Ed Ellingson's Blog

9. We’re Already in the Transition

People want to understand just how this energy change will play out, peer into the future, if you will.  We want to adjust our lives to prepare for this and take advantage of it as best we can.  I think the first thing to understand is that we’re already into this transition, so we have some history to review.

The nominal, real (inflation-adjusted) price of oil has generally declined from the time it was drilled commercially until the Arab/OPEC Embargo of 1973.  It went through many “boom & bust” cycles, but the trend was generally down.  The disruption of that and the later Iraq/Iran war resulted in the first really significant price changes in decades.  What is showed was that there was very little excess capacity, and that the demand for oil was very inelastic.  The higher price and disruption caused a world-wide recession.  It was also a turning-point in the politics of oil; this was the start of countries seriously claiming ownership of the oil under their surface, and demanding control of production and a significant sum of money before releasing it .

Oil is so important that it has led to a resource war.  The USA invaded Iraq with only a slight pretext (later fully discredited) that it was anything but a resource war.  The only really significant proven oil reserves are in the Middle East.  Our economy runs on cheap oil, and our national security depends upon it, so there is little wonder that we would take such drastic steps to keep the oil flowing.  We’re basically making the Middle East safe for Big Oil to drill, pump and refine

The average working male’s real income has been basically unchanged since the 70’s, highlighting another characteristic of our situation.  If “everything” is automated, there’s no real room to increase productivity, so ultimately no room for wage increases.

Anecdotal information suggests that the real rate of return on business investments is decreasing.  Business owners I know (mostly small businesses) claim that they’re working harder each year, and they just stay even, not getting ahead.  Every business seems to have razor-thin margins; they’re set up to be “successful” if everything fits into their carefully constructed business plan, but minor disruptions, like the cost of energy doubling, can push them over the edge.  If everything is powered and automated, it’s hard to come up with a new business that offers a big advantage, and thereby a high return on investment.

Certainly the present Great Recession shows how tenuous our economy is.  A slight shortage of oil causes a “panic” that causes the price to shoot up, and the high price basically cripples the economy.  The high price eventually results in increased supply, and a reduction in demand.  We don’t have direct experience to rely on, but models imply that as you get closer to a “tipping point” the aberrations (ie, the boom & bust cycles) get more frequent and more extreme.

Our reserve capacity in oil production is estimated now to be less than 5%.  A growth in demand or a decrease in supply, or a combination, that exceeds this value will mean that someone who wants to buy oil isn’t getting any.  This will result in disruption, as they try to secure the energy they need.  The shortage situation might come on slowly, just through growth in economic activity, but it is more likely to be brought on by war or terrorism, or by destruction from natural causes.  Consider the damage that a hurricane could do in the Gulf of Mexico, or an earthquake in Venezuela, or terrorists in Saudi Arabia, or an unfortunate combination; if these take out 5% of the supply, there’s no more cushion in the system to make it up, and there will be shortages.

Conversely, the discovery of a new oil field, and the excess capacity, could work to lower the price of oil.

An analysis of the money spent on oil exploration in 2005 resulted in discoveries of oil worth about half that invested, at the prevailing price.  This is essentially the dilemma of our time; how do we make the investment in things that we need/want, when these things don’t have the payback that’s necessary to keep the economy going?


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