Oil market crisis and new EU environmental plan

Two recent news items, apparently unrelated, caught my attention. The first concerned the ongoing disputes within OPEC Plus coupled with fluctuations in the oil market and the other concerned a proposal to overhaul the carbon tax levied by the European Union (EU). The outcome of these two events could have a profound impact on future economic growth and climate change.

In early July, the world was in turmoil when the cartel of oil producers, known as OPEC Plus, failed to agree on a production plan, and crude oil prices soared record in commercial markets. Then, within a week in mid-July, the EU announced new measures to reduce carbon emissions and oblige its trading partners to do the same. The EU is trying to streamline its existing carbon tax program known as the Emissions Trading Scheme (ETS). If implemented, its expanded tax scheme known as the Carbon Border Adjustment Mechanism (CBAM) will affect imports from its trading partners outside the bloc, possibly including Bangladesh.

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The International Energy Agency (IEA), a Paris-based intergovernmental organization set up within the framework of the Organization for Economic Co-operation and Development (OECD), has warned that the recent failure of OPEC and its allies to agree on a plan to ease production cuts in August means oil market investors face conflicting concerns of undersupply and oversupply. In early July, the price of oil jumped to over $75 a barrel, its highest level in seven years. While the price fell a bit soon after, it remained in the significantly higher range than lately.

To understand price swings, the possible outcome of infighting, especially the Saudi-UAE fight, and OPEC Plus’s role in this drama, one needs to dust off the old books of undergraduate economics and revisiting the “spider’s web theorem”, market equilibrium and oligopoly theory.

The price of oil depends on supply and demand, but the crude oil market is controlled by a few large producers and OPEC. The latest phase of the drama began last year, at the start of the Covid-19 pandemic. In anticipation of declining global oil demand, OPEC and non-OPEC oil-producing nations, collectively known as OPEC Plus, took the preemptive step of cutting oil production to maintain the price of crude. Now, as the global economy and simultaneously oil demand head for a comeback, OPEC Plus hopes to ease production restrictions and allow more crude into the market. Saudi Arabia, OPEC’s top producer, wants production to increase in stages by a total of two million barrels per day (bpd) between August and December and wants to extend the remaining OPEC Plus cuts until at the end of 2022, instead of letting them expire as planned next April.

The UAE balked at the extension and said it could support a two million bpd production increase through the end of 2021, but wanted to postpone talks on extending the pact beyond April 2022, a position that Saudi Arabia has so far rejected.

The virtual OPEC Plus meeting earlier this month ended in a stalemate. Members were expected to accept a gradual increase in production, to meet growing demand but to allow prices to remain stable. On July 5, it was announced that Saudi Arabia and the United Arab Emirates could not agree on the combined production of the group, with the United Arab Emirates maintaining its request for a larger share of the quota.

A July 18 deal restores temporary calm to the market as an open split between Saudi Arabia and the United Arab Emirates could lead to a scenario where OPEC members could simply turn on their taps and flood the market of oil.

Last Sunday’s deal calls on OPEC Plus to increase production by 400,000 bpd each month through the end of 2022. This will reverse any cuts the two groups agreed to make at the start of the pandemic, when it reduced 9.7 million bpd per day in its collective production or 10% of its 2019 demand.

The price of oil has an impact on alternative energy sources, including coal, gas and renewables. At this critical juncture, the global economy is on track to recover from a downturn and cheap energy will be an important consideration in the future choice of technology and carbon intensity of goods.

Oil, coal and gas prices determine a number of decisions that economies will make in the years to come as greenhouse gas emissions continue unabated. Cheap oil, an abundance of fossil fuels, including coal and gas, and the global Covid crisis have managed to sideline the implementation of the Paris Agreement on climate change. It is hoped that COP26, to be held in November in Glasgow, and initiatives by OECD countries will reset the clock to save the targets needed to keep global warming below 2 degrees Celsius.

As mentioned, the EU has taken the lead. The European Commission, the EU’s executive arm, has detailed how the bloc’s 27 countries can achieve their collective goal of reducing net greenhouse gas emissions by 55% below 1990 levels by by 2030, a step towards “net zero” emissions by 2050. The “Fit for 55” measures will require the approval of member states and the European Parliament, a process that could take two years (The Daily Star, July 14 2021).

The Commission also wants to impose the world’s first carbon border tariff, to ensure that foreign manufacturers do not have a competitive advantage over EU companies who are required to pay for the CO2 they have produced by manufacturing carbon-intensive goods such as cement, steel and fertilizer.

It is unclear how the EU Green Deal will perform or what its overall impact will be. There are several trade restrictions aimed at protecting the environment, but these could run counter to WTO regulations. Border tariffs would require the creation of a new agency to monitor the carbon content of imported goods. Companies importing covered products would have to register with the EU agency and hire companies to audit their suppliers’ greenhouse gas emissions. The proposal unsettled some US officials.

The EU is apparently making an effort to push China, which now contributes 27% of global carbon emissions. China is too dependent on coal for its electricity production. Given the recent increase in the price of coal, China’s planning agency Natural Development and Reform Commission announced a plan to boost coal production.

Unfortunately, other developing countries will suffer the negative effects of CBAM. Brazil, South Africa and India, in addition to China, have already expressed “serious concern” that CBAM may impose unfair discrimination on European imports of their products. Economic models show that this will lead to lower exports in developing countries to the benefit of developed countries, which tend to have less carbon-intensive production processes. In order to compensate affected LDCs, UNCTAD suggests that the European Union consider “flanking policies”, including the use of revenues generated by CBAM, to accelerate the diffusion and adoption of more productive technologies. owned by producers in developing countries.

Dr. Abdullah Shibli is an economist and IT consultant. He is also a Senior Research Fellow of the International Sustainable Development Institute (ISDI), a Boston-based think tank.

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