June 20, 2008

Introduction, and overview


I've been interested in energy issues ever since I read the first report from the Club of Rome. I've been a management consultant for 30 years, and our group, among many other things, assists with energy conservation and purchasing. Along the way, I've learned some answers to some of my energy questions, and I'd like to share them. I'll start with some basics, and as I have time I'll add more detail to them, as well as answer additional questions. The following provides an outline - please see other posts for more detail on individual points. And always, keep in mind that "Predictions are hard, especially when they're about the future." (Yogi Berra). That means, don't rely on anyone (including me) as an Authority: use this information to inform and sharpen your own judgement, and come to your own conclusions (especially when it comes to life decisions and investment decisions!).

The first question is: what are the most important upcoming energy issues?

Answer: I think Peak Oil (generally speaking, the idea that oil production is now, or soon will be inadequate for our needs in a way that is irreversible, and will only get worse) is real - see "What can we do about disappearing oil imports? for further discussion. I also think anthropogenic climate change is real, and rather more important than Peak Oil.

What will Peak Oil look like?

I think current oil prices (they're about $140 right now, but I have in mind anything that stays consistently above $100) will shave off the peak in oil production and consumption, and put world oil consumption in a mild decline, which is all to the good. I suspect that we'll be in that mode for at least 10 years, which will give us time to begin to replace oil with renewable electricity.

I think people badly underestimate the effect of prices over $100, and the importance of the crash in oil services industries in the 90's. For instance, the US is likely to grow in production, or at least maintain level production. Other countries which are peaking, such as Mexico, are probably doing so due to underinvestment. Estimates that maximum world production will peak in 2-4 years make sense to me. On the other hand, on the whole I estimate that the decline after the peak will be slow, due to enormous growth in drilling over time, for at least 10 years.

Could we repeat the experience of the 70'? In other words, could this just be another cycle of commodity boom and bust?

Yes, it could, but if it is, the cycle will take at least as long as it did then. In other words, very high prices are likely to last at least 10 years. After that, prices could crash if governments, private firms and individuals react strongly to the combination of Peak Oil and climate concerns, and aggressively replace oil with electricity.

How will Peak Oil affect the economy?

The gradual reduction in oil consumption won't hurt the economy much, but the transfer of wealth to oil-exporters will hurt a great deal. I think the transfer of wealth problem is much more important than the reduction in oil consumption, per se. A reduction in oil consumption would be relatively trivial over a sufficiently long period for substitutes (say, from ICE to PHEV/EV) - the shorter the period, the greater the disruption of change.

But, the transfer of wealth is big. At the very least it creates enormous debt, and transfer of ownership of assets, such as corporate stock. If the recycling of petrodollars isn't handled well (and so far it's been mediocre - Collateral Debt Obligations, the derivatives at the heart of the Mortgage Crisis, were one such instrument of recycling), then there is real potential for financial disruption.

The likeliest outcome is some combination of somewhat higher inflation and somewhat lower GDP growth than would have been the case. There is a real risk (perhaps 10%) of a dollar crash due to a sustained current account deficit, and a roughly similar risk of a short term event like that of 1979, only worse, due to a crisis in the Persian Gulf.

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