What happened to peak oil?

Up until two days ago oil was crashing down toward $110 a barrel as demand growth estimates have been clipped. So what happened to peak oil? Nothing happened; peak oil should still be a concern.

For a larger context on peak oil, see my June post ‘Peak oil: are we there yet?‘ From where I sit, I see oil as having played a major role in creating the downturn we are now experiencing. Basically, oil prices rose to the point where we cried uncle, reduced our consumption accordingly, and the economy suffered as a result. Before 1973, the world had never see an oil shock. But, this is the 4th such oil shock since the end of Bretton Woods in 1971 when Nixon ended the U.S. dollar peg to gold and ushered in an era of floating currencies. Methinks I see a connection.

Now, the real point of peak oil here is not that oil supplies are running out, the sky is falling and the world is coming to an end. Rather, it is an understanding that there will come a time when the ever-increasing global demand for oil will permanently outstrip the supply. What does that mean? Well for starters, it means that oil shocks will not be the result of supplies being artificially constrained by some monopoly like the Seven Sisters, the Texas Railroad Commission or OPEC. Peak oil means that oil producers will simply not be able to cost-effectively pump enough oil out of the ground rapidly enough to meet the rising oil demand.

And oil demand is price inelastic. Translation: we need the stuff — we need the stuff a lot. We use it to heat our homes, drive our cars, make plastic containers, pave the roads — oil is ubiquitous. It just won’t do to have it in short supply. The result is that, with peak oil, oil prices must rise exponentially before the necessary demand destruction is created to bring supply and demand into balance. That’s what has just happened.

So, what happens when demand destruction sets in? Economics would tell you that the price collapses again but to a new higher equilibrium level. And then the whole pattern reasserts itself again. That means higher lows and higher highs for the price of oil as we go through each business cycle. Obviously, this is a recipe for global economic instability and that leads to war, famine, revolution and some other pretty nasty stuff.

There are two things that can stop this train wreck:

1. Finding additional sources of oil that can be tapped at prices high enough that oil producers actually make money to drill for oil in these previous no-go areas. As far as the U.S. election goes, this is the McCain strategy, if you will: drill for more oil in order to increase supply to meet demand. However, this strategy is short-sighted for a number of reasons – demand will eventually outstrip supply again anyway, the potential recoverable oil is not that large, and in the short term, this does nothing for consumers.
2. Looking for wind, solar, nuclear, geothermal and other alternative energy sources. This is the Al Gore strategy. The benefit of this strategy is that there are unlimited supplies of alternatives to oil, so it will secure our future. The downside to this strategy? Cost. Our whole infrastructure is built around oil and that is not going to change anytime soon.

Like it or not, we have limited alternatives for a solution to this problem. However, we do have solutions. Now is the time to act on them.