From the Jan/Feb issue of World Watch
The economic effects of peak oil go far beyond spending more at the
You will never wake to the headline, "World Runs Out of Oil."
Rather, global oil production will rise, reach one or more peaks, and decline.
Well before production declines to very low levels, the peak will mark a point
of no return that will be a watershed in the economic history of the 21st century.
For the first time, industrial economies will be forced to a lower-quality energy
source. And this decline will affect every aspect of modern life.
The notion of a world speeding towards a peak in oil production was made famous
by the geologist M. King Hubbert. In the late 1950s and early 1960s, Hubbert
used a simple bell-shaped curve to forecast the annual rate of production in
the lower 48 U.S. states. At a time when oil production was increasing rapidly,
Hubbert forecast that it would peak in about a decade (1965-1970) and decline
thereafter. Despite provoking nearly unanimous derision, his forecast was remarkably
accurate. Oil production peaked in 1970 and declined fairly steadily thereafter.
A similar bell-shaped pattern appears in several other oil producing nations,
such as Norway, the United Kingdom, and Egypt.
Subsequent research indicates that Hubbert's forecast was part genius and part
luck. U.S. oil production is determined by the costs of production, the price
of oil, and the quantity of oil "shut in" by the Texas Railroad Commission,
which aimed to stabilize prices by opening and closing oil wells in Texas to
ensure a balance between supply and demand from the 1930s through the early
1970s. Had prices evolved over some alternative path or had the Commission controlled
production using some other criterion, Hubbert's prediction probably would have
been less accurate.
The element of luck has been overlooked by those who use Hubbert's method to
forecast the peak in global oil production. Their forecasts have consistently
erred, suggesting an imminent peak, only to be revised when production continued
to rise after the predicted date. Hubbert's methodology cannot predict the peak
in global oil production because it mistakes the price-induced slowing of oil
consumption during the 1970s and 1980s for the effects of resource depletion.
The genius in Hubbert's approach stems from a simple aspect of his bell-shaped
curve: relatively large uncertainties about recoverable oil supply have relatively
little effect on the timing of the peak. For example, updating Hubbert's analysis
through 2003 and including Alaskan production indicates that about 230 billion
barrels will be produced from fields in the United States, which is nearly 30
percent more than Hubbert's original estimate of 171 billion barrels. Despite
this increase, the timing of the peak "backcast" hardly changes. Put
simply, compared to pessimistic assessments, optimistic estimates for the amount
of oil that remains only postpone the peak slightly. Given this fact, I can
confidently state that the peak in global oil production will occur in my lifetime
(I am 48).
The peak in global oil production marks a fundamental change in supply. Prior
to the peak, production can increase significantly with little or no increase
in price. This is possible because most of the world's supply is found in a
few very large fields. For example, there are more than 14,000 oil fields in
the United States. Of these, the largest 100 contain nearly 40 percent of total
supply. Increasing production from these large fields is relatively inexpensive.
But once these large fields are depleted, they are replaced with fields that
are one-tenth or one-hundredth their size. These high-cost fields reduce the
profitability of production even at higher prices.
The importance of production costs is illustrated by the history of U.S. production.
Oil production in the lower 48 states increased more than ten-fold between 1900
and 1970, but the real price of oil barely increased. After 1970, real oil prices
doubled and then tripled. This price increase caused drilling to double. Nonetheless,
production declined nearly 20 percent. As a result, the oil and gas sector increased
its fraction of national investment without increasing its contribution to GDP
-- in effect, hundreds of billions of dollars were flushed down a dry hole.
The economic effects of the peak go beyond spending more at the pump. Because
oil readily comes from the ground and is easily refined, it generates a large
"energy surplus," which is the difference between the energy obtained
and the energy used to obtain it. The large energy surplus powers the non-energy
sectors of the economy, such that goods can be imported and exported at little
extra cost, people can live far from work, and a small fraction of the workforce
can feed those that produce the goods and services we associate with modernity.
All of this may change following the global peak in oil production. After the
peak, each barrel of oil will require more energy to extract, leaving less to
power the non-energy sectors of the economy.
No alternative fuel now being researched generates a greater surplus or can
be used more efficiently than oil. This reduction in the energy surplus differentiates
the peak in global oil production from previous energy transitions. As society
changed from wood to coal and from coal to oil, each new energy resource was
"better" than its predecessor. It could be used more efficiently and
it generated a greater surplus.
This creates an additional difficulty for the inevitable transition away from
oil. Alternative fuels can generate an energy surplus large enough to power
the U.S. and world economies, but to do so the infrastructure for the alternative
fuel needs to be larger than the current oil infrastructure. If 1 Btu (British
thermal unit) of oil could be used to extract 50 Btu of new oil from the ground
(which was the ratio at the U.S. peak), most alternatives currently produce
2-10 Btu per Btu invested. The infrastructure for such alternatives would need
to be five to twenty-five times larger than the current oil infrastructure.
The expanded infrastructure requires a timely transition. If the infrastructure
for the alternative energy source is put in place before the peak arrives, the
energy used to do so will have a relatively small impact on non-energy sectors.
Conversely, if society waits until the peak, constructing the large infrastructure
for the alternative fuel will siphon large amounts of energy from the non-energy
sectors of the economy at the very time that the total supply and energy surplus
from oil is shrinking. In short, society has to pay the costs for the transition.
We can pay them now, while we have oil in the bank, or we can pay them later,
when our oil bank account is emptying.
Economists often assure us that the competitive market will induce the needed
investments in a timely fashion. I am less sanguine. The markets' ability to
anticipate the timing of the peak and the rate of decline is limited by a lack
of transparency in the world oil market. Estimates from the Organization of
the Petroleum Exporting Countries (OPEC) of its proven reserves are a mix of
geology and politics. This uncertainty is critical because much of the oil produced
between now and the peak (and beyond) will come from OPEC. As such, the market
cannot know how much oil remains and therefore cannot cause prices to rise in
anticipation of the peak.
The market therefore needs help to ensure that the entrepreneurial spirit will
manage the transition from oil. But not the kind embodied in the Energy Policy
Act of 2005. No serious person can believe that it will help. The current bill
demonstrates that Republicans and Democrats have the same view of energy policy:
they just give tax money to different groups. Sound policy should instead establish
an economic environment that increases the economic returns and reduces the
risk to long-term research and development on alternative energies. Policy should
impose a large Btu or carbon tax on energy that is phased in over a long period,
perhaps 20 years. This would signal entrepreneurs that there will be a market
for alternative energies.
Furthermore, increases in the energy tax should be offset by reducing other
taxes, such as payroll or corporate taxes. Economic studies show that such an
approach can generate a win-win solution--reduce energy use (and the environmental
damages not paid by users), stimulate research and development on alternative
energies, and speed economic growth. Notice that the tax does not pick technologies--that
will be left to the market, which is smarter than any politician (or economist!)
Government policy aimed at the next energy transition must strive for economic
efficiency, but efficiency cannot be the sole criterion. The potential for large
impacts may force policy makers to rely heavily on the precautionary principle
(see p. 30), which compares the costs of being correct against those of being
incorrect. We know that oil production will peak within our lifetime, we are
pretty sure that market prices will not anticipate this peak, and we know that
not having alternatives in place at the time of the peak will have tremendous
economic and social consequences.
So if society does too much now to stimulate alternative energies, as opposed
to later, there will be some loss of economic efficiency. But if society does
too little now, as opposed to later, the effects could be disastrous. Under
these conditions, doing too little now in the name of economic efficiency will
appear in hindsight as rearranging deck chairs on the Titanic.
Robert K. Kaufmann is an author, a professor at the Center
for Energy & Environmental Studies at Boston University and a consultant
to the Japan National Oil Corporation, the European Central Bank, and the U.S.