arezki
et al. [1]), investment banks (such as Goldman Sachs Global
Investment Research division's report on “The New Oil Order” [2]),
various (energy) economists, and of course mostly internal reports by
oil and gas companies. Most of the written work is speculative and
some of it downright conspiratorial. There are yet only a handful of
papers, which apply the rigorous and quantitative analysis of the recent
oil price shock. Most notably, Baumeister et al. [3] argue that demand
factors were most important in explaining the behavior of oil prices,
while the Studies [4–6] argue that supply (rather than demand) factors
played the largest role. Baumeister et al., 2015 [3] used the reduced-
form representation of the structural oil market model developed in
Kilian et al., 2014 [7] and argued that, out of a $49 fall in the Brent oil
price, $11 of this decline was due to adverse demand shocks in the first
half of 2014, $16 to (positive) oil supply shocks that occurred prior to
July 2014, while the remaining part was due to a “shock to oil price
expectations in July 2014 that lowered the demand for oil inventories
and a shock to the demand for oil associated with an unexpectedly
weakening economy in December 2014, which lowered the price of oil
by an additional $9 and $13, respectively”. Fantazzini et al., 2016 [8]
suggested that there was a negative bubble in oil prices in 2014/15,
which decreased them beyond the level justified by economic funda-
mentals. A negative financial bubble is a situation where the increasing
pessimism fuelled by short positions lead investors to run away from
the market, which spirals downwards in a self-fulfilling process.
Similarly, Arezki et al., 2014 [1] suggested that unexpected lower

⁎
Corresponding author.
E-mail address: mk42@hw.ac.uk (M.I. Khan).

http://dx.doi.org/10.1016/j.rser.2016.10.026
Received 16 April 2016; Received in revised form 29 September 2016; Accepted 16 October 2016
1364-0321/ © 2016 Elsevier Ltd. All rights reserved.
M.I. Khan et al.
demand between June and December 2014 could account for only 20–
35% of the price decline, while Hamilton et al., 2014 [9] found that
only two-fifths of the fall in oil prices were due to weak global demand.
Various potential factors which could have influenced the oil price
decline are discussed in an extensive World Bank policy research note
by Baffes et al., 2014 [4]. They found out that supply shocks roughly
accounted for twice as much as demand shocks in explaining the fall in
oil prices. An alternative explanation is put forward by Tokic et al.,
2015 [10] who suggested that the 2014 oil price collapse was partially
an irrational over-reaction to the falling Euro versus the dollar. This is
consistent with Donahue et al., 2016 [11] who stated that a stronger
dollar, coupled with a slowing global economy, was one of many
reasons for the recent falling oil prices.
The report issued by Bank of International Settlements, Switzerland
[12] shows that production and consumption alone are not sufficient
for a fully satisfactory explanation of the collapse in oil prices. In this
regard, the report advanced the idea that “if financial constraints keep
production levels high and result in increased hedging of future
production, the addition to oil sales would magnify price declines. In
the extreme, a downward-sloping supply response of increased current
and future sales of oil could amplify the initial decline in the oil price
and force further deleveraging”. On the other hand the work done by
Behar et al. 2016 [13] shows that although the relative importance of
each factor is difficult to pin down, OPEC's renouncement of price
support and rapid expansion of oil supply from unconventional sources
appear to have played a crucial role since mid-2014.
Similarly Tokic et al., 2015 [10] suggested that the oil price collapse
2014/2015 could have been caused by the increased leverage of oil
firms (the debt of oil and gas sector increased from $1 trillion in 2006
to $2.5 trillion in 2014): the increasing need to keep high production
levels and to hedge future production to satisfy financial constraints
could have easily amplified the initial price decline due to economic
fundamentals. Therefore, a revised and more effective regulatory
framework should include not only oil traders/speculators, but all
market participants including oil producers. The design of this revised
framework is definitively an important avenue of future research.
In this paper, we extend the literature in a number of respects. We
have discussed the various other possible causes of the recent oil
plunge including disparities of recent oil plunge with the previous ones
and its impacts on renewable energy sector.
Clearly, this sharp oil plunge is an issue of highest national and
international importance that needs to be addressed properly based on
empirical facts and historical knowledge. Many policymakers have been
pondering the question of what caused this sudden decline, the severity
of which surprised even industry experts, and whether the decline is
likely to continue [1]. Although sustained declines in the price of oil
have occurred before, notably in 1986 and in late 2008, a natural
question is whether this oil price decline is different and, if so, how.
Considering the past events of such sharp drop in prices synchronized
with considerable variations in inflation, the causes, and outcomes of
and OPEC's policy reactions to the recent episode of crude oil prices
have triggered an intensive debate. The main aim of this study is to
improve the theory of recent oil plunge by analyzing different scenarios
based on event study and get more accurate oil price analysis results
closer to reality. This study presents an evaluation of the recent plunge
in oil prices to address four main questions that have been the focus of
recent discussions:
• How does the recent plunge in oil prices associate with previous
episodes?
• What causes a sharp drop in oil prices?
• What are the connections between renewable & Oil prices
• How falling oil prices could affect the Renewable Energy
We address the above questions to use event base study methodol-
ogy by examining the various parameters affecting which affect the oil
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Renewable and Sustainable Energy Reviews 68 (2017) 609–622
prices over the period January 1996 through February 2016.
The rest of the paper is structured as follows. Section 2 highlights
the historical perspective of oil prices decline from 1998 to 2008.
Section 3 describes the indicators of global activity and their ability to
capture the demand for oil. Section 4 investigates the role of the major
influencers. Section 5 assesses the impacts of low oil prices on
renewable energy. Section 6 concludes.
2. Historical perspective of decline in oil prices: 1998–2008
In contrast to the previous three episodes of oil prices decline, the
recent oil plunge differs in several ways. The first one, in 1998, was
mostly associated with a dwindling demand in the wake of the Asian
crisis of 1997, and steady increase in OPEC production to mid-1998
[14]. In spite of poor oil prices, the global economic recovery remained
sluggish during most of 1998, partly because of financial stress in the
US and major emerging markets. It gained momentum only in 1999–
2000, as growth in the US, Euro Zone and a number of large developing
economies recovered. One of the key difference of 1998 oil price decline
to recent drop was that 1998 oil prices decline occurred from a normal
oil price level (roughly $30 in current dollars), meaning it very quickly
approached marginal cost levels.
Again in 2001 the disturbances and insecurity triggered by 9/11
terrorist attacks, strengthened slowdown the slowdown in growth
already underway as the “dotcom” bubble deflated. Softening global
economic activity and growing uncertainty were the major drivers
behind the sharp drop in the prices of crude oil around that time.
However, aggressive financial policy facilitating by the Federal Reserve
and other major central banks bolstered a rapid recovery in activity,
while low oil prices might have provided some further support.
Similarly, in 2008, a steep decline in global demand sent all
commodity prices dipping during the Great Recession of 2008-09.
The recent drop in oil prices is significantly steeper than the fall in the
price of other commodities, whereas almost all commodities prices
dropped by similar rates in 2008-09.
In many ways, the recent shale oil boom resembles the extension of
oil supplies from the North Sea and the Gulf of Mexico offshore fields in
1970s and early 1980s. The technology to produce oil from offshore
fields was even available in 1950s but the high prices of oil in 1970s
made the use of such technology cost-effective. During 1973-83, the
Gulf of Mexico and the North Sea collectively enhanced the global oil
market by some 6 million barrel per day — as much as by unconven-
tional oil sources i.e. US shale oil and Canada sand oil supplied to the
global oil market during 2007–2014.
3. Global oil demand and supply
More than any other sector of the market, the energy sector, and in
particular oil, is influenced by two main aspects: the supply/demand
mechanism and market expectations, being the sector mostly based on
futures contracts. Demand for oil is related to economic activity, so the
higher the economic activity and the higher oil demand, and to
seasonal aspects, it spikes for example during winter time. On the
other hand, supply is determined by weather, which can affect
production, and by geopolitical issues.
A first question is whether there have been important changes in
global oil production since June 2014. Unexpected changes in oil
production traditionally have been considered important in explaining
oil price fluctuations [15]. Arezki et al. [1] found surprise increases in
global oil production as one of the main causes of the decline in the
price of oil. However, it is often difficult to have a clear understanding
of the total supply of oil, since many of the world's large suppliers are
not transparent about what they produce.
Fig. 1 shows world total liquid supply and consumption since 1996.
Empirical estimates suggest that the supply factors have played a
somewhat larger role than demand factors in driving the drop in the
M.I. Khan et al.
Fig. 1. Oil prices vs supply/demand.
Source: Prepared by the authors based on: U.S. Energy Information Administration (EIA) – Data.
price of oil from October 2014 upto February 2016. These results are
also compatible with those in some recent studies. For instance, Arezki
et al. [1] found that demand linked factors contributed 20–35% to the
plunge while supply related factors OPEC's policy not to cut production
were more significant in driving the fall in oil prices. Hamilton et al.
[16] claim only 40% of the drop in oil prices in 2nd half of 2014 was
caused by weak global demand. Baumeister et al. [3] argue that more
than half of the oil price decline reflects the combined impacts of earlier
oil demand and supply shocks and the remaining impacts comes from a
slowdown in global economy.
The major contributor to demand factor is the domestic increase in
production from the United States and Iraq. US domestic oil produc-
tion rose from about 5.6 million barrels per day (mb/d) in 2010 to 9.4
million barrels per day (mb/d) today (Fig. 2), pushing out oil imports
that need to find another home. Saudi, Nigerian, and Algerian oil that
that was once supplied to the United States, is now competing for Asian
markets, and the supplier are enforced to lower the prices.
As shown in Fig. 2, the domestic supply surge greatly offset US net
crude oil imports, shrinking them from 8.5 mb/d in 2012 to less than
6.6 mb/d in October 2015. US oil imports from OPEC have fallen to a
28 year low. Moreover, the same technologies that have enabled the
shale oil shale boom – fracking and horizontal drilling – have also led
to a nearly 40% increase in U.S. natural gas production since 2007.
Now one of the lowest cost fuels, natural gas is expected to further
reduce the United States’ reliance on oil, particularly for electricity
generation, heating, chemical manufacturing, and even transportation.
Similarly, one other contributor to demand factor was the increased
investment in renewable energy. In 2014, investments in “clean”
energy, including renewable, have dramatically increased, in particular
in countries like China and USA that have always been the biggest
energy buyers. In China investments increased by 32% to 89.5 billion
US $ and the growth continued despite falling prices of oil and gas.
Fig. 2. Oil prices vs us oil production/imports.
Source: Prepared by the authors based on: U.S. Energy Information Administration (EIA) - Data.
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Renewable and Sustainable Energy Reviews 68 (2017) 609–622
China accounts for 29% of global investment in clean energy and their
lead is expected to increase in the following years because of their
imperative need to reduce urban pollution. At the beginning, analysts
were of the opinion that the recent oil plunge would harm the growing
markets for renewable energy and reduce the attractiveness of cars
which use alternative fuel sources. But contrary their opinion the
investment in renewable energy (other than biofuels) has been
increased. The reason is that the wind and solar power make electricity
while oil is rarely used to generate electricity. In the US despite an
increase in oil production investment in clean energy rose 8% to 51.8
billion US $.
Although oil consumption in the US and Europe peaked about 08
years ago and has been on a downward trend ever since. This largely
reflects the improving efficiency of motor vehicles, with the fuel
economy of new cars in the Europe and USA, measured in terms of
miles per gallon, around 20% higher than 10 years ago. However, the
overall world consumption rate is following the increasing trend as
shown in Fig. 1. The same is also confirmed by IEA “Oil market report”
which estimated that consumption grew by 1.8 mb/d on a global basis
in 2015 [17]. The pickup in consumption in oil importers has so far
been somewhat weaker than evidence from past episodes of oil price
declines would have suggested, possibly reflecting continued delever-
aging in some of these economies [18].
The Fig. 1 shows that the current oversupply is about 2%. This
doesn’t seem like much but it actually has a huge effect on oil prices.
The oversupply could be further increased with the recent release of
economic sanctions on Iran. With the sanctions lifted, Iran can once
again sell more oil to global markets. However, it's worth mentioning
that price can change faster than the fundamentals of supply and
demand. In the last seven month period (June 2015 to January 2016)
the price of oil fell by 52% while there was no change in the demand or
supply over those months to justify such a large change (Fig. 3).
M.I. Khan et al.
Fig. 3. Oil prices vs supply/demand.
Source: Prepared by the authors based on: U.S. Energy Information Administration
(EIA) - Data.
It is not true that the decrease in world oil demand over the past
two years has come from China due to slower economic growth there as
stated by various reports [19–21]. In fact, in 2014 the consumption
increased by 2% in second half of year and 3% for the year 2015. In fact
last year, despite economic headwinds all year, China registered an all-
time high in oil consumption. Fig. 4 exhibits that since June 2014
consumption has been increased in China rather than reduction. Both
OPEC and the IEA expect Chinese oil demand to grow somewhere
around 3% this year.
As in Fig. 4 we can observe that the oil prices do not follow the
demand and supply's principle in true spirit. It means that there are
some factors which can affect the oil market significantly. The most
important of these factors is global geopolitical strategies. We discuss
the role of the geopolitical strategies in current oil plunge in section 08.
Those who claimed that the current oil plunge is due to supply/demand
disturbance of the oil market especially due to US shale oil boom, have
missed empirical estimates released by the various organization before
summer 2014 about the current demand/supply status. For instance,
Short-Term Energy Outlook report which was released by US Energy
Information Administration (EIA) just before the 2014 oil crisis,
projected the oil prices, U.S. total crude oil production, world total
oil production and consumption for the year 2014 and 2015. Figs. 5
and 6 illustrate the relevant data of the report in graphical form. It can
be seen that the projected figures of the production and consumption
are in very close match with each other. This consequently means that
the demand and supply formula is not applicable for the current oil
plunge. Even the claim of a surge in US oil production cannot be fully
justified as the same was already forecasted by the report. All
parameters except prices remained almost on the same track as they
were projected.
Fig. 7 illustrated the historical relation between oil prices and
OECD inventory level. It can be observed that the OECD inventory level
has been increased by some 15% since June 2014.
Fig. 4. Oil prices vs consumption by China, USA & Europe.
Source: Prepared by the authors based on: U.S. Energy Information Administration (EIA) - Data.
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4. The role of the major influencers: shale oil, OPEC, Saudi
Arabia, Dollar
4.1. The evolution of U.S. shale oil production
One of a key factor driving the collapse in recent oil prices is the
unexpectedly extraordinary renaissance in the US shale oil production.
Output surged from 5 million bpd in 2008 to an average of more than
8.5 million bpd in 2014, and stood above 9 million bpd at the start of
2015.
The US shale oil revolution has changed the perception of the oil
industry and has dramatically revitalized oil exploration and produc-
tion while unlocking vast new reserves of oil. Shale oil refers to
conventional oil trapped in very low-permeability tight formations
known as shales, which makes extraction difficult. In order to release
the oil and gas from shale, drillers use a method called hydraulic
fracturing, also known as fracking, essentially pumping water, sand,
and chemicals at high pressure to fracture the shale formation and
create artificial permeability. Shale oil developers use a technique
called pad drilling, with up to ten drill wells radiating horizontally for
distances of up to six miles from a single site, or pad. Shale-oil and gas
fracking was first developed in the early 2000s in the United States in
the Barnett shale formation in northern Texas and Oklahoma. These
shale oil formations have been known to geologists for decades, but
they were never economic to produce until the advent of fracking and
directional drilling technology. By 2012, the International Energy
Agency - IEA projected that the United States would become the
world's leading crude oil producer, overtaking Saudi Arabia by the mid-
2020s and evolving into a net oil exporter by 2030 [22].
The key shale regions in the US are the Bakken, Eagle Ford,
Niobrara, Permian, Utica, Marcellus (see Fig. 8), and Haynesville,
respectively. Out of these seven shale regions, the Bakken, Eagle Ford,
Niobrara, and Permian are the four major shale crude oil producing
regions.
The persistently high levels of oil prices in recent years made shale
oil exploration economically viable. However, several factors were in
place in the United States that allowed the shale oil revolution to occur
first there and not elsewhere: a history of shale gas exploitation, legal
incentives for landowners and an advanced oil production infrastruc-
ture [23]. Outside the United States, shale oil production is expected to
take off only slowly, despite the fact that technically recoverable
resources of shale oil are estimated to be abundant worldwide i.e. five
times the size of the ones in the Unites States [24]. Nevertheless, the
unconventional technologies used for shale extraction could be used to
boost the production of existing conventional oil fields globally.
The use of increasingly sophisticated drilling techniques and huge
improvements in cost efficiencies has not only reduced the costs
associated with the production of shale oil, but it has also made the
extraction resemble a manufacturing process in which the quantity
produced can be altered in response to price changes with relatively
M.I. Khan et al. Renewable and Sustainable Energy Reviews 68 (2017) 609–622

Fig. 5. Actual price/supply/demand vs EIA projection of price/supply/demand.

Source: Prepared by the authors based on: U.S. Energy Information Administration (EIA) - Data.

ease, which is not the case for conventional oil extraction which
requires large capital expenditure and lead times. The drilling time
for shale oil continues to become increasingly more efficient. Two years
ago, it took six weeks to drill a single well. Today, it takes approxi-
mately two weeks. Cost-saving technologies include more efficient
exploration methods, onsite automation systems, and intelligent pro-
duction monitoring software. Beyond cheaper hardware, the next
saving opportunity lies in advances including more automation:
intelligent control systems requiring less physical workforce, less
downtime and improving yields of existing wells. It is worth to note
that due to the current advances in shale oil production it now takes
only 20 days and $10 million to drill for shale while it takes $10 billion
and five to ten years to launch a deep-water oil project [25].
The shale oil projects differ from conventional ones in that they
require relatively low capital costs and have a shorter lifecycle (2.5–3
years from the start of development to full extraction) than that of a
conventional well, with production typically falling by as much as 70–
80% in the first year [26]. As a result, oil supply from these sources is
likely to respond far more quickly to changes in prices than conven-
tional oil production. The lead times between investment decisions and
production of US shale can be measured in weeks, rather than the years
taken for conventional production. As such, as prices fall, investment
and drilling activity will quickly decline and production will soon
follow. Likewise, as prices recover, shale oil will increase, limiting any
spike in oil prices. In this respect, shale oil becomes the new swing
producer and will act as a form of shock absorber for the global oil
market.
With low oil prices, it becomes increasingly harder for higher cost
production methods, like U.S. shale, to compete with low-cost produ-
cers like Saudi Arabia. Last year Reuters estimated [27] that the
marginal cost of producing one new barrel of oil for U.S. shale
producers was between $70 and $77 whereas Middle East Onshore
marginal cost was between $10 and $17. Thus, oil prices below $70 per
barrel, US shale would no longer be profitable whereas the Middle East
could still reap significant profits. While due to advancements in
production efficiency over the past year, some experts arguing that
break-even prices could be as low as $30 for U.S. shale producers, such
low-cost production is likely only available in the best areas of already
existing oil plays [28]. Furthermore due to steep decline rates of shale
wells, continuous investment is needed for production to keep flowing
from these wells.
Those who cite record US oil production figures in early 2015 as
proof of the resilience of US shale producers misunderstand the
connection between prices and output. It is precisely the most heavily
indebted and highest cost producers – in this case, the US shale oil
producers – who in conditions of an oil price fall are under the greatest
pressure to step up production to maintain their cash flow so that they
can service their debts.
4.2. The role of OPEC and their strategy
The Organization of Petroleum Exporting Countries (OPEC) was set
up in the mid-1960s with the aim to promote the interests of some of
the world's key producing countries, many of them located in the
Middle East. The cartel consists of twelve countries that hold about
72.6% of the world total proved crude oil reserve [29] and currently
producing 40% of the world's crude oil demand. Since its inception, the
influence of OPEC on global oil prices has been mixed. From rise in oil
prices in 1973 and 1979, to the oil price plunge of 1986, and to the
roller-coaster story from 2005 to 2008, OPEC has been labeled for
exercising quasi-monopolistic control over rising oil prices, and
dismissed for being incapable of applying any control over plunging
oil prices [30]. It typically acts as a “swing producer” in the oil market,
increasing its production in the face of supply disruptions in other

Fig. 6. Actual US production vs EIA projection of US production.

Source: Prepared by the authors based on: U.S. Energy Information Administration (EIA) - Data.

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M.I. Khan et al.
Fig. 7. Oil prices vs OECD commercial inventory level.
Source: Prepared by the authors based on: U.S. Energy Information Administration (EIA) - Data.
Fig. 8. Marcellus shale outcrop in Pennsylvania.
producers or rises in demand, and reducing it in the opposite case [31].
Fig. 9 shows the historical production trend of OPEC. When oil
prices dropped significantly in the past, OPEC countries would cut their
oil production to bolster the price of oil: for example, in 2008/9 with
the global economy in deep recession, and oil prices plunging from
$145 to $35, OPEC cut production by nearly 3 Mb/d helping to
stabilize prices. Similarly, OPEC raised production sharply in 2004
when global demand suddenly surged. However in the recent episode
of oil plunge, inspite of growing fiscal deficits in many OPEC nations
[32], the cartel did nothing. At its recent 166th, 167th and 168th big
meetings on 27th November 2014, 5th June 2015 and 4th December
2015 respectively held in Vienna, OPEC couldn’t quite agree on a
response and ended up keeping production unchanged, thus dropping
oil prices even further in the global market. Against this backdrop, one
wonders why the cartel, is not taking steps to cut production so prices
Fig. 9. Oil prices vs OPEC and Saudi Arabia production.
Source: Prepared by the authors based on: U.S. Energy Information Administration (EIA) - Data.
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Renewable and Sustainable Energy Reviews 68 (2017) 609–622
could be stabilized on the world market. We believe the two major
reasons to answer this question are the geopolitical strategies and US
shale oil boom. OPEC is now facing a permanent headwind in the shape
of shale oil. Each rise in price will be capped by a surge in US output.
Following its decision not to cut oil production after November
2014 meeting, OPEC expected oil prices to drop to $70 a barrel, which
they thought would be enough to squeeze many shale oil producers out
of the market. The reality proved otherwise, shale oil producers were
able to react quickly in order to reduce their costs through various cost-
cutting measures to weather the storm of low oil prices. And many of
them managed to survive at those prices. For OPEC, that meant only
one thing; oil prices have to slump further, therefore OPEC’s members
pursued their market-share strategy and kept pumping. In January
2015, oil prices were down at levels around $45-$55. During that time,
OPEC’s Secretary-General was calling the bottom in oil prices. He
offered a bullish statement during his speech in London on Jan. 26 by
saying ‘Now the prices are around $45-$55, and I think maybe they
have reached the bottom and we will see some rebound very soon’. It
was not too long after that, oil prices fell further making the remark of
OPEC’s Secretary-General another layer of noise. Things didn’t go as
OPEC expected and oil prices are still falling till today to levels not
OPEC nor anyone else has expected at that time. At the time of OPEC's
decision in 27th November 2014, the global markets were probably
oversupplied by 1–2 million bpd. If OPEC had merely decided to
remove 2 million bpd off the world markets — only 5.5% of the group's
combined 2014 production — the price drop could have easily been
arrested and maintained in the $80-$90/bbl range. That would have
still given them 38.9% of the global crude oil market.
Although some argue that the current OPEC's policy implies that it
will no longer act as the swing oil producer. Instead, the marginal cost
of unconventional oil producers may play this role [33,34]. But
analyzing the current situation of US shale oil and Canadian sand oil
M.I. Khan et al.
market, it seems that OPEC is winning, but it’ll take time for oil prices
to jump. Current data looks like the pressure OPEC has put on U.S.
shale producers is working. Most companies can’t make money with oil
as low as $30 per barrel, but it’ll also take time to squeeze those players
out of the market. In conclusion, the authors believe that OPEC will
still play a critical role in balancing the global oil market in future.
4.3. The role of Saudi Arabia and their strategies
Saudi Arabia is one of the largest players in the global oil market: it
produces more than a 10th of the world’s oil output and owns a quarter
of the world’s proven reserves. The Kingdom is also a key OPEC
member, typically playing a central role in OPEC’s decision-making.
Saudi Arabia’s spare capacity is much larger than the aggregate spare
capacity of the rest of the oil producers [35]. It typically acts as a “swing
producer” in the oil market, increasing its production in the face of
supply disruptions in other producers or rises in demand, and reducing
it in the opposite case [31].
The Saudi Arabian government is heavily dependent on oil reven-
ues, with almost 90% of the government's revenues coming from oil
and this income enables the regimes to provide their populations with a
high standard of welfare. In other words, oil revenues translate into
highly subsidized services and products. For example, the cost of one
liter of oil in Saudi Arabia is 16 cents – less than the price of a bottle of
water. The regimes are also the principal employers and the source of
pay increments and bonuses, without charging any tax. On the other
hand, residents can’t exercise any political rights, and this de facto
citizens-state contract is bound by the idea that the king takes care of
its people while they accept non-intervention in the government. Hence
there is a close nexus between oil revenues and regime’s stability. The
drop in oil prices will make it hard for the kingdom to maintain the
momentum of development and higher living standards.
The recent fall in oil prices is likely to result in a higher government
deficit and may result in lower government spending. This is bound to
have a significant impact on job creation within the country, as most of
the private sector jobs that are available are based on government
contracts. Though in the short term the reduction in revenues due to
low oil prices won’t be an issue due to the fact that the Saudis can dip
into their US$737 billion sovereign wealth fund for revenues, in the
longer term Saudi Arabia needs around US $104 billion to balance its
budget. The government ran a record deficit of about $98 billion, in
2015 around 15% of GDP [36]. The International Monetary Fund –
IMF estimates that the budget deficit will reach 20% of GDP this year,
or roughly $140bn [37]. If the Saudi economy does not diversify its
exports and revenues, it will remain at risk. Far from retrenching, the
Saudi government has launched a costly war against the Houthis in
Yemen and is engaged in a massive military build-up – entirely reliant
on imported weapons. With spending about $9.8 billion in 2015, the
Fig. 10. Oil prices vs US dollor index.
Source: Prepared by the authors based on the data available at: www.investing.com.
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kingdom is now the world's largest importer of defense equipment
[38].
But even after the drastic fall in oil prices, the Saudis haven’t cut
their oil production in order to push oil prices upward. They stopped
supporting prices and opted instead to flood the market and drive out
rivals, boosting their own output from 9.7 mb/d (July 2014) to
10.6 mb/d (November 2015) as shown in Fig. 9. The reason why
Saudi Arabia kept the price of oil down is largely motivated by its fear
of Iran’s regional ambition to become the region’s hegemon. Most of
the energy analysts believe that the Saudis are driving oil prices lower
to inflict pain on Iran. Any collateral damage to US shale producers is a
secondary or tertiary benefit. Though low oil prices hurt Saudi Arabia,
they negatively impact Iran in a much greater way and it crimps Iran’s
ability to fund sectarian uprisings in Saudi Arabia’s backyard.
Essentially, they are forcing Iran to choose between higher oil prices
and the economic prosperity that comes with it, and the desire to
foment Shia uprisings in the Middle East [39]. In essence, we believe
Saudi Arabia and Iran are fighting a war without tanks and jets but one
with oil prices.
The other possible reason owing to which the Kingdom has refused
to reduce its oil production is the global climate change accord agreed
to by 195 nations in 2015 United Nations Climate Change Conference,
held in Paris in December 2015. The parties committed themselves to
reducing the consumption of hydrocarbon fuels in the 2nd half of this
century to the point where their use produces no more carbon dioxide
than can be absorbed by the world's trees [40]. Each step they take
toward reaching that goal diminishes the value of Saudi Arabia's vast
crude oil reserves. The Saudis apparently figure that they might as well
sell as much as they can now for whatever they can get, rather than
leave it in the ground and see its value wither. As one American
analysis of the climate pact noted, it “sends a strong message to the
hydrocarbon industry that much of the global remaining reserves of oil,
gas, and coal must remain in the reservoir and cannot be burned.” The
Saudis have feared not that they will someday run out of oil but that
they will run out of customers for it. They anticipate that electric
vehicles, industrial efficiencies, bio-fuels and climate-change concerns
will turn consumers away from oil.
4.4. The role of the U.S. dollar exchange rate
One reason for the muted demand response to the low price signal
has been the increasing strength of the US dollar relative to other major
world currencies. Oil is bought and sold in US dollars across the globe.
When the dollar gets stronger (as it has over recent months), it makes
oil more expensive to buy in countries outside the US. That, in turn,
weakens worldwide demand and further puts downward pressure on
oil prices. An examination of the Fig. 10 reinforces the truth that the
recent drop in oil prices has corresponded to a strengthening US dollar.
M.I. Khan et al.
The chart shows that the US dollar index has risen by more than 10%
against major currencies in trade-weighted nominal terms since July
2014. Empirical estimates of the size of the US dollar effect cover a
wide range: the high estimates suggest that a 10% appreciation is
associated with a decline of about 10% in the oil price, whereas the low
estimates suggest 3% or less [41,42]. To the extent that both the price
of oil and the U.S. exchange rate depend on the evolution of the global
economy, one cannot think of the exchange rate having an independent
effect. For the recent oil plunge Baumeister et al. [3] claim that
variation in the US dollar has no independent effect on the crude oil
price.
5. Impacts on renewable energy
As the current oil plunge make the oil and natural gas cheaper
sources for transport and heating fuels across the globe. Therefore
there is fear that the shift could undermine the case for investing in
renewables and slow the development of more environmentally
friendly energy sources that could replace fossil fuels. In this section,
we will analyze the impact of current low oil prices on the non-hydro
renewable energy sector.
Historically, the renewable energy markets i.e. solar, wind and
biofuel have suffered when prices of crude oil have fallen. For example
in the 1980s and 1990s, when nascent solar, wind and geothermal
markets in California keeled over as North America suddenly became
awash in cheap oil and natural gas [43]. But energy markets dynamics
have changed in the 21st century. Oil is no longer a source of major
power generation. In the 1970's, fossil fuels such as diesel accounted
for 25% of the global power generation. Today that figure has dropped
to 5%. In the U.S, only 1% of total power generated is fossil fuel based.
Even in regions where oil plays a bigger role in power generation (for
instance, the Middle East, North Africa, and in Japan), renewable
energy remains price competitive because of rapidly declining cost of
renewable energy technologies. Over the last five years, the cost of
large-scale solar energy generation has dropped by 80% and wind
energy generation cost has dropped by 60% [44].
However, there is an indirect link between oil and renewable energy
for electricity production. Lower oil prices cause lower natural gas and
coal prices, these spill over to reduced electricity prices, which in turn
can make an investment in renewables less financially attractive [45]. It
is difficult to gauge how large this impact will be, and it depends in
large part on the political response. In the short run, the impact may, in
fact, be limited, as many countries either procure electricity from
renewable energy sources through mechanisms that are only partially
dependent on fossil fuel or electricity prices, or which directly target a
quantity of generation. Some energy analyst believes that if lower
natural gas and coal prices were to persist, however, this would drive
renewable energy sources further away from “parity” with fossil fuel
options. Countries or markets may then choose to give renewables a
smaller role in their future energy choices. Overall, however, there are
several reasons why renewable energy can continue to be a valuable
contributor to energy supply even in a world of lower oil (and natural
gas) prices [46–48]:
i. Renewables energy do not compete directly with oil in the vast
majority of the world. As discussed above, only 5% of global power
is generated using oil and in Europe and the U.S., it is below 1%.
And these regions do not have the oil generating capacity to switch
to oil and it highly unlikely that these regions will build oil
generation because even with oil prices at $50 other technologies
are cheaper for generating power.
ii. The better benchmark for most renewables is the wholesale power
price which is determined by lots of factors including but not
limited to fossil fuel prices. In Europe, power prices have been at
ten year lows for all of 2014 (i.e. before the fall in oil price) and in
the U.S. wholesale power prices, despite collapsing oil prices and
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falling coal and gas prices, rose at every major trading hub in 2014
(as can be seen in the graph below).
iii. The world is going digital, and all those digital devices require
electricity, not oil. The computer, Internet, mobile phone, and the
vast array of electrically powered devices that are so essential to us,
are all products of the digital age. They all require electricity,
making electrification indispensable to our modern lives. As times
goes by, everything will go digital (including our transport system)
and we will need increasing amounts of electricity and renewables
will not only remain but become a larger part of that energy
generation mix because of decreasing costs, concerns about the
environmental impact of fossil fuels and nuclear and the increasing
cost competitiveness of self-generation using solar and other related
technologies. Whatsmore the competition from falling fossil fuel
prices should push innovations and costs for renewable down even
quicker.
iv. The financing of renewable energy projects through LCOE analysis
places a heavy emphasis on the upfront capital costs, which are
much easier to estimate and, more importantly, are decreasing with
advancements in technology. As renewable energy is a technology
dependent sector (and at this stage of the experience curve), costs
will continue to decrease with the refinement and improvement of
manufacturing methods, installation techniques, and development
of know-how. Fossil fuels, on the other hand, are an extraction-
dependent sector, where costs increase as resources become harder
to find. Arguably, fossil fuels stand to benefit from technology gains
and cost deflation as well, but technology development for drilling
and extraction is often slow and limited. This differentiation
between technology-based and extraction-based industries is a
critical point to communicate to potential investors. With dropping
module prices in solar energy and progressing research towards
energy capture and storage, renewable energy could leverage the
opportunity spurred on by the current state of crude oil to depress
or possibly reverse further penetration of conventional power
sources.
v. Demand for renewables across most of the world is driven by
government policy, which is not dependent on oil prices. Today,
countries are investing in renewable energy for environmental
reasons, most importantly to prevent global warming. For example,
China, which is the largest investor in renewable energy today,
refuses to reduce its investments in renewable energy with falling
oil prices and with the falling coal prices, which is the main source
of electricity generation in China, because the purpose of invest-
ment in renewable energy is first to reduce pollution in cities and
secondly to diversify energy sources and achieve energy security. In
Japan, the Fukushima disaster has caused the shutdown of nearly
all Japanese nuclear power stations and renewables is clearly seen
as a viable alternative. In Europe, climate change motivations, as
well as energy security concerns, are pushing a strong move towards
renewables which is reflected in the so-called 20–20–20 targets.
Then there is the United States, which despite low gas and coal
prices for the last years has been very aggressively pushing renew-
ables. This will continue as 30 states have renewable portfolio
standards (RPS) in place which mandate increases in renewables in
the coming years. What's more, energy price falls will be good for
renewables as U.S. states will be less under pressure from energy
price sensitive voters to get rid of RPS. In summary, because
countries are investing in renewable energy for environmental
reasons or to diversify energy sources, oil prices today no longer
have a significant effect on investments in renewable energy.
vi. Renewable resources are mainly used in the electricity system, and
electricity prices are almost entirely independent of oil prices.
Fig. 11 illustrates the relation between electricity prices and oil
prices.
a. Subsidies for fossil fuels have distorted many markets against
M.I. Khan et al.
Fig. 11. Relation between electricity price and oil price.
Source: Prepared by the authors based on: U.S. Energy Information Administration (EIA) - Data.
renewables. According to the IMF, we subsidize fossil fuels by over
$1.3tn each year. The present oil price slump presents an opportu-
nity for countries to implement policies that bolster the world's
efforts to decarbonize [49]. Now is the time to cut fossil fuel
subsidies [50] and implement a Carbon tax [51], it argues, as the
low oil price reduces the policies’ effect on consumers [52]. Both
policies would help cut emissions and keep renewables competitive
in the long-run. So while falling oil prices may threaten renewables
in the short-term, climate policies have the potential to act as a
counterweight, encouraging long-term, low carbon, investment [53].
b. There is a very clear cultural shift in many countries such as
Germany, Japan, and Denmark by their people who are pushing
their governments to move away from fossil fuels and in some cases
nuclear. This is probably related to the realization by most people
that the climate is changing. And the facts speak for itself. 2014 was
the warmest year on record in the U.K., Germany, and initial
estimates are that it could be the hottest globally.
c. Much of renewables is distributed generation such as solar, which is
largely insulated from commodity price movements. The retail
customer who puts solar on his roof is comparing the cost of doing
so with the cost of buying from the utility which includes not only
generation costs but transmission, distribution, and taxes. In the
case of Germany where wholesale power prices only make up 10–
15% of the rate the customer pays, even a substantial fall in
commodity prices has little or no effect on the viability of solar.
Even in the United States where the commodity prices comprise 30%
of what the consumer pays, the economics of solar do not change
much. And already in place like Africa and large parts of Asia solar is
the most competitive way to bring power to the people. In
Bangladesh for instance, some 2–3 million people use home solar
systems.
d. Although low natural gas prices created by the emergence of the
process of fracking to release shale gas has provided a low-cost
feedstock for electricity production, the retail price of electricity has
continued to increase as shown below. This is due to the cost of
electricity transportation to get the electricity from the power plant
to the place it is used. This cost has increased substantially over
recently years due to investments in the power grid.
The increasing cost of electricity has opened the door for solar
production where the distance from production to usage is small.
Conventional fossil fuel power stations are centralized and require
electricity to be transported over long distances to users. However,
solar systems such as rooftop solar and community solar are
decentralized and located close to the users. This is called “dis-
tributed energy resources” or DES. Although DES installations are
small, the cost savings from shorter grid connections are beginning
to outweigh the economy of size advantage of conventional systems.
e. Renewables provide a shelter from oil and fossil fuel price volatility.
We are clearly back in a world of oil price volatility, and fossil price
volatility, not to mention currency volatility, which is particularly
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bad for European and Japan consumers noting that both these
currencies have lost almost 10% against the US$ over the last few
months. It is complicated to predict the oil price going forward but
clear is that at the current price many oil projects are not covering
cash operating expenses and that production will begin to close.
More importantly, though investments in extreme oil (deep sea, tar
sands, Artic Circle, North Sea) will be cut back and so oil prices
should rise again, but when and how fast is not clear. Add to that the
political element i.e. what will Saudi Arabia do and it clear that we
are in for a volatile and unpredictable time on the oil market. But it
is not just oil as the gas and coal prices are somewhat determined by
the oil price. The Wind and solar, on the other hand, do not have any
fuel costs and they have very low and highly predictable variable
costs (basically some O & M costs) which reduce the risk for both
power producers and users.
f. The low oil prices mean that we are more likely to get a Climate Deal
in Paris later this year. The low price makes it is easier for
governments to put in carbon schemes such as carbon taxes and
higher carbon prices will make fossil fuel generation more expensive
relative to renewables.
g. Over 45 m barrels of oil are used every day for transport for which
there has been no real alternative up till now. If electric vehicles
continue their technical progress this might change very quickly and
you could see oil going the way that whale oil did 140 years ago in
which it disappeared overnight because there was a cheaper and
better technology out there. In 2000, Sheikh Yamani, the former oil
minister of Saudi Arabia, gave an interview in which he said: “Thirty
years from now there will be a huge amount of oil – and no buyers.
Oil will be left in the ground. The Stone Age came to an end, not
because we had a lack of stones, and the oil age will come to an end
not because we have a lack of oil.” Only time will see.
A complete picture of renewable energy markets considers the
competitiveness of renewable sources like solar and wind against other
primary fossil fuels (e.g. coal and natural gas), within the context of
power generation. While oil-fired power generation has previously been
a key contributor to the power supply, its relative importance has
diminished over the past 40 years, favoring natural gas, coal, and (in
some regions) nuclear. In fact, coal and natural gas – accounting for
over 40% and 20% of power production in 2014 (Fig. 12a and b),
respectively – are forecast to maintain their stronghold of the global
energy market throughout the foreseeable future, while solar and wind
energy are also expected to grow from a market share of five percent in
2014 to almost 15% in 2035 [47]. Including hydroelectric power,
renewable energy may account for around 35% of global power
generation by 2035.
5.1. Global trends in renewable energy cost, investment, and growth
Using the price of oil as a proxy for the price of energy, there has
M.I. Khan et al.
Fig. 12. (a) Primary energy production by source. (b) Primary energy consumption by
sector.
Source: Prepared by the authors based on: BP Statistical Review of World Energy 2016 -
Data.
been considerable variation in energy price levels from the 1970s
onwards. Rising prices during the 1970s spurred investment in energy-
efficient products and technologies, resulting in a 50% increase in the
production and consumption of renewable energy in the US between
1973 and 1983. Renewable energy consumption then stagnated until
2001 when it began another upward trend to nearly double 2001 levels
today. While renewable energy consumption seems to have initially
been stimulated by high oil prices in the 1970s and 2000s, the recent
volatility of the oil price plunge has yet to slow renewable energy
consumption [54].
Between December 2010 and July 2014, oil barrel prices were
quoted, on average, above 100 dollars [55]. During that time, there was
an exponential growth in energy generation from alternative sources,
mainly solar and wind sources. In other words, high oil prices seem to
make countries that are financially and technically capable and highly
dependent on oil, encourage research and development of alternative
sources in order to reduce their dependency on such an expensive fuel
in the search for more energy security. The increase in global
awareness regarding climate change, the Kyoto Protocol and the
impactful reports from the Intergovernmental Panel on Climate
Change (IPCC) not only established environment exploration limits,
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Renewable and Sustainable Energy Reviews 68 (2017) 609–622
Fig. 13. Investment trend in renewable energy.
Source: Prepared by the authors based on: Ref. [56].
but also served as motivational elements to build a less carbon-
intensive society and raised the issue to a global level.
There are growing indications that the tie between fossil fuel prices
and renewable investment decisions is eroding. In 2015, renewable
energy set new records for investment and new capacity added. Clean
energy investment surged in China, Africa, the US, Latin America and
India in 2015 and reached nearly $329 billion [56], over five times
more than in 2004, and, for the first time, more than half of all added
power generation capacity came from renewables. 2015 was also the
highest ever for installation of renewable power capacity, with 64 GW
of wind and 57 GW of solar PV commissioned during the year, an
increase of nearly 30% over 2014 [56]. Solar investments made up
almost half of the total for the year at $149.6 billion, 25% more than
the year before, followed by the wind with $99.5 billion. However,
Europe was an exception with the lowest clean energy investment since
2006. Fig. 13 shows the trend in global clean energy investment since
2004.
Similarly, the International Energy Agency (IEA) expects renew-
ables to account for 25% of power generation in 2018, up from 20% in
2011 [57]. In 2014, non-hydro renewables accounted for almost half
(48%) of net new power capacity. This was the third year in a row the
figure was above 40% [57]. Solar, in particular, is hitting its stride and
has grown an average of almost 30% a year for the past decade. Healthy
investment in clean energy may surprise some commentators, who
have been predicting trouble for renewables as a result of the oil price
collapse since July 2014.
Because renewables have been relatively expensive, historically,
most investment has come from developed countries; poorer ones felt
they could not afford these energy sources. In addition, oil-rich
countries, many of them in places well suited for solar, didn’t bother
either, because they could burn cheap oil. In recent years both of those
assumptions are swiftly changing.
China is a major factor in the world economy and has made a
commitment to renewable energy. Currently, China is the largest
investor in renewable energy (Fig. 14) with a generating capacity of
378 GW (2014) [47]. By comparison, the U.S. had a capacity of
172 GW in 2014. China continues to invest in renewable energy even
as oil prices have fallen. This is because China's renewable energy
strategy is not based solely on the price of oil. Air pollution in China's
cities is at a critical level. An example is a smog-laden air in Beijing.
Another factor is China's desire for energy security. Reliance on
imports of fossil fuels increases China's exposure to geopolitical shifts
in unstable parts of the world. Renewable energy can be created at
home from water, sun, and wind. Plus, because renewable energy is an
emerging industry requiring new technology and manufacturing abil-
ity, China sees the production of renewable energy systems as an
M.I. Khan et al.
Fig. 14. Share of various regions in total renewable energy investment for the year 2015.
Source: Prepared by the authors based on: Ref. [47].
important segment of their future economic growth.
It's also worth noting that some countries in the Middle East are
getting much more thoughtful about the possibilities of solar. A Saudi
conglomerate recently purchased a major Spanish solar developer,
Fotowatio Renewable Ventures, which has a pipeline of almost 4
gigawatts of capacity. Egypt wants to increase renewables to 20% of
capacity by 2020 and is nearing approval of a $3.5 billion, 2-gigawatt
solar project with Bahrain's Terra Sola. And Dubai's state utility signed
a deal late last year with a Saudi solar company for what could be the
cheapest solar in the world—less than six cents per kilowatt-hour.
McKinsey estimates that even at prices of $35 to $45 per barrel of oil,
solar PV pays for itself—and that frees up more oil for Saudi Arabia to
sell.
Today, we find that renewable energy technologies have greatly
evolved, no longer constituting an expensive alternative to conven-
tional energy sources. For this reason, the recent fall in oil prices did
not have a significant effect on investments in renewable energy.
Renewable energy technology is continuously and rapidly developing
leading to large price reductions. Fig. 15 compare the cost of electricity
production from various sources of energy.
Oil and gas may now be a lot cheaper than a few years ago, but solar
and wind are cheaper, too. Since 2008, prices have plummeted 60% for
large-scale solar, and 40% for the wind [58]. Fig. 16 [59] shows the
percentage cost reduction of renewable energy technologies since 2008.
It can be observed that PV module costs have dropped nearly 80% since
2008, while the balance of system costs have fallen between 39% and
64% in the same period. The cost of solar panels has dropped
precipitously in recent years and this decline is expected to continue.
Some Chinese manufacturers are achieving sub $0.50/W already in
2014. Assuming the current fast decline in the cost of solar, some
Fig. 15. Renewable today vs other forms of utility scale electricity generation (Cents/KwH).
Source: Prepared by the authors based on: Ref. [61].
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experts believe solar will reach “grid parity” to 80% of global markets
within the next two years. Grid parity is the point where the Levelized
Cost (LCoE) of renewable energy generated electricity equals or less the
cost of the electricity available on a utility's transmission and distribu-
tion “grid”. Levelized cost is the net cost to install a renewable energy
system divided by its expected lifetime energy output. For example, if a
solar energy system costs $10,000 to install (after all rebates) and it
provides 100,000 kWh of electricity over its life, then the Levelized Cost
of the solar energy system is $10,000/100,000 kWh =$0.10 per kWh
[47]. According to a study by the Fraunhofer Institute for Solar Energy
Systems [60] the cost of electricity generated with solar power is
already lower than that generated from new coal and gas-fired plants,
predicting that solar-produced electricity will be as low as 2–4 cents
per kilowatt hour.
Similarly, Vishal Shah [61] analyzed the cost of solar energy in 60
countries and found that half of the countries are currently at grid
parity. The study further revealed that in the US, solar is currently
competitive in more than 14 states without any additional state
subsidies. Solar LCOE in these states ranges between 10-15c/kWh
and compares to retail electricity price of 12–38c/kWh. The study
estimated that by 2016, nearly 47 states would be at grid parity in the
US. Similarly, in Japan, solar LCOE of ~$0.14/kWh compares to retail
electricity price of ~$0.26/kWh. In India, the ratio of coal-based
electricity to solar electricity was 7:1 four years ago. This ratio is now
less than 2:1 and could likely approach 1:1 by end of 2016.
The economics of wind energy also continues to improve. In the
U.S., wind power prices reached an all-time low in 2014, lower than
wholesale electricity prices in five out of seven regions [62]. Looking to
the future, we can be confident that solar and wind energy prices will
continue to fall and transportation will be increasingly electrified, with
electric vehicles on a growth trajectory steeper than hybrid vehicles.
Meanwhile, the price of fossil-based power generation remains as
predictably unpredictable as ever.
5.2. Adverse effects of falling oil price on renewable energy
From an economics perspective, oil and renewables are not sub-
stitutes: when the price of one decreases, demand for the other does
not decrease. Although the recent oil plunge has not affected the
demand for renewables but weaken the stocks of some major solar
manufacturer. One of the biggest reasons for this fallout has been the
loss of investor confidence in the financial structure of Yieldcos, a
publicly traded company that is formed mostly by renewable compa-
nies. Simply put, it's a problem of perception [63]. It is engrained in the
public consciousness that the price of oil represents the price of energy
in general. It's a guttural connection people make, based more on
feeling than on facts. This correlation is a perceptual challenge with
widespread financial and political repercussions. The mistaken logic
that all energy is cheap because oil is cheap can create a disincentive for
investors, policymakers, and customers to support renewables and
M.I. Khan et al.
Fig. 16. Falling costs for clean energy technologies.
Source: Prepared by the authors based on: Ref. [59].
energy efficiency [64].
With the current low oil prices, there is growing concern that it will
be increasingly difficult to meet climate change goals going forward and
that much of the momentum gained around renewables and energy
efficiency will be reversed. According to a recent analysis compiled by
climate science and energy policy group, The Carbon Brief [52], climate
policies may not be enough on their own to encourage continued
investment in renewables if the price of oil continues to fall. The
analysis highlights particular problems for those countries in which
renewables compete with oil as an electricity source, e.g. Central/South
America, the Middle East where oil accounts for about 10% and
30−50% of electricity production respectively. There could be a
question mark over Saudi Arabia's plan, announced in 2012, to invest
$109bn in 41 GW of solar power by 2032 [65]. Saudi Arabia burns up
to 900,000 barrels of oil per day to generate over 50% of its electricity.
The low oil prices bring negative effects for bio-fuels sector e.g. bio-
diesel, bio-jet fuel, and bio-ethanol – which competes directly with oil
as a transport fuel. Biofuels – a major plank in efforts to decarbonize
transport fleets in the US, Brazil, and China - were already in trouble
when the oil prices were at $50 [66]. Each drop in crude oil prices puts
biodiesel at a competitive disadvantage to diesel fuel. Fig. 17 shows the
impact of low fuel prices on biofuels in US market. The difference
between the feedstocks and heating oil futures means that the BOHO
(Bean Oil Heating Oil) spread, which measures the relationship
between biodiesel and diesel fuel that producers use to determine
margins, has jumped dramatically in recent times. On Jan. 20, 2016
the BOHO spread reached $1.33/gal, the highest level since June 1,
2011. Low ULSD futures put biodiesel at a competitive disadvantage. It
doesn’t make financial sense to obligated parties when diesel fuel is so
cheap. This is especially the case in countries like Brazil where
customers have a choice of filling up with either ethanol or gasoline.
Nevertheless in some regions like the USA where there is a volumetric
mandate that ethanol must make up 10% of gasoline, so the impact on
Fig. 17. Diesel price vs bio-fuel price in US market.
Source: Prepared by the authors based on: U.S. Energy Information Administration
(EIA) - Data.
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bio-diesel from the oil price fall so far is likely to be small [65].
However, at a macro level, falling oil prices do not bode well for biofuel
producers. Brazil's biofuel sector, which is predominantly concentrated
on sugarcane-based ethanol, has been hit by competitive pressures
from cheaper oil, placing downward pressure on biofuel prices [67].
In some markets, gas is linked to the price of oil. Because gas is a
major player in power production (27% in the United States and 18.6%
in Europe), in effect it becomes the floor price for power. That matters
because, in most markets, most renewables are still more expensive. So
it is certainly possible that cheap gas can drive out or at least slow the
growth of renewables. But that need not be crippling. Furthermore as
because energy investment is long term, changes in the spot price of gas
will not in themselves derail investment in other sources. As long as
renewables keep getting cheaper, there is room for both. Also, it bears
remembering that wind and solar are inherently intermittent: the wind
doesn’t blow on demand, and the sun sets every day. Therefore, a
backup source of power that can be switched on and off at will—as coal,
gas, and nuclear can—is essential for the industry. In this sense, cheap
gas can actually complement renewables.
One key negative impact might be a slowing in the penetration of
electric and hybrid vehicles [68]. For example, in the US, there is
already a slow down but this has not been seen in other automobile
markets where fuel taxation is more material. Hybrid vehicles like the
Toyota Prius and plug-in hybrids like the Chevrolet Volt saw sales
decline last year by 16% and 24% respectively [69].
The risk of low prices is that they will divert people’s attention from
the policies needed to improve our air and climate: policies that require
continually improving fuel economy as well as cleaner fuels in cars and
other vehicles; that provide incentives for clean vehicles that surpass
the minimum requirements; and that promote compact, walkable
communities that require less driving [70]. Clean energy is driven
largely by policy, not price. If the only thing we can say with certainty is
that the future price and availability of different energy sources are
uncertain, investment theory tells us that the best strategy for protect-
ing against such uncertainty is to avoid putting all our eggs in one
basket [54]. Instead, diversifying energy supplies and the energy-
related stocks in our investment portfolios should be the main
objective. Even if investments in renewable energy technologies are
(relatively) unprofitable under current conditions, they provide options
that can be exploited later, as and when changing conditions make
them profitable. The fact that these technologies are currently less
profitable does not render them valueless; rather they display the
characteristics of an “out of the money option”. In the context of
renewable energy, this gives the holder the opportunity to benefit if
favorable price movements occur at a later date. There's a chance the
money invested in the option is lost. But in the event that conventional
energy becomes more costly relative to renewable energy, the returns
earned on a renewable energy investment will be many times greater
than the initial cost and help to mitigate or offset the increasing costs of
M.I. Khan et al.
conventional energy.
6. Conclusion
Both long- and short-term factors contributed to this plunge,
including a surge in oil supply due to the shale revolution in the U.S.
and Canada, robust production in the Middle East from Saudi Arabia
and Iraq, change in OPEC policy objectives, a slowdown in the Chinese
economy that has diminished expectations of future demand, and a
rapid rise in the value of the dollar relative to other currencies. The
exact contribution of each of the factor is difficult to quantify. It is
observed that the supply and demand haven’t changed enough to create
a 72% plunge in oil prices. It means that the major fall in oil prices
since June 2014 may be about a shift in trading, rather than a change
in the fundamental supply and demand equation. While U.S. shale oil
producers will struggle to stay profitable amongst low oil prices, their
rise has significantly changed the economics of global oil production.
The very fact that Saudi Arabia and other OPEC members chose not to
cut production in order to boost oil prices because they are wary of
losing market share suggests that a future oil embargo like that of the
1970s is unlikely. Any attempts to cut production and limit the supply
to the rest of the world will quickly revive shale oil production in order
to fill the supply gap.
The study shows that the renewable energy sector reached a level of
high maturity where oil prices no longer affect its fate. Despite the fall
in oil prices since mid-2014, renewable energy investment reached a
new high. Low oil prices are not good for Electric vehicle sales and
renewable energy sources such as biofuels, which compete directly with
oil in the transport sector, but the transition towards lower carbon
energy systems overall will survive the oil price plunge. Another
important factor that is likely to impose a more continuous and
sustained incentive for investment in renewable energy is climate
change. Growing amounts of legislation will help the further growth of
greener energy and may enhance the development of technologies for
storing energy generated from renewable sources which are highly
intermittent, such as the wind and solar power.
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