We were invited by Milieudefensie to offer our expert opinion on matters pertaining to the effect of the Reduction Obligation (RO) imposed on Shell by the District Court (and challenged by Shell on appeal) on global oil and gas production and greenhouse gas emissions (GHGs)—especially but not only the price effect of any withdrawal of oil and gas supply by Shell pursuant to the RO. Our respective expertise in matters relevant to this letter is set out in the Appendix (brief biographies) and our attached CVs. This letter was jointly authored and represents our joint opinion. Our time spent producing this letter has been provided pro bono.
In our opinion, the RO would likely reduce global GHGs. The most direct channel through which this reduction is likely to occur is through the price effect, which is the primary subject of this letter. We discuss this first (Section 2). We then discuss the evolution of demand for oil and gas over the longer term, and Shell’s ability to influence that demand and the wider market (Section 3). Finally, we outline some other (financial, legal and political) channels through which the judicial imposition of the RO on Shell may reduce GHG emissions (Section 4).
The price effect is characterised by the following causal chain:
However, Shell’s argument is incorrect, as we explain here; we first address link (b) and (c) together, followed by link (d).
The dispute concerning links (b) and (c) concerns the expected direction, and magnitudes, of the responses by oil and gas market participants (producers other than Shell, and consumers) to the reduction in Shell-controlled supply pursuant to the RO.
Shell’s argument here is, in its most concise form, that, if the RO is imposed and Shell’s supply is reduced, then “The continued demand for oil and gas will need to be met. If the Shell Group does not do so, then others will step in” (Shell SOA, para 3.2.20(c)).
But this claim fails even the most basic principles of economics, which is that supply and demand are related to each other, via price.
First, on supply, it is not necessarily the case that “others will step in” at the same speed, scale, or cost, were Shell to reduce its production of oil and gas by giving up production licenses: other suppliers may be limited in their capacity (e.g., labor or capital) to extract as much oil or gas from the licenses; that capacity could be delayed; or governments that offer the licenses may not reissue the licenses. In all such cases, the overall supply of oil or gas to the market would be reduced.
Still, Shell believes that the substitution could also happen closer to the point of sale, not at the point of production: “For example: as long as gasoline cars are on the road, a reduction of supply of gasoline by the Shell Group will mean that other companies will supply gasoline to keep these cars running” (Shell SOA, para 3.2.20(c)).
But that example fails to consider how demand is not static. If Shell were to close its gasoline stations (reduce supply), many consumers who regularly used those gasoline stations would now find it less convenient to get gasoline. They may have to travel further to fill their tanks (an added burden, or cost, on their demand), which may prompt them to consider driving less or using other transportation options, such as an electric vehicle (EV) they can charge at home. Indeed, as Shell acknowledges, “Consumers would continue to make choices based on cost, availability and security of supply” (Shell SOA, para 2.5.8). Shell’s error here is in assuming that those choices can only include fossil fuels, leaving no change in oil or gas demand.2
More broadly, any restriction in the supply of oil or gas, whether at the point of extraction or at the point of sale, is going to increase the price of that fuel to consumers. And when prices (and expectations about future prices) go up, consumers change their behaviors, even if only a tiny amount, to mitigate the increase in price. They drive less or at slower (more fuel-efficient) speeds, drive more-efficient cars that they already own, or purchase new, more efficient cars when they next replace a vehicle. Countless economic analyses across the world have shown this basic dynamic to be true, in studies that assess the price “elasticity” of demand, which is the change in demand as a ratio to change in price.3These studies show that demand is affected by a change in price, and therefore is somewhat elastic (never perfectly inelastic). Naturally, there is a debate about the magnitude of the response (which we address in subsequent paragraphs), but there is no serious debate about the net direction of the effect of a supply reduction, i.e. that there will be less oil and gas consumed than would otherwise be the case.
This relationship between supply and demand, via price, is so basic, so widely understood (including by Shell’s own experts4), that the burden of proof for claiming otherwise should rest firmly with anyone wishing to assert the contrary. Namely, in this case, the burden of proof should be on Shell to demonstrate that the oil and gas markets are characterised by demand that is completely unresponsive to price and, therefore, to changes in supply. We cannot fathom how they could hope to substantiate this claim. In fact, we are aware of no study that shows demand in oil and gas markets to be perfectly inelastic.