Transition triggers demand shocks that lower prices to below thirty dollars.

The economic literature has typically assumed that fossil fuel prices will be negatively affected by climate policies (see e.g., Nordhaus and Boyer, 2000, Hassler and Krusell, 2012, van der Ploeg and Rezai, 2020). For example, the International Energy Agency (2022) estimates that prices will decline as fossil fuel consumption falls by 60 percent until 2050 in a net-zero emissions scenario. The implicit assumption is that the energy transition is driven by a series of negative fossil-fuel demand shocks. Subsidies to electric cars, for instance, cause negative crude-oil specific demand shocks, as oil is substituted with electricity, leading to lower prices.

This paper shows that a declining global fossil fuel production path can also arise from curbing fossil fuel production (i.e., from negative supply shocks), leading to increasing oil prices over the long term. This is in line with theoretical models by Hoel (1994) and Harstad (2012), where oil prices can increase in the face of supply-side climate policies. For example, climate regulation may directly restrict oil production while public preferences may shift in favor of sustainable investment—thereby, increasing the cost of capital for fossil fuels companies and, eventually, lowering oil supply (Delis et al., 2019, Ehlers et al., 2022, Seltzer et al., 2022). Higher policy uncertainty could also lead to a decline in fossil fuel investment (Bogmans et al., 2023). Importantly, as policies are mostly formulated at the country level and the mix between demand side and supply side policies is hard to predict at the global level, the energy transition raises uncertainty about the price outlook.

We apply structural scenario analysis following Antol ́ın-D ́ıaz et al. (2021) to model the impact of the energy transition on oil prices as a sequence of either oil-specific demand or oil supply shocks. The derived shock series match the global oil consumption scenarios from 2023 to 2030 (and in an extension to 2050) from the International Energy Agency (2022). In other words, our structural approach finds series of shocks that incentivize the oil consumption and output paths in line with the scenarios. We then derive the implied scenario price paths. Modelling the energy transition in this way has the advantage that we can distinguish among structural supply and demand shocks, which have substantially different implications for prices.

We find that if we only consider demand-side policies, oil prices could decline to $25 (inflation-adjusted) in 2030. This would have negative consequences for oil producers as both prices and volumes would decline. Rents would diminish and oil production would come under pressure in high-cost regions changing its current geographical distribution and moving towards a more concentrated market.