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Tuesday, October 04, 2005

"Peak Oil"

Like lots of folks, I have been wondering the last few months: what's the deal with rising gas prices? $3 a gallon was a new record, I think (assuming you're ignoring inflation!). Two questions come up: will it keep going up? and if so, what will happen to the greater economy -- like, is the value of my real estate going to "burst" in the next couple of years? Consider me motivated.

Yesterday I was reading Tim Bray's blog, as I do most days, because he's often intelligently skeptical of software industry nonsense. Occasionally he comments on politics, too -- always intelligently, but usually wrong, being a skeptic of philosophic principals as well (as is almost everyone). This time was no exception. Now, sure, this notion that multiculturalism is a tree grown from seeds planted in the Western intelligentsia by the KGB from 1930 to 1950 is a little lacking in scope even if at all true (the seeds were rather planted by people like Plato and Paul), but the important thing is actually that this post is getting close to stating something Ayn Rand figured out over 50 years ago: the altruist's is the Morality of Death. So, yes, suicide bombers and anti-globalizationists do have a premise in common. Mr. Bray, however, miss that and rather linked to a "brilliant" comment on the post, written by another intelligent-but-principle-averse author, claiming that the Roman Empire fell because of the Romans' "excessive comfort" (I can't make this stuff up!), and that Western culture is not "sustainable."

Hmm, what's that last? Some environmentalist notion about running out of trees or arable land? No, he means our energy usage is not sustainable. The comment ends by mentioning "Peak Oil." Is that some controversial company that's in the news? I had to Google it.

Turns out it's not a company; it's a theory, an event, and a mind-boggling economic prediction. It goes like this:

The global ability to extract oil from the Earth cheaply is about to come to an end, because we are, just now, reaching the "peak" of easily-accessible oil (following from a 1950's theory that oil extraction follows a bell curve, with time moving left to right). It's a downhill slope from here, and this means we are entering an era of permanently-increasing energy costs. And not just a casual increase, because our entire fiscal system assumes that energy will continue to be cheap, and once the masses in the marketplace figure out it is not, including the folks in places like China who are just starting to demand serious quantities of oil from the world market, there will be a harsh spike in prices driven by panic. Whereas today a barrel of crude oil is about $60, by 2010 the Peak Oil people predict at least $100, possibly closer to $200. A gallon of gas may shoot up to $7 in the next couple of years.

The problem, when this happens, will not just be a recession, but a severe and sudden recession in which it will be too expensive to invest in the research and implementation of a wide-scale infrastructure for alternative energy sources: it will be too late to swap in another "fix" for our oil addiction, because such would take trillions of dollars and decades of enormous capital-investment projects (think of retrofitting 200 million automobiles, for starters). Oil has an extraordinary high output of energy relative to its volume and transportability, and there is no comparable energy-source like it to be extracted from the Earth or invented, barring a miracle. Since our civilization is super-dependent on oil (transportation, manufacturing ... actually just about every human activity and product in a first-world country has essential dependencies on oil), once oil becomes extremely expensive, things will start to seriously unravel -- and the "invisible hand" of capitalism won't have time to react. The ultimate prediction? A Super-Depression in which hundreds of millions will die to starvation, disease, and relentless "oil wars". As one book's title puts it: The party is over. So how are you at working a plough?

As crazy as all this sounds, the actual article I read yesterday morning can seem pretty convincing. By the time I was done, I was wondering if I shouldn't be selling all non-tangible investments to prepare for "the end of civilization as we know it"! Read the article, it is fairly brilliantly argued so as to (seemingly) smash every possible counter-argument you can imagine three times over. At the end is a quick note that "if you're feeling a bit terrified or shocked, please realize that feelings of anxiety, depression, etc. are pretty much par-for-the-course when it comes to learning about this."

For two hours I stewed on it, feeling a bit terrified and shocked, and I kept searching and reading. There have been several popular books written about it in the last few years, and many very intelligent people believe it. Apparently even people as intelligent as the father of XML, Mr. Bray. I wondered: How is Amy going to take the news that our kids are going to grow up in the post-petroleum apocalypse?

One rule about the Internet is: for every opinion you find, you can find its opposite in less than 10 seconds. So I started searching for things like "peak oil debunked". And not surprisingly this whole topic has been argued about a lot recently, and there are dozens of typical arguments coming from both sides, everything from "there's never going to be a shortage of oil, because the Earth naturally manufactures oil without using biomatter!" to "nuclear power doesn't scale, it won't help us!" A typical exchange is:

Person A: The "peak oil" catastrophe was originally predicted for the 70's. Guess what, it didn't happen. Now the hoax-sters are just revising their dates to next year -- this is typical of doomsayers.

Person B: Actually the prediction for the 70's was that oil extraction would peak in US oil fields -- and it did. An "oil shock" did occur in the US in the 70's, but we were able to recover by transferring to other sources of oil outside of the US. The difference now is that in about 2008, oil extraction will peak globally -- so there will be nowhere to run. And civilization will be toast.

All the different arguments can actually be pretty confusing, because they often dip into historic or technological or scientific claims that would be difficult (or impossible) for the lay person to research and verify.

The most helpful discussion I've come across is in the comments section of a blog posted on Freakonomics, and I think the best comment is this one, that starts "Let's clear up a couple of misunderstandings...".

Finally, by the end of the day, I figured it out. No need to invest in rooftop solar cells, or to fill the basement with canned food and firearms, or to inform Amy that our lives are essentially over. The fundamental flaw of the Peak Oil prediction is its fundamental premise: that oil prices will soar quickly and irrevocably. Economics 101 (if taught by a really good professor) says otherwise.

Here is the relevant assertion in "Life After the Oil Crash":

[By 2020,] worldwide demand for oil will outpace worldwide production of oil by a significant margin....

I don't claim this is wrong, I claim it is meaningless.

Supply equals demand -- that is the essence of Say's Law. Demand can only "outpace" supply at a certain theoretical price. For example, there is no supply for my desire to buy gasoline at a penny a gallon -- so at that theoretical price, my demand exceeds the supply. But that's a hypothetical. In the market, demand and supply always meet at the market price, because they define the market price (so long as the price is not artificially held low or high, as governments unfortunately like to do).

Given Say's Law, even if the global supply of oil starts shrinking, the price will rise concurrently -- and that will immediately initiate all sorts of reactions, like: reduced end-user consumption, increased investment in more expensive but more effective modes of oil extraction, increased investment in alternative energy sources, increased investment in efficiency R&D, etc. -- all of which constitute and cause reduced demand, for which reason the price cannot go into the stratosphere and stay there. So to imagine a steep and irrevocable price increase is to forget the intractable counterbalance forces of the market.

Furthermore, prices don't just adjust after the fact of an event, they adjust based on the total knowledge and predictive power in the brains of millions of investors. If the price of oil is going to triple or more in the next five years, then the people buying futures of oil at around the current price of oil must be incredibly stupid or ignorant compared to the authors of the Peak Oil books.

Another way of looking at this: if the rate of oil production is not going to suddenly drop precipitously (and no one is claiming that it will), why would everyone panic and drive the price into the stratosphere? From every angle, the Peak Oil prediction depends on the notion that humans are unable to make the kind of rational judgments which they in fact make everyday.

Once the notion of a quickly and irrevocably soaring oil price is rejected, absolutely nothing else in the Peak Oil prediction survives -- whew! -- because there would be money and time for mankind to plan and react if oil extraction were to slow down because of technological limits. This is not speculation, this is already how markets work every single day. In fact we can already see it acting in the upsurge in demand for hybrid cars -- even when it is arguably too soon to make such a purchase based on the current low price of oil: many people will not see a net savings by buying a hybrid now instead of a regular Honda Civic, due to the extra thousands of dollars that a hybrid costs up-front.

Update: "The price of oil fell to its lowest level in two months on Wednesday as evidence builds that the high cost of gasoline and other fuels is sapping demand." - Reuters


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