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Climate Change and Oil and Gas Prices

Climate Change and Oil and Gas Prices

At the end of October 2021, the Saudi energy behemoth Aramco announced their third quarter results[i], and they were exceptional. The company’s net income was $30.4 billion, an increase of 158% relative to the previous quarter. The key reason for the successful quarter were high oil prices. They nudged over $85 a barrel and some seasoned observers talked about $90 or even a $100 oil price.

With the COP26 Climate Change Conference and expectations that the global oil demand should peak soon[ii], bumper profits by all the oil producers seem to be a contradiction in terms. What is going on in the oil and gas markets and why are we seeing high energy prices at the time when we are supposed to be transitioning to cleaner fuels? How are climate change and policies designed to curb our greenhouse gas emissions impacting oil markets?

Saudi Arabia's state-owned oil and gas company, Aramco's, Dhahran oil plants, 2018 (Aramco).

The first and clearly visible impact of climate change has been a predicted[iii] increase in extreme weather events. The events have included heatwaves and droughts resulting in forest fires, more damaging tropical cyclones, and heavy precipitation causing flooding, mudslides and other events that physically affect the existing energy infrastructure.

Hurricane Ida, which hit the Gulf of Mexico at the end of August this year, cut off most offshore oil and gas infrastructure for weeks and damaged platforms and onshore support facilities[iv]. In the process, some forty million barrels of oil were lost, contributing to the already tight oil markets. While a number of refineries and pipelines were also affected, they were quicker to rebound, facing a shortage of feedstock which further supported end-user prices[v].

Earlier this year, winter storms froze the gas infrastructure in Texas, causing a massive electricity generation failure that led to shortages of water, heat, and even food for several days. Wholesale power prices increased by some 400 percent as a result[vi].

For decades, oil prices included a ‘geopolitical premium’, reflecting the fact that many of the world’s oil supplies came from potentially politically volatile countries, such as Iraq and Libya. It is very likely that the current market is also pricing in a ‘climate premium’, caused not only by frequent and extreme weather events but also by potential legal liabilities and regulatory risks for fossil fuel producers.

The current market is also pricing in a ‘climate premium’, caused not only by frequent and extreme weather events but also by potential legal liabilities and regulatory risks for fossil fuel producers.


Also this year, an unusually long winter and hot summer, drought in South America, floods in China and other weather events helped create an ‘energy crunch’ with gas prices increasing fivefold, and having a knock on effect on the prices of electricity and even oil. The link between gas prices and power is obvious, especially in countries such as the United Kingdom where almost a half of all the electricity is generated by gas. The link between gas and oil prices can be more subtle than just burning oil instead of gas in the power and industrial sectors.

Oil refineries generate their own power and with gas prices exceeding oil prices based on their energy content[vii], it is less costly for them to burn oil rather than gas. Refinery gas is also used for the production of hydrogen[viii], which is in turn used for the desulphurising (removing sulphur) of clean petroleum products. In a market driven by short-term demand shocks[ix], refineries can pass on the higher costs to the consumer, driving up end-user prices. The other channel through which high gas prices impact oil is through the petrochemical sector where the petrochemical cracker feed can often vary between gas (LPG) and naphtha. With the recent high gas prices, naphtha has been their feedstock of choice, further supporting gasoline prices (naphtha is used for gasoline blending).

Across the globe, governments under pressure from environmental activists have been vocal about their commitments to net-zero policies. This has been particularly obvious this year with the COP26 conference in Glasgow, and publications by the Intergovernmental Panel on Climate Change and the International Energy Agency (IEA) pointing to ways of achieving climate change goals. The IEA claimed that: ‘Beyond projects already committed as of 2021, there are no new oil and gas fields approved for development in our pathway…[x]

Most of the policy responses to climate change has been based on the supply-side, leaving demand unchecked.


At the same time, there has been pressure on banks, companies, and governments not to approve new fossil fuel projects. So, most of the policy responses to climate change has been based on the supply-side, leaving demand unchecked. Only Europe, Canada and California have meaningful prices, designed to curb the burning of carbon.

The net result of these policies has been higher oil and gas prices, exacerbated by extreme weather events. Rocketing energy prices have been rather unpopular with the electorates of the largest consumer nations, already facing rising inflation rates from the supply-side bottlenecks and monetary easing in the wake of the Covid pandemic. This has led to the bizarre situation where consumer nations plead OPEC[xi] to provide additional supplies of oil – ideally at lower prices – at the time when they are trying to cut their own carbon emission rates.

This situation has served major Middle Eastern oil producers well, filling up the government coffers and generating extraordinary profits for their national champions such as Aramco. This asymmetry of policy approaches is likely to further exacerbate volatility in the oil and gas markets. What is more, it may well slow down the process of diversification from oil, especially in MENA countries. However, the public outcry against climate change, clearly visible during recent COP26 meetings in Glasgow, scorching summer temperatures in the Middle East and the predictions of rising sea levels in the region may yet be strong arguments to finally force a meaningful energy transition process.

[i] https://www.aramco.com/-/media/publications/corporate-reports/saudi-aramco-q3-2021-results-press-release-english.pdf?la=en&hash=1C7C6D3B5E35AEF023CC70401CD6E736360BB3BA
[ii] See: IEA: ‘Net Zero by 2050 A Roadmap for the Global Energy Sector’, 2021, p.160.
[iii] See: IPCC AR6 WGI report p.11.
[iv] See: https://www.reuters.com/business/energy/oil-losses-hurricane-ida-rank-among-worst-16-years-2021-09-07/
[v] See: https://www.reuters.com/business/energy/hit-oil-output-ida-overshadows-demand-impact-says-goldman-2021-09-13/
[vi] https://www.reuters.com/business/energy/results-tally-up-billions-profit-texas-freeze-gas-power-sellers-2021-05-06/
[vii] In October this year, gas prices climbed as high as $130 a barrel oil equivalent.
[viii] By steam reforming methane, converting it into hydrogen.
[ix] Recent research points to very low short-term price elasticity of demand. See Lutz Kilian: ‘Understanding the Estimation of Oil Demand and Oil Supply Elasticities’, Federal Reserve of Dallas, September 2020.
[x] IEA: ‘Net Zero by 2050 A Roadmap for the Global Energy Sector’, 2021, p.21.
[xi] See: https://www.reuters.com/business/energy/biden-push-g20-energy-producers-boost-capacity-ease-price-pressures-2021-10-30/

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2 July 2022

“Economics and Rebuilding in the Middle East and North Africa” showcases articles about the various ways of conceiving the region’s economies as well as reconstruction.