A Crude Guess About The Future

Though it has an upside for the biosphere that shouldn’t be ignored, $100/barrel oil definitely isn’t much fun for our pocketbooks or the world economy. And could worse times be ahead?

When we see spikes like this, there are inevitably voices predicting stratospheric prices for crude just beyond the horizon. The basic reasoning is that oil supplies are finite (clearly, in the very big picture they are), and that world oil demand is set to skyrocket thanks in large part to the motorization of India and China (it is—see my last post.) “Peak oil” advocates maintain that at some point we are simply bound to run out of the stuff.

I’ve never been a big fan of the peak oil story. First, price signals will encourage conservation as oil gets more dear, reducing demand pressure. We’ve already come a long way on that front; in 1970, the average car on the road got about 14 mpg, and the average van, light truck or SUV about 10. Today, the averages for new cars and trucks sold are considerably more than double those figures, and things continue to move in the right direction thanks to government regulation (rising CAFE mpg standards), new technology (including but not limited to hybrids), and the fact that consumers respond to oil price increases pretty much like economists predict they should, changing purchasing, travel and location decisions in order to conserve when oil prices rise.

Much more dramatic than anything on the demand side, though, has been our stunning record at increasing supply, which has been a true testament to the power of human ingenuity.

Consider this variant on the Simon-Ehrlich wager, in which an ecologist (Ehrlich) bet an economist (Simon) that the inflation-adjusted prices of five commodities would rise in the 1980s. (All five fell, and Ehrlich lost.) This table (below) shows historical gas prices stretching back to 1919. At 25 cents per gallon in that year, I’ll grant that you’d probably give your right arm for a time machine big enough to fit you and your Toyota Tundra. (Be sure to get your influenza inoculation before you go, however.)

Source: Energy Information Administration (Mar 2005).

But in constant 2010 dollars, that 1919 price of gas was $3.14. True, at the moment we’re paying a bit more—about $3.96. However, keep in mind that in 1919 there were 7.58 million motor vehicles on America’s roads. Today, Americans own about 254 million vehicles. That means that gas prices have risen 26 percent since 1919, while US vehicle ownership has risen 3,250 percent. And those vehicles are being driven more intensively than their 1919 counterparts. We now drive 6,800 percent more miles per year than in 1919, while gas prices have stayed pretty much stable.

Much as I’d love to, it’s beyond my power to conduct a séance and call up the spirits of oil executives and petroleum engineers from 1919. (Besides, if I could raise the dead I’d be concentrating my efforts on Jerry Garcia.) But I bet if I could conjure up oilmen from the past, they’d tell me that thanks to the wondrous, futuristic science of 1919, most of the oil that the laws of engineering and physics would permit man to cost-effectively extract had been discovered, and that supplying 800 million vehicles worldwide would be a mathematical and physical impossibility, by orders of magnitude.

As they say in the investment biz, past performance is no guarantee of future returns. But to this point man has managed to keep up with the demand curve, and just as it’s a certainty that the world’s oil supply is limited, it’s also a certainty that human creativity is limitless.


G Pendergast

The best way to end a time of high oil prices is to let the oil guys produce. We respond to bigger paychecks just like everyone else.

It also would be nice for the govenment to let us keep some of the money we make.

Nosybear

a) The oil companies are producing as fast as they can. They are also responding to bigger paychecks, hence the desire to drill through two miles of rock one mile underwater.
b) If you're not keeping some of the money you make, you need a better accountant.

polvos

If there's certainty about the limitless of human creativity, why didn't the Romans invent steam power when they ran out of slaves?

caleb b

One issue with fuel efficiency is weight. Simply making the car lighter increases fuel efficiency. However, a car made too light becomes a safety hazard. Car manufacturers need to balance government fuel-efficiency requirements with government safety standards.

James

No, it doesn't. In fact, lighter cars would increase safety. The problem is the false perception that big & heavy = safe, which causes many people to buy the biggest, heaviest car they can afford.

Jack

OK so ingenuity and huge drilling rigs mean we have access to more and more oil but at what cost? The more oil you burn extracting each barrel the higher the cost? As extraction energy increases price must increase exponentially.

Nosybear

I'm sorry, Eric, human ingenuity is only limitless to one who believes we always act perfectly rationally on perfect information. We can't change the laws of physics (required to extract the oil) or the amount of oil left in the ground. Those of us who deal with the real world are bracing ourselves for the day when demand outpaces supply, not relying on some metaphysical force to ensure our supply and demand of oil are always perfectly balanced. If in your article you are maintaining there will not be a sharp peak, I'd agree with you even though experience when we had our local "peak oil" would not bear us out but if you're arguing that supply will always exceed demand, your arguments are about as believable as homo economicus.

Geoff

A valid case can be made that gas remains cheaper than most times in the past. In the 1950's you could purchase gas for around 18 - 25 cents per gallon.

Converting real money (a couple silver dimes) to its modern value and you get about $5/gallon (0.072 troy ounce * $35/ounce). No one in America is paying that quite yet.

Dan

That graph confirms something that I began to suspect when reading of all things, On The Road. For those who don't know, the novel takes place in the late 40's early 50's. In it the narrator makes numerous cross country trips, usually with the help of a car pooling service. Each time the narrator points out that this was specifically for the purpose of saving money on gas. This struck as surprising as I had never heard of people forming temporary carpools like this. It occurred to me that gas may have been comparatively expensive back then, which it seems that it was.

Paul Zander

To say more fuel-efficient vehicles reduce overall "demand pressure" for gas (and, so, oil) is true -- but won't a continuing rise in total numbers of vehicles affect that reduction, and if so, how? (I don't have any data or numbers here; just curious...)

Jason Z

Interesting post, but I believe you misrepresented Peak Oil - it does not entail running out of oil, as its name implies, it entails worldwide oil production peaking, and then declining thereafter. The fact is that new production from deep water, tar sands, etc. is significantly more expensive to produce than conventional oil. In fact, conventional oil production is already declining - check the EIA website. As you say, as oil and its products get more expensive demand declines, but that is exactly the point. The increasing cost of oil is fundamentally driven by a struggle for oil production to keep up with oil demand.

Moreover, just because it was possibly to increase supply of commodities in the past (Simon vs. Ehrlich) does not mean it will be possible to increase supply of commodities in the future, or find suitable substitutes. That's like saying Russian Roulette is a fun game for the whole family because the gun never went off yet.

Rather, the limitless creativity you refer to, sometimes dismissed as "happy talk," may actually manifest itself as a realization that the finite is not infinite - particularly with energy. It's my hop that this creativity is applied to ensure enough energy and resources while using them more wisely.

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CraigW

Your statement "But to this point man has managed to keep up with the demand curve," is unsupported and false.

In 2002, nine short years ago, oil was at $16 / barrel. Today oil is 6x that price, while supply is nearly flat. This is because demand continues to increase and supply is essentially inelastic to 6-fold price increases. "Man" has not been able to keep up with demand for years despite plenty of economic motivation.

If this trend continued, oil would be $600 / barrel in 9 years. This is a logical, rational (and oversimplified) economic model consistent with the data. Any economic model that didn't predict a stable $100/barrel oil for 2011 should be looked upon with scepticism and analyzed for "normalcy bias".

What does your model say oil should be now? $20 per barrel? And in nine years? Are you keeping supply flat, or increasing it due to some magic that $100 per barrel has yet to deliver?

Before you attempt to predict the future, make sure you can at least accuractely characterize the past 9 years of supply and demand. Only then can you float a credible economic model that first fits the historical data, and possibly gives some insight into the economic future. The current artcle seems more about the powers of "limitless human creativity" somehow breaking the laws of physics to manifest cheap, abundant oil -- not a area of analysis I expect to read about in Freakonomics.

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GraffitiGrammarian

This was an interesting, take, Eric, but oil is actually just a subset of natural resources that humans are currently running out of.

The phenomenon is called "overshoot" and refers to the fact that we've got too many people consuming at too high a level to be able to sustain the natural systems that support human econmies, and life in general.

So it's not just "peak oil" that we need to be thinking about. It's peak water, peak eco-diversity, peak climate capacity to absorb CO2, peak topsoil for agriculture, peak rare earth minerals for tech gadgets, and on and on.

I'd like to read your thoughts in a future essay on the economic meaning of this overshoot. I can suggest one really good book to get you started: Paul Hawkins's The Ecology of Commerce.

Hawkins (who was one of the founding partners of garden-tool company Smith & Hawkins) believes that business is the most effective, efficient, useful institution that humans ever created. But he is concerned that business in general is accelerating the process of overshoot in ways that we may not be able to repair.

I urge you to give the topic a look -- it will take you a level beyond the discussion of peak oil.

cheers, GG

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Bob

"...if I could raise the dead I’d be concentrating my efforts on Jerry Garcia.)" Really? This should be the start of another post in Freakonomics (or a high school essay). If you could resurrect one person in history, who would it be and why? I suppose you were trying for humor. But Jerry Garcia? As a matter of full disclosure, I own a Jerry Garcia designed tie.