Archive for December 2nd, 2010

The Importance of Oil

Few people talk about the skyrocketing oil prices of 2008.   News later that year of a financial crisis and resulting recession have dominated discussions, as oil prices fell drastically on declining demand.   Yet oil is back up to near $90 a barrel, even though the world economy has not roared back.   And, of course, the more we pay for oil, the less we have to buy other things.

Oil price increases have been a factor in the timing of the last three major recessions.   The oil price hike in the wake of the Iranian revolution in 1979 ignited the 1980-83 recession, and the short lived hike at the start of the Iraq war in 1991 led to a small but intense recession from 91-92.   Those recessions would have happened anyway at some point, but the rise in oil prices pushed the economy over the edge.   And, of course, the dramatic run up in oil prices to nearly $150 a barrel helped prick an already deflating housing bubble, laying bear the financial shenanigans engaged by the big investment banks.

Having oil back up near $100 a barrel at this point in time enhances concern that the days of cheap energy are over.   Back in the late 1800’s most oil in the US was found in Pennsylvania with wells yielding 10-20 barrels of oil per day.   Then in January 1901, following the hunch of a geologist, oil was found on Mt. Spindletop, Texas, shocking people with initial yields of 100,000 barrels a day.  The oil age had begun, just as cars and air planes were being invented.  For the next century cheap oil would define our lives.   It would help us light up cities, engage in unprecedented global trade, and create a standard of living in the industrialized West that was second to none.   With oil plentiful and the price low it seemed that this could go on forever.  Our life style, our ability to have power at our fingertips whenever we want it, is based on cheap oil.

The oil shocks of the 70s made it clear how vulnerable we could be to disruptions in the oil supply or sudden price hikes, but those shocks were followed by declining prices, again lulling people into a sense of complacency.   When gas was 80 cents a gallon in 1999, it was even said we had a oil glut.  However, that may have been a very dangerous delusion.

Oil demand is price inelastic.   That means that changes in supply can have a dramatic effect on price.    A slight increase in demand (or decrease in supply) can drive up prices dramatically, as it takes large increases to get people to buy less oil — people still need to drive, heat their homes, and run cities.  If demand drops, like it did in 2009, it can have a similar effect downward, the price can fall radically.  This means that either an increase in demand caused by a reviving economy, or a decrease in production caused by aging oil fields, could yield another round of skyrocketing oil prices.

This is not controversial.  Nor is the fact that oil at some point will “peak,” with production starting to decline as the oil fields of the Mideast begin to run dry.   Large increases start when half the oil is gone, because that’s when production starts declining (oil wells and fields follow a normal curve of increasing and then decreasing production).   Moreover, it can go down rapidly, as it becomes more expensive to recover remaining oil.   Even if we turned Alaska into a giant oil field, that would not alter the dynamics, Alaska doesn’t have that much oil and natural gas.  Off shore drilling can expand the supply somewhat, but without another major oil find (the last one was in the 60s, and people have been looking all over), we’re seeing a change in our way of life looming ahead.

Officially, this peak is expected around 2030, based on reserve estimates from OPEC countries.   However, there is reason to worry that these reserve claims, which have not been verified, are false.  Consider this graph posted on
OPEC oil reserves

Notice the sudden increases in the Mid-eighties, and the apparent lack of draw down on oil reserves.   The increase in the 80’s took place as oil prices plummeted.   It is suspected that these sudden increase in reserve estimates were made not because of new discoveries, but in order to increase the quota of how much oil states could sell (OPEC quotas are based on oil reserves).     Oil countries were reeling due to price reductions, and wanted to sell more in order to earn more.

More than that, oil production now has no relevance to the quota.   All states except Saudi Arabia produce at full capacity, and even the Saudi capacity is doubted.   If we are already at the peak of production, then any economic growth in the global economy will drive up oil prices quickly.   Moreover, it gets dramatically worse within a few years, oil prices could quickly rise over $200 or $300 a barrel.

That would take us into completely new economic territory, altering every aspect of our lives and could lead to a massive depression or global unrest.   After all, not that long ago the prices we paid in 2008 were seen as the stuff of alarmist fantasy.

The global economy is still slow, yet oil prices are rising.  Partially that’s due to growth continuing in China and elsewhere (China’s demand for oil has been steadily increasing), but it could be a sign that the problems we face are deeper than saving banks or sovereign debt crises.   It may be that we’re at the start of a fundamental restructuring of how we live on every level, not just going through another bad recession.

Alarmist?   So were folk who warned about al qaeda in the 90s, talked about the housing bubble and tremendous rise in public and private debt back in 2006.   The evidence is very strong that this could be happening.  I would go so far as to see it’s probable that the peak of oil production is around now or at the very least much closer than 2030.   If that’s the case, we don’t have time to fully develop alternatives, reality is going to impose itself on us in very painful ways.

The other day I pushed the elevator button to go up to the third floor from the basement.  The slow elevator was already on floor three, and when I saw that I decided to zoom up the stairs rather than wait.  It occurred to me that I have been spoiled to not even think about that as using a tremendous amount of energy, just to carry one person up three flights.  And when it wasn’t right there,  I didn’t even use it!   We’re all spoiled by the age of cheap energy and power at our finger tips.   If that era is ending we need to start working now to develop alternatives and plans to transition.    Unfortunately, humans are good at ignoring problems until they become so severe there are no easy solutions.