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Is Oil Becoming Stranded?

The sudden plunge in the price of oil is reminiscent of how long-term policies intended to address climate change led to the collapse in the price of coal. Investors expecting a cyclical price recovery for oil may instead find that environmental regulations make their assets uneconomical to develop.

LONDON – The conventional wisdom regarding the recent plunge in the price of oil is that we are seeing a repeat of the 1985-1986 collapse, when Saudi Arabia ramped up production as part of a dispute with other members of the OPEC cartel. This time, the thinking goes, Saudi Arabia is doing the same in response to its loss of market share to shale-oil production in the United States.

But there is another parallel that is even more relevant – with important implications for the long-term price of oil. The recent collapse is reminiscent of a similar dive in the price of coal – which crashed from a brief high of $140 a ton in 2008 to about $40 a ton today – which led some deposits to become “financially stranded,” meaning that the cost of developing them outweighs potential returns.

The drop was the result of long-term environmental policies, including programs aimed at mitigating climate change, which undercut demand for coal. Efforts to improve air quality in China, US carbon and mercury emissions standards, cheaper natural gas, and growing investments in renewable energy have all eroded coal’s share of the energy market.

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