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Tuesday, September 20, 2011

(Un) Economic Peak Oil is what really matters

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In several of my recent posts, such as here, here, and here, I have argued that concentrating on the geological peak of oil production is a distraction. What really counts are the severe economic implications for New Zealand and the world economy as oil prices trend upwards and become more volatile. And I have highlighted the substantial impacts on our economy even without global oil production actually peaking, or declining. Production being on a plateau since 2005 has been sufficient.

Chris Skrebowski, an expert oil analyst and trustee of the UK-based Oil Depletion Analysis Centre (ODAC) advances these propositions cogently and persuasively in a recent article. Essentially he argues that there is economic peak oil. This economic peak oil is the point at which the price of oil becomes unaffordable to consume and therefore to produce. 

Here is a synopsis of Chris Skrebowski’s arguments:-

First he maintains that Peak Oil is largely an economically driven phenomenon. It occurs when the cost of supply for oil producers exceeds the price economies can pay without destroying growth at a given point in time.

Oil production costs rising

Saudi Arabia needs an oil price of $90-100/b for its revenues and expenditures to balance. Many, if not all of the other OPEC members have revenue/expenditure breakeven oil prices comparable to those of the Saudis. The Saudis are the world’s oil price setters.

The escalation of oil development costs is being driven by the depletion of the low-cost, easily exploitable oil and its replacement by less accessible and higher-cost oil. The chances of any significant and sustained price fall, barring a major global depression, look remote.

Higher oil prices helped trigger ‘Great Recession’ and cause of current “slow recovery”

$147/b oil in mid-2008 helped trigger the ‘Great Recession’. The run up in prices to around $120/b in 2011 brought growth to a near halt in a number of western economies, and notably in Europe. A study by University of California-San Diego economist James Hamilton, links oil price spikes to 10 of the last 11 recessions.

Developing nations better able to cope with higher prices than advanced economies

In mature economies, such as the US, there is a significant economic impact at over $90/barrel whereas China can probably sustain oil prices in the $100-110 range. Why is China’s tolerance higher? Because the value of oil is higher there.

Will this higher price tolerance mean developing economies could keep developed economies in growth-less stagnation by paying oil prices that were just above those that bring developed economies to an economic halt?

Current cost of production unaffordable

In its most recent survey, Barclays Capital indicates that oil companies’ budget assumptions have risen to $87, literally the maximum carrying capacity of the US (and probably European) economies.
Thus, on current trends, the oil companies will be approving projects that deliver oil at prices which are literally unaffordable for advanced economies.

Slow adaptive responses and fast oil price rises leads to economic peak oil

Adaptive responses, on the basis of the reactions after the first (1973) and second (1979) oil crises, are slow (taking 10-20 years) while oil prices have been faster moving going from $25 to $100 in the eight years between 2003 and 2011.

All the indications are that adaptive responses have failed in terms of both size and speed to restrain the steady rise in oil prices seen after 2003. The only break in the steady oil price increase occurred as a result of the 2008 economic crisis and the subsequent ‘Great Recession.’

The adaptive response is to use oil more efficiently or to back out lower added-value uses of oil or to move to other fuels. Either way this shows up as improved efficiency in use (volume of oil per unit of GDP.

The graph below plots an oil price rise of $10/year (blue line) and a productivity gain of 3%/year (adaptive response) – red line. The graph shows the price increases, driven upwards by depletion, outrunning the adaptive responses that higher prices induce, to give a crossover in 2014. The crossover gives the timing of the economically determined Peak Oil. 

The crossover point gives the economically determined Peak Oil when sustained growth becomes impossible.

Adaptive responses are not large and fast enough to constrain the upward trend of oil prices. The primary adaptive response will therefore be periodic economic crashes of a magnitude that depresses oil consumption and oil prices. These have the effect of shifting consumption from incumbent consumers—the advanced economies—to the new consumers in the developing economies.

This is exactly what happened in the last recession when between the start of the recession in January 2007 and 2011 demand rose by 4.3 million b/d in the non-OECD nations and fell by 4 million b/d in the OECD area.


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