21 June 2006George Orwel
I have often been reminded of a Chinese saying that basically translates into something like this: Long is not forever. In other words, everything comes to an end; it doesn't matter how long it takes. I've been covering the oil industry for a long time and I often talk with many economists about the status of the market. They are a very optimistic lot. That's good because they deal with issues of wealth creation, except that when they let unreasonable optimism color their thinking in such a sway that their only concern is the short-term financial benefit, they run the risk of losing their credibility.
I say that because something new is happening in the modern world. For a long time, we've been used to classical economics championed by the likes of Milton Friedman. But there is a new breed of what one might call renegade economists whose focus is not based merely on competition alone, but also on community good. These economists, just like scientists, are now debating the consequences of a world with reduced petroleum supplies. They are asking, "Why can't we start preparing for the time when we probably won't have it?" Like geologists who are now calling our attention to an oil peak, these skeptics think the oil industry is taking itself for a ride by being overly optimistic that natural resources will stay abundant. Very soon, we shall see a shift in mainstream economic thinking from unbridled, red-hot free markets to something grayish.
Which brings us to the debate about peak oil. Let's just assume that world oil production peaks in about 15 years. What will that mean to us, in concrete terms? It won't mean we'll run out of oil right away. It only means that net oil availability will decline at an annual rate of about 2 percent thereafter, and we should expect that supply will be down by 20 percent by about 2035, when world population will be doubled, along with fuel consumption. This is still speculative and things might turn out differently, including development of new technologies that would make life a little easier, but it's going to a huge problem. It's safe to say that the general progression of events points to a scary future.
In the last two years we have already seen a preview of this movie, in the form of oil supply not being able to keep up with demand. The result has been high fuel prices and a dent in the economy and in consumer confidence. It's important to remember that current high fuel costs aren't bad compared to what we should expect in the future. It will be a crisis when supply is so drastically reduced that it won't matter whether you have the money to pay for the fuel. As anyone knows, when money loses meaning because there's nothing you can buy with it, what you are left with is primordial existence.
It's going to be tough to deal with the impact on transportation, health, agriculture, and other development issues. In the event of a general power outage, think of what would become of our metropolitan subways, our hospitals, our farms, our offices, and our houses. Our economy depends so much on fossil fuel that a lack of oil without any alternative fuel sources would lead not only to a virtual crash of the economy but to total chaos. As James Howard Kunstler points out in his book, "The Long Emergency: Surviving the Converging Catastrophes of the Twenty-First Century," the U.S. economy has gradually evolved from the use of solar energy to the artificial patterns of living subsidized by cheap fossil fuel.
I'm typically an optimist and my view is that living off oil may not be as artificial as Kunstler puts it, but I have to appreciate his central point. He says that we depend on computers for work, for learning, and for shopping. That we are used to microwaving our food and using gas to cook is not in doubt. The systems we have developed in the West, he argues -- systems that are supposed to improve efficiency -- can't survive without some kind of energy, mostly fossil fuel energy.
Others have also noted that the financial boom of the early to mid-1920s was spurred by oil. The economy was propelled by automobiles as well as by the first great wave of suburban expansion. Both generated enormous business activity in other sectors, from real estate to manufacturing. Some 8 percent of American households had electricity in 1907, and that number jumped to 35 percent by 1920. Car production rose from 45,000 units in 1907 to 3.5 million in 1923. Most important, the United States met its own oil needs from domestic production. The fact that oil was cheaply available here in the United States saved us a ton of money, which we invested in Wall Street.
But that oil boom also meant trouble for the farm economy, which got neglected as we moved toward industrialization during the mid-20th century, with exports of manufacturing goods to Europe just as the Second World War got under way. U.S. farms, which had done well by exporting grains to Europe during the First World War, began to hurt in the 1930s as mechanization led to an oversupply of farm products such as grains. Grain prices crashed, and the financial depression of the early 1930s gave way to farm depression later in that decade. The system we had depended on collapsed during the Great Depression. Some think the current scarcity of energy sources could push our economy toward a similar situation.
Up until now, we haven't started thinking of what we can do to keep these systems running in the event that we run out of fossil fuels. In Kunstler's view, the reason we haven't invested in alternative fuels is simple: we have left the decision to neoclassical economists who don't think a crisis is looming. The result, he says, is that our economy will stop growing at some point in the near future. In the past two years, high energy costs have cut growth by a small percentage, lowered consumer confidence, and impacted earnings of both the auto makers and airlines. When the U.S. economy takes a major hit, we are likely to feel it -- not only in our pocketbooks, but also in the social structures we have built -- because of the potential collapse of services.
Change isn't going to happen overnight. The automobile industry is one of the most energy-intensive modes of transportation ever created. Car ownership in the United States, at 217 million, is the highest in the world. Because of urban sprawl in the south and west, in places such as California and Arizona, we have a social dependency on car transportation. The highway system, which was built in the 1950s, has only encouraged this urge to drive in a huge car alone. Millions of gallons of gasoline are being used in the process. In the decades ahead, there may be no need to build more highways because there won't be many cars to use them. We might be well advised to start moving toward a mass transit system even in cities that currently don't have one. The reason is simple: the need to conserve fuel is becoming greater by the year.
A study several years ago by Randall G. Holcombe of Auburn University in Alabama shows that the automobile industry would sustain by far the most significant damage in the event of an oil shock, due to either an embargo by producers or other supply shortages. Also, a large part of the economic damage is from a decline in the demand for output rather than as a direct consequence of reduced petroleum supplies. Holcombe considers this significant for two related policy reasons. First, it implies that even if policy makers could replace all of the embargoed oil, major economic disruptions could still result from an embargo or just from limited supply. Secondly, policies designed to minimize demand disruptions can achieve significant benefits at low cost, and should have a high priority in policy matters pertaining to embargoes. That's a powerful argument for early planning.
The above article is excerpted from Black Gold, copyright © 2006 by George Orwel. Published by Wiley; June 2006.
George Orwel is an oil analyst and senior writer for both the Oil Daily and Petroleum Intelligence Weekly. He has appeared on CNN, BBC and NPR, and written for the L.A. Times and the Christian Science Monitor, among other publications.
