2006 April 23 Sunday
Thinking About The Economics Of High Oil Prices

I just paid $3 a gallon to fill up my car and the price of oil has just hit $75 per barrel. I'm coming across all sorts of doomster survivalist writing in the effects of expensive oil:

John P. is heading for Idaho with his partner, Sultry Susuun, for some low-cost Snake River electricity and a more sustainable lifestyle, more walking, less driving. Says he: "Idaho is the place to be when the Night of the Long Knives comes. Guess you could call us energy refugees."

When the talking heads on TV prattle on about the meaning of Peak Oil, that is exactly what that term means: The cheap oil party is over, no more big fields are out there, economists of all stripes are beginning to agree. And that means $100-a-barrel oil, unemployment and the collapse of auto tourism.

The guy wants to move from sunny warmer Arizona to Idaho to survive declining oil production. Does that make sense? Maybe winds blow hard where he's moving and he expects to build a wind tower to get energy. Or maybe his imagination has taken off into full flight.

As for the writer's claim about a coming collapse in auto tourism: I do not buy it. There'll be a reduction in driving due to higher prices. But a collapse? Suppose the price of gasoline doubles to $6 a gallon. Imagine you want to drive across the United States and back again in a 6000 mile trip and you want to cruise in comfort in a large automobile. A 2006 Lincoln Town Car gets 17 mpg city and 25 mpg highway. Suppose you get only 20 mpg on the cross country highway trip. That's 300 gallons to do the 6000 mile trip. At $6 per gallon that's $1800. The car costs about $50k and depreciates each year by a lot more than $1800. Even the far more affordable but same mpg Mercury Grand Marquis depreciates by thousands of dollars in its first year of ownership. So I do not expect to see Lincoln drivers all abandon the open road should the price of oil rise to $150 or $200 per barrel.

If the Lincoln driver wanted to economize and still hit the open road in comfort then the Mercury Grand Marquis with same physical size as the Town Car comes at under $30,000 with the same mpg. The cost savings would pay for the gasoline for 10 trips back and forth across the United States.

Of course, given $6 per gallon gasoline people will respond by buying much more fuel efficient cars. A Jetta TDI diesel will get 36/41 mpg city/highway for about $22,000. Your fuel costs cross country with $6 per gallon diesel would probably fall below $1000. For a working couple with dual incomes that's quite affordable for a vacation. Hotel rooms and food during a few week trip will probably cost much more than the gasoline or diesel fuel.

You can go further up the scale in fuel efficiency with a Toyota Prius for about $22,000 and make an even cheaper cross country trip. So life lived on the open road will go on. Given $6 per gallon gasoline more car features that increase fuel efficiency will become cost justified. For example, Chrysler's Multi-Displacement System dynamically turns on and off the use of cylinders for a net gain of 10% to 20% more fuel efficiency and other car makers have similar technologies in the pipeline. So a doubling of gasoline prices will not double the cost of travel per mile at equivalent levels of comfort.

Noted oil prognosticator Jan Lundberg says expect panic buying and huge disruptions.

Global Public Media "When you say Petrocollapse, what do you mean?"

Jan Lundberg: "Petrocollapse is a term I coined to describe the effects of Peak Oil. Peak Oil in itself is a geological phenomenon that affects the market, and how we have depleted the stores of oil in the earth. But the actual process of coping with peak oil and its effects on the economy, on society -- that's a different matter than just a geological theory. So we have to look at the likely effect of the oil market on our supplies of energy and how people intend to keep living their normal lives as consumers and using so much energy.

"So if we have sudden shortage that is exacerbated by the market and people start hoarding -- which is our experience from the 1970s, when we only had a 9% shortfall in 1979 when my firm Lundberg Survey predicted the second oil shock -- I anticipate that we're going to see some very sudden, difficult times that will snowball rather rapidly. Because when prices skyrocket and it's very difficult to get fuel because everybody wants to get it right now so that it won't be more expensive or completely unavailable tomorrow, then the eventual effect of this after a few days is that people cannot get to work, and next we'll see the trucks not rolling into Walmart and Safeway.

"This is probably going to take down the whole economy, and that's because there is no Plan B, as Matthew Simmons has pointed out. When the alternative energies are not online and cannot even be implemented on the scale required, people are going to be without the usual means to get to work or attain food. And then we have to look at the other uses of oil and how we'll be impacted, and then by extension we can look at natural gas, which is a petroleum also. And the natural gas situation is comparable to oil, roughly, in terms of the supply pinch and our dependence on it."

I do not buy this argument. If the government does something stupid like in the 1970s and puts price controls on gasoline then, yes, we could have shortages and lines at pumps. But if prices are allowed to rise then any sudden spike in demand due to panic buying will be met with a spike in prices. People will learn to refrain from buying in a panic because prices will ultimately subside after panics. Panic, what panic? To really mess up our economy in response to "Peak Oil" we'd need to put Jimmy Carter back in the White House and regulate oil distribution through a federal agency. Barring such idiocy panic buying won't bring a collapse of civilization.

Matthew Simmons, a Houston oil investment banker and author of a pessimistic book about the size of Saudi oil reserves (Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy), told an Irish newspaper that peak oil production will not cause an economic collapse.

Global reserves expert Simmons also said expensive oil will not create economic collapse. He said his concern was that a shortage could be created by wasteful overuse of low-cost oil and that yesterday’s $74 a barrel high was good news.

Simmons sees high current oil prices as a needed signal that we need to get serious about increased energy efficiency and the development of alternatives. I agree.

High oil prices lower living standards. But high oil prices do not lower living standards by more than the amount of additional money we pay to buy the fuel. At 21 million barrels a day the United States would spend about $153 billion per year for oil. Quadruple that price to $80 per barrel (and we may be there soon) and the United States would spend about $613 billion per year. On an over $12 trillion per year economy the increase in fuel costs works out to about 5%. So our living standards drop by at most 5%. If the price of oil doubles again then our living standards drop by maybe 11%. But we will adjust to the high prices and gradually living standards will rise up again.

Granted that a 10% drop in living standards is not fun. But it does not rise to the level of "lets go live on a remote mountain in Idaho with lots of traps and gunshells for hunting and for keeping out Mad Max".

I doubt that a rise of oil prices to $160 per barrel is sustainable for long in any case. Such a high price would trigger the development of substitutes such as oil shale and coal-to-liquid (CTL) using variations on the Fischer-Tropsch process. The big question we face at this point is just what are the real costs for oil alternatives? For example, at what price of oil would CTL become cost competitive? What is the real cost today for CTL?

Share |      By Randall Parker at 2006 April 23 11:52 AM  Economics Energy


Comments
Dennis said at April 23, 2006 12:06 PM:

What a drag. I was rather looking forward to a post-Apocalyptic dystopia where I could finally survive by my wits and cunning alone, engaging in running highway battles with Australian neo-punks (how they were going to end up in the Pacific Norhwest, I don't know), rescuing comely lasses and scruffy waifs from marauding bands of twenty-first century Visigoths, etc.; all while re-discovering my lost humanity amid the rotting spoils of society. I even have a whole part about creating society anew; but you've wrecked that. Thanks a lot. I'm going to go find someone with a more romantic take on things.

Randall Parker said at April 23, 2006 12:22 PM:

Dennis,

I'm really sorry. I didn't realize you had that much stake in civilizational collapse.

But, look, there are other possible ways for everything to fall apart. A huge volcanic explosion would do the trick. A repeat of Tambora would get us part the way there. But even more effective, a repeat of Toba would definitely bring on Mad Max conditions.

Now, you are going to have to prepare for this. Build a huge underground secret storehouse for the coal or wood you are going use for heat to keep alive your harem of rescued comely lasses. Another secret storehouse would have the food you'll need for them. Plus, you'll want to have thousands of gallons of fuel for your vehicle to use to make the occasional mad dash to somewhere to trade with other survivalists.

Really, the big volcanic eruption is the ticket. We'll be able to deflect asteroids, what with new tech going up in satellites and ground stations in the next few years which will greatly accelerate our rate of discovery of asteroids. The next big volcanic eruption seems unstoppable by comparison. Though an asteroid still remains a possibility for Mad Max conditions.

Another possibility is a severe repeat of a mini Ice Age.

dennis said at April 23, 2006 1:35 PM:

Thanks, I feel much better.

RueHaxo said at April 23, 2006 1:42 PM:

Good point about volcanoes. In Kim Stanley Robinson's Mars Trilogy a chain of volcanoes underneath the Antarctic ice sheets erupt, melting about half of Antarctica and raising ocean levels about 7 meters. London is submerged. The whole population of Bangladesh must be evacuated. Coastal countries such as Belize and Holland disappear from the map.
As for peak oil and high oil prices, no doubt it will hurt in the short run, but in the long run it's probably the best thing that could happen to us. Encourage nuclear power and later perhaps solar power satellites for the grid. Employ CTL until fuel cells or other clean technologies become feasible for transport. Anyone sensible building a home now would employ electric heat or corn or wood pellets. It might take sacrifice, but we're survive the end of cheap oil and prosper.

Kurt said at April 23, 2006 7:17 PM:

Man, I was underemployed with essentially no income before and, even then, decided that the price of gas would have to go to the $5-6 per gallon range before it would affect my driving habits. Now, that I am making money, even $7 per gallon gas is not going to keep me down much. My wife and I visited the Oregon coast this weekend. We spent $100 on the room, $50 on the seafood dinner and, maybe, $20 on the gas. Of course, we drove a VW Jetta, which does not consume that much gas.

Also, plane travel, compared to long distance car travel, becomes more economical as oil prices increase. It was the oil "shortages" of the 70's that helped drive the sales of 747s for Boeing during the mid-70's.

Generally, the pump price of gas goes up 2.5 cents for each dollar per barrel. Oil at $80 per barrel will be about $3 per gallon at the pump. $150 per barrel oil would make $6 per gallon gasoline at the pump. At $150 per barrel, even the Fisher-Tropsch coal to gas technology is economically competitive, and we got so much coal that its price is 50% based on transportation cost.

TangoMan said at April 23, 2006 11:07 PM:

Also, plane travel, compared to long distance car travel, becomes more economical as oil prices increase.

It all depends on how many people are in the car with you. Consider that the fuel efficiency of modern airliners is about 49 miles per gallon per passenger. http://www.iata.org/whatwedo/environment/fuel_efficiency.htm

Higher oil prices are likely to lead to a host of lifestyle and business changes that stress greater efficiency of fuel usage. This reminds me of the American Geophysics Union holding a conference in San Francisco a few years ago and they had 10,000 people fly in and one of the media messages that they were pushing was the need for everyone to cut down on fuel use and greenhouse gas production. I thought that their message would go down a bit better if they had actually lived their message by having a tele-conference. Think about how many gallons of fuel were used to transport 10,000 people around the nation/globe so that they could get together to chat, and sit in on lectures.

Ann said at August 8, 2006 10:20 AM:

It is always pleasant reading how had you not began earning more you would have been more considerate of gas consumption, but since you are earning so much more $6 or $7 per gallon won't stop you from enjoying your weekend travel by car. How wonderful for you and the wife.

While I know that it is not your fault, nor your concern about the lower class who are not as fortunate as you and the wife, it is something that the little job they had they can no longer afford to get to, because gas has outpaced their salaries. In the city we have a transportation system and since I removed myself from having to give in to the greed of gas companies I will survive. I will not drive myself, if it can be avoided, as I will not allow the gas companies to take another dollar directly from me again. My car is for sale.

There will come a point in the very near future when the lower classes rise up against the upper classes/ the rich and uncaring and I pray you are viewed as one of "them".

People are choosing between food and gas and you are discussing an affordable road trip.


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