Alternative energy is at risk of severe curtailment.
Over the last two months, oil prices have decreased from $100 to $80 per barrel. While consumers are rejoicing at the pumps, alternative energy suddenly looks severely less economical than lower-cost oil.
Solar and wind stocks have plummeted over 30%.
What we are witnessing in the oil market goes against all conventional wisdom. Historically, the entire world has counted on Saudi Arabia to be a swing producer – increasing and decreasing production to stabilize oil prices in line with supply and demand.
But what has occurred over the last two months is a marked change in direction from a country we once heavily relied upon.
Saudi Arabia has not decreased production. Without such market leadership and moderation of short-term volatility in oil prices, we have seen rapid gyrations and a collapse in prices. Why? In large part, due to a new uncertainty.
What’s Saudi Arabia’s incentive?
Widespread speculation is that Saudi Arabia’s hands-off policy is driven by the country’s inherent motivation to eliminate competition, essentially to drive U.S. producers out of business. If Saudi Arabia is worried about supply in the long-term, it is logical that the nation would want to encourage low short-term prices and establish a barrier to entry for new competitors.
But, the collateral damage from lower-priced oil is that alternative energy projects are all dependent on high energy prices.
Low oil prices depress the price of natural gas as consumers become less willing to substitute products. In turn, lower natural gas prices dampen solar and wind prices. Alternative energy suddenly looks very expensive. While short-term project cancellations are unlikely, due to the current glut of natural gas in the United States, a prolonged period of lower energy prices is plausible. This will prove to be a death knell to alternative energy. In countries outside of the United States, in which natural gas is less plentiful, the effects will be even more severe.
The impact on future availability of alternative energy could quite feasibly be drastically curtailed. Is this clarion warning to the progress we’ve made on global warming? With profitability crimped in the oil industry, it is highly plausible that green policies might be halted as well.
Goldman Sachs, among a few other bulge-brackets, has weighed in on the issue – contending that OPEC has been dethroned and replaced by U.S. shale producers. This argument is faulty as it assumes that U.S. shale producers are both willing and able to increase and decrease production as necessary.
Likewise, numerous economists have erroneously concluded that the potential impact of Saudi Arabia has been diminished by the rapidly growing increase in shale oil produced in the US. Despite this increased production, the oil market is only oversupplied by a trivial amount. There does not exist a legion of tankers swirling the world with a year’s supply of oil. Saudi Arabia has the ability, and has in the past shown the will, to turn off the spigot and cut production to restore prices. No other country, or company, has ever stepped up to the plate with such determination.
However, beyond actual production, future oil prices are set based on the degree of confidence the market has in rational actions of producers. Saudi Arabia remains the sheriff in town. Even without drawing a weapon, the return of the sheriff could restore order.
Which leads to the ultimate question – why is the sheriff stagnant now? In the past, the typical response of Saudi Arabia has been to lower production. Are they also driving alternative energy out of business? Is that their purpose?
While intentions might not be inherently evil, it seems reasonable to conclude that the negative externalities are not lost on this massive nation.