Undercover Economist

Fossil fuels have had an aeon’s head start

Will we ever stop using fossil fuels? The question matters because fossil fuels are the largest contributor to climate change. Although finding better ways to produce cement, combat deforestation or even reduce the flatulence of cows and sheep would all be welcome, our only hope of dramatically cutting greenhouse gas emissions is by finding cleaner methods of generating power.

This won’t be easy. Coal, gas and oil are wonderfully concentrated sources of energy, neatly synthesising aeons of solar radiation. The late Professor David MacKay, author of the remarkable Sustainable Energy — Without the Hot Air (2008), underlined that truth with the book’s pointed dedication “to those who will not have the benefit of two billion years’ accumulated energy reserves”. The concentrated nature of fossil fuels means that alternative energy sources are competing against a formidable head start; the head start is lengthened by the fact that our entire existing energy system revolves around fossil fuel.

Despite all this, there are two obvious scenarios in which we might replace fossil fuels with alternative energy sources for purely commercial reasons. The first is grim: we begin to run out of fossil fuels and they become too expensive to use as a source of bulk energy. The second, more benign possibility, is that alternative energy sources become so cheap as to outcompete coal, gas and oil at almost any price; as the former Saudi oil minister Sheikh Yamani once commented, the Stone Age did not end because we ran out of stones.

The grim scenario is unlikely, because we are unlikely to run out of fossil fuels any time soon. According to the BP Statistical Review of World Energy, we have used up all the proven oil reserves that existed in 1980, yet have more than we started with. Gas reserves aren’t falling either. (Coal reserves are but from immense levels.) This shouldn’t be too surprising: “proven reserves” are resources that have been identified, measured, and look profitable. As old reserves are exhausted, new reserves are sought to replace them, and so far we have had little trouble in finding more fossil fuels whenever we wish to.

Another way to observe this is to look at economic behaviour. If the supply of oil was limited and known, owning an oilfield would be like owning any other investment. Producers would have to decide when exactly to sell their finite barrels of oil, and the only logical path for the oil price would be a gentle upward trend, matching the rate of return on other assets such as shares or bonds. (Any other price-path would be self-defeating: a lower price tomorrow would provoke a rush to sell immediately; a sharply higher price tomorrow would mean no oil was sold today.) This well-known theory, demonstrated by the economist Harold Hotelling in 1931, is, of course, in contradiction to the actual behaviour of oil and gas prices: fossil-fuel producers are clearly not treating oil and gas as though they were non-renewable resources.

But the cheerier scenario, in which low-carbon energy sources become very cheap, may be unlikely too. At first glance the signs seem promising — Denmark, Germany and Portugal have all reported occasions this year when their entire electricity grid was fuelled from renewable energy sources. And photovoltaic solar power, in particular, has become dramatically cheaper, largely for the simple reasons that China has over-subsidised production of the panels, which now come in easy-to-install kits.

But it is too soon to declare victory. On a commercial basis, renewable energy sources must do more than outcompete fossil fuels on price. Solar and wind deliver power when the sun shines or the wind blows. Fossil fuels deliver power when people need it. That is a big advantage.

And because fossil fuels pack a lot of energy into a small space, they’re ideally suited for transport. Electric cars are not competitive. A recent survey in the Journal of Economic Perspectives by the economists Thomas Covert, Michael Greenstone and Christopher Knittel estimates that current fuel cells would only be cheaper than gasoline at an oil price of $425 a barrel, eight times current levels. Fuel cells will fall in price, of course, but that figure gives a sense of the scale of the challenge.

And nuclear energy? Economist Lucas W Davis, again in the Journal of Economic Perspectives, concludes that there is little prospect of a nuclear renaissance because nuclear power stations simply cost too much to build. It would require a large upward shift in the price of fossil fuels, not to mention a change in the political winds, to see the technology return at scale.

Overall, there is little prospect of running out of fossil fuels, and it seems unlikely that alternative energy sources will outcompete them. And yet we must make the shift, or risk catastrophic climate change. Our reserves of fossil fuels may be no constraint but the atmosphere’s capacity to safely absorb carbon dioxide is.

There is some space for optimism. Renewable energy sources are no longer impossibly costly. Nor is nuclear power, even though the costs have moved in the wrong direction. We cannot wait for the market to make the switch unaided — but the gap is no longer so wide that sensible policy cannot bridge it. The centrepiece of such a policy would be to raise the price of carbon dioxide emissions, using internationally co-ordinated taxes or their equivalent. Such a tax would make renewable energy sources more attractive — as well as encouraging energy efficient technologies and behaviour. Market forces can do the rest. Low carbon energy is not free — but it is worth paying for.

Written for and first published on FT.com.

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