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Away from Oil: A New Approach

Public Policy

The time of large SUVs is over: this is what experts in the automobile industry said in 2008, when the oil price was at its peak. Times can change very fast. The oil price fell sharply in 2014 and not much has changed since then. SUV sales in the US reached a new record in 2015. This is not good news for the world climate and it is worth having a closer look at the crude oil market.

Crude oil has a specific economic feature. It is a physical good that is produced, traded and consumed. But it is also the basis of a financial asset and traded in the form of futures contracts. Hence the same item is traded in two different but still closely connected markets: the oil spot and futures markets. Even though the efficient market hypothesis tells us that financial markets are a mere reflection of economic fundamentals, we know that due to uncertainty, financial asset prices have their own dynamics. Speculation is effective and price bubbles can emerge.

In recent years, we have featured ultra-expansive monetary policy in industrial countries. As money is provided at the cheapest conditions and since financial investors want to escape the low interest rate environment, demand for financial assets increases. Likewise, speculative investment in oil futures grows, which results in a higher oil price. Due to the double character of oil as a physical good and a financial asset, this transmits directly to the oil spot market. Oil producers enjoy higher profits and as a reaction, investment in production capacity shoots up. Sooner or later, overcapacities pull the oil price down. We end up at a new level, which is lower than the one prior to the price hike because capacities have increased meanwhile. Once heavy production equipment is installed in the oil market, it does not disappear so soon. This is what we have observed in recent years: the high oil price level, also driven up by speculation in the futures market, triggered giant investment (think about the fracking boom) that finally led to the collapse of the price in 2014.

Two main problems arise from the connections between monetary policy, financial markets and the oil market: the first is financial and economic instability caused by oil price volatility. The second is an environmental problem: a lower oil price inevitably means more oil consumption. This is a threat to the world climate.

Is there a joint answer to these problems? There is. While hitherto existing policy propositions like futures market regulation or a tax on fossil energy face some advantages and disadvantages, they are not able to deal with both the economic instability and the environmental problem at the same time. What is proposed here is a combination of monetary and fiscal policy. Let’s call it the oil price targeting system.

First, to achieve economic stability in the oil market, a stable oil price is needed. Second, to reduce oil consumption, the oil price should be increasing. So, let us imagine that the oil price moves on a stable and continuously rising path in order to fulfill both conditions. To implement this, the oil price has to be determined exogenously. Due to price exogeneity, speculative attacks cannot have any influence on the price and bubbles cannot emerge anymore. The oil price target can be realized by monetary policy by means of purchases and sales of oil futures. Since the central bank has unlimited power to exert demand in the market, it can basically move the oil price wherever it wants.

However, an increasing oil price has consequences in the spot market. Production becomes more and more profitable for producers and they increase investment and enlarge production capacities. To keep the oil price at its target, the central bank would have to purchase ever more futures contracts to match increased oil supply. To prevent imbalances and to keep the central bank’s futures holdings constant, oil production is charged with a tax. This increases production costs, lowers producers’ profits and hence prevents overinvestment. The appropriate mix of monetary and fiscal policy keeps the oil market balanced while both oil production and consumption decrease.

In a more detailed discussion, further aspects like practical implementation, central bank independence or potential goal conflicts between different monetary policy objectives could be discussed. Yet, this short introduction shows that the oil price targeting system is an effective and efficient way to restore stability in the oil market. Moreover, it establishes long-run transparency and convinces all market agents that investment in fossil energies is a losing deal. As the most important result, this policy proposition makes investment in renewable energy and energy efficiency soar and protects the climate.

What is new about this blueprint for a specific macroeconomic governance? First of all, it is the insight that monetary policy can do more than just guarantee overall price stability. The economic mainstream considers markets as self-regulating and the only task left to monetary policy is to prevent any distortions of market equilibria. However, we know well enough that uncertainty, production processes, growth dynamics and the elasticity of the monetary system involve inherent instability in the economy. These are good reasons for monetary and fiscal policy to intervene and to tackle the problems that markets are unable to solve. Given the way monetary policy is practiced and justified today, a paradigm change is required. We should think about new ways to employ these macroeconomic instruments to the benefit of society, be it related to environmental or social issues. There is certainly more potential for new approaches than the economic mainstream tells us.

social Europe

8 Comments on "Away from Oil: A New Approach"

  1. Davy on Thu, 3rd Aug 2017 6:43 am 

    This article is hopeless. You are not going to change monetary policy without participating a collapse. Tell me how you are going to keep the “extend and pretend” going. How are you going to evaporate huge amounts of dysfunction that excessive debt represents? We are here because we have been running from reality of overextension. We are blaming policy, markets and a resource for our ills. The problem is us. We are the problem. We are the ape like creature with behavioral problems. We want our cake and eat it. You can’t peruse increasing affluence indefinitely on a finite planet. You can’t have modern affluence that is clean and green. Sacrifices demand the wisdom of “no” and “less”. There is no other reality but natural balance. Humans chose to pursue other realities that are fantasies for perpetual affluence and development.

    Oil is not going away until modernism does. The paradigm change spoken of above points to our change not policy and markets. We are not going to change resources and achieve a hyper modernism based in affluence. Intelligence has limits and it is wrought with deception. We are our own worst enemies. We think there are solutions to predicaments and we tell ourselves this over and over until we believe it.

    The “new approaches” are partly the pre-modern “old approaches” we can still incorporate many valuable lessons from our species overshoot. We have learned much and once things fall apart we can combine some of this with what man used to do and find some kind of new approach that is a hybrid of the new and old. That is if we are blessed with a second chance. The second chance needs to start now because there is much to do. Unfortunately we will continue in the same rut of more with less that in reality is just “Moar”. The “Moar” that is the pursuit of more affluence disguised as clean and green.

  2. Cloggie on Thu, 3rd Aug 2017 7:10 am 

    Yesterday, diesel got another image-blow in Germany in the wake of the “diesel-gate” scandal:
    (“With diesel in the abyss”)

    Diesel sales are sinking dramatically, all because of the image problem diesel has.

    The Berlin diesel-summit yesterday will only increase the “flight” into e-vehicles.

    But the real breakthrough will come from the combination of e-vehicles and autonomous cars, breaking the fatal link between being an average member of industrial society and the near-necessity of having to own a car.

    Autonomous cars (small vans probably), complete GPS location awareness, smart phones and smart algorithms will enable a personal transport effort with far less cars/vans, with high occupation rate (5 rather than 1).

  3. CAM on Thu, 3rd Aug 2017 7:18 am 

    This article proposes in effect to remove oil, and thus the entire oil industry, from the free market capitalist system. But wait! Everything else is tied to oil. What this article is proposing is thus the end of the free market and capitalism. Arguably not a bad idea, but what then!!

  4. Cloggie on Thu, 3rd Aug 2017 8:13 am 

    Away from oil latest…

    New (old rather) approach to offshore wind: two blades:

    Claim: easier maintenance, less material, simpler design because of automatic turning rotor into the wind.

    But wait! Everything else is tied to oil. What this article is proposing is thus the end of the free market and capitalism.

    In 17th century capitalist Holland everything was tied to classic wind mills (now operating of museum for tourists).

    In 19th century capitalist Britain everything was tied to coal.

    Capitalism survived. It will survive the transition towards renewable energy.

    Your point?

  5. dave thompson on Thu, 3rd Aug 2017 2:59 pm 

    Transition towards renewable energy? Who the fuck in their right mind would ever think that a transition is possible in the first place, suffers from the dominant cultures voice of infinite growth on a finite planet, delusion of human hubris. Capitalism is in it’s death throws. BWAHAHAHA idiots of the world unite.

  6. rockman on Thu, 3rd Aug 2017 11:51 pm 

    “…the same item is traded in two different but still closely connected markets: the oil spot and futures markets.” That item being oil. But an insignificant amount of physical oil is traded in the futures markets. Future contracts are nothing more the bets made on the price oil future contracts will be sell for when the previously purchased contracts expire.

  7. Cloggie on Sat, 5th Aug 2017 5:57 am 

    Let’s finish off this “low renewable EROI” of solar BS, promoted by some here, shall we?

    EROI = total lifetime energy output/energy input to create solar panels

    There is no controversy about output, that can be accurately measured, by the utility company.

    The real controversy is about energy input. What should count as energy input?

    Over the past few years we have seen the rise of thin film solar, basically plastic foil with a few layers of atoms sputtered onto it. You can “feel with your clogs on”, as the Dutch saying goes, that not much energy is required to produce plastic foil with a few atom layers deposited on it.

    And see, Cadmium-Tellurium thin film solar delivers:

    Average EROI of 34, with room for further improvement.

    In 3-5 years time you will be able to buy a standard 100 cm x 160 cm 300W thin film solar panel for less than $100 at Walmart, making a mockery of every notion of “energy problems” we don’t have.

    Current prices are still over $200,-

    That panel will be able to produce 30 * 300kwh = 9,0000 kWh [*] over thirty years (in Dutch circumstances) or far more than 10,000 kWh in say Arizona.

    In Holland we pay 25 eurocent for a kWh. So these 9,000 kWh will represent a lifetime electricity production of 2250 euro, or a spectacular financial return on investment of 2250/100 = 22.5

    The calculation is not entirely correct, because regular utility kWh involve a lot of tax and you can be sure that the government will manage to get its tax loss compensated somewhere else.

    [*] – under Dutch conditions nameplate power in Watt accidentally equals yearly energy production in kWh.

  8. Cloggie on Sat, 5th Aug 2017 6:20 am 

    How fast can an energy transition go?

    Take the example of The Netherlands.

    On 22 July 1959, on the land of “boer Boon” (farmer Bean), on of the largest gas fields in history was discovered at 2500m depth:

    In 1963 the Dutch government decided that in the entire Netherlands a network of gas pipelines should be build and merely ten years later 75% of all Dutch households were indeed connected.

    This should give an indication of how fast a fundamental energy transition could happen once the price level is ok:

    a decade.

    For that reason it is absolutely not far-fetched to take into consideration that the EU guideline of largely fossil-free by 2050 is extremely conservative and that in reality most of the job could have been done by 2030.

    Five years ago I was a Heinberg-adept, today peak-oil (and CC in its wake) is one big yawn.

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