Crisis in the oil market and EU’s new environmental plan
Two recent news items, apparently unrelated, caught my attention. The first one was about the ongoing bickering within OPEC Plus coupled with fluctuations in the oil market and the other one was concerning a proposal on overhauling the carbon tax levied by the European Union (EU). The outcome of both of these events could have a profound impact on future economic growth and climate change.
In early July, the world was abuzz when the oil-producing cartel, known as OPEC Plus, failed to agree on a production plan, and crude oil prices soared to a record high in the trading markets. Then, within a week in mid-July, the EU announced new measures to curb carbon emissions and to force its trading partners to do the same. EU is attempting to streamline its existing carbon-taxes programme known as Emissions Trading Scheme (ETS). If implemented, its expanded tax programme known as carbon border adjustment mechanism (CBAM) will affect imports from its trading partners outside the bloc, including possibly Bangladesh.
The International Energy Agency (IEA), a Paris-based intergovernmental organisation established in the framework of the Organisation for Economic Co-operation and Development (OECD) warned that the recent failure of OPEC and its allies to agree on a plan to ease production cuts in August means oil-market investors face the contradictory worries of both undersupply and oversupply. In early July, the price of oil jumped to over USD 75 a barrel, the highest seen in seven years. While the price went down a little soon thereafter, it stayed in the range that is significantly higher than in recent times.
To understand the price gyrations, the possible outcome of the infighting, particularly the tussle between Saudi Arabia and UAE, and the role of OPEC Plus in this drama, one has to dust off the old undergraduate economics books and revisit the "cobweb theorem", market equilibrium, and theory of oligopoly.
Price of oil depends on supply and demand, but crude oil market is controlled by a few large producers, and OPEC. The latest phase of the drama started last year, at the beginning of the Covid-19 pandemic. In anticipation of the drop in world demand for oil, OPEC and non-OPEC oil-producing countries, collectively known OPEC Plus, took the pre-emptive step of cutting back oil production to hold up the price of crude. Now, as the global economy and concurrently demand for oil heads for a comeback, OPEC Plus is hoping to ease production restrictions and allow more crude into the market. Top OPEC producer Saudi Arabia wants output raised in stages by a total of two million barrels per day (bpd) between August and December and wants to extend remaining OPEC Plus cuts until the end of 2022, instead of letting them expire as planned next April.
The UAE baulked at the extension and said it could support raising production by two million bpd until the end of 2021 but wanted to defer discussion on extending the pact beyond April 2022, a position Saudi Arabia has so far rejected.
The virtual meeting of OPEC Plus at the beginning of this month ended in a deadlock. It was expected that the members would agree to a gradual increase in output, to accommodate the growing demand but to allow price to hold steady. On July 5th, it was announced that Saudi Arabia and UAE could not agree on the combined output of the group, with UAE holding on to its demand for a greater share of the quota.
An agreement reached on July 18, restores a temporary calm in the market since an open split between Saudi Arabia and UAE could lead to a scenario where OPEC members could have simply opened up their spigots and flooded the market with oil.
Last Sunday's deal calls for OPEC Plus to raise production by 400,000 bpd each month through the end of 2022. That will unwind all the cuts the two groups agreed to make at the beginning of the pandemic, when it slashed 9.7 million bpd a day in its collective output or 10 percent of its 2019 demand.
The price of oil has an impact on alternative sources of energy including coal, gas, and renewables. At this critical juncture, the world economy is set on a course to recover from a slowdown and cheap energy will be an important consideration in the future choice of technology and carbon intensity of goods.
Prices of oil, coal, and gas determine a number of decisions that economies will make in the coming years as greenhouse gas emissions continue unabated. Cheap oil, an abundance of fossil fuels including coal and gas, and the Covid-related global crisis, has managed to sideline implementation of the Paris Agreement on climate change. It is hoped that COP26, to be held in November in Glasgow, and initiatives by OECD countries will reset the clock to salvage the goals necessary to keep global warming below 2 degrees Celsius.
As mentioned, EU has stepped up to the plate. The European Commission, the EU executive body, set out in detail how the bloc's 27 countries can meet their collective goal to reduce net greenhouse gas emissions by 55 percent from 1990 levels by 2030—a step towards "net zero" emissions by 2050. The "Fit for 55" measures will require approval by member states and the European parliament, a process that could take two years (The Daily Star, July 14, 2021).
The Commission also wants to impose the world's first carbon border tariff, to ensure that foreign manufacturers do not have a competitive advantage over firms in the EU that are required to pay for the CO2 they have produced in making carbon-intensive goods such as cement, steel, and fertiliser.
It is not clear how the EU's Green Deal will fare or what its overall impact will be. There are several trade restrictions aimed at protecting the environment but these could run afoul of WTO regulations. Border tariffs would require the establishment of a new agency to monitor the carbon content of imported goods. Companies importing covered products would need to register with the EU agency and hire companies to audit the greenhouse-gas emissions of their suppliers. The proposal has unsettled some US officials.
EU is apparently making an effort to nudge China which is now contributing to 27 percent of global carbon emissions. China is overly reliant on coal for its power generation. In view of the recent increase in the price of coal, China's planning agency Natural Development and Reform Commission announced a plan to boost coal production.
Unfortunately, other developing countries will be adversely impacted by CBAM. Brazil, South Africa, and India, in addition to China, have already expressed "grave concern" that CBAM could impose unfair discrimination on European imports of their products. Economic models show that it will lead to declines in exports in developing countries in favour of developed countries, which tend to have less carbon intensive production processes. To compensate the affected LDCs, UNCTAD suggests that the European Union could consider "flanking policies", including the use of revenue generated by the CBAM, to accelerate the diffusion and uptake of cleaner production technologies to developing country producers.
Dr Abdullah Shibli is an economist and IT consultant. He is also Senior Research Fellow of International Sustainable Development Institute (ISDI), a think tank based in Boston.