Negative oil prices and a fuel price surcharge

On Monday April 20^th, 2020 the price for May 2020 delivery of West Texas Intermediate (WTI) oil, the benchmark oil futures contract in the U.S., went below zero for the first time ever. According to news reports:

“West Texas Intermediate crude for May delivery fell more than 100% to settle at negative $37.63 per barrel, meaning producers would pay traders to take the oil off their hands.”

This was caused by the lack of storage capacity as demand crashed when people stopped traveling due to the stay-at-home orders during the pandemic, and oil supplies were already inflated due to a recent price war between OPEC and Russia.  Other oil price benchmarks were low but not negative (the price for the June oil contract was still above $20 per barrel, and the price for Brent Crude was about $26 a barrel).

A below zero oil price is a big turnaround from what was predicted only a few years ago.  Prior to the shale oil (“fracking”) breakthroughs in 2015 or so, peak oil theorists had been thinking diminishing production would result in oil prices skyrocketing and then crashing the economy.  The downward side of the peak oil curve would be characterized by boom and bust cycles, unless governments adopted a more managed descent approach by adopting “caps” on fossil fuel production.  The managed descent could occur through a Cap & Share program or a policy such as The Oil Depletion Protocol, as described by author Richard Heinberg, which calls for a quantitative import limit that decreases over 2% per year.

In a pre-COVID world where oil demand continued to stay high in developing countries like China and India, FEASTA and others advocated for a “dividend” to redistribute the rents (excess “windfall” profits) that would otherwise go to the fossil fuel companies back to the citizens.  But a global pandemic with mandatory stay-at-home orders has caused a drop in oil prices much sooner.  In an economy with a negative oil price, a few modifications are needed.

Raise the price of gas, capture the windfall, return it to the people

Low (or negative) oil prices send the wrong price signal to consumers, and could potentially forestall the transition to electric vehicles.  The boom and bust cycle for oil prices described above send a scrambled policy signal to would-be investors in low-fossil fuel alternatives.  In 2008 Severin Borenstein of the University of California Energy Institute proposed an interesting economic intervention he calls the Fuel Price Stabilization Program (FPSP).  The FPSP is a fuel surcharge that moves inversely with the price of oil.

The concept is that when geopolitical or other factors cause the price of oil to plunge, governments could implement a surcharge to keep the price at the pump approximately level. Normally a drop in oil prices would stimulate demand for oil and throw a wrench into the development of more efficient, lower carbon transportation options. By keeping prices at the pump steady, the surcharge would provide a more predictable environment for developing and piloting and bringing online those low-carbon options.

In addition, the surcharge would raise needed revenue for climate-transition programs in a way that is relatively painless for consumers, since they would continue paying the same price they had paid before. They wouldn’t feel a pinch. What programs should get the funding?  The money could be used to incentivize the continued uptake of electric vehicles or subsidize public transit users, or (FEASTA’s preference) the funds could be returned to households as a climate dividend.

The example target price in Borenstein’s paper is $82/barrel, which would set gas prices at $3.00/gallon (which Californians over the past decade would see as a bargain).  Borenstein estimates the surcharge would be equal to 2.4 cents for every dollar difference between the price of crude oil and the target price.   Since oil is currently at $10/barrel, the surcharge would add $1.72/gallon to the price of gasoline.  With California drivers using about 48 million gallons of petroleum per day, the surcharge would raise almost $83 million per day.  If that amount were returned to households in California, a family of 4 would receive $250/month.  As the price of oil approaches the target price, the surcharge would phase out, but governments could reset the target rate higher to preserve a continuing price signal, and continue to capture and return the “rents” back to the people.

Last month the demand for oil crashed, and the price followed.  With unemployment surging under stay-at-home orders due to the pandemic, governments can institute a fuel price surcharge and return revenues to households.  This would provide an income stream to residents, capture rents for the people, provide a long-term price signal to investors, and help get the economy off of fossil fuels.

Featured image: oil barrel. Source: https://www.freeimages.com/photo/oil-north-sea-beach-1058521