Oil depletion and economic instability

[GliderGuider]

It is an assumption of the Peak Oil crowd that a decline in the oil supply will lead to economic instability, possibly on a global scale. This conclusion is rarely supported beyond a first-principles feeling that "oil is in everything" or "oil is the primary driver of economic growth". As a counter to this, economists typically point out that the energy intensity of the GDP, particularly in the West, has fallen dramatically since the 1970s, and (ceteris paribus of course ) should continue to do so in the future. A recent Peak Oil book by David Strahan called The Last Oil Shock (which I cannot recommend highly enough) contains a pointer to the analysis that supports the worriers and discredits the standard economists' position. I'll paraphrase the ideas here.

The standard economist's position has been based on a theory developed by Robert Solow in 1956. In Solow's analysis economic growth was driven by two factors, capital and labour, both of which were quantified financially. 70% of the money flow in the world goes to labour as salaries, 30% goes to capital as rent, dividends etc. Solow used some equations called Cobb-Douglas equations to map the growth function of an economy as labour and capital increased. He got nice curves, but when he tested his theory using historical data he found that it under-predicted the observed economic growth by two thirds. In other words, economies grew three times as fast as his theory predicted. The discrepancy was never explained (or even much discussed for that matter) but Solow got a Nobel prize anyway.

Two physicists, Reiner Kummel and Robert Ayres, independently observed the global economic slowdown following the oil shocks of the 70s and 80s and wondered if the role of energy in the economy was being under-valued. Their analysis convinced them that the price of oil (which was used by Solow in his analysis) underestimated the productive contribution of oil by a factor of ten. In other words, to truly reflect the contribution of oil to the economy, it should be priced about ten times higher. They developed their own economic model that started from Solow's work but incorporated their findings about oil's productive contribution, and found that their predictions matched observed economic growth perfectly. In other words, for the role of oil to be properly reflected in a purely financial economic model, it would have to be priced at over $300 per barrel (they did their analysis when oil prices were much lower than they are now).

It looks as though economic growth is actually being driven by four factors, the most important of which is energy supply. The other three are energy efficiency, capital and labour. If any of the four increase an economy will grow, but energy supply has by far the largest influence.

What does this imply for a post-peak world? Well, the models by Kummel and Ayres predict that for every 1% increase in energy inputs you get about a 0.7% increase in GDP on average. The immediate implication is that a reduction of 1% in energy will cause a corresponding 0.7% drop in GDP. So if the the world's oil supply were to decline by 30% (as would happen in ten years of a 4% annual decline), the global GDP would lose 23% of its value.

Of course, this is a linear extrapolation, and doesn't take into account such things as the effects of investor psychology in the context of a declining global economy. The realization that the economy is in permanent decline will have a dramatic impact on investors' willingness to fund capital, thereby worsening a bad situation by reversing another of the four crucial growth factors. In addition, there is much speculation that a third of these factors, energy efficiency, may not be able to keep growing because efficiency improvements are asymptotic and we have already picked much of the low-hanging fruit. That leaves labour, of which there is likely to be a growing under-utilized pool.

Much of the mitigation of this scenario depends on alternative energy now. Kummel and Ayres' work did not differentiate between types or uses of energy, so a growth in non-fossil energy supply will help somewhat. We need to keep in mind, however, that the proposed replacements have much lower net energy (EROEI) than oil, natural gas and coal. That means that more of the economic growth they provide will stay within their sectors of production, and less will be available for making refrigerators, televisions, tractors or combines.

Then there is the ever-present problem of scale. Replacing that 30% drop in oil production with ethanol (which only contains two thirds of the energy of oil) would require the net production of just over half a trillion gallons of ethanol per year. When you factor in the net energy consideration mentioned above, you end up with a gross production requirement on the order of one and a half trillion gallons of ethanol per year. That's more ethanol than the oil we are currently producing, just to replace 30% of that oil.

We are in a lot of trouble, people.

[phantom power]

1. The witching hour begins when people really *internalize* a future of recession.

So much of our economy is predicated on basic faith in the economy. Specifically, that it will (on average) grow over time. More capital, more investment, more consumers, more producers, more resources....

Having grown up as a fish in that water, it's hard to imagine what a world looks like where the accepted wisdom is exactly the reverse. The closest thing I can come up with is the Dark Ages, when the dominating religeous philosophy seemed to be predicated on the idea that the world was in a continual state of falling from grace. The past was the golden age, never the future.

[GliderGuider]

2. Dark Age Ahead

Jane Jacobs warned us
http://en.wikipedia.org/wiki/Dark_Age_Ahead

But in her warning she describes five pillars of civilization whose principles can be managed to mitigate the slide.

[phantom power]

3. Yeah. We could call it.... The Foundation.

just with less psychohistory, and a lot more chaos.

[razzleberry]

4. the author is misinformed

paragraph five seems to imply,
that all energy comes from oil.
that is certainly not true.

just my opinion, but,
I think that electricity is more
important to an economy's well being,
that oil.

in the US, very little electricity
comes from oil.

IMO, in the US, half of the use of oil for transpotation
is essentially frivolous, ie, 90% of jet travel,
half of car travel, gotta have it tomorrow-delivery-service,
etc.

the same can't be said for poor counties,
elecricity comes from oil.
stoves are fueled by kerosene.
rail service is primitive, everything travels by road-truck.

guess who gets clobbered when the price
of oil goes up?

[Javaman]

5. Here's a good read for you...

http://www.energybulletin.net/29919.html

[The2ndWheel]

6. "is essentially frivolous"

Well yeah, if something cheap, you can just easily throw it out the window and get a new one. The cheaper energy is, the more frivolous our daily actions will become.

[GliderGuider]

7. Globally, about 88% of all energy comes from fossil fuels

We all know the oil peak is here. Those of us who have been paying attention know that disruptions to the natural gas supply are not far off. And as Javaman has reminded us, even King Coal is going to have its troubles sooner than we thought. That leaves nuclear and hydro to pick up the slack.

FYI, in 2006, 36% of the world's primary energy came from oil, 24% from NG, and 28% from coal. That's 88% of the world's energy needs that are at moderate to severe risk of decline in the next decade and a half. If you don't think that will have an impact on the global economy, you're dreaming in Technicolor. The USA may fare better than some other countries because of the large amount of discretionary consumption, but the world's national economies do not exist in isolation.

I know you don't like the idea of declines in energy, economies, civilization and ultimately population, but Mother Nature really doesn't care. In this game my bets are all riding on Gaia.