The impact of falling prices on the energy transition

After a year of drama in the energy market triggered by the war in Ukraine, oil and gas prices have fallen back to levels below those prevailing when the war began.  The reasons for the fall are relatively clear.

–          On the supply side Russia has managed to maintain oil production and exports.   China, India and numerous African countries have ignored sanctions and happily accepted oil at discounted prices.

–          Gas supplies from Russia to Europe have been cut back by 80 per cent but Europe has managed to find alternative gas supplies from other sources including the US.   None of the fears of blackouts or rationing have been realised.

–          High prices through much of last year have stimulated extra production from existing oil and gas fields and encouraged investment in new projects around the world.

–          Economic growth has remained limited.  Chinese growth last year was no more than 3 per cent, Europe remains constrained by post Covid austerity and there are now fears of something close to a recession in the US which could be more serious if agreement between the President and Congress on borrowing levels cannot be reached.


The result is that there is simply no shortage of supplies to meet current levels of demand.  Even maintaining current prices could require tougher action by OPEC and other suppliers to limit production.

The mood of insecurity provoked by the Ukraine war has softened and reduced the pressure for a radical shift in favour of renewables.

Solar and wind continue to grow – helped on the dramatic fall in costs over the last decade.  Wind and solar are now competitive with any other source of supply for power generation and are likely to dominate new generating capacity around the world.  That is a significant step forward but does not mean that existing capacity based on burning coal for instance in India and China will be replaced anytime soon.  Coal is still embedded as a significant part of many economies – not least as a source of jobs.  In China the total number of jobs associated with the coal industry is 6.6 million including 4.1 million working for state owned companies.  In India, one recent study suggested that 40 per cent of India’s 736 local districts had some form of coal dependency with 3.6 million people employed in coal mining and power generation.

Similarly, as we have seen in recent months, Natural Gas including shale, has become an embedded element in the United States – including shale gas and associated gas which is produced with the oil from shale rock.  Shale oil and gas have not just kept US prices down in comparison to Europe and other developed economies.  The availability of high quantities of local oil and gas supplies has encouraged some re-shoring of manufacturing and other industrial activity.   In economic terms and in the absence of a carbon price hydrocarbons remain very competitive sources of supply.

The next phase of the energy transition will come on the demand side – in areas such as transport and home heating.  Over the last year the hope has  been that high energy costs, particularly at a time when the cost of living is the dominant public policy issue would encourage consumers to shift their energy use in favour of low carbon options on simple economic grounds.

The electric vehicle market is one of the front lines of the challenge. The current position has been spelt out in an excellent new study from the International Energy Agency.   At one level progress is encouraging.  The number of electric vehicles – that is cars and light vans – on the world’s roads increased by some 10.5 million last year – a growth of 55 per cent over the 2021 number.

The high growth rate must however be seen in context.  The number of internal combustion engine driven vehicles (ICEs) is now approximately 1.35 billion.  The total number of light vehicle sales worldwide was 81 million. Almost half of of those sales were of SUVs making them the most popular vehicle model.  Some SUVs are hybrid but only 16 per cent of the SUVs are powered by electricity.

The growth in electric vehicles will continue, but on Wood Mackenzie’s estimate is that even by 2040 after years of strong growth the number of EVs on the road will only be 323 million – perhaps a fifth of the total global fleet of cars and light vehicles.  The contribution of EVs to the energy transition also needs to be clearly understood.  Most of the world’s electric vehicles are in China.  But “electric” does not necessarily mean low carbon.  Most of China’s electricity is still produced by coal.  A coal powered EV offers no environmental gain.

If oil prices had stayed at last year’s exceptional level, we might have expected a substantial shift to EVs on price grounds.  But that has not happened.  Oil prices are back at just over $70. They will no doubt as always be volatile, but they are not heading to $150 or $200.

A similar story applies in the case of the switch in home heating which is another key element of the transition.  Switching from gas to electric powered sources such as heat pumps carries a cost even if a new boiler requires less upfront spending than a new electric car.  High prices could have induced consumers and households to make the shift.  Low prices offer no such incentive.

The lesson of all this is that if Governments want to meet their emissions targets and pledges on moving towards net-zero, they will have to regulate or even mandate the shift.  Renewables do not enjoy a sustained cost advantage, particularly if the upfront capital costs of changing the capital stock associated with energy consumption are taken into account.

Regulation works – the improvements in vehicle efficiency are good examples of effective intervention – but tend to produce change more gradually.  All the more reason to begin the process of re-regulation as soon as possible.