More good news about Peak Oil, on the demand side

Many in the Peak Oil community have trumpeted the rise of oil prices from their 1990’s average of aprox $20 (measured by West Texas Intermediate, aka WTI). For example, note these posts at The Old Drum:

• The Bet
• Oil Price Touches $100 a Barrel; Signal of Pending Oil Shortages Ignored
• Holding Daniel Yergin and CERA Accountable

Unfortunately much of this analysis not only misleads but also might prove counterproductive.

First, the “typical” Peak Oil explanation is likely wrong, even myopic. For example: “Despite the talking head rationale for today’s $4 rally, the underlying reasons for the 8 year+ climb in crude are geologic in nature.” As I discussed here, oil has risen since the recovery began in late 2002 along with the prices other industrial materials. Expansions often strain the supply of industrial inputs, which is why copper is often called Dr. Copper (due to its accuracy as an economic indicator). Oil has risen with commodities in general over the past year, a symptom of the inflation resulting from the rapid expansion of the global money supply in the past few years — also a typical late-cycle event.

More importantly, the straight-line extrapolations of many Peak Oil enthusiasts — forecasting using only a ruler — occasionally works, but usually proves unreliable over time. Cycles, not lines, dominate the real world. That is why folks earning a living in the risky business of forecasting, like Yergin, cannot be stuck clocks (always giving the same answer, right only twice a day).

So that we too are not stuck clocks, let us consider what cyclical dynamics might flatten or even decrease oil demand during the next few years?

I. A global recession

Those forecasting an immanent Peak Oil often extrapolate current economic growth far into the future. They describe rapid growth creating a world desperate for oil, which ignores the extraordinary nature of this economic cycle. The global economy has had only one recession since 1982, and that was short and shallow. The global economy has grown at aprox 5%/year during the last five years (using IMF numbers), the fastest period of economic growth since the 1960’s. Perhaps the fastest rate of global growth of any five years since the invention of agriculture, as billions of people in the emerging nations and former Soviet Union join the modern industrial era.

This will not continue. Even if the foundation of the modern financial system are sound (which I doubt, as described here), the business cycle still rules. Fast growth means sharp, deep recessions. The neo-Keynesian dreams of smooth, managed growth are just that. Economists of the Austrian school will have their innings too.

Also, history shows that fast economic growth is volatile growth — unlike riding a bicycle, where the wheels act as gyroscopes. The length and magnitude of the down-cycle might prove just as surprising and large as the expansion, and catch just as many experts by surprise.Consider the two poles of the global growth engine: China and the US.

China’ s probably has a bright future, but they too have a business cycle. There are many signs the end of this boom approaches, although no one can accurately predicting when it arrives. The following bust might be ugly. China’s new — and hence poorly developed — economic command and control apparatus makes policy errors, and hence a severe downturn, very likely. The US government’s response to downturns if usually late and often misguided. And compared to the US…

• China’s government has less ability to collect accurate and real-time information about the economy.
• Their short experience with capitalism gives them a short baseline with which to analyse the data.
• Their institutions have little experience in managing a rapidly growing and increasingly complex economy.

As for the US, our 25 year long debt-fueled expansion epitomizes unsustainable, even foolish, growth — as described here: Death of the post-WWII geopolitical regime, III — death by debt.

A global recession means real GDP increases at less than 2%. This is a different definition than used for US, where a recession is unofficially defined as two consecutive quarters of falling GDP (the National Bureau of Economic Research uses a more complex and subjective set of criteria to officially define recessions). Global oil consumption probably decreases as growth falls below 2%, according to this relationship (which changes over time):

Change in liquid fuel demand = .6 * (real global GDP growth – 2%)

A global recession might bring three years with an average GDP growth of 2% (one year of which is < 2%). That would give three years to boost production for the next boom, and three years for prices to spur increased efficiency and conservation.

However painful for us, over generations of time recessions are usually forgettable (the 1930’s is an exception). Even a severe recession might mark only a blip on the march to a better world, an opportunity to replace the now-rickety post-WWII economic machinery with something better suited for the 21st century.

II. Removing price ceilings on oil products.

Many emerging nations (esp. China) and oil exporters have price controls on oil products, shielding their economies from the effects of sharply rising oil prices. As a result, they consume more than they would at world prices. As oil prices rise, this both becomes increasingly expensive (in lost income or opportunity costs) and distorts their economies.

Worse, prices controls usually prove futile over time, unsuccessfully preventing the virus of inflation from infecting and spreading through the economy. As they realize this, they will likely phase out price controls in favor of less-expensive and more effective remedies — such as fiscal and monetary policy, and re-valuing their currencies.

Higher oil prices will then work their magic in these countries as it has in the developed world, driving behavioral changes and capital expenditures which reduce oil consumption (i.e., conservation and increased efficiency). Price elasticity of demand — the “law” of higher prices forcing less demand — often catches even experts by surprise. Just as Newton’s laws of motion often seem counter-intuitive, both nonetheless work inexorability. The resulting change in demand might astonish us.

Conclusion

A period of slow growth in oil demand, or even falling demand, will give us more time to prepare for Peak Oil. Wonderful, but only if we use it. Since the February 2005 Hirsch et al. “Mitigations” report proves that adaptation will take at least 20 years, we cannot afford any delays — however well-intended their source.

The many post predictions of Peak Oil have created understandable skepticism about the current predictions. Another failed prediction might discredit the concept among both the public and decision-makers, interrupting the process of adaptation.

This is part of a wider problem. The exaggerated claims of certainty characteristic of much literature about Peak Oil, and the even more extreme claims (see note below) about the apocalypse following Peak Oil, are in my opinino counter-productive. They hinder our preparations for that historical period when we leave the age of oil for …whatever comes next.

Extreme claims about the post-Peak Oil world

It is difficult to provide just one example, as there are so many contenders for most absurd doomster energy scenario. My personal favorites are the “Die Off” forecasts, apocaplyse caused by too-little energy. One of the better known is Richard Duncan’s The Peak of World Oil Production and the Road to the Olduvai Gorge. Wikipedia has a brief summary. However bizarre, it is taken seriously by many folks (such a some posting on The Oil Drum, as a Google search will show). For simple rebuttals see this and this.

About The Oil Drum (TOD)

You will see it on my blogroll. Many of its contributors’ work I find of great value, such as that by Rembrandt and Stuart Staniford. However, the folks running it show too little interest in grappling with opposing data and analysis. So it shows only one side of the coin.

Please share your comments by posting below (brief and relevant, please), or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For more information about Peak Oil

1. When will global oil production peak? Here is the answer! (1 November 2008)
2. The most dangerous form of Peak Oil  (8 April 2008)
3. The world changed last week, with no headlines to mark the news   (25 April 2008)
4. Peak Oil Doomsters debunked, end of civilization called off  (8 May 2008)

Here is an archive of my articles about Peak Oil.

Here are other resources about Peak Oil.