Not All Energy Transitions Are Alike: Disentangling the Effects of Demandand Supply-Side Policies on Future Oil Prices Lukas Boer, Andrea Pescatori and Martin Stuermer WP/23/160 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 2023 AUG WP/23/160 © 2023 International Monetary Fund IMF Working Paper Research Department Not All Energy Transitions Are Alike: Disentangling the Effects of Demand- and Supply-Side Policies on Future Oil Prices Prepared by Lukas Boer, Andrea Pescatori and Martin Stuermer* Authorized for distribution by Petya Koeva Brooks August 2023 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. ABSTRACT: We use structural scenario analysis to show that the climate policy mix—supply-side versus demand-side policies—can lead to different oil price paths with diverging distributional consequences in a netzero emissions scenario. When emission reduction is driven by demand-side policies, prices would decline to around 25 USD per barrel in 2030, benefiting consuming countries. Vice versa, supply-side climate policies aimed at curbing oil production would push up prices to above 130 USD per barrel, benefiting those producing countries that take the political decision to keep on producing. Consequently, it is wrong to assume that oil prices will necessarily decline due to the clean energy transition. As policies are mostly formulated at the country level and hard to predict at the global level, the transition will raise uncertainty about the price outlook. Keywords: Conditional forecasts; structural vector autoregression; structural scenario analysis; energy transition; oil prices; climate change. Author’s E-Mail Address: lboer@imf.org, apescatori@imf.org, mstuermer@imf.org *We are grateful to Christiane Baumeister, Lutz Kilian, Gregor Schwerhoff and Christoph Ungerer for helpful suggestions and to Juan Antolin-Diaz, Juan Rubio-Ramirez and Ivan Petrella for sharing their code with us. We thank Rachel Brasier and Wenchuan Dong for excellent research assistance. The views in this paper are those of the authors and do not necessarily reflect the views of the International Monetary Fund, its Executive Board, and IMF Management. WORKING PAPERS Not All Energy Transitions Are Alike: Disentangling the Effects of Demand- and Supply-Side Policies on Future Oil Prices Prepared by Lukas Boer, Andrea Pescatori, and Martin Stuermer 1 Introduction 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