April 27, 2010

Will energy alternatives be too expensive? Feasibility vs Competitiveness:

Chemical companies like Dupont still use oil as chemical feedstock to make plastics, glues, etc because it is still cheaper than alternatives. Won't alternatives raise prices and therefore lower living standards?

Yes, but not much. There is a basic paradigm that's useful here: "feasibility" vs "competitiveness". In most industries a very small cost difference can make you uncompetitive. That means that slightly higher cost solutions will be avoided, which can give the impression that those solutions are higher cost than they are. On the other hand, if changes in the business environment (or natural environment!) change the costs of alternatives for everyone, suddenly alternatives can become acceptable in that industry.

So, for instance, recycled materials are in general slightly more expensive than virgin materials, plastic included. But, if oil becomes more expensive then recycled materials may suddenly become the standard. If something can be recycled with only 10% loss at each generation, that can reduce the consumption of virgin materials by 90%, with only a very small additional cost for the industry.

Similarly, electric vehicles cost more than internal combustion engines fueled by dirt cheap gasoline. But, they don't cost any more than ICEs when gasoline reaches $3 per gallon, a level we only reached relatively recently.

Another example: Observers of the coal indutry sometimes think that "The cheapest and best coal is gone." But the US has a lot of Illinois Basin coal, and it's both high quality, and from a larger perspective only slightly more expensive to handle due to it's sulfur content. In a competitive environment, it's winner takes all, and only slightly more costly sellers lose out completely.

So, we have to "think outside the box", and consider that we could have whole industries that eliminate oil entirely, at a cost which is surprisingly affordable.

Why didn't we do that a long time ago, then?

Because, change is painful, and we don't do it if we don't have to, as I talked about in my last post.


Anonymous said...

What about the sunk cost of the existing heavy vehicle off road fleet of farm tractors that have another 20 years of service pay back their capital costs? Converting them to electric will be expensive, possibly more than the cost of fuelling them. Either way it impacts on the price of food which may leave many people without the money or credit to upgrade to an EV.

Nick G said...

Anonymous, there are several reasons why this isn't a large problem.

1st, diesel prices are unlikely to rise more than 100% above where they are now, because so many other consumers will reduce their consumption of oil, gasoline, etc.

2nd, fuel is only a small % of farmer's costs - less than 10% overall, IIRC. So, if fuel rises 100%, farm costs only rise 10%.

3rd, farm commodity costs are only a small % of the cost of food to the consumer, less than 15%, IIRC. So, if farm costs rise about 15%, food costs will only rise about 1.5%.

Finally, food cost comprises roughly 20% of consumers' incomes, so their incomes will only drop .3%.

I hope that helps.

Anonymous said...

Food Prices:

An increase in oil/fuel costs would be passed on to the consumer at all levels of the supply chain, not just in the additional "fuel cost" to farmers. The calculation wouldn't be quite that simple.

Fertilizer, diesel use for growing/harvesting, diesel use for transport along the supply chain, etc.

I would actually guess that the bulk of price increase would come from the transport sector under the current paradigm rather than on the production side. Trucking companies operate on pretty thin margins as is and as there are multiple movements between production and retail. The price increase passed on to the consumer would be magnified for each step in the process.

Nick G said...


Please use a name or "handle" of some sort, so that I (and other readers) can keep track of who says what.

Your comment would seem to make sense, but as a practical matter it doesn't work that way.

Forty years ago, things did work that way. When the US was hit by oil shocks, prices rose generally. OTOH, in the most recent oil shock, that wasn't the case - direct energy costs rose, but other prices didn't.

Why the difference? Competition has become more intense, and markets have become more efficient because of dramatically better communications (in large part due to the internet). Companies are now much less are able to pass on increased costs to their buyers, and have become much more aggressive about reducing their costs.

So, if long-haul truckers see a fuel cost increase, they add aerodynamic hoods to their trucks, put in larger batteries to reduce idling to power refrigerators ("hotel load"), buy more efficient tires, etc, etc. If that doesn't do the trick, they drive longer hours and reduce their pay.

If that still doesn't work, they raise their rates, see their customers move to the railroad, and go out of business. The trucking companies that are left are the ones that are lucky enough to have newer, more efficient trucks, but the trucking industry is still smaller.

Ultimately, the customers who are moving things see little of the original cost increase. And, if they do, they go through the same process as the truckers, so as to not pass it on to their customers.