It seems to me that most policymakers have missed some basic issues with respect to our energy problem. One of these is that world oil supply is very inelastic–that is, even with high price, it doesn’t rise much, if at all. Another issue is that free international trade makes world-wide impacts of policies fairly different from what the effects seem to be, when measured within the boundaries of the country. It seems to me that the combination of these issues is contributing to one of our current problems–rising world CO2 emissions, even as countries struggle to contain CO2 within their own borders.
Furthermore, the policies being designed today are being selected primarily from a CO2 perspective. These policies aren’t being designed to address the problems that inelastic oil supplies bring, which include recession when there is even a small imbalance between supply and demand. Unless policymakers understand the broader picture and develop policies that consider all of the issues (that is, (1) inelastic oil supply, (2) CO2 impacts, and (3) spill-over effects to Emerging Markets), they cannot make optimal decisions.
Inelastic Oil Supply
The usual assumption with most resources is that supply is elastic–that is, with a higher price, more will be produced. But with oil, oil production doesn’t rise much regardless of price. Back in April, I showed this graph:
Figure 1 above is on an “all liquids” basis, so includes biofuels, natural gas liquids, and almost anything else that might act to extend oil supply. Even on this broad basis, liquids aren’t rising much at all.
On an annual basis, world crude oil production has been close to flat. There was a dip in production in 2009 when oil prices dropped too low (also note Figure 1), but when prices spike, high oil prices do virtually nothing to add more.
Economists talk about inelastic supply, or about a vertical supply curve, when higher price doesn’t result in more production.
When there is a nearly vertical supply curve, even a small increase in demand results in a sharp upward price spike, and even a small decrease in demand results in a sharp drop in prices. Doesn’t this sound a whole lot like what we have been seeing with oil supply recently? Everyone assumes “speculators must be causing the increase” because the increases and decreases are so sharp, but even a small out-of-balance between supply and demand could be causing these fluctuations, if supply and demand are balanced very tightly, as they are with a nearly vertical supply curve.
Substitutes Can’t Rise Much, Very Quickly, Compared to Current Oil Consumption
There are a few products that are “sort of” substitutes for oil, with biofuels coming closest. Even biobuels are pretty inadequate, however. Biofuels, at least as they are made today, are not chemically equivalent to oil, so can be added only as a small percentage of the fuel (recently raised to 15% for ethanol). It also takes a lot of cropland for biofuels. The Wall Street Journal recently showed this graph, when talking about corn used for ethanol in the United States.
It is pretty clear that if ethanol currently requires over 40% of our corn supply to produce a liquid that replaces 3% of our petroleum consumption (on an energy basis–comparing Btus of the two fuel sources for 2010), then we are not going to be able to replace much of our petroleum supply with corn ethanol. There are other types of biofuels that researchers are working on, but so far they are very small–nothing we can count on replacing any sizable percentage of oil with, on a short-term basis.
How Inelastic Oil Prices Result in Recession and Falling Home Prices
What happens when oil prices rise greatly, because of even a small increase in demand? Oil is refined and used to make products of all sorts–for example, gasoline, diesel, jet fuel, home heating oil, asphalt for roads, shingles for roofs, fabric for clothing, herbicides, and pesticides. It is also used in farming, in construction, in making all kinds of disposable medical products, and, of course, for transporting goods of all types.
So when the price of oil rises, the price of all of the products that are affected by the oil price theoretically needs to rise at least a little. This rise in price does not provide any improvement in the products from the customer’s point of view. The buyers don’t have any more money to buy these higher priced products, at least in oil importing nations. (In oil exporting nations, there are ways around some of these problems. Prices of the oil-related products can be subsidized. Also, some of the higher profits from the state-run oil companies can be used to increase subsidies for food. )
If we think of
demand = amount people can afford,
then demand falls for a very broad range of products, because of the rising prices of goods with oil-related price increases. This drop in demand leads to employment cut backs, and even further drop in demand, because the newly unemployed cannot afford as much. With price increases on oil-related products and employment cutbacks, more people default on loans. Businesses take out fewer new loans, because they have no reason to expand their businesses. Home prices are likely to fall, because people without jobs may default on their loans, and because people who are spending more on oil-related goods are likely to cut back on their expectations regarding buying a more expensive home.
Impacts of Nearly Vertical World Oil Supply Curve on Policies
In the face of a nearly vertical oil supply curve, programs to reduce oil supply use, such as carbon taxes, more efficient vehicles, and cap-and-trade programs are likely to work differently than originally intended. Since world oil consumption remains essentially constant regardless of price, these programs don’t reduce world oil consumption, or world CO2 emissions related to oil, since any oil saved will be quickly used by someone else, perhaps at a bit lower price. These programs may still have some oil-related benefits–allowing more people to share in the oil that is available, and reducing oil imports to a particular country. But the impact on world oil production / consumption is minimal, if the total world oil supply is virtually fixed, and there is free trade among nations.
What effect these programs have depends on what happens to the demand that is “saved” by the tax or the greater efficiency. In the case of energy efficiency, this might be the money the buyer of a more fuel-efficient car has left over to spend on other things because of lower fuel use. In the case of a carbon tax, this might be the fuel use that is transferred to a lower CO2 source such as natural gas or wind.
In the case of energy efficiency, suppose that the buyer with money left because of lesser fuel use uses this left-over money to buy goods that are manufactured in Emerging Markets. The net impact, at least from a CO2 perspective, may be negative, because of the large amount of coal these countries use both in manufacturing goods and in the way the workers spend their salaries.
In the case of a carbon tax or cap-and-trade, the effect may be to transfer fuel use to another type of fuel more quickly than otherwise would have been the case. If the fuel is natural gas, one could argue that the policy results in a more-rapid rise in use of natural gas, and leaves world oil usage virtually the same, so that there is a net increase in CO2 emissions. In the case of a transfer to wind, wind turbines take fossil fuel energy to create. If there is no savings in world oil consumption, but an increase in fossil fuel use for wind production, the effect is still an increase in world CO2, but a smaller one than with natural gas.
As a practical matter, OECD Fuel consumption (Figure 6) has shifted far more to natural gas than to renewables, such as wind, in the past 20 years. (In the BP data shown above, biofuels are “buried” in oil. Renewables are wind, solar, geothermal, biomass, and waste.)
Of course, if there really isn’t enough oil, maybe what is important is to transfer oil usage to another fuel source to prevent oil prices from spiking even worse than in the past, and causing even more recession. So from this point of view, maybe CO2 policies are working better from a “transfer to other usage perspective” than from a CO2 perspective, or from a “savings of fossil fuels” perspective.
Policymakers Need a Broader View
My concern in all of this is that the scientists and regulators looking at these questions seem to have blinders on. They seem not to have figured out that world oil supply is extremely inelastic and that there is a real problem with oil prices spiking and recession following. Because of this issue, policy-makers need to adjust their focus to consider more than just CO2.
Furthermore, with free international trade, it is very important where money from a country is being spent. Obviously, products produced in many Emerging Markets use coal-fired electricity in their production. But equally as important, the salaries that the workers in these countries receive allow them to have air conditioning and other products that use coal fired electricity. This means that even services, like computer programming outsourced to India, can have a negative impact on world CO2 emissions.
I think the time has come to start thinking seriously about which goods and services we produce at home, and which ones we purchase abroad. When we purchase goods and services abroad, we basically abdicate control to local authorities. If we are not paying any attention to this, and just focusing on what happens within our own borders, we are likely to see a rerun of what has happened recently–a rapid shift to coal viewed from a world-wide perspective, with most of the growth coming from Emerging Markets. We also lose the jobs and wages that get transferred to Emerging Markets, making our struggle with recession even worse.
If we need to be using coal, maybe we need to be doing it at home, and making certain efficiency of manufacturing operations is high, and pollution controls are optimal. Or maybe we need to be figuring out how to do without these goods and services all together. But I don’t think that blindly wandering along, assuming CO2 programs for individual countries will fix world oil supply issues, makes sense any longer.
If we don’t understand the problem fully and we don’t look at all of the indirect ramifications on a world-wide basis, we cannot possibly figure out a rational energy policy. We really need to look at the whole picture, and think about options we have never considered in the past.
Wind, heat pumps, solar, and conservation (city & family planning) are easily meeting the futures energy demands.
Oil, Gas, Coal, Nuclear, & SprawL are unnecessary prescriptions for pain either by accident, natural disaster, WAR, climate change, market speculation, or peak supply.
Caps good. Trade bad.
Carbon trading is an attempt by the North (who created most of the waste) to shift responsibility for fixing climate change to the South (who is experiencing most of the consequences).
Perhaps a mea culpa will illustrate the overall problem.
I have been well aware of the finite nature of fossil fuels since the ’60s, of AGW since the ’80s. My wife and I were “homesteaders” in the early part of our marriage during the ’70s, living on 35 acres on the Olympic Peninsula, but somehow still wanted to work outside the homestead.
This should not be surprising, since providing for most of one’s food and fuel is not romantic after the first few months, just a necessary, albeit satisfying, grind.
Sometimes I meet people who wonder why those who are self-sufficient via subsistence agriculture would want to leave their “idyllic” surroundings and move to some noisy and dirty mega-tropolis. The short answer is that for most people, doing the same thing over and over and over for one’s entire life is booooring. They want the bright lights of the big city and “free” time for entertainment, education and exploration. I can’t blame them.
So my wife and I had cars for travel to work; when we had children we accepted plane tickets from grandparents to visit on holidays; we bought clothing in department stores; etc etc.
And even though we were far more carbon-neutral than most, living off-grid with small hydro, growing trees as fast as we burned wood for heat and cooking fuel, we did our share of burning through the world’s fossil stockpile.
As a developer and researcher in the field of renewable energy, I sometimes consoled myself with the thought that my work partly made up for my family’s negative impact on the world and that eventually the world economy would segue into a renewable energy future, leaving fossil fuels and their CO2 behind. But that transition never came, so now there is no consolation at all, only guilt and not a little fear.
There are many people, like myself, who are totally aware of the acute problems facing the world, yet do little or nothing by way of personal example to lead an exemplary life (that is, not participating AT ALL in the OECD economy). So how can we expect the attitudes of the non-aware or the policies of our elected officials to change? We can’t and they won’t. All we can do now is prepare as much as possible to face the horrific conditions that will be forced on all of us.
Thanks for your insights.
Even though everything was generally very boring, it seems like you would need to know a lot–first aid, handling crop problems, building fences, etc. And things like clothing you would almost have to depend on department stores, because we are not set now days for going all the way from cotton or flax or wool to cloth and clothing.
Even if we move to a very local scale we will still have specialists and machines. The loom to weave clothes will be powered by water, wind or PV but as the posters said nobody likes boring work. I can think of little as boring as weaving. I am sure as a craft making a few items for fun to give as gifts is great. But making clothes for a family of four every year is not something I want to do.
We can be local and still have machines. Small machines that have limited output just enough to meet local demand.
There will be local saw mills, textiles, shoes, nails, wire, pottery, iron casting?, internet post office?, printing/newspaper. Even when New England was first colonized they got their shoes from England. There will be sailing ships bring tea and coffee as high value rarities. There will be a local trade in salt, a must have item to live. Trade in sugar and alcohol. Local schools talk about local control of education 🙂
Agreed. These things will be a lot more possible if we plan ahead. If we find ourselves with everything falling apart, it will be hard to start from scratch making all of the pieces and getting everything together.
I think the fact that a devout believer in Ayn Rand, calling himself an economist, ran the Fed for nearly two decades says it all. To me he was an “occultist” not an economist. As I told someone the other day, I’m on the Titannic. A few people are running around trying to convince people we’re going to sink but the vast majority think it’s a joke. Like the Titannic, the joke will quite suddenly turn to panic. Then it’s pure survival instinct. I figure the day the panic strikes people will still be discussing what, when, where and is it really true. For me the interesting thing is how the panic is coming in layers. Lowest decks have been on survival mode for some time. Blog commenters are still drinking in the upper deck bars. Shoulds, oughts and could be’s are not reality based but fun to talk about.
I was once a pilot for United Air Lines. I, clearly, remember being told for several months that a layoff was coming. No way I said as the layoffs marched ever closer. Right up to the day I got my two week notice, I was doing “shoulds, oughts and could be’s”. I remember sitting at the table, stunned and without a clue as to how I was going to make a living. Reality had arrived in the mail.
I think your expectation of significant increased coal consumption is unrealistic. China is by a very large margin the world’s largest coal produce and the world’s largest coal consumer. Yet the evidence (mainly rapidly rising Chinese coal imports) suggests China’s coal production has reached a peak. Other countries (mainly Australia and Indonesia) have stepped in to fill the gap, but Australia will have great difficulty increasing its output (for manpower, political and financial reasons) and I suspect the other major exporters will have similar problems. The U.S., the world’s second-largest coal producer, has large reserves, but largely of low grade coal and largely in Montana and Wyoming, far from any river or ocean port. In India (the world’s third largest producer) the coal ministry has just announced an expected shortfall in coal supply for 2012 of up to 142 million tons.
The amounts of coal needed simply to make up for increasing shortfalls in Indian and Chinese production are so large relative to the size of the industry in the rest of the world that increasing the overall amount of coal produced is hardly likely. Moreover, as oil becomes more expensive (or even stays at its current high price) the cost of transport for coal will increase. Certainly coal can be used as a fuel for steam powered bulk carriers, but how many of then are still in service? Coal could also be transported around the world in sail powered bulk carriers, but I haven’t seen many of them either. And to get coal to a port to load a bulk carrier takes rail lines and locomotives. As far as I know, Australia is the only large coal exporter which transports a large amount of its coal by rail without using diesel locomotives. Indonesia has much of its coal close to the coast or a river.
You may very well be right. I know they are also looking to US exports, and I remember reading that their average cost of coal has risen 20%, further suggesting that they are maxing out on supply.
Somehow we need to be getting ready for the changes that are coming, and I think in some ways that needs to be focusing more on supplying our own needs, not blindly depending on world trade that is not likely to continue. Perhaps that should have been my point.
Energy policies will continue to be reactive: draining the swamp will not be a consideration when the alligator chomps down.
You’ve heard this from me before, but the ‘blinders” phenonium (IMHO) is the single most important issue for our collective predicament. Scientists, politicians, regulators, entrepreneurs, and all ordinary folks pretty much have the intellectual capacity to understand exactly the case you are making – and yet, they are “blind” to the issues. I find very few people who have even heard of PO. Most have heard of GW and believe it is some kind of hoax (lots of FOX news listeners around here) – BTW, I live in a county with above average education and wealth – I recall we are the 30th most wealthy county in the US.
It seems to me that ideology/religion, not science, facts, or rationality is what drives the belief systems of most people. Further, these beliefs appear to be driven by a tiny minority of corporate/political/religious folks who enjoy great wealth/power/prestige from BAU.
Although your analysis is excellent (as always), I don’t think it will directly affect any change. Indirectly, it provides the basis for other solutions. Effective solutions are predicated upon solid goals (otherwise they usually fail). The goal here is simply to get a critical mass of humanity to recognize the problems and to support your statement “We really need to look at the whole picture”.
I’m not sure what exactly are the “right” actions – good solutions tend to be iterative with feedback loops and modifications. But, I do believe we need to expose corporate disinformation campaigns (remember tobacco); we need to disassociate political ideology from science (previously,I’ve recommended getting the National Academy of Science involved); we need a vigorous push for Separation of Church and State – only a truly delusional person believes we can continue to breed without restrain as the religious right would prefer. There are other actions like these – the point being that we have little hope for dealing with PO/GW/etc until the basic problems are understood by most people. I’m not hopeful.
I got to thinking after I wrote this post–if back about 1975 or 1980, we had asked ourselves what we could do to increase world CO2 emissions, what we would have come up with? It seems to me that the logical “solution” to such an absurd goal would have been to somehow get non-OECD countries up to OECD level of fuel use–to somehow introduce them to the good life, and show them how to mine their own minerals. Giving them positive reinforcement, like making them the source of imports to OECD countries would help a lot in this regard. We, in fact, figured out a way to do all of this, while at the same time convincing ourselves that we were saving the world by getting someone else to do the energy-intensive work for us. Of course, our oil had peaked in 1970, and our Appalachian coal was on a downslope, and Britain’s coal was on a downslope. There were many years when we didn’t know how long we could count on natural gas, either. So getting others in on the bandwagon, to provide energy-intensive products and all kinds of other things, sounded like a great idea. When cheap labor was added to the mix it sounded like a really good deal to OECD countries. But as a solution to the world’s CO2 problems, it really was a non-solution. Having more oil and gas and coal mined around the world just added to the world’s total. But if you do the accounting in the right way, it looks great from an individual country’s perspective.
I believe you have created a paradox: on one hand, you seem to imply that setting goals and implementing related solutions for our predicament is a fool’s errand fraught with uncertainly and unintended consequences; on the other hand, you note that influential people are blind to the real problems and
So, the question is why bother to admonish the decision makers to take off the blindfolds and look at the whole picture – for what purpose if it is useless to set goals and implement actions that we hope will mitigate the worst consequences of fossil fuel shortages (plus GW and other bad stuff)?
I didn’t quite understand the relevance of the CO2 example – I can’t imagine how such a goal would ever be established (as you said: absurd). Perhaps a goal of having cheaper goods for US citizens would have been possible – but then the kind of rational policy making process you suggest would have considered the loss of jobs and many other issues. As I see it, there was no rational decision making process from the POV of the common good – just a lot of powerful, self-interested folks pushing their own agenda.
This is not an academic question. It is the question I wrestle with in my personal life: should I really worry about trying to influence policy makers (letters to editor, elected officials, supporting candidates and causes, etc); or should I just concentrate on issues related to my own family and friends? Why bother with trying to be an “activist citizen” if as the Borg say: “resistance is futile”.
We really have two problems, that are in some ways in opposite directions–peak oil, which is too little oil, and CO2, which is related to too much fossil fuels. It is hard to figure out a solution for both.
The only solution I really see for both is trying to transition to a life without fossil fuels, based on local materials. I am afraid that is really where we are going to have to end up, anyhow, in not too many years because if the financial system collapses and/ or international trade collapses we are not going to be able to keep up fossil fuels (any of them). If we don’t prepare ahead of time, we will be even worse off than otherwise. The good thing about such an outcome is that the CO2 issues are less severe than originally believed (but maybe still beyond what the earth’s atmosphere can handle).
Theoretically, a society can make two transitions–one to a “medium level” using some fossil fuels and local materials, and a second one to no fossil fuels. I am not certain that we have time for two transitions though.
Whatever we do, I don’t think it will involve huge amounts of trade with countries half way around the world, based on who can make products most cheaply.
Gail, you wrote (beginning at para. two):
“Furthermore, the policies being designed today are being selected primarily from a CO2 perspective. These policies aren’t being designed to address the problems that inelastic oil ***prices*** bring, which include recession when there is even a small imbalance between supply and demand. Unless policymakers understand the broader picture and develop their policies that consider all of the issues (that is, (1) inelastic oil supply, (2) CO2 impacts, and (3) spill-over effects to Emerging Markets), they cannot make optimal decisions.
Inelastic Oil Supply
The usual assumption with most resources is that supply is elastic–that is, with a higher price, more will be produced. But with oil, oil ***price*** doesn’t rise much regardless of price.”
In the ***highlighted*** instances above, do you not mean to say: supplies, and supply? More certain with regard to the second instance, since the statement “price doesn’t rise much regardless of price” is nonsensical. The first instance seems to make more sense as “supplies,” in that if demand outstrips an inelastic supply, recession can result from the skyrocketing price of fuel and consequent business slowdown with no increasing supply to offset the price.
Your writing is normally very technically precise so I hope I am not being dense. I stopped reading soon after and am looking forward as always to finishing your post. Thanks for your continuing insight.
I will fix those instances. I meant inelastic oil supply. After I write a while, all of the words start to sound alike. I find it hard to proofread my own work. I stop thinking.
I agree completely that we can not solve global issues by local action. Local action just shifts the problem to low cost, dirty producers elsewhere.
On price inelasticity we have to keep in mind there is a long time lag maybe 10 years. It takes a long time to bring the Canadian tar sands into large scale production.
I think we will see the price per barrel go up until it exceeds the cost of a substitute. The volume of sales may be low but there will always be rich folks who can afford $20 per gallon for the Hummer. I expect a spike to $200 per barrel before 2015 and a long term average of $130 in 2014.
We have been mining the bituminous sands in Canada since 1967. Our progress has been painfully slow to date, and I find it hard to believe it will really step up. One of the big issues is needed capital. Unless the price of oil really stays high, and borrowing remains available, it is very hard to make it happen. There is also the capital needed for all of the additional pipelines and upgraded refineries.
I think I agree with Arthur Robey. I don’t we will see as high oil prices again. We are already running into too much recession. The big problem ahead is recession.
Thanks for reminding me of price elasticity Gail. It brings things into clearer focus.
I’ll wager that the price per barrel will never reach $146 again because the economy of the world is not robust enough to sport such an extravagance.
So I believe that we will see ever lower spikes as we decend stepwise into a permanent depression.
The “Limits to Growth” models showed that if certain major corrections were taken in 1980 to the economy of the world we would be able to sustain a per capita income equivalent to that of 1898. None of their recommendations were implemented.
This prediction has the folowing caveats. That the present population projections are smooth (No Black Swans) and that no silver bullet is found as a substitute for oil as an energy source.
Let us hope that we haven’t developed a Death Wish.
It seems like an energy silver bullet would have come along a long time ago. We thought we had one with nuclear, but that hasn’t worked out as well as originally hoped, partly because of accidents, partly because of cost, and partly because of lack of solution for left-over fuel. Energy infrastructure of any type takes a long time to build, and the cost of a change is huge.
I agree with all you have stated here. But the situation in regard to volatility of oil prices is even worse than you suggest, because the short-run price elasticity of demand is very low; in other words, not only is the supply curve close to a vertical line, but the short-run demand curve for oil is also nearly vertical. Thus small shifts in either the supply curve or the demand curve will have large effects on prices.
The long-run price elasticity of supply for oil is also low, because regardless of substantial price increases it becomes harder and harder to increase the quantity supplied of oil, and regardless of future price increases the amount of oil produced is going to decline.
The future seems to be one of increasing price volatility with a long-term upward trend in the price of oil as oil production and net imports decline. Of course, a Greater Depression could hold down both the demand for oil and also its price for several years, and that scenario is fairly likely.
Thanks, Don. I’m glad you agree with what I wrote, since you are coming at this from the point of view of someone who has taught economics.
It is hard to get in all of the issues in one post–if a person focuses on one thing, they end up slighting other issues. I will keep your comments in mind for future posts, though.
There are a number of steps I believe we should be taking;
1. Enter into a global GHG emissions reduction treaty that has ramifications for those trading partners who are not signatories.
2. Embark on a number of mobility adjustment measures:
a. Carpool (Good)
b. Increase number of local bus lines (better)
b. Greater infusion of rail mass transit (best)
c. Far greater number of bike commuters (best)
d. Far greater number of telecommuters (best)
3. Significantly increase building energy code efficiencies
4. Shift more taxes to oil (and coal), reducing those on income.