Why “Peak Oil” isn’t what really worries me

To flog a dead horse, here’s another post on oil depletion. This one is a few thoughts, mostly rebuttals to some points that have arisen about the validity of the argument around “Peak Oil” — that we’re a few years away from the greatest oil production we’ll ever see, and it’s downhill from there.

This post follows from my post on Price Elasticity of Oil, as well as this post on blogwaffe, and a whole collection of excellent, but scary, posts on Ted Brenner’s blog.

One of the more common replies to Peak Oil concerns is that oil production is not merely a function of how much oil there is in the ground, but rather a raft of other factors — such as the price of oil (determing what deposits are economical to drill), technology, investment in expanding existing fields, and political stability. I have two points here: the problems of keeping up with demand, and what higher prices mean.

Keeping up with demand

In my opinion, Peak Oil is not our immediate problem. If only it were. Rather, the problems will start when supply growth can no longer match demand growth. Oil demand is growing rapidly, at both ends of the wealth spectrum. US oil consumption is still growing, while that of China is growing even faster. And I can’t see a way that this fact can change.

Per person, first world citizens use a number of times the oil of the bulk of the world’s population. Thus as places like China, and perhaps soon India, approach first world living standards, their oil consumption is going to dramatically increase. Developing countries around the world, especially China, are doing particularly well at the moment, so this is going to drive global demand growth for many years to come.

What could cause demand not to grow? Either getting richer will have to happen without increased oil demand, or getting richer itself will have to stop. Now the US is more oil efficient than China per dollar of GDP — but only by a factor of 2. This efficiency gain, if realised in its entirety, would slow China’s demand growth for only a few years. Is further efficiency possible? Absolutely — blogwaffe is full of good ideas. But are the people who matter interested? No.

The other option is stopping the process of getting richer. Note that this implies stopping GDP growth in the US too — but the effect is even greater for the developing world. In effect, it would mean the developed world saying to the developing world, “There’s not enough oil for all of us to be as rich as we are, so in order for us to stay rich, you’ll have to stay poor”. Besides being almost unenforceable in today’s global economy, this would probably lead to widespread war.

So demand growth is going to continue for the forseeable future. Thus we don’t need to maintain supply, we need to be continuously increasing supply. Thus if, for example, one claims that using the Canadian shale oil will in a few years/decades replace, say, Russian oil (which has smallish reserves), then one has to show that Canadian shale oil can produce a lot MORE than Russian oil has up to now. It’s not a case of finding reserves to replace exhausted fields, we need to be finding more and/or bigger reserves than ever before, all the time.

Facts on the ground show that the rate of discovery is, if anything, decreasing. But the point is that anything less than continuously increasing is not enough.

The Effect of Higher Prices

Yes, higher oil prices will lead to new oil sources being exploited. But this isn’t that helpful, for two reasons I can think of:

1. If oil prices are rising due to supply exhaustion, then because of continous growth in demand, we need new sources of supply immediately. New technologies and fields need a long time to come on line. The only way to make demand growth stop while we wait, is for prices to rise so high that global GDP growth stops — so this is what will happen (note that this relies on oil having a low price elasticity of demand). Such a price rise is disasterous, for the reasons below. We are not seeing much speculative investment in oil supply at higher prices, so this supply lag seems to be real problem.
2. Again, rising demand implies that the new sources that become available at higher prices need to be bigger than our current oil sources. And this needs to be true at every future price level. This doesn’t seem to be the case — Saudi Arabia’s huge oil reserves are already all available at the current price, for example.

More to the point is the economic effects of higher oil prices — because it isn’t just a simple overall slowing in growth rates. The oil industry constitutes a significant proportion of the world’s GDP. This is a rough indication of the proportion of the human race’s resources — labour, capital, research, risk mitigation insurance (explaining the instability premium in the current oil price), etc. — that are spent on oil extraction. Increased oil price results from a greater proportion of humanity’s resources being dedicated to oil extraction, and so less to other things. This leads to a drop in production of other products, and a corresponding drop in human welfare.

Different products leverage the oil price to differing degrees. Food, transport and energy are obviously highly dependent on the oil price, while the market price of CDs or movies depends on it very little. The people who experience the drop in welfare the greatest are those who spend the greatest amount of their income on products highly dependent on the oil price. This will be the poor of the world, who spend most of their money on food, transport and energy.

Oil price rises are thus a moral tragedy for the poor. But even worse, this means that the largest energy consumers, namely the rich, will “feel the pinch” comparatively later, and so will not reduce their oil demand till prices rise much higher. The poor will be starving long before drastically higher petrol prices stop the sale of SUVs.

So what does this mean?

I’ve argued that Peak Oil isn’t the immediate problem. Rather, we need to worry about supply growth slowing. Relying on new sources of oil to be found or become available at somewhat higher prices won’t help, as the rate of discovery needs to be constantly increasing — something it isn’t doing. Also, the time lag for supply to catch the endlessly growing demand will mean disaster already, and anyway price rises have the wrong demand-side effects, by hurting the poor rather than the largest consumers.

The only way out, seems to me to be:

1. Immediate, serious efforts to reduce oil consumption. This means energy efficiency drives such as raising the price of petrol in the rest of the world to Europe’s level, through taxation. Rather a gradual increase, allowing market forces to alleviate some of the suffering, than a sudden collapse when oil price inelasticity catches up with us.
2. Massive investment in alternatives to oil in the short term, such as biologically-derived plastics or fertilisers, or even bio-diesel.
3. Massive investment in long-term power alternatives, particularly fusion.
4. Stop gambling — even if you happen to believe we’ll keep finding ever larger amounts of oil, our civilisation is a lot to gamble! The Easter Islanders chopped down all their trees, and then starved when they couldn’t build canoes. Our situation is not too dissimilar.

In the end, it may be a race to see whether we develop fusion first, or whether the supply curve finally drops below the demand curve first. The result is somewhat important.