During the 1990’s an increase in oil prices of $10 reduced growth of real GDP by approximately one-half percent. Hence the concern after 2001 as oil rose from $20 to $40, then panic as oil rose from $40 to $80. At $120, oil prices are up 6x from the 1990’s average. Where is the global recession most economists expected if oil prices skyrocketed? (Matthew Simmons was one of the few experts who questioned this consensus, saying that rising oil prices were not necessarily poisonous to GDP.)
Or, reversing the equation: oil production has been almost flat since mid-2005. Where is the global recession Peak Oil doomsters predicted for a period of flat oil output? Since mid-2005 global real GDP has risen approximately 10%, despite Peakists’ prediction that growth was impossible without more oil.
The key to all of the above is the price of oil. The magic of prices. The response to rising oil prices comes in two forms. First, there are the conventional rapid responses to rising prices (e.g., drive less, slower economic growth). More important is the lagged effect of prices. Over months and years people change their personal behavior and business practices, and make capital investments that adapt to higher oil prices. Result: the global economy grew at almost 5%/year as growth in oil production slowed — then stopped.
What made this possible?
- The economic stimulus from re-cycling of funds from oil exporters to consuming nations through investments and purchases of goods/services.
- Reduced discretionary consumption (e.g., vacation locally instead of at DisneyWorld, moving the thermostat higher in summer and lower in winter).
- Capital investments that yield increased efficiency (e.g., hybrid cars, insulating buildings).
- Fuel-switching (e.g., electric vehicles, solar for diesel generators).
- Substitution, as high prices change cost structures (e.g., local goods replace far-away ones, rail transport replaces trucks).
- Economic stimulus resulting from alternative energy projects.
In economic jargon, the price elasticity of oil demand changes as prices rise. it just takes time. As we saw in the 1970’s, this Econ 101 dynamic surprises people. For a current example, see this Bloomberg article.
This process is just starting. Oil prices spiked in 1972. By 1979 these dynamics kicked in strongly. After 7 years of rising oil prices, global oil demand was flat for the next 14 years. After six years of rising oil prices, we might see something similar occur during the next few years.
Aprox 40% of Asia’s consumption is at subsidized prices, an expensive way for governments to mute the price signal — slowing their nations’ adaptation process. The world’s adaptation to peak oil will accelerate as these government’s are forced to reduce subsidies for oil.
A more important lesson learned
In hindsight we see that economists were wrong, but that bald statement overlooks the valuable lesson to be learned. What passes for analysis in energy research is in fact mostly inspired guesswork. Consider reports like the Robert Wescott’s “What Would $120 Oil Mean for the Global Economy” (April 2006):
If oil increased to $120 a barrel {from $60 – 70} and stayed there for a year because of coordinated terrorist attacks on oil facilities, the world’s oil bill would be about 8% of world gdp (even assuming some reduction in the quantity of oil demanded) — higher than at any time in modern history. Such oil prices would almost certainly precipitate a global recession. In addition to negative demand effects, there would be large negative supply side effects, policy effects, and confidence effects.
Meanwhile, financial markets would likely judge these attacks on global energy supplies more seriously than Iraq’s 1990 invasion of Kuwait or the 9/11 attacks, because of their continuing disruptive effects. Stock market valuations would likely fall more than they did after the Kuwait invasion or after 9/11. Given the negative confidence effects and negative supply effects, the global recession would likely be severe.
While current conditions do not match his scenario — oil prices rose over two years (not instantaneously), and have lasted only weeks (not a year) — yet it is clear that this report did not adequately weight the effects described above.
What should worry us all is that work like Wescot’s and the Oil Shockwave simulations of 2005 and 2007 are among the best-funded and executed energy forecasting projects — and are just sidewalk sketches compared to what we need. The complexity of the task and its importance to America’s future means that far more data collection and sophisticated modeling is needed to produce results that are better than guesses.
There are many confident recommendations for our response to rising oil prices — based on guesses — but few calls for more research about the problem. Perhaps too many of our experts are comfortable guessing. With each new change in the energy world they blow bubbles of froth, comforting or terrifying depending on their personal predilections.
It need not be so. We have the talent to assemble multi-disciplinary teams (e.g., chemists, geologists, mathematicians). We either have or can buy most of the data needed. A key piece the CIA could probably acquire: what are the reserves from our Middle Eastern allies.
The cost would be trivial, as government projects go, and would provide a foundation for planning and investment to prepare for Peak Oil — whenever it happens. Conceptually this would be like the creation of the great National Income and Production Account “flowcharts” in the 1930’s, which are the foundation for today’s economic reporting and analysis systems.
The elephant is great and powerful, but prefers to be blind.
David Halberstam, The Best and the Brightest (1972)
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For more information about Peak Oil
- When will global oil production peak? Here is the answer! (1 November 2008)
- The most dangerous form of Peak Oil (8 April 2008)
- The world changed last week, with no headlines to mark the news (25 April 2008)
- 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.
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