Since I first wrote about the price of oil last December, the global oil price has fallen to levels not seen in over five years. For many, the recent price decline brings back memories of the 1980s oil price collapse, which followed the 70s oil price spike and drew attention away from renewable energy and other alternatives—famously prompting U.S. President Ronald Reagan to remove the White House solar panels that had been installed by the previous administration.
Thankfully, this time around, the outlook for renewable energy isn’t so bleak. In fact, it’s possible low oil prices could actually improve the economics of renewable energy. It all comes down to the relationship between oil and gas production and the price of electricity, which directly affects the bottom line of technologies like wind and solar.
In 1973, the year the Arab Oil Embargo caused a steep rise in oil prices, the United States produced 17 percent of its electricity using petroleum. When the oil price increased, the price of electricity increased too. This increase in price prompted greater interest in domestic sources of electricity, like coal, nuclear, and renewable energy.
Due in part to the turn away from oil in the 70s, today the United States produces just 0.7 percent of its electricity using petroleum. Therefore, the price of oil has no direct impact on the price of electricity. Most electricity comes from coal (39 percent) and natural gas (27 percent), with the remainder coming from nuclear, hydroelectric, wind, and other renewables. The fuel with the most direct impact on the price of electricity is natural gas, because natural gas generation often sets the price of electricity in the market. To gauge how low oil prices might affect the price of electricity, it’s really important to think about how they might affect the price of natural gas.
Although oil and natural gas prices have decoupled in recent years, there is still an indirect link between the price of oil and the price of natural gas, because both oil and natural gas are often produced from the same well. While most U.S. natural gas is produced from wells drilled for the express purpose of extracting gas, a portion comes from wells that are drilled to extract oil, but produce natural gas as a byproduct. This “associated gas” or “casinghead gas” is often flared in regions like the Bakken in North Dakota, which has limited pipeline infrastructure. However, in regions like Texas’s Eagle Ford and Permian Basin, this gas is often injected into the existing pipeline network. Because drillers are really after the more-valuable oil, associated natural gas is often simply dumped into the pipelines at little or no cost—depressing the overall price of natural gas.
The Railroad Commission of Texas, which regulates the oil and gas industry, collects separate data on natural gas produced from gas wells and natural gas produced as a byproduct from oil wells. These data show that, while overall Texas natural gas production has increased since 2008, the amount of gas produced from purpose-drilled gas wells has actually declined. On the other hand, natural gas associated with oil production has increased markedly since 2008.
This trend in the share of natural gas produced from oil wells versus gas wells can be explained by the spread in natural gas and oil prices seen since the U.S. hydraulic fracturing boom introduced a glut of natural gas to the market. Since 2009, the natural gas price has hovered around $4 per million BTU—just one third of its 2008 high of $12 per million BTU. The oil price, on the other hand, more or less increased from 2008 all the way until the most recent price collapse. This spread in prices prompted more oil drilling and less gas drilling, thereby increasing the proportion of natural gas produced as a byproduct of oil production.
The question is: how will the current oil price collapse affect the natural gas price, and thereby affect the price of electricity, which has a direct impact on the economics of wind, solar, and other renewable energy technologies? There is a possibility that the low oil price could cause a reduction in U.S. oil production, and thereby reduce the supply of cheap natural gas produced as a byproduct. This could cause a corresponding bump up in the price of natural gas—increasing the price of electricity as a side effect.
Things have changed since the oil price plummeted in the 1980s. Oddly enough, this time around, there is an economic feedback effect that might cause low global oil prices to increase the domestic price of natural gas and electricity. To see whether or not this theory holds any water, we’ll have to wait and see. There are indications that the price of oil could be very low for some time, so we’ll have a lot of time to gauge the effect oil prices have on natural gas, electricity, and renewables.