As oil prices remain high, we once again see murmurs of anticipated doom from various quarters. Such fears are grossly miscalculated, as I have described in my 2007-08 articles about how oil at $120/barrel creates desirable chain reactions, as well as my rebuttal to the poorly considered beliefs of peak oil alarmists, who seem capable of being sold not one, but two bridges in Brooklyn. Today, however, I am going to combine the concepts in both of those articles with some new analysis I have done to enable us to predict when oil will lose the economic power it currently holds. You are about to see that not only are peak oil alarmists wrong, but they are just about as wrong as those predicting in 1988 that the Soviet Union would soon dominate the world, and will soon be equally worthy of ridicule.
Unenlightened Punditry and Fashionable Posturing :
As I mentioned in a previous article, many observers incessantly contradict themselves on whether they want oil to be inexpensive, or whether they want higher oil prices to spur technological innovations. One of the most visible such pundits is Thomas Friedman, who has many interesting articles on the subject, such as his 2007 piece titled 'Fill 'Er Up With Dictators' :
But as oil has moved to $60 to $70 a barrel, it has fostered a counterwave — a wave of authoritarian leaders who are not only able to ensconce themselves in power because of huge oil profits but also to use their oil wealth to poison the global system — to get it to look the other way at genocide, or ignore an Iranian leader who says from one side of his mouth that the Holocaust is a myth and from the other that Iran would never dream of developing nuclear weapons, or to indulge a buffoon like Chávez, who uses Venezuela’s oil riches to try to sway democratic elections in Latin America and promote an economic populism that will eventually lead his country into a ditch.
But Mr. Friedman is a bit self-contradictory on which outcome he wants, as evidenced across his New York Times columns.
In short, the best tool we have for curbing Iran’s influence is not containment or engagement, but getting the price of oil down
So here’s my prediction: You tell me the price of oil, and I’ll tell you what kind of Russia you’ll have. If the price stays at $60 a barrel, it’s going to be more like Venezuela, because its leaders will have plenty of money to indulge their worst instincts, with too few checks and balances. If the price falls to $30, it will be more like Norway. If the price falls to $15 a barrel, it could become more like America
Either tax gasoline by another 50 cents to $1 a gallon at the pump, or set a $50 floor price per barrel of oil sold in America. Once energy entrepreneurs know they will never again be undercut by cheap oil, you’ll see an explosion of innovation in alternatives.
And by not setting a hard floor price for oil to promote alternative energy, we are only helping to subsidize bad governance by Arab leaders toward their people and bad behavior by Americans toward the climate.
All of these articles were written within a 4-month period in early 2007. Both philosophies are true by themselves, but they are mutually exclusive. Mr. Friedman, what do you want? Higher oil prices or lower oil prices? Such confusion indicates how the debate about energy costs and technology is often high on rhetoric and low on analysis.
Much worse, however, is the fashionable scaremongering that the financial media uses to fill up their schedule, amplified by a general public that gets suckered into groupthink. To separate the whining from the reality, I apply the following simple test to verify whether people are actually being pinched by high oil prices or not. If a large portion of average Americans have made arrangements to carpool to work (as was common in the 1970s), then oil prices are high. Absent the willingness to make this adjustment, their whining about gasoline is not a reflection of actual hardship. This enables us to declare that oil prices are not approaching crisis levels until most 10-mile-plus commuters are carpooling, that too in groups of three, rather than just two. Coordinating of carpools is thus the minimum test of whether oil prices are actually causing any significant changes in behavior.
Fortunately, $100 oil, a price that was considered a harbinger of doom as recently as 2007, is now not even enough to induce carpooling in 2011. This quiet development is remarkably unnoticed, and conceals the substantial economic progress that has occurred.
Economic Adaptations :
The following chart from Calculated Risk (click to enlarge) shows the US trade deficit split between oil and non-oil imports. This chart is not indexed as a percentage of GDP, but if it were, we would see that oil imports at $100/barrel today are not much higher of a percentage of GDP than in 1998, when oil was just $20/barrel. In fact, the US produces much more economic output per barrel of oil compared to 1998. We can thus see that unlike in 1974 when the US economy has much less demand elasticity for oil, today the ability of the economy to adjust oil consumption more quickly in reaction to higher prices makes the bar to experience an 'oil shock' much harder to clear. US oil imports will never again attain the same percentage of GDP as was briefly seen in 2008.
Of even more importance is the amazingly consistent per capita consumption of oil since 1982, which has remained at exactly 4.6 barrels/person despite a tripling real GDP per capita during the same period (chart by Morgan Downey). This immediately deflates the claim that the looming economic growth of China and India will greatly increase oil consumption, since the massive growth from 1982 to 2011 did not manage to do this. At this point, annual oil consumption, currently at around 32 billion barrels, only rises at the rate of population growth - about 1% a year.
This leads me to make a declaration. 32 billion barrels at around $100/barrel is $3.2 Trillion in annual consumption. This is currently less than 5% of nominal world GDP. I hereby declare that :
Oil consumption worldwide will never exceed $4 Trillion/year, no matter how much inflation, political turmoil, or economic growth there is. Thus, 'Peak Oil Consumption' happens long before 'Peak Oil Supply' ever could.
This would mean that oil would gradually shrink as a percentage of world GDP, just as it has shrunk as a percentage of US GDP since 1982. Even when world GDP is $150 Trillion, oil consumption will still be under $4 Trillion a year, and thus a very small percentage of the economy. Mark my words, and proceed further to read about how I can predict this with confidence.
The Carnival of Creative Destruction :
There are at least seven technologies that are advancing to reduce oil demand by varying degrees, many of which have been written about separately here at The Futurist :
1) Natural Gas : Technologies that aid the discovery of natural gas have advanced at great speed, and supplies have skyrocketed to a level that exceeds anything humanity could consume in the next few decades. The US alone has enough natural gas to more than offset all oil consumption, and the price of natural gas is currently on par with $50 oil.
2) Efficiency gains : From innovations in engine design, airplane wing shape, reflective windows, and lighter nanomaterials, efficiency is advancing rapidly, to the extent that economic growth no longer increases oil consumption per capita, as described earlier. There are many options available to consumers seeking 40 mpg or higher without sacrificing too much power or size, and I predicted back in early 2006 that in 2015, a 4-door family car with a 240 hp engine would deliver 60 mpg (or equivalent) yet still cost no more than $35,000 in 2015 dollars. People scoffed at that prediction then, but now it seems quite safe.
3) Cellulose Ethanol and Algae Oil : Corn ethanol was never going to be suitable in cost or scale, but the infrastructure established by the corn ethanol industry makes the transition to more sophisticated forms of ethanol production easier. But fuels from switchgrass and algae are much more cost-effective, and will be ramping up in 2012. Solazyme is an algae oil company that went public recently, and already has a market capitalization of $1.5 Billion.
4) Batteries : Most of the limitations of electric and hybrid vehicles stem from shortcomings in battery technology. However, since batteries are improving at a rate that is beginning to exceed the traditional 5-8% per year, and companies such as Tesla are able to lower the cost of their fully electric vehicles, the knee of the curve is near.
5) Telepresence : Telepresence, while expensive today, will drop in price under the Impact of Computing and displace a substantial portion of business air travel, as described in detail here. By 2015, geographically dispersed colleagues will seem to be closer to each other, despite meeting in person less often than they did in 2008.
6) Wind Power : Wind Power already generates almost 3% of global electricity consumption, and is growing quickly. When combined with battery advances that improve the range and power of electric and plug-in hybrid vehicles, we get two simultaneous disruptions - oil being displaced not just by electriciy, but by wind electricity.
7) Solar Power : This source today generates the least power among those listed here. But it is the fastest growing of the group with multiple technologies advancing at once, and with decades of steady price declines finally reaching competitive pricepoints. It also has many structural advantages, most notably the fact that it be deployed to land that is currently unused and inhospitable. Many of the countries with the fastest growth in energy consumption are also those with the greatest solar intensity.
Plus, these are just the technologies that displace oil demand. There are also technologies that increase oil supply, such as supercomputing-assisted oil discovery and new drilling techniques. Supply-increasing technologies work to reduce oil prices and while they possibly slow down oil demand displacement, they too work to weaken petrotyranny.
The problem in any discussion of these technologies is that the debate centers around an 'all or none' simplicity of whether the alternative can replace all oil demand, or none at all. That is an unnuanced exchange that fails to comprehend that each technology only has to replace 10% of oil demand. Natural gas can replace 10%, ethanol another 10%, efficiency gains another 10%, wind + solar another 10%, and so on. Thus, if oil consumption as a percentage of world GDP is lower in a decade than it is today, that itself is a huge victory. It hardly matters which technology advances faster than the others (in 2007, natural gas did not appear as though it would take the lead that it enjoys today), what matters is that all are advancing, and that many of these technologies are highly complementary to each other.
What is also overlooked is how quickly the pressure to shift to alternatives grows as oil becomes more expensive. If, say, cellulose ethanol is cost-effective with oil at $70, then oil at $80 causes a modest $10 dollar differential in favor of cellulose. If oil is $120, then this differential is now $50, or five times more. Such a delta causes much greater investment and urgency to ramp up research and production in cellulose ethanol. Thus, each increment in oil price creates a much larger zone of profitability for any alternative.
The Cost of Petrotyranny :
This map of nations scaled in proportion to their petroleum reserves (click to enlarge) replaces thousands of words. Some contend that the easy money derived from exporting oil leads to inevitable corruption and the financing of evil well beyond the borders of petro-states, while others lament the misfortune that this major energy source is concentrated in a very small area containing under 2% of the world's population. Other sources of energy, such as natural gas, are much more evenly distributed across the planet, and this supply chain disadvantage is starting to work against oil.
However, as we saw in the 2008 article, many of these regimes are dancing on a very narrow beam only as wide as the span between oil of $70 and $120/barrel. While a price below $70 would be fatal to the current operations of Iran, Venezuela, and Russia, even a high price leads to a shrinkage in export revenue, as domestic consumption rises to reduce export units to a greater degree than can be offset by a price rise. Furthermore, higher prices accelerate the advance of the previously mentioned technologies. For the first time, we can now estimate how long oil can still hold such an exalted economic status.
Quantifying the Remaining Petro-Yoke :
For the first time, we can make the analysis of both technological and political pressure exerted by a particular oil price more precise. We can now quantify the rate of technological demand destruction, and predict the actual number of years before oil ceases to have any ability to cause economic recessions, and regimes like Iran, Venezuela, and Russia no longer can subsist on oil exports to the same degree. This brings me to the second declaration of this article :
From the start of 2011, measure the dollar-years of area enclosed by a chart of the price of oil above $70. There are only 200 such dollar-years remaining for the current world petro-order. We can call this the 'Law of Finite Petrotyranny'.
Allow me to elaborate.
Through some proprietary analysis, I have calculated that the remaining lifetime of oil's economic importance as follows :
From the start of 2011, take the average price of West Texas Intermediate (WTI), Brent, or NYMEX oil, and subtract $70 from that, each year.
Take the number accumulated, and designate that as 'X' dollar-years.
As soon as X equals to 200 dollar-years, then oil will not just fall below $70, but will never again be a large enough portion of world GDP to have a significant macroeconomic impact.
You can plug in your own numbers to estimate the year in which oil will cease to exert such power. For example, if you believe that oil will average $120, which is $50 above the $70 floor, then the X points are expended at a rate of $50/year, meaning depletion at the end of 2014. If oil instead averages just $100, then the X points are expended at $30/year, meaning it will take 6.67 years, or until late 2017, to consume them. Points are only depleted when oil is above $70, but are not restored if oil is below $70 (as research projects may be discontinued or postponed, but work already done is not erased). For those who (wrongly) insist that oil will soon be $170, the good news for them is that in such an event they will see the X points depleted in just two short years. The graph provides 3 scenarios, of oil averaging $120, $110, and $100, and indicating in which year such a price trend would exhaust the 200 X points from points A, B, and C, which is the area of each of the three rectangles. In reality, price fluctuations will cause variations in the rate of X point depletion, but you get the idea.
Keep in mind the Law of Finite Petrotyranny, and on that basis, welcome any increase in oil prices as the hastening force of oil replacement that it is. My personal opinion? We average about $100/barrel, causing depletion of the X points in 2017 (scenario 'C' in green).
So what happens after the Law of Finite Petrotyranny manifests itself? Let me pre-empt the strawmen that critics will erect, and state that oil will still be an important source of energy. But most people will no longer care about the price of oil, much as the average person does not keep track of the price of natural gas or coal. Oil will simply be a fuel no longer important enough to cause recessions or greatly alter consumer behavior through short-term spikes. Many OPEC countries will see a great reduction in their power, and will no longer be able to placate their citizens through petro-handouts alone. These countries would do well to act now and diversify their economies, phase in civil liberties while they can still do so incrementally, and prepare for a future of much lower leverage over their current customers.
So cheer oil prices higher so that the X points get frittered away quickly. It will be fun.