Peak Oil, the problem or the solution?

I was reading the three futures black swan posting by Paul, and wondered whether Peak Oil would really be such a disruption to the way we work. It seems indeed that Peak oil is now mainstream in the public debate, but the consequences of it are rarely thought through. The camps seem to be divided between believers, predicting catastrophe, and unbelievers. Even in the most oil-dependent country in the world, the discussion on energy policy seems mostly superficial. In this it reminds me of the Climate change debate. It seems that there is scant real planning for the future going on, just doomsayers and deniers.

The debate going on, it looks like even normal economic concepts, like demand and offer, are forgotten.

A marginal revolution

Wikipedia defines Peak oil as the point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline. I would like to use a different concept. The peak production as defined above depends on the price, and we could imagine prices to be higher, so much higher that a lot of now uneconomical fields go into production. So “ peak oil” is in fact only defined at a certain price. Of course, in the end production will eventually have to go down, but it will go down first because extraction is not cost effective at the price people are ready to pay for it, not because there is no oil left anymore. In the end, oil will never run out, only the price will rise so high nobody will buy it anymore.

For this blog, I will use the definition of peak oil as the price of oil where major alternatives become as viable as oil itself. Within this definition, peak oil is reached for different uses at different prices. Taxes and subsidies are equally part of the picture.

Most of these alternatives need investments and constant demand, making them a bad bet when prices are just fluctuating, leading to peaks and troughs in demand for the new resource (while for oil these investments are in place). It is not worth investing in the alternatives that risk to be uneconomical for most of the years to come. However, once the prices move to a long term high, the picture changes.

For home heating, peak oil is already reached: for a price of 100 US$ a barrel, it is apparently worthwhile to build a passive house in a temperate climate, as people are doing so in droves. So the energy bill of the house for heating becomes approximately zero. You only have to calculate the depreciation of the system. Even for older houses, insulation is cutting the bill with up to 3/4. The move from petrol-based heating (gasoline) to gas or even heath pumps (nuclear) is general, thanks to a little subsidy left or right. Indeed, this is taking into account the subsidies, but as heating oil in general is not taxed like other goods, this argument cuts both ways.

For decentralised electricity production the use of solar power in sunny countries with a low cost of roof space and a high cost of energy transport, might already be reached. Wind energy is not far behind. When prices are high, the use of bio-fuels seems to be economical in countries with a good year round vegetable production potential.

For centralised electricity production nuclear energy seems to be an alternative I am reluctant to support, and as much as a loath it, coal is still around.

For fueling cars the production of bio-diesel based on palm oil seems to be economical at high price points (perhaps 120 USD/barrel, we saw it already happen a few years ago), but in the long run the use of electricity as a plug-in option for hybrids or as a full electrical option seem relevant. The problem with electricity seems to be more the infrastructure and the upfromt investment cost than the economical use of energy (just like with the passive houses). Indeed, if highways would be standard providing a “third rail” like for subways, we would be wondering who authorized the use of dangerous inflammable technology like the internal combustion engine.

Overall, there are many alternatives for oil, and more to come, each of them economical from a different price point. The most promising for the moment is energy savings (house insulation, less consuming cars, less car use, etc.). However, as prices rise, innovation will explode.

In the long run, under constant incentives from prices and government propaganda, the silent hand of alternative choices shows up: what about changing a house with 4×4 in the countryside for an apartment in a livable city and all the money for holidays you can imagine? What about just using a plastic case instead of aluminum?

Lack of price elasticity is worse than high prices.

For the moment, the price of energy is linked to oil: the other energy sources, coal, nuclear energy, wind-energy, bio-fuel, solar energy, sell their energy on a market where the price is more or less set by oil.

It seems like oil production is on average rather stable, while prices are not.



Total global oil production, in millions of barrels per day, annual 2002-2010 (data source: EIA)

With an economy at full swing, the demand for oil grows and so do prices, as production lags. If suddenly oil prices go up, there is a problem. More fuel economical machines are not installed on the spot: the demand for oil stays fixed until some buyers drop out of the market and essentially close shop: a crisis. Prices of products go up, demand for products goes down: crisis. Less demand for fuel.

Also when oil production is under thread (you know, the Middle East), prices will skyrocket, with a serious risk of a recession. As oil production is not very flexible, prices will go up suddenly and come down crashing.

The roller coaster ride in the price evolution are a systemic risk to the global economy. But also to the national economy and the household. I did not do any simulations, but it seems reasonable to put that the economy would be able to hum on more nicely at a predictably and steadily rising price.
This calls for a policy by the government to protect the economy by diminishing the risk posed by petrol price peaks.

Peak oil and global warming.

So what do we do?

We can chose to ignore global warming AND ignore the whole peak oil debate.

In the case of global warming, this will probably not help, as the scientific consensus on it is quite huge and, moreover, if you visit the Alps you can see the glacier’s decline. At a certain stage the warming will impose itself. it will be way to late to stop any of it, but in any case, there will be a need for investments in air-conditioning, roof insulation, storm and water works. Meanwhile, we could expect the oil prices not to come down at the 20 US$/barrel anytime soon, as the whole world seems to be getting out of poverty. With a fast growing demand, even with unlimited reserves, it will be difficult to pump fast enough. As most of the oil sits in dangerous countries, the current roller coaster of prices seems to be inevitable.

A policy trying to limit the impact of oil shocks would even in this case be good policy. Just drilling more would not change the prices a lot, but making the economy as a whole less dependent on oil, or energy if possible, would. What are these measures? The same as what you would do if you believe in global warming.

What kind of society?

If we know global warming is coming and oil prices are expected to go up, an active policy to go for oil and coal independence is urgent.

With the current technology, it might be possible to nurture decentralised systems or go for evermore centralisation. Solar panels on the roof or fusion energy.

Or we could hedge our bets. We don’t want to nuclear power providers get into a powerful position like the Arabs are, so the development of more diffuse power production is a necessity to balance the centralised powerhouses.

Indeed, big oil, big energy and big finance have a similar track record. They wield enormous power. They are able to resist reform, even if the systemic risk becomes too high. Democratic control is often failing.

Concluding, as any response to the increasingly unstable petrol prices will take time, I would agree with Paul that the first ten years of Peak oil will be rough.

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