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Thursday, July 10, 2008

The Peak Oil Crisis: Assessing $200 Oil

by Tom Whipple

Falls Church News-Press (July 03 2008)

Three months ago anyone talking about $200 oil was considered a fear monger, or worse, but things happen fast these days. In the intervening period, oil prices have risen by nearly $40 a barrel and show no signs of stopping. All of a sudden it has become fashionable to start talking about much higher prices and to start thinking about the implications of multi-hundred dollar oil.

Among the many debates going on over oil is one holding that crude will never get much beyond $200 a barrel because at such an extreme price, demand for oil products will drop so much that prices will fall back to more affordable levels. Countering this argument are those who point out that nearly half the world's population can buy oil products subsidized by their governments or national oil companies, will never be subjected to the high world prices and will go merrily along increasing their consumption for a while longer. While demand for oil products in the US, Europe and other OECD countries is starting to slip, this drop in consumption is more than being made up in the subsidized societies of Russia, the Middle East, India and China.

If oil prices move from $140 to $200 the impact is going to be felt more harshly than during the climb from $20 to $140 that has taken place in the last few years. To the surprise of many, oil consumption in the US did not begin to drop noticeably until the price moved beyond $100 a barrel and even then it is only in the last few months as gasoline approached $4 a gallon that a significant drop in consumption was noted.

As oil approaches $200 a barrel, the impact will be distributed unevenly, depending on one's circumstances, job, lifestyle, geographical location and a host of other factors. It may be easy to say that consumers will simply cut back on discretionary spending, but in the US's "service economy", a large share of the jobs currently depend on discretionary spending. As a larger share of disposable income goes for the essentials of life - food, shelter, clothing, medical services and of course transportation to places of employment - discretionary spending on vacations, recreation, entertainment, eating out and "stuff" is bound to fall sharply.

It is easy to conclude that the mix of essential/discretionary spending will shift, but to quantify just how bad things will get is far more difficult. The situation of course is muddled by the current financial crisis that shows every sign of becoming much worse with each passing day.

Last week the Los Angeles Times ran a story entitled "Envisioning a World of $200-a-Barrel Oil" {1} which was sort of a tour d'horizone of all the bad things that are going to happen when oil reaches $200 a barrel. The story was replete with quotes such as "You'd have massive changes going on throughout the economy", and "Some activities are just plain going to be shut down". Other quotes were apocalyptic "The American people would be kicked in the teeth so darned hard by $200-a-barrel oil that they won't have the ability to buy much of anything".

The authors recognize that nearly every aspect of our current lifestyles will be affected from simply having a job to getting to work. Naturally, costs of nearly everything made from oil will increase and even shipping stuff from China will increase its costs by fifteen percent. Major declines in the stock market will create havoc with pensions and personal wealth. There will, however, be a few upsides to $200 oil such as less traffic and more opportunity for local manufacturing and agriculture.

It is well enough to point out that a myriad of problems will come with $200 oil, but so far few have attempted to quantify just what might happen in the next few years. One recent effort to assess $200 oil was undertaken by Canada's CIBC bank. Starting with the well publicized decline in auto sales, the bank concludes that US light vehicle (cars, trucks, SUV, and vans) sales will be down to eleven million by 2012 from seventeen million a few years ago. The share of SUVs and light trucks is expected to be less that half that of their banner years. Increased scrapping of light vehicles combined with lower sales leads the bank to conclude that there will be roughly ten million fewer registered vehicles on US roads by 2012.

While this may sound like an impressive number, Americans are currently driving around 230 million light vehicles so ten million less is not too significant. The more important question is how much the remaining vehicles are going to be used. Here the bank foresees a fifteen percent drop in the average miles driven by 2012. Presumably an increasing share of these miles will be driven in newer, more efficient vehicles so that that the drop in US gasoline consumption would be greater than fifteen percent.

The CIBC study, which deals primarily with transportation, certainly anticipates a relatively benign world in which we scrap our old cars, don't buy SUVs and those households earning less than $25,000 a year and have access to public transportation, take the bus. The people interviewed by the Los Angeles Times seem to have a much darker view of the immediate future.

There are simply too many unknowns out there to form a conclusion as to just how bad it may get. The Bank's $200 oil in 2010 could easily prove to be optimistic for some are talking about $200 before the year is out even without a major supply disruption. Then we have the hurricane season. And many are convinced that the Bush administration will not leave office with an Iranian nuclear program still in place.

While some sort of quantitative evaluation of our future would be nice, $200 oil easily could be here before anyone can crunch the numbers.

Link {1} "Envisioning a World of $200-a-Barrel Oil" by Martin Zimmerman, Los Angeles Times (June 28 2008),0,5485259.story

Bill Totten


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