26 August 2008

Oil Will NEVER Get Cheaper

The sting of higher fuel prices are probably nowhere more apparent than here in the southeast US where people drive more, earn less, and define themselves by the size of their pickup trucks and SUVs. Naturally, this distress has generated all kinds of strange theories on what’s causing these unprecedented fuel prices (actually, in constant dollar terms, we are only now returning to the elevated fuel costs of the 1970s.) Everyone from the lowly gas station attendant to Saudi oil sheik to the shadowy speculator have been a target of wrath from truck owners who have just spent $100 to fill up their tank. But what really is the cause of this increase?

The answer is simple: an unprecedented increase in global demand. Prior to the last decade, the demand for fuel—and for other resources such as metals—was more or less directly related to the economies of developed, western countries. What has changed now is that the rest of the (developing) world is catching up with us. Countries formerly behind the iron curtain and throughout much of Asia, Africa, Latin America have been held back economically for decades (by corrupt and/or incompetent governments, I would argue.) Now we are seeing economic (even if not political) liberalization across the board—you can nearly count the exceptions on one hand, and even in those countries, like Cuba and North Korea, micro-enterprises are starting to flourish. Why is this happening? Because even neo-communists like Hugo Chavez and Evo Morales recognize, at least to some extent, that freer markets are the key to economic prosperity—which, incidentally is why we shouldn’t worry so much about the leftist resurgence in South America.

The economic, regulatory, and even cultural barriers that had prevented progress over so much of the developing world have been lifting in the last two decades. This freedom, in turn, has resulted in upward mobility in the population of these countries as businesses grow and trade increases. As these people—who are the majority of the 6 billion of us here on this planet—move into a sort of middle-class (by world standards at least) they begin to demand the same kind of goods that we in the west have been used to for generations: richer food, comfortable housing with modern fixtures and appliances, and even motor vehicles. [update: see this article in February 12, 2009 The Economist]

Granted, this global “middle class” cannot be compared to America’s middle class in terms of conspicuous consumption and outright waste. In fact, nobody could reasonably expect any country, industrialized, “transitioning,” or developing, to ever approach the wasteful level of energy use of Americans. However, even if the rest of the world begins to use just one-fourth of the level of resources per capita of Americans, we are looking at an incredible amount of increase in demand for everything that is mined, manufactured, and grown.

Consider Tata Motors of India; its new $2500 “Nano” 4-seater is in the price range of this emerging, third-world middle class. This means that, theoretically, there could soon be a billion (or even billions of) new cars on this planet! Compare this to the millions of cars that are sold in the west, and you will see why I think that high fuel prices are here to stay; demand has exploded, and will continue to grow at an exponential rate—a rate that supply will have a hard time to match. I realize that fuel prices have dipped back down a little in the last few months (and SUV owners are breathing a little easier,) but I am talking long-term trends here. I have yet to see anyone demonstrate how global supply of fuel or any other natural resources—for that matter—can possibly rise as fast as worldwide demand is ramping up. [2016 Update] Do-oh, I guess that I didn't have any idea about fracking in in 2008

When you look at the potential (and likely) rise in global consumption of almost any resource now, it is downright scary! Furthermore, this surge has just begun; when it comes to gasoline, California alone still uses more gasoline than any other country beside the US (Wired article.) This year, China is poised to overtake this one state in gasoline usage, but certainly not the entire US. This is both an indictment of our (and especially California’s) car culture (China has 1.1 billion inhabitants compared to California’s 36 million,) and an alarming preview of how much more of this particular resource we will needed in the future.

What is being proposed?

Everyone is looking for a silver bullet to solve this problem. There is a widespread assumption that some breakthrough is on the horizon that will save us from having to face difficult choices, and—on the fringes—there are those that think technologies are being purposely suppressed by incumbent energy companies and even governments. Whether we are talking about ethanol, bio-diesel, hydrogen fuel cells, electric cars, solar panels, or wind power, what is consistently overlooked—or perhaps omitted—are the facts regarding the lead-time for these technologies, the energy debt they require, and the simple physics that prevent some from ever becoming an effective solution.

Regardless of how revolutionary a new energy source or method of using energy more efficiently may be, it is practically impossible for such an invention to ease our energy crunch this year, or next, or even 4 years from now. Assuming you’ve invented a widget that would make all current cars twice as efficient, and it is so simple that it requires no further research and development; it would still take years to manufacture, distribute, and install this device. (Incidentally, I trust that you already know that ALL after-market gas-saving devices out here are total scams, the only way they can work is by placebo effect—you may subconsciously drive more carefully after installing one of these devices.)

Likewise, if solar panels finally crossed that magical tipping point of economic feasibility, we simply couldn’t make them fast enough to supply our energy needs because the very manufacture, transportation, and installation of these “energy saviors” would require several times more energy than they produce in a year—not to mention the all the aluminum, steel, copper, glass, silicon, and various other esoteric (and often toxic) materials used to produce solar panels. The same goes for wind power, despite this article’s assertion that offshore wind farms could produce all of America’s current electric needs, neither the article nor any of the comments below it address the energy and natural resource requirement of such a enormous project. Please don’t misunderstand me, I am not against alternative energy; I think it’s a shame that America lags Europe in this respect—places like Germany and Denmark already produce a significant percentage of their electricity by wind and solar. All that I’m saying is that this can’t happen overnight. [Update 6-Sept-08] Just found this article that show how urban wind turbines are actually bad for the environment!

Hydrogen is being touted as the ultimate in alternative fuels for vehicles, since its only emission is water vapor. However, free hydrogen does not exist on earth; it only occurs in compounds with other elements: namely with oxygen, to form water; and with carbon to form various hydrocarbons. In order to isolate hydrogen from these compounds you have to use more energy than the hydrogen can ever produce, regardless of whether it is used in a combustion engine, fuel cell, or an entirely new, revolutionary technology. These are the laws of physics that simply can’t be broken (see this article.) Therefore, all hydrogen can ever be is a method of energy storage—just like a battery. This, in turn, would require even more clean electrical power generation than mentioned in the previous scenario in order to be a truly environmentally-friendly solution.

What can’t we do?

Obviously we cannot prevent the third world from developing. I use the word “cannot” in every sense of the word; it is nearly impossible to stop the “invisible hand” of the free market from expanding these economies, certainly any coercive action to keep the third world in its previously underdeveloped state would be unthinkably immoral, and even requiring—or just encouraging—policies that would mitigate the impacts that we have experienced in our development over the last century, seem incredibly hypocritical to third world populations that now want to “test out their new wheels!” In other words, I think we have no moral authority to prevent the third world from following the path we have already taken regardless of the economic and environmental outcomes.

What needs to be done?

Depending on your background and political biases, you likely lean towards either conservation or further development of existing supplies. Certainly everyone is for developing alternative energy sources—well except for those that feel their homes or properties will be directly or indirectly effected (interesting nutcases against wind turbines.) However, I think it is obvious that we need to do all of the above. Despite the manifestly evident need for conservation, no politician is going to propose this, since it reeks of weakness (remember Jimmy Carter’s “sweater speech”?) Thankfully, the market will take care of this…which brings me to my next point.

What will happen?

What will happen is that the market self-corrects. Naturally, as the demand for something increases, the price does as well—thereby tempering the demand while, at the same time, encouraging greater production of said resource and its substitutes (alternative energy in our case.) This is why it is so important that our leaders do nothing to distort the market. McCain and Clinton’s proposed gas tax holiday was just such a bone-headed idea: it would have softened the very necessary market signals that tell us, as consumers, to reign in our consumption and producers (including alternative energy upstarts) to ramp up production, exploration, research, and development. Likewise, incentives to produce ethanol from corn, which is horribly inefficient, has proven to be a boondoggle that nobody but Iowa corn growers benefit from.

The other option is to introduce a dizzying array of counter-balancing regulations, taxes, and subsidies: laws and incentives to force individual and industrial consumers to conserve artificially inexpensive resources plus incentives and outright subsidies to producers to increase production and develop new sources despite a price that is too low to make an economic case for such investments. These prohibitions and inducements would, of course, be gamed by all sides despite legions of bureaucrats to administer it all!

I have been planning to write and publish the post for some months now. What has happened in those intervening months seems to counter my thesis that fuel prices will remain high indefinitely. The reason that fuel prices have fallen (slightly) this summer is that demand has slumped—bringing about the concept of a “staycation” for instance, and production has risen—Canadian oil sands are now economically feasible for example. However, as I’ve said before, this is a temporary dip; the pent-up demand for fuel and other resources in the developing world will only continue to rise, negating the effect of all our conservation efforts. Furthermore, the higher cost producers require to maintain new sources such as marginal oil wells or oil sands means that we can never get back to the prices of the previous decades unless worldwide demand commensurately shrinks to that time as well, idling these more expensive resources. (Interesting CNN article about this)

We simply need to get it through our thick skulls that energy will never again be as cheap as it used to be. The recent rise in fuel prices is not an anomaly that will quickly pass; oil (and other natural resources) are indeed scarce enough to demand these prices (not to mention yet unknown cost of environmental impacts of using said resources.) We now need to reorganize our lives and communities to deal with this new reality. Ever the optimist, I actually think that—for the most part—we are learning this. For example, even the gearheads at Motor Trend are admiring compact, fuel efficient European cars.

[Update – March 2009] With gas still under $2/gallon, and no sight of a serious economic recovery in the near future (necessary for demand to rise,) one might think that I would want to retract this post. However, I stand by everything I have written here last year. I am confident that, in the long-term, I will be vindicated in saying this is just a temporary dip in the price of fuel. No one knows how long this recession will last, and even after a recovery there will be a surplus of oil that has been cached all around the world during this period of low demand. Never the less, I challenge anyone to claim the following is bad advice: “Do not allow your local car dealer to convince you that now is a good time to buy a gas-guzzling SUV or truck because gas prices are going to stay low. Within the service life of any new vehicle you buy now (let’s say around 5 years,) gas will rise back up to the $4-$5 per gallon range.”

[2016 Update] OK, I give up. I was wrong. Largely as a result of the fracking revolution, America suddenly has more oil than it needs. However, I still would not buy an SUV; regulatory pressure and long-suppressed uptick in resource demands from the developing world still loom in our future.
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