A new National Bureau of Economic Research (NBER) working paper by Ryan Kellogg, a professor and deputy dean for academic programs at the University of Chicago Harris School of Public Policy finds that when oil producers anticipate a long-run decline in demand for oil, they begin investing less into exploration and drilling even before the decline in demand occurs. This counters a long-held belief that oil producers would do the reverse.

The long time horizons of oil investments will likely prompt most producers to stop investing before demand falls—making good business sense and allowing climate policies to be successful.

—Ryan Kellogg

Many have long believed that if oil producers saw a decline in demand on the horizon they would quickly move to extract as much as they could before the demand, and prices, fall. In doing so, they would negate any reduction in emissions that could have come from climate policies and new technologies. But Kellogg finds the opposite is likely true.

Producers make fewer long-term investments—reducing their initial rate of investment by 2%, despite no initial change in oil demand. Over time, the anticipation of a decline in oil demand pushes them to reduce oil production by 4.8% more than what would have been reduced if they had not anticipated the decline. Over a 75-year period in which oil demand gradually falls to zero, the oil industry would reduce its investments by 35% overall, reducing production by 27% in total. This results in fewer emissions.

OPEC+ members outside of Kuwait, Saudi Arabia and the United Arab Emirates, as well as non-OPEC producers such as those engaged in deepwater drilling reduce their investments the most because their extraction involves investments with long time horizons. The core OPEC members—Kuwait, Saudi Arabia and the United Arab Emirates—do not follow this trend. Instead, they increase their investments in response to the anticipated demand decline because their low costs and high reserve valuations induce them to extract before demand falls too far. Shale producers tend not to respond to anticipated demand changes because their investments have short time horizons.

Kellogg finds that producers, in aggregate, would increase their investments in response to an anticipated decline in demand only if both their investments have a short time horizon—shorter than shale oil—and the scarcity value of reserves is large throughout the globe. These conditions seem unlikely to hold individually, let alone jointly.

This analysis suggests that policies aimed at reducing future oil demand will not be undercut by a spike in oil production and the unintended increase in near-term emissions that would cause.

—Ryan Kellogg