Chris Skrebowski, founder and Director of Peak Oil Consulting Ltd., adds his views on how peak oil is causing the global recession and debt crises among governments.   You can read his A Brief Economic Explanation of Peak Oil at The Oil Drum along with many thoughtful comments at the bottom of the post.

The focus of this article is to highlight the ongoing debate between geologists and economists over what exactly is “Peak Oil.”  The geologists maintain that peak oil (maximal production) is a geological imperative imposed because petroleum reserves are finite even if their exact magnitude is not, and cannot be, known.

In contrast many economists maintain high crude oil prices will resolve any sustained supply shortfalls by providing incentives to develop more expensive sources or substitutes. Economists do concede that the adaptation may be slow, uncomfortable and economically disruptive. (Daniel Yergin’s new book The Quest, makes this argument.  See the Wall Street Journal review here.)

Chris sides with the economists but takes it one step farther.  He defines peak oil as the point at which the cost of oil is so high that it starts to destroy economic growth in countries dependent on it for that growth:

The reality, I believe, is that both groups have part of the answer but that Peak Oil is, in fact, a complex but largely an economically driven phenomenon that is caused because the point is reached when: The cost of incremental supply exceeds the price economies can pay without destroying growth at a given point in time. While hard to definitively prove, there is considerable circumstantial evidence that there is an oil price economies cannot afford without severe negative impacts.

The corollary is that if oil prices fall back to and sustain levels that do not inhibit growth, then economic growth will resume, with both recoveries and downturns lagging oil price changes by 1-6 months.

The current failure of most western economies to achieve anything more than minimal growth this year (2011) is most likely because oil prices are already at levels that severely inhibit growth. Indeed, research by energy consultants Douglas-Westwood concludes that oil price spikes of the magnitude seen this year correlate one-for-one with recessions. (emphasis in original)

Chris also stresses that one of the leading causes of higher oil prices is the extra taxes imposed by Middle East governments to finance their social policies.  These costs get passed on to consumers around the world since producers of higher priced sources of oil (tar sands, heavy oil sands, deep water oil) act as price takers with Saudi Arabia effectively setting the price floor.

Governments in a number of OPEC countries and some non-OPEC producers have dramatically boosted government expenditures to reduce the risk of social upheaval leading to their being overthrown. Increased military and security expenditures feature alongside greater hand-outs and benefits to the population.Saudi Arabia dramatically illustrates this phenomenon. On the latest budget projections, Saudi needs an oil price of $90-100/b for its revenues and expenditures to balance and if it is not to run deficits and consume financial reserves. It is likely that many, if not all of the other, OPEC members have revenue/expenditure break-even oil prices comparable to those of the Saudis.

This means that, whatever the public statements, most OPEC members now require oil prices around $100/barrel to balance their books and will seek to secure higher prices by restraining supply if necessary. However, under sufficient economic pressure oil prices would fall with severe impacts on Opec budgets.

As Saudi Arabia is the only oil producer with significant reported spare capacity, its policies effectively set the world selling price for oil. All other suppliers are effectively price-takers and will sell at the highest price available to them. Producers other than Saudi Arabia have the negative power to drive prices higher by reducing production but there are few, if any, prepared to forgo current income in the hope of greater income at a later date. (emphasis in original)

Currently crude oil is trading in an $80-$110 per barrel range which appears to be the effective incremental supply curve.   This curve is gradually being pushed higher by the depletion of low-cost, easily exploitable oil and its replacement by less accessible and higher-cost oil. Barring a major global depression, prices will continue to move slowly upward. This is bound to ensure slow or stagnant economic growth in the advanced economies unless and until they can find lower priced energy alternatives to replace oil as well as adapt to more efficient transportation fuels and technologies combined with social and organizational changes.

Chris suggests that Europe and the US can only grow when the price of oil is below $90 per barrel (which is below OPEC’s $100 requirement).  China is able to withstand a higher price, say about $100 to $110.  Which raises an interesting question:

Would this higher price tolerance mean developing economies could keep developed economies in growthless stagnation by paying oil prices that were just above those that bring developed economies to an economic halt? (emphasis in original)

Chris is skeptical that advanced economies will be able to respond quickly enough to stave off a decade or more of economic stagnation.  Witness the impact on Western economies of the 1973 and 1979 oil crises.  Japan never did fully recover from these crises.

These factors lead him to conclude that sometime in the 2014-2015 period the advanced economies will reach peak oil and sustained economic growth will become impossible.  With transportation consuming 70% to 75% of crude oil supply (85% in the US), there is limited scope to substitute alternative energy in the transportation sector in such a short period of time.

The radical change – moving to electrical power – is not yet fully economic and is really only applicable to surface transport. Biofuels are being actively promoted but are really only fuel extenders. In addition the food or fuel challenge has not been fully resolved. The so-called second and third generation biofuels solve the food/fuel dilemma but are not yet economic. The use of natural gas for transport in places like Pakistan, India, Brazil, Iran and other emerging economies is becoming fairly widespread. However, in all economies, any transition takes significant time and investment.

In short the ability to substitute oil-derived transport fuels, other than in the longer term, is quite limited while transport demand is growing strongly, particularly in Asia, Africa and South America. In addition there is an existing global fleet of over 800 million vehicles that run on gasoline and diesel

The upshot is, according to this author, that unless the advanced economies are able to rapidly adapt to upward trending oil prices, the result will be periodic economic recessions that depress oil consumption and oil prices.  These then have the effect of shifting consumption towards the developing economies and their rising consumer classes.








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