A commitment by the G7+EU member nations to cut oil demand in the next two decades would incentivise global producers to flood the market with cheap oil and cut financing for Vladimir Putin’s regime, write Robert Jeszke and Jan Witajewski-Baltvilks.
Dr Jan Witajewski-Baltvilks is an expert at the Centre for Climate and Energy Analyses (CAKE) at the Polish National Centre for Emission Management (KOBiZE). Robert Jeszke is the head of the strategy, analysis and auction department at CAKE.
Russia’s invasion of Ukraine pushed global oil and gas prices even higher than they stood in 2021 because of the Russian export restriction. Many experts believe that further sanctions on Russia, including the gradual isolation of Russia in the sphere of global trade, would keep oil and gas prices high in the medium term.
Ironically, high global prices imply that many Asian countries are more likely to purchase Putin’s oil, especially if it is offered at a lower price. Should this happen, Putin’s oil revenues will remain high, and sanctions by G7 countries will not achieve their primary goal.
This risk can be avoided if sanctions are complemented by a firm climate policy.
The ability of climate policy to influence the oil market and oil prices is illustrated in the so-called green paradox. The green paradox is a hypothetical scenario in which the announcement of a rigid climate policy becomes a signal for oil producers that the demand for oil will end soon, motivating them to sell as much as they can as soon as they can.
Flooding the market with oil depresses its price and incentivises consumers to use more. If this were to happen, emissions would increase, rendering the climate policy ineffective. The green paradox is particularly relevant in the context of oil markets, but the mechanisms of the paradox can also apply to natural gas and coal.
Until recently, the green paradox was a problem for climate change economists, but the one who should be most concerned is, in fact, Vladimir Putin. The green paradox has the potential to turn radical climate policy into a weapon against Putin’s regime. It is especially important because Russia, the second-largest worldwide gas producer and the third-largest oil producer, currently uses fossil fuels as a weapon against the West for the purpose of pacification.
A clear and credible commitment by the largest economies in the world to halve the consumption of oil over the next two decades would be a clear signal to all oil producers that their resources will soon lose value. No producer with low extraction costs will keep its reserves for the future — they will attempt to pump their oil into the market as long as it exists.
Low-cost oil from Saudi Arabia and the United Arab Emirates will, at least partly, crowd out the more expensive product from Russia, Venezuela and Iran. Even if that crowding out is not complete, the low oil price will render these countries’ oil revenues negligible. In Russia, where oil rents constitute more than 9% of the nation’s GDP (36% of public-sector revenue), this will unavoidably complicate the financial landscape of the regime.
Should we worry about the second part of the green paradox? Of course, we should. In theory, low fossil-fuel prices will incentivise the consumption of fossil fuels — if not in the G7, then in other regions of the world — which will lead to higher consumption, more emissions and the acceleration of global warming.
This risk will not materialise if the commitment by G7 member countries to reduce oil consumption is credible, sudden and fast and if it is accompanied by massive investment in the development of low-carbon technologies and their transfer to less-developed countries.
The falling price of electric vehicles makes the oil cut credible for the first time. We must complement it with a credible commitment to adopt market-based climate policy measures, such as emissions trading and carbon taxes, to signal to the private sector within the G7 that investments in oil-intensive technologies will be unprofitable even when the oil price is low.
In addition, commitment to climate policy will provide an impulse for private sector investment in the further development of low-cost, low-carbon technologies. The decrease in demand must be sudden and fast to ensure that regions outside the G7+EU will not have time to adjust their demand upward in response to falling oil prices.
By contrast, if the commitment were to make changes only in the distant future, other regions would invest in carbon-intensive technologies already anticipating a low price. Finally, support for the development of low-carbon technologies ensures that oil-intensive technologies will become less competitive in all regions of the world in the long term.
This will ensure that, in the long run, firms and consumers outside the G7+EU coalition will cut their demand for oil too.
The policy must also be coordinated so that every G7+EU economy fully commits. Individual countries might have a strong temptation to leave the coalition to take advantage of low oil prices, which would put the entire plan at risk. Every economy matters.
If one economy continues to invest in the deployment of oil-intensive technologies, it will signal to firms worldwide that the market for these technologies still has a future. Instead of redirecting their R&D effort toward low-carbon alternatives, the firms would keep fuelling the development of carbon-intensive technologies. That would push up demand for oil and associated emissions in the long run.
Instead, if all major economies commit to low-carbon technologies, their progress will speed up, their costs will fall faster, and the transition will be less painful for the global economy.
It should be emphasised that we already have a reasonable basis for collaboration in global climate policy. Collaboration can be implemented under Article 6 of the Paris Agreement. Accelerating the implementation of appropriate international mechanisms will enable the broader inclusion of businesses and the transfer of low-carbon technologies to less-developed countries, thus protecting against the risks associated with increased oil consumption.
An accelerated transition away from oil will involve economic costs for the private and public sectors. Most low-carbon technologies, such as electric cars, are still more costly than oil-intensive alternatives. Construction of infrastructure, such as a network of high-speed trains that could replace air travel, and support for R&D investment and technology transfer will be costly.
However, some of these costs can be covered by oil tariffs and carbon taxes revenues. Moreover, as we argue above, the size of this cost can be minimised if the policy is coordinated between G7 members.