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Peak-Oil Economics Unscrambled [Carbonomics, Ch. 3]

December 29th, 2006 by Steven Stoft, Berkeley

History shows that the world economy did not collapse when oil supply peaked sharply in 1979, so where have the peak-oil geologists gone wrong in their thinking?

[They were too much influenced by Mad Max movies.] Starting in 1979, the Mad Max film trilogy painted a bleak and violent picture of a world plagued by oil shortages that cause a nuclear war. Since then, predictions of a similarly grim economic future have become attached to peak-oil theory.

Peak-oil’s Mad Max economics assumes markets work like this:

The demand for oil increases as wealth and population increase. The supply of oil will fall after peak oil. Therefore supply will not meet demand, and a crisis will destroy the world economy.

However, that is confused economics. Basic economics predicts that unless the government interferes, markets will work like this: The demand for oil increases as wealth and population increase. The supply of oil will fall after peak oil. Falling supply will cause the price to rise, and that will cause people to use less. Demand for oil will fall until it equals supply.

That is what happened in the early 1980s. Deffeyes, the Princeton geologist, knows both theories and explains in his book Beyond Oil why he thinks basic economics is wrong. “For the first time since the Industrial Revolution,” he begins, “the geological supply of an essential resource will not meet the demand.”

This is partly right. Markets have worked for all essential resources. But Deffeyes is worried that the law of supply and demand is about to break down for the first time in 250 years. Other peak-oil proponents blame this breakdown on markets, but Deffeyes, remembers the real reason: “Virtually all economists visualize it as price increases that bring supply and demand into a new equilibrium.” Exactly. By equilibrium he just means supply equals demand. But after remembering the reason, he rejects it.

“That outlook is widespread,” Deffeyes says. “It must be something that Gerber puts in baby food.” He doesn’t believe that price will do the job. Instead, he has another theory, which he supports with two examples from history:

• “Historically, President Nixon regulated the oil price.”
• “President Roosevelt had us carrying little red and blue gasoline ration coupons.”

Deffeyes is right that, if the government intervenes, it can break the market and then demand will fail to equal supply. According to Deffeyes, this is why, after 250 years, the market for oil will break down when oil production peaks.

Deffeyes argues that the government will intervene because “when the situation gets serious, there will be immense political pressure to ‘do something.’” But Deffeyes overlooks what happened after Richard Nixon regulated the price of oil. By the end of the OPEC crisis, virtually the entire elaborate system of oil-price controls, gasoline-price controls, and quantity rationing had been eliminated. This took immense political wrangling, but eventually there was widespread agreement. The country learned something back then, and I don’t think it’s about to forget it and cause the collapse of the American economy—or the world economy. [...]

Steve Stoft

These are excerpts from chapter 3 of my forthcoming book Carbonomics.

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4 Responses to “Peak-Oil Economics Unscrambled [Carbonomics, Ch. 3]”

  1. John Busby Says:

    The passing of peak conventional oil production in 2005 led to investment in biofuels, tarsands and in gas-to-liquids (GTL) and coal-to-liquids (CTL) liquid fuel substitution processes. Unfortunately the conversion thermal efficiency of both GTL and CTL is poor, so that gas and coal production peaks will be brought forward, while the fuel produced will be expensive.

    Wether this leads to economic problems depends on the ability of societies to adjust to using around a quarter of the energy they currently consume. In the UK the seeds for this are sown in the Transition Towns initiatives and in the US in the “localisation” movement, enshrining what they call “energy descent”.

    These will lead to a restoration of community values and neighbourliness and families will enjoy having a father working at home on the Internet or digging on his allotment to feed them.

    The casualties will be the motor and aviation businesses already in decline. The problems will not be caused by the passing of peak oil, but by politicians trying to maintain an economic “status quo”. When in a hole the answer is not to dig it deeper by building airports and roads or by subsidising nuclear power destined to run out of fuel.

    It is the localisation movements that will provide the ladder out of the emerging hole.

  2. Steven Stoft Says:

    The comment above is an example of the “local communities” cult that pushes the peak-oil catastrophe “theory.” In fact, the cult’s two principal leaders, Campbell, a geologist, and Heinberg, the leading author in the US, with fraudulent credentials, both believe that about 4 billion people will be killed in the peak-oil “die-off.” (see dieoff dot org).
    As documented in my chapter, both think 4 billion dead a good thing, because it will force us back to “tribal” communities. Heinberg was writing about this “collapse” in the 1990s before he heard of peak oil. He’s an old-time commune-style cultist.
    Real geologists study peak oil. But no real economists discuss, or believe in, the economic collapse, and history shows there is overwhelming evidence against it. The collapse theory is simply a cult that disrupts people lives and accidentally helps Big Oil sell the idea of synfuel subsidies. See my chapter 3 for details.

  3. John Busby Says:

    In 1972 the Club of Rome published “The Limits to Growth” in which a 21st mid-Century die-off was warned together with measures for its avoidance. This was because of the reducing efficiency of capital due to the progressive reduction in the available concentrations of resources of which oil is but one. Its conclusions were mis-represented as predicting the end of oil in the last century, which it did not.

    The “die-off” will not be in the developed countries, which are emptying the reserves of undeveloped countries in an attempt to sustain their lifestyle. A good example of this is the substitution of biofuels for transport, competing for land needed for growing food.

    The growing Transition Towns movement in the UK is a response to the breakdown in society caused by excessive consumption and mobility, but certainly is rooted in a desire to achieve energy sustainability, taking cognisance of the passing of peak oil. Paradoxically, it is an example of the working out of economic theory and the operation of Adam Smith’s “invisible” market forces. It will avoid the economic collapse of local communities.

    Unlike Jonah in the whale, Colin Campbell would not be dismayed if his prophesies are unfulfilled; his motivation is the hope that societies can avoid the coming catastrophe.

  4. jon Says:

    There is a huge issue with your alternate economic theory. That is that you take the underpinnings of Smith’s free market for granted. The key assumption you fail to account for is that an alternate product is available (if apples cost too much, I’ll buy a pear). It also assumes rapid changes are possible and a well informed public. Oil is such a quintessential part of our existence from transport to agricultural to consumer goods, that it’s a necessity to maintain our current economic output. There is no alternate good or product to replace oil. Even as we begin to adapt, it will never be fast enough. The entire infrastructure of western society is based around the unlimited availability of oil. And the worst part is that the public is so ill informed , that they can’t even make a proper decision in the free market.

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