Oil and the Economy: Why it is important to figure out approximately where we are headed

There seems to be a lot of conflict among folks attempting to make plans for the future. I think the basic cause is different views regarding where we are headed, and how fast changes may take place.

The most popular view among the general public, including research scientists, is that growth will continue practically indefinitely. Let’s call this Scenario A. This forecast by Price Waterhouse Coopers might be typical of what one would expect:

Expected base case GDP and population growth to 2050 from Price Waterhouse Coopers report

Figure 1. Expected base case GDP and population growth to 2050 from Price Waterhouse Coopers report

These growth rates don’t look all that high when presented on an annual basis, but they really add up over time. At an annual growth rate of 7.6%, India’s GDP in 2050 can be expected to be 27 times its real GDP in 2005. At an annual growth rate of 0.8% per year, by 2050, India’s population can be expected to 43% higher than in 2005.

A second scenario, which I call Scenario B, is one that is held by quite a number of people who have been studying oil and gas depletion models. It is focused on an expectation that oil and gas production in the future will follow a pattern such as this one prepared by Colin Campbell, taken from the April 2009 ASPO-Ireland Newsletter.

Colin Campbell forecast of future oil and natural gas extraction, made in April 2009

Figure 2. Forecast by Colin Campbell of future oil and gas production, made in April 2009

Note that in this scenario oil production starts dropping off about now by about 2% a year. Natural gas production doesn’t drop off as quickly. Substitutes, such as ethanol and coal aren’t shown on the chart, but many think they will help cushion the decline. With this view, the big concern is adapting to having a little less oil and gas each year.

A third scenario, which I call Scenario C is a very rapid drop off in fossil fuels of all types, such as might happen if a financial crash, or a major disruption of international trade, suddenly affected world economies. This is a graph I made for an Oil Drum post in 2009:

One theoretically possible outcome with respect to future oil supply, if a financial crash or some other disruption should seriously disrupt our current way of making markets work.

Figure 3. One theoretically possible outcome with respect to future oil supply, if a financial crash or some other disruption should seriously disrupt our current way of making markets work.

Under this scenario, the big concern is that the exponential growth we see in many things–real GDP, bank deposits, world population–will suddenly (or perhaps over a period of, say, 20 years) come to an end, and may in fact lead to collapse. As Kenneth Boulding was quoted in saying in yesterday’s post, “Anyone who believes that exponential growth can go on forever in a finite world is either a madman or an economist.”

We are depending on fossil fuels to maintain and increase our food supply. It is doubtful that with a much smaller fossil food supply, the world will be able to continue to support a population of 6.9 billion people.

The Connection between Oil Supply and World GDP

One other thing that it is helpful to understand is the apparent connection between oil use and GDP.

Graphic by Robert Hirsch showing the relationship between world GDP growth and oil production growth.

Figure 4. Graphic by Robert Hirsch showing the relationship between world GDP growth and oil production growth.

This graphic indicates that for the historical period shown, a rise in the world oil consumption of a given percentage seems to be associated with an increase in World GDP that is about 2.5 times as large. No doubt, increases in the supply of other fossil fuels play a role in this GDP growth as well.

We are not really certain precisely how the relationship between GDP and oil consumption will work on the way down. At least part of the growth in GDP is from oil substituting for manual labor. If we start moving the other direction–toward more manual labor–will that bring GDP down more quickly, since manual labor does not produce a very large quantity of goods and services, in comparison to oil? Efficiency gains and substitution of natural gas and coal may work to keep GDP from dropping as quickly, but these require investment–for example, building electric cars to replace gas-powered ones.

Looking at the three scenarios

Scenario A – Economic and Population Growth continues almost indefinitely

This is the scenario that underlies the pronouncements in the press. Even most mainstream scientists seem to believe this view of the future.

With this view, oil, natural gas, and coal use continue to rise, practically indefinitely, and forecasts of CO2 levels are very high. Climate change is a major concern, as is getting countries to voluntarily cut back on their fossil fuel use. The expectation is that economic growth will continue forever (although perhaps at a bit lower rate) even if major cutbacks in fossil fuel use are made.

One detail that is sometimes raised by those in the peak oil community is that it is not entirely clear where all the fossil fuels assumed in the climate change models will come from, since climate models seem to assume more fossil fuels (oil, natural gas, and coal) than are available.

Comparison of Fossil Fuel assumptions used in climate models of 2008 IEA World Energy Outlook with Luis de Sousa and Euan Mearns' view of the amount of fossil fuels actually available.

Figure 5. Comparison of Fossil Fuel assumptions used in climate models of 2008 IEA World Energy Outlook with Luis de Sousa and Euan Mearns' view of the amount of fossil fuels actually available.

Figure 5 is from this Oil Drum post by Luis de Sousa. This difference will not be an issue to many people, because of concern for being near a climate change “tipping point,” but it does give rise to differing viewpoints on how urgent it is to cut back.

The other detail that “peak oilers” raise is that oil production seems likely to decline on its own. While there is still a need to limit coal use, and perhaps natural gas use, a large share of the oil problem perhaps will naturally take care of itself. If there is a way to ease the transition away from oil, for example through tax structure, that perhaps makes sense, but the reason for the move away from oil may be as much because the oil won’t be there, as it is for climate change reasons.

Scenario B – Oil and natural gas production estimates based on depletion analyses govern the likely future

With this view of the future, future oil price and technology changes are viewed as likely to have relatively small impacts. Oil and natural gas production are expected to progress in accordance with models which take into account the tendency of oil supply from oil fields to decline. Typically, the models assume that much of this natural decline is offset by infill drilling, development of new (usually smaller) fields, and very slow development of unconventional oil.

With this view of the future, the issue is to try to hold up GDP (or some other measure of prosperity) by substituting materials for material that are expected to be in short supply, such as oil–for example, building electric cars, to replace gasoline powered vehicles. The type of decline in GDP that perhaps might be expected is perhaps something like this:

Scenario B - Two possible options for future real GDP

Figure 6. Scenario B - Two possible options for future real GDP (Selected by author).

Some with this view have focused on adding wind and solar to the electric grid, to increase electric capacity for electric vehicles and for general “growth” in the use of electricity. Some who are not concerned about climate change issues may also suggest an increased role for coal in electricity generation, or even coal-to-liquids, as a substitute for oil.

Most of the transition-type plans one sees for the future seem to follow the belief that the future will follow Scenario B. The plan is often to substitute approaches which use a little less oil for current approaches, which use more oil. Or the plan may try to substitute electricity for oil, or reduce electricity use.

Gardens or small farms will often have diesel operated equipment, and may be irrigated, perhaps using a solar pump. Electric fences may be used. Improved public transportation, such as long distance trains, may be part of the plan. Because the expectation is that the economic situation is not deteriorating too quickly, climate change is often a major consideration, because of its connection with coal usage.

Scenario C – Crash scenario, because the “system” does not hold together in some way.

The assumption in Scenario B, above, is that depletion will govern the amount of future oil and gas extracted. This implies that oil and gas companies will continue to do infill drilling, and will continue to drill in new fields they are developing. It also assumes that systems will work together pretty much as they do today–our electric system will keep operating; our governments will keep operating, and the markets (based on supply and demand) will continue to operate.

But it can be argued that the depletion models really set an upper bound for oil and gas production (assuming no new major innovations in extraction technology, and assuming prices remain high enough to encourage drilling at the level assumed in the depletion models). The question is whether our systems can in fact work together as well as we hope. If not, there could be a major disruption–perhaps not as soon as suggested by Figure 3 above, but it could be quite soon–certainly within the next 20 years.

One of the big concerns is whether the financial system will be able to continue to function as it does today, since it needs growth to maintain its current method of operation. Without growth, huge debt defaults seem likely, and growth is tied in with oil supply. Of course, even if the financial system does fail, there is the possibility that new system could be devised. Also, as long as the means of production remain, it is possible that other systems may be able to continue operating, even if, say, the banks fail.

The problem is that we have many vulnerabilities, and we may not even understand all of them. Our “just in time” delivery system is one. Another is our international trade system. Almost every high-tech product requires raw materials from around the world, so disruption in this system could be a major issue. If electrical companies go bankrupt, or are unable to pay their employees because of financial disruptions, this could lead to widespread electrical outages.

For a person who is concerned about these types of issues, the way to plan for the future becomes more problematic. One of the issues is just keeping the current system together as long as possible. Making major changes–and this could be as simple as adding a lot of wind and solar to our current electrical grid–could be the type of change that brings the system down.

Faced with possible immediate problems, climate change may move down the priority list for some. If a Scenario C type of situation should occur, it would likely pull down natural gas and coal production, in addition to oil production. Food and water supplies could easily be affected. One might expect population to decline–if not immediately, over a period of years.

It seems to me that one of the types of mitigations we would want to consider in planning for Scenario C  is restoring technology of the type we had prior to the industrial revolution. At that time, there were wind turbines made with local materials that were used to power some factories. We also made use of canal boats for transportation of goods. Ropes and knots were also used to a significantly greater extent than they are used today.

Steps would also need to be taken to develop food production capabilities without using fossil fuels, and also for pumping or otherwise gathering water. Food storage would be another major area of concern.

If Scenario C is really an issue, one almost feels powerless. What politician would ever consider such an extreme scenario? But even if a Scenario B evolves toward a Scenario C because things start falling apart after many years, one would still need plans for local food and water production that do not depend on fossil fuels.

I should add that I do not see any way that wind and solar PV are, on their own, self-sustaining. To me, they can only be produced with fossil fuels. They will stop working not long after fossil fuel support ceases to be available. For example, suppose you have a solar PV panel. If it is part of a grid connected system, it will stop functioning when the grid stops. If it is separate, it will be useful only as long as the appliance to which it is connected still works. If we lose the ability to make new computers and light bulbs, the solar panel will have much less use.

Blending Scenarios

Most people would say that we really don’t know for certain which scenario is ahead. As a result, we perhaps need to look at both Scenarios B and C, weighted as we think appropriate, in terms of what types of planning we will do.

There are no doubt some variations I left out. If one sees financial markets as being able to mitigate Scenario B, perhaps this might lead to higher oil and gas prices, and more fossil fuel production. In this case, the result may be something between Scenario A and Scenario B.  The reason I tend to discount this possibility is because high fossil fuel prices tend to cause recession, and bring oil and gas prices back down again. At this point we don’t have good substitutes (on any reasonable scale) for oil, gas, and coal, either. The substitute that comes closest is ethanol, and it is in competition with resources needed for food.

It is important that we think through which scenario(s) are most likely, and how this affects where we choose to place our priorities. While it would be nice to be able to do every type of mitigation, some may not be helpful, and may even be counter-productive. We also don’t have resources to do everything, so we need to make choices.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to inadequate supply.
This entry was posted in Introductory Post, Oil and Its Future, Planning for the Future and tagged . Bookmark the permalink.

28 Responses to Oil and the Economy: Why it is important to figure out approximately where we are headed

  1. Keith Akers says:

    Thanks for this post and for your web site. It’s important to figure out approximately where we are headed, and you are right to exclude scenario A.

    To me, the real reason it is important to figure this out is political. Right now, intelligent policies are not politically viable (even if we knew what they were). These better policies would surely have the effect of enforcing a lower material standard of living while hopefully establishing basic climate, energy, and food security, and greater equality.

    But after a crash of some sort, people might start paying attention. To me it is less important to decide between “quick crash” versus “slow decline” than to understand at what point political intervention could work (you could get elected or take power) and could be successful (you could stay elected or stay in power, your policies would stabilize things). FDR was fortunate, in this respect, in taking office almost at the very bottom of the previous Great Depression. We may not get great timing like that, but part of the battle is knowing what to wish for.

  2. Pops says:

    Hi Gail, glad to see you blogging on your own, I always appreciated your pragmatic postings at TOD and was wondering if they would continue with the new focus. As the instigator of the ‘planning for the future’ forum at peakoil.com way back when, I’ve always been more interested in the “doing” part.

    I started looking for more information about peak oil after the ’98 SciAm article but it was 9/11 that really shook me. At first I was concerned about a “fast crash” but gradually my outlook moderated.

    However the obvious fragility of our debt-based, non-localized local economies these last couple of years has made me reconsider. The tipping point for me was the Tipping Points* paper, which convinced me that there will be no general move toward mitigation, the widespread acceptance of the end of energy growth will signal the end of the economic growth necessary to repay the loans our system is based on. If everyone were to attempt to move from virtual wealth to physical assets at the same time, well…

    Good luck and keep up the good work,

    Mike

    http://www.feasta.org/documents/risk_resilience/Tipping_Point_summary.php

    • Yes. I would recommend the Feasta Tipping Point document that you link to, to anyone.

      It seems like if you look very deeply into the current situation, you come to the conclusion that at some point the current “system” has to stop working. People’s views will differ on how soon that will be. But even if it is, say, 50 years away, it would make sense to start figuring how to do things would fossil fuels again.

  3. Michael Irving says:

    Gail,

    You said:

    “For example, suppose you have a solar PV panel. If it is part of a grid connected system, it will stop functioning when the grid stops. If it is separate, it will be useful only as long as the appliance to which it is connected still works. If we lose the ability to make new computers and light bulbs, the solar panel will have much less use.”

    This is another of those “truths” that is so often not discussed, even in the ranks of those prepping for peak oil. How do you light your home if a collapse occurs? And what does that mean, really? If the answer is PV’s then preparation must also include appropriate quantities of electric light bulbs/tubes. So how many is that exactly? The PV system should also include parts, probably enough to rebuild the system from the ground up. Who has money for that? And how do you store it so it is readily available after 3 or 5 or 10 years. Also, the life of the panels is 25 years. Where will you get replacements? Likewise with batteries, except the lifespan is much less. Most people using stand alone PV systems have a generator backup for which the same questions about repair and replacement apply, with the addition of worries about where to get fuel and the rapid degradation of stored fuel.

    So maybe a person thinks that one step back in time will give the answer to home lighting, after all before electricity people used kerosene. Well its peak oil, remember? Before that it was whale oil and for obvious reasons that won’t work either. All the other alternatives present problems too etc. The same can be said for all other aspects of preparing for a possible collapse of the techno-industrial society.

    So that puts us in the Kenyan position described in “Life after the Crash: Lessons from Kenya” or “Don’t Worry, Be Happy.” Or as you said:

    “If Scenario C is really an issue, one almost feels powerless.”

    Michael Irving

    • I wish there were an easier way around these problems. Hopefully one can find enough kerosine for lighting purposes, but one doesn’t really know.

      If we were working on this problem, we could at least have things as good as people had it back in 1800 or so (but I am not sure there would be enough of everything to go around). But if we wait to start working on the problem until after a major collapse, it seems like we have a lot of work to do to build the new infrastructure we need so that we can again make clothing and paper, for example.

    • Pops says:

      Re: lighting, etc.
      I may be drifting off topic, but I think the way forward in general is in blending what we knew back when with what we’ve learned since. So, for example, in my 100 year old, pre-electricity house the windows are tall and relatively narrow because that configuration lets in the maximum amount of light for a given glazed area as well as providing floor to ceiling cross ventilation. Now if your openings are oriented correctly, double glazed, caulked well and have insulated shades on the inside, you have the optimal natural light during the day, no air infiltration and relatively good insulation.

      Then when it gets dark you go to bed. :^)

  4. Kenneth says:

    Gail – Is your personal view that it is Scenario C or a blend of B&C ?

    Also I have read a variety of dates for Peak Oil or for oil shortages, most from 2012 to 2017.
    If you were to put a date of Peak’s oil shortages creating economic turmoil, what would that be?

    I feel lost in my personal belief that Peak Oil is eniment, but none of my of friends and family want to hear about it.

    • Kenneth,

      My view is closer to Scenario C than to Scenario B. It may be that even when the fall takes place, it takes place over a period of years, though.

      It seems to me that we are already on the edges of the economic turmoil. The debt problems in Europe are symptoms. All of our mortgage problems are symptoms. As home prices continue to drop, and prices for business property continues to drop, there are likely to more debt defaults. The government’s huge gap between revenue and expense is another symptom. I expect some of these things will make the problem worse in not too long. The trigger could be governments raising tax rates and laying off employees, in an attempt to balance budgets. This could be as soon as 2012, I would think, but we don’t know for sure.

      It is hard to tell friends and family about our problem, because we don’t have a good solution. Maybe there are some partial mitigations, and maybe there are ways we can change our thinking, so we are not so disturbed by the possibility of the upcoming events. But the problem is still there. Some have called it a predicament, rather than a problem, since it has no good solution.

  5. Phyllis says:

    Thank you for starting up your blog again, and for allowing and inviting comments.

    re: “or a major disruption of international trade, suddenly affected world economies.”

    I wonder if anyone has done the following:

    1) First, is there really any such thing as “international trade”? Or, is it more accurate to talk about the number of multi-national corporations controlling the extraction of resources, production (using those resources) and shipment of specific goods from one region to another?

    And then changing the patterns to find the cheapest sources of labor?

    Also, we have the differences in how the different governments, such as China, manage and control their version of the international corporate entities. How does this system compare with that of the other multinational actors (in the resource extraction, production and ship-to-consumer business)?

    In other words, if a corporation is really supra-national, in what sense is it useful to talk about “international trade”? Might there be a more useful way to approach it?
    (Not that I know what this might be – I’m just making the suggestion.)

    2) This very intricate (and at the same time highly controlled) system: Are there predictable disruptions already in progress? I’d say the answer is “yes.”
    How to categorize these? How to describe them?

    3) Then, if this is the case, the “disruptions” are not hypothetical, they are predictable outcomes of current situations. This might enable one to look at positive action steps.

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