Bill Totten's Weblog

Friday, January 14, 2005

There's no fuel like an old fuel

We pay too little for gas, not too much.
The real price shock will come when oil starts to run out.

by William Rees

The Globe and Mail (March 29 2000)

Canadians live in a big, cold country. We depend on fossil fuels to heat the place in winter and to transport virtually everything we need to survive over vast distances within the country. On a per capita basis we are the world's largest trading nation, totally dependent on fossil fuels to connect us materially to the world. Thanks to production agriculture and industrial food processing, the food we eat now "contains" more fossil energy than solar energy. In fact, for all the paper wealth being generated by high-tech and Internet stocks, the country's entire post-industrial economy still floats on a stream of oil and gas. No wonder that in recent weeks Canadians have been take aback by a large increases in the price of gasoline, diesel fuel, heating oil, and now natural gas.

The federal government has responded to the price hikes by announcing that the Conference Board of Canada will undertake an independent review of competitive forces operating in the industry's refining and marketing sectors. The Canadian Automobile Association has responded by calling the review a waste of time. According to the CAA, since almost half the cost of gas at the pump is taxes, the government should cut excise taxes and the GST (Goods and Services Tax) on fuel by several cents a litre. So who's to blame here, greedy oil companies or the government?

In the interest of getting our money's worth out of the projected $600,000 Board review, I'd like to propose that the study be extended in scope - and consider longer-term factors affecting the price of energy. It would be a costly error to assume that a competitive marketplace necessarily tells the truth about the real costs of fossil fuel or that government intervention to ensure fairness would reduce prices to consumers.

There are two parts to this argument. A 1998 report by the Washington-based International Centre for Technology Assessment - titled The Real Price of Gas - quantified the numerous external costs associated with the use of fossil-fueled motor vehicles that are not reflected in US consumer prices: hidden costs such as direct subsidies to the oil industry from governments; publicly funded infrastructure costs; and the health and environmental costs associated with burning fossil fuels (for example, breathing "second-hand exhaust"). These direct and indirect subsidies seriously distort energy markets and burden the economy with rampant inefficiency.

Depending on the definition of the subsidies and the quality of available data, the report found that total unaccounted cost in the United States was as much as $1.7 trillion (US) annually. A fuller social-cost accounting for fossil fuel use would result in a gasoline price per gallon of between $5.60 and $15.14 (as much as ten times what Midwest Americans currently pay after recent price hikes). The array of subsidies to the oil industry and users of fossil fuel in Canada is roughly comparable to that in the States, so we can translate this into a price of roughly $2.00 (Canadian) to $5.40 per litre of gas.

Add in the recent escalating costs of climate change and prices would climb considerably higher. In other words, even with the burden of existing taxes, North Americans are paying a fraction of the price they would pay for gas in a perfectly functioning market.

The invariable consequence of underpricing is overuse. We live in large energy-inefficient houses, drive ever-bigger and less fuel-efficient vehicles and are generally squandering, in a few decades, a non-renewable resource that took tens of millions of years to accumulate. Even if there were no other issues at hand, it would be economically rational for the government to intervene in today's energy economy to correct at least some market imperfections. This would certainly result in significantly greater taxes and prices at the pump.

But there's another issue at hand. The world is running out of oil. Recent price hikes are mere tremors heralding the real price shock to come.

Oil "production" (that is, extraction) peaked in North America in 1984. Several recent studies project world oil production to peak by 2013 or sooner, possibly as soon as 2007. Even the necessarily conservative International Energy Agency in its World Energy Outlook, 1998 concurred for the first time that global output could top out between 2009 and 2012 and decline rapidly thereafter. IEA data project a nearly 20-per-cent shortfall of supply relative to demand by 2020 that will have to be made up of from "unidentified unconventional" sources (that is, known oil-sands deposits have already been taken into account). Other studies show that by 2040 total oil output from all sources may fall to less than half of today's 25-26 billion barrels of oil per year.

And running out of oil is not running out of just oil. Oil is the means by which industrial society obtains (and overexploits) all other resources. The world's fishing fleets, its forest sector, its mines, and its agriculture all are powered by liquid portable fossil fuels - seventeen per cent of the US energy budget, most of it oil, is used just to grow, process, and transport food alone. Keep in mind too that petroleum is not just a fuel. Oil and natural gas are the raw material for medicines, paints, plastics, agricultural fertilizers and pesticides. Since oil is directly or indirectly a part of everything else, the scarcity of oil and the coming price shock means higher prices all round.

Some economists argue that rising prices enable us to exploit less accessible deposits, that the resource is "constantly renewed as it is extracted". This is grossly misleading. The physical stock of exploitable oil is not being "renewed". Improved technology has simply made a dwindling supply more accessible. Abundant short-term market supplies then effectively short-circuit the price increases that would otherwise signal impending real
scarcity, even as finite stocks are depleted.

Moreover, oil exploration is very much subject to diminishing material returns. Despite increasing effort, we currently discover less than six billion barrels of new oil a year, not even a quarter of present consumption. In much of the world, oil extractors used to discover fifty barrels of oil for every barrel consumed in drilling and pumping. Today the ratio is five to one, heading to one for one by 2005. At that point, there will no point in extracting oil at any price even though plenty will be left in the ground.

What about substitutes? The fact is that no suitable substitutes are yet in sight for the fossil fuels used in heavy farm machinery, construction and mining equipment, diesel trains and trucks, and ocean-going freighters. Jet aircraft cannot be powered by electricity, whatever its source. It is also no small irony that we need high-intensity fossil fuel to produce the machinery and infrastructure required for most alternative forms of energy. Sunlight is simply too "dilute" to use in manufacturing the high-tech devices and equipment required for its own conversion to heat and electricity. Industrial civilization faces a paradox: we need oil to move beyond the age of oil.

The human population has grown six-fold in less than 200 years. The global economy has quintupled in less than fifty. No factor has played a greater role in the explosive growth of the human enterprise than abundant, cheap fossil fuel. No other resource has changed the structure of economies, the nature of technologies, the balance of geopolitics, and the quality of human life as much as petroleum. Little wonder that some scientists believe that
passing the peak of world oil production will be a shock to the human enterprise like no other event in history. Population and consumption are still on a steep trajectory but the rocket is running out of fuel.

In this light, the Conference Board of Canada has a duty to urge governments to get real about energy policy and pricing in Canada and the world beyond. Significant price increases are long overdue. Governments have known about the deteriorating supply situation for years - yet prefer to allow the public to wallow in ignorance. This in turn creates a political climate in which a looming crisis remains invisible and corrective action is impossible.

We need higher energy prices now to signal the scarcity to come. Without higher prices we won't invest in the technologies needed for a smooth transition to the post-petroleum age. Without higher prices we won't conserve the fossil energy needed to manufacture alternative technologies. Without higher prices, the life expectancy of industrial society may well be one generation.

William E Rees is an ecological economist and professor in the University of British Columbia's School of Community and Regional Planning.

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Bill Totten