Scenario: News
Newspaper for 1st June 2015

Response to Freakonomics view of Peak Oil

Dr. Levitt, the author of Freakonomics, a book that looks at many aspects of life from an economists point of view, wrote a piece in his blog on Peak Oil and it received a massive, and on the whole, surprisingly well informed and polite response.  http://www.freakonomics.com/2005/08/peak-oil-welcome-to-medias-new-version.html

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What most of these doomsday scenarios have gotten wrong is the fundamental idea of economics: people respond to incentives. If the price of a good goes up, people demand less of it, the companies that make it figure out how to make more of it, and everyone tries to figure out how to produce substitutes for it. Add to that the march of technological innovation (like the green revolution, birth control, etc.). The end result: markets figure out how to deal with problems of supply and demand.
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I think his article and the responses he recieved encapsulate the current thinking on peak oil.  Comments range from: There is no problem, Alberta tar sands, abiotic oil, looking harder etc. is all it needs, to there is no alternative to oil and life as we know it is about to end.  The arguments are much better informed than even a year ago but still fail to consider the big picture, oil is tightly bound into our way of life.  We made decisions about where we live, where we work, what kind of work we do, what we eat, where we eat, what businesses to invest in all based, indirectly, on the assumption that we have and will continue to have cheap and plentiful supply or energy AND oil. 

If we look simply at individual uses for oil and not the relationships between them, we miss the real issues.  For example, Petrol becomes more expensive?  Go to biodiesel/methonol.  Fertilizers and pesticides become more expensive? go organic.  Imported food becomes expensive? buy locally.  So now there huge pressure on agricultural land to grow both food and fuel.  The market for local food has increased and farmers are selling direct to customers using the internet rather than to WalMart, need for agricultural workers has increased while long distance truck drivers and supermarket staff are being laid off.  The people living in the suburbs are commuting to work in the country rather than the town… Change one factor and it has a knock on effect on all the others and it’s this exploration of the whole system that I hope we can help with using scenario planning.

There are pages and pages of comments, here are a few:

Yes the market will respond. As Hamilton points out, the framing of this question in terms of peaks or sudden cliffs where prices shoot up instaneously is naive. However, nothing in the market-economics arguments addresses:

- the size of the dislocation (small increases in oil prices can multiply their effects as it raises costs throughout the economy)

- the time to respond. This is the big one. A rational response to a rise in oil prices involves consuming less transportation. Everyone who lives spread out in the suburbs will be hurting and, perhaps, be economically motivated to live in a denser development pattern where they can rely on human-power or public transit. However, getting to that state requires an enormous shift in investment, public and private. It’s not going to happen quickly and it’s going to cause pain.

- Speaking of pain, downturns, recessions, and depressions can all be part of a market response. While a long-view economist can interpret it all as a welcome and necessary correction, that doesn’t lessen the pain for individuals involved.

I agree that as long as cooler heads prevail, this does not mean the end of civilization, but modern civilization is built on the idea of growth. Our current system where the rich get richer will only work when there is growth in the system. This will become extremely difficult once energy becomes constrained.

peakguy said…

Dr. Levitt

I urge you not to make hasty comments about this subject without more deep analysis. Oil is not just a commodity, it is THE commodity that makes everything in our modern world possible, in particular food production and most forms of transportation.

Transitioning to all these new technologies will take a lot of oil when oil is getting scare. Additionally our economy currently depends upon cheap oil. Which means that transitioning away from oil takes a lot of capital when there will be (at least) a recession going on, multiplying the apparent cost to transition.

Gene Hoffman said…
There are two separate issues and problems here. One set is macro and one set is micro.

On the macro side, people are confusing cheap oil with cheap energy. The US economy is dependent on cheap energy. The US economy is so large and diversified that it can easily absorb a slight increase in what is the definition of cheap energy as the mix shifts away from oil simply on price. To show an anecdotal story to explain this, look at domestic transport. People point to trucks and trains as causing a huge impact on the price of consumer goods if oil prices increase substantially. However what is much more likely is that subsidized long haul trucking shifts in favor of rail lines that are more effecient and can further convert to electrical energy sources. We do face a technological challenge around batteries. Lots of alternative energy sources would be viable if we had serious improvements in our ability to store energy. The sad thing is that the best energy storage mechanism we’ve come up with is pumping water uphill. That should give you a sense of where we can make dramatic technological changes that would have a very real impact on the cost of useable energy.

On the micro front, two items are pushing current prices higher. One is simply the lower value of the dollar relative to other currencies. As the dollar recovers strength the price of oil in dollars will decrease. The second is that the Chinese economy is distorting the price of oil by placing caps on the price paid at the pump. This is an attempt to stimulate growth but is not long term sustainable. As the political-economic reality sinks in, their demand will decrease and potentially decrease at a surprising rate. Artificial price mechanisms are as brittle as folks would like to say relatively free markets are.

Clear and well illustrated view on where we are with oil and why there are no simple answers: http://cogsci.ucsd.edu/~sereno/oil05.pdf

Anon said,

Everyday I ride a bus to work on a half-empty bus and observe that almost every car that passes me has only one passenger. I would venture that the amount of gas used for commuting could be cut by 60% to 75% in the United States without enourmous effort simply by prividing sufficient price incentives to fill every existing bus and encourage people to drive into work with one or two other person in each car.

It is the difference between “end of the world” and “end of the world as we know it”

Anonymous said…
Let’s clear up a couple of misunderstandings:

First, for those criticising the OP for writing about oil when he doesn’t know much about oil specifically: Economists can do this because the information they need revolves around prices, incentives, and the response of people to them. Economists can predict the movement of prices on pork bellies without knowing anything about pig farming. They can predict demand for real estate at a given price point without having to know how houses are built. And they can predict how consumers of oil will react when the price increases, without having to understand the oil industry.

Now, assuming the market will ‘solve’ the problem supposes a couple of things: one is that alternatives to a commmodity exist, and the other is that prices reflect the true cost of a commodity and people are free actors to choose to buy or not.

In the case of oil, this is not necessarily the case. For one thing, the price is not free to move with demand, due to the OPEC cartel, local price caps and subsidies, and other market-distorting interventions. For another, the availability of substitutes for oil is still debatable. Certainly it’s possible to replace oil with alternatives, but there are legitimate questions about the rate at which this can be done and the eventual cost.

However, we can make some good inferences from currently available information. The biggest is the price of oil futures. I believe 10 year oil contracts are currently set at about 65 dollars. This almost certainly represents our best understanding of what we’re going to be paying for oil ten years from now. If some oil expert really knew that oil was about to peak, he would be buying up futures like mad and driving up the price. If he knew oil was much more abundant and that we’re in a price bubble, he’d short like mad and drive the futures price down. So the futures price in a free market is a pretty good distillation of current understanding.
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So the last question is whether or not we can move to an alternative fuel regime in a timely manner. And I believe the answer to that is yes, especially if the real problem takes a few years to appear. The current move to hybrids is important because it gives us a way to disconnect the drivetrain of a car from its fuel source. The power source for the car is electricity. How that electricity is generated doesn’t really matter. For example, it would not take much of a change at all to turn a hybrid into a ‘plug-in hybrid’. Add a little bigger battery and a charging plug, and now for short commutes (say less than 50 miles) the gas engine doesn’t even come on. You’ve just completely removed the dependency on gasoline from the car, or reduced the consumption to just a fraction of the amount you need now. Perhaps we’ll all be driving electric cars that still have gas engines, but the gas engine is really just an emergency charging device. Plug-in hybrids can get 100 mpg on average across the fleet.

You still need to generate the electricity, but we know we can do that. Nuclear power. France gets 70% of its electrical energy from nuclear. The U.S., only 20%. Roughly 175 new reactors could produce enough hydrogen to completely replace gasoline for the U.S. vehicle fleet, assuming no changes in efficiency. So it can be done, and will be if we need to.

Marty said,

The worry is that as population continues to grow and China and India modernize, all of those conservation measures will only allow us to break even on fossil fuel energy usage. Certainly, this hasn’t happened yet: last year oil usage went up 3%, natural gas went up 3.3%, and coal went up 6.3%—all in a single year). Hopefully, all the things you mention will start to happen soon. But eventually, many of us fear that when the system has had a lot of the inefficiencies wrung out of it, the SHTF anyway.

Emmanouil Rou. said…
I ‘d like just to mention that the shift from one energy form to another, especially without the pre-existed social structures would substantially hurt the personal consumption of all individuals all around the world. Why? because the 10,000$ car you bought yesterday isn’t worthy a penny today, because your house in the suburbs can’t be sold in the price it used to before and not to forget that someone has to pay to create the new infrastructure and get rid of the existing one. In a country in which almost everybody is in debt and personal consumption counts for 67% of G.D.P. the devaluations of assets (what economists like to call “the wealth effect") and even a small increace in taxes in order to pay for the new infrastructure would cause a lot of troubles.