Oil price volatility undermines economic growth, says Sir David King

Professor Sir David King was chief scientific adviser to Tony Blair and Gordon Brown, and advises William Hague these days. Photograph: David Sillitoe for the Guardian

Governments need to deter oil speculators, set aside reserves of crude oil and take steps urgently to reduce their dependence on fossil fuels in order to escape price volatility that undermines stable economic growth, according to a report co-authored by one of Britain's top scientists.

The exploitation of shale oil and gas may mitigate damaging price fluctuations in future but it will be terrible news for the environment and is not a longer term solution to the world's energy needs, said the report co-written by Sir David King, published on Tuesday.

The study for Oxford University by King, Oliver Inderwildi and Zoheir Ebrahim, describes the volatility of crude oil prices, which has characterised this commodity market over the last four decades, as "a fundamental barrier to stability and economic growth" around the world.

King is a former Oxford professor and government chief scientific adviser who, these days, is special climate change representative for the foreign secretary, William Hague. The paper recommends policies to tackle supply and demand in the oil industry, including further action to clamp down on high frequency trading.

"Policy must focus on re-aligning the use of the oil derivative market away from speculation and towards its initial purpose: hedging. Improving derivatives market regulatory systems and working towards international derivatives regulatory standards will be vital in achieving this goal but efforts to curb speculation so far have been lacklustre," says the report, which is called Macroeconomic impacts of oil price volatility: mitigation and resilience, and is published in Frontiers of Energy.

It predicts that the European Commission's proposed Financial Transactions Tax will fail because it will not be high enough – at 0.1% on share trading and 0.01% on derivatives deals – and does not differentiate between speculators and genuine hedgers.

Britain's use of fossil fuels will come under further scrutiny this week when a government-commissioned study will urge ministers to boost North Sea oil and gas production by forcing companies to share infrastructure.

Meanwhile the Oxford study calls for more far-reaching policies to manage demand in a bid to reduce the world's dependence on oil.

"Part of this role will require the politically challenging task of energy subsidy and tax reform to incentivise the consumption of alternative fuels and disincentivise oil consumption, particularly in non-OECD countries where oil price subsidies have been institutionalised," it said. "But a significant opportunity in reducing the demand for oil is also to be found in policies that are aimed at improving energy efficiency such as the adoption of fuel-economy standards and the construction of codes and requirements for greater energy efficiency in various sectors of the economy."

The report's authors highlight the importance of collective responsibility, discussing the strategic oil reserve administered by the International Energy Agency (IEA), which can be used to reduce price volatility in times of crisis. Given the IEA's projection that oil prices will reach at least $215 a barrel by 2035, the study says global co-operation will be fundamental to the management and reduction of price volatility.

The study also suggests regulating to force large oil-reliant industries to maintain their own oil stocks, which would insulate them from sudden spikes in prices.

Governments should also incentivise business to invest in infrastructure promoting alternative fuel and energy sources or that promotes greener energy provision, says the study.

The authors note that additional unconventional fossil fuel obtained through processes including fracking will come online over the next decade, suggesting that they are highly likely to keep oil prices relatively low. It describes this development as "terrible news for the environment" but "excellent news for the economy" which will "buy us time for decarbonisation endeavours".

Inderwildi, a Senior Policy Fellow at Oxford, said: "Unconventional fossil fuel resources are a blessing at the moment as cheap fuel will support the global economic recovery. In the long term, however, we have to reduce our reliance on fossil fuels because of the great damage they are causing to the environment and the toxic economic effect of price volatility."