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WSJ Gets it Wrong on 'Why Peak Oil Predictions Haven't Come True'

On Monday, September 29, the Wall Street Journal (WSJ) published a story called “Why Peak Oil Predictions Haven’t Come True.” The story is written as if there are only two possible outcomes:

  1. The Peak Oil version of what to expect from oil limits is correct, or
  2. Diminishing Returns can and are being put off by technological progress–the view of the WSJ.

It seems to me, though, that a third outcome is not only possible, but is what is actually happening.

3. Diminishing returns from oil limits are already beginning to hit, but the impacts and the expected shape of the down slope are quite different from those forecast by most Peak Oilers.

Area of Confusion

In many people’s way of thinking, the economy is separate from resources and the extraction of those resources. If we believe economists, the economy can grow indefinitely, with or without the use of resources. Clearly, with this view, the price of these resources doesn’t matter very much. If one kind of resource becomes more expensive, we can substitute other resources, once the scarce resource becomes sufficiently high-priced that the alternative makes financial sense. Incomes can rise arbitrarily high–all it takes is for each of us to pay the other higher wages. And we can fix any problem with the financial system with more money printing and more debt.

This wrong version of how our economy works has been handed down through the academic world, through our system of peer review, with each academic researcher following in the tracks of previous academic researchers. As long as new researchers follow the same wrong thinking as previous researchers, their articles will be published. Economists were especially involved in putting together this wrong world-view, but politicians helped as well. They liked the outcomes of the models the economists produced, since it made it look like the politicians, with the help of economists, were all-powerful. All the politicians needed to do was tweak the financial system, and the world economy would grow forever. There was not even a need for resources!

Peak Oilers’ Involvement 

The Peak Oilers walked into a situation with this wrong world view, and started trying to fix pieces of it. One piece that was clearly wrong as the relationship between resources and the economy.  Resources, especially energy resources, are needed to make any of the goods and services we buy. If those resources started reaching diminishing returns, it would be harder for the economy to grow. The economy might even shrink. Dr. Charles Hall, recently retired professor from SUNY-ESF, came up with one measure of diminishing returns–falling Energy Returned on Energy Invested (EROEI).

How would shrinkage occur? For this, Peak Oilers turned to the work of M. King Hubbert, who worked in an area of geology. He wrote about how supply of a resource might be expected to decline with diminishing returns.

Hubbert was not concerned about what effect diminishing returns would have on the economy–presumably because that was not his area of specialization. He avoided the issue by only modeling the special case where no economic impact could be expected–the special case where a perfect substitute could be found and be put in place, in advance of the decline caused by diminishing returns.

Figure 1. Figure from Hubbert's 1956 paper, Nuclear Energy and the Fossil Fuels.

Figure 1. Figure from Hubbert’s 1956 paper, Nuclear Energy and the Fossil Fuels.

In the example shown above, Hubbert assumes cheap nuclear would take over, before the decline in fossil fuels started. Hubbert even talked about making cheap liquid fuels using the very abundant nuclear resources, so that the system could continue as before.

In this special case, Hubbert suggested that the decline in resources might follow a symmetric curve, slowly declining in a pattern similar to its original rise in consumption, since this is the pattern that often occurs in extracting a resource in nature. Many Peak Oilers seem to believe that this pattern will happen in the more general case, where no perfect substitute is available, as well. A perfect substitute would need to be cheap, abundant, and involve essentially no cost of transition.

In the special case Hubbert modeled, Hubbert indicated that production would start to decline when approximately 50% of reserves had been exhausted. Peak Oilers often used this approach or variations on it (so called “Hubbert Linearization“), to forecast future production, and to determine dates when oil production would “peak.” Of course, as technology improved, additional oil became accessible, raising reserves. Also, as prices rose, resources that had never been economically extractible became extractible. Production continued beyond forecast peak dates, again and again.

Peak Oilers got at least part of the story right–the fact that we are in fact reaching diminishing returns with respect to oil. For this they should be commended. What they didn’t figure out is, however, is (1) how the energy-economy system really works, and (2) which pieces of the system can be expected to break first. This issue is not really the Peak Oilers fault–it is the result of starting with a very bad model of the economy and not understanding which pieces of that model needed to be fixed.

How the Economic System Really Works 

We are dealing with a networked economy, one that is self-organized over time. I would represent it as a hollow network, built up of businesses, consumers, and governments.

Figure 2. Dome constructed using Leonardo Sticks

Figure 2. Dome constructed using Leonardo Sticks

This economic system uses energy of various kinds plus resources of many kinds to make goods and services. There are many parts to the system, including laws, taxes, and international trade. The system gradually changes and expands, with new laws replacing old ones, new customers replacing old ones, and new products replacing old ones. Growth in the number of consumers tends to lead to a need for more goods and services of all kinds.

An important part of the economy is the financial system. It connects one part of the system with another and almost magically signals when shortages are occurring, so that more of a missing product can be made, or substitutes can be developed.

Debt is part of the system as well. With increasing debt, it is possible to make use of profits that will be earned in the future, or income that will be earned in the future, to fund current investments (such as factories) and current purchases (such as cars, homes, and advanced education). This approach works fine if an economy is growing sufficiently. The additional demand created through the use of debt tends to raise the prices of commodities like oil, metals, and water, giving an economic incentive for companies to extract these items and use them in products they make.

The economy really can’t shrink to any significant extent, for several reasons:

  1. With rising population, there is a need for more goods and services. There is also a need for more jobs. A growing networked economy provides increasing numbers of both jobs and goods and services. A shrinking economy leads to lay-offs and fewer goods and services produced. It looks like recession.
  2. The networked economy automatically deletes obsolete products and re-optimizes to produce the goods needed now. For example, buggy whip manufacturers are pretty rare today. Thus, we can’t quickly go back to using horse and buggy, even if should we want to, if oil becomes scarce. There aren’t enough horses and buggies, and there aren’t enough services for cleaning up horse manure.
  3. The use of debt for financing depends on ever-rising future output. If the economy does shrink, or even stops growing as quickly as in the past, there tends to be a problem with debt defaults.
  4. If debt does start shrinking, prices of commodities like oil, gold, and even food tend to drop (similar to the situation we are seeing now). These lower prices discourage  investment in creating these commodities. Ultimately, they lead to lower production and job layoffs. If deflation occurs, debt can become very difficult to repay.

Under what conditions can the economy grow? Clearly adding more people to the economy adds to growth. This can be done by through adding more babies who live to maturity. It can also be done by globalization–adding groups of people who had previously only made goods and services for each other in limited quantity. As these groups get connected to the wider economy, their older, simpler ways of doing things tend to be replaced by more productive activities (involving more technology and more use of energy) and greater international trade. Of course, at some point, the number of new people who can be connected to the global economy gets to be pretty small. Growth in the world economy lessens, simply because of lessened ability to add “underdeveloped” countries to the networked economy.

Besides adding more people, it is also possible to make individual citizens “better off” by making workers more efficient at producing goods and services. Most people think of greater productivity as happening through technological changes, but to me, it really represents a combination of technological changes, plus a combination of inexpensive resources of various kinds. This combination often includes low-cost fossil fuels; abundant, cheap water supply; fertile soil; and easy to extract metal ores. Having these available makes possible the development of new tools (like new agricultural equipment, sewing machines, and vehicles), so that workers can become more productive.

Diminishing returns are what tend to “mess up” this per capita growth. With diminishing returns, fossil fuels become more expensive to extract. Water often needs to be obtained by desalination, or by much deeper wells. Soil needs more amendments, to be as fertile as in the past. Metal ores contain less and less ore, so more extraneous material needs to be extracted with the metal, and separated out. If population grows as well, there is a need for more agricultural output per acre, leading to a need for more technologically advanced techniques. Working around diminishing returns tends to make many kinds of goods and services more expensive, relative to wages.

Rising commodity prices would not be a problem, if wages would rise at the same time as the price of goods and services. The problem, though, is that in some sense diminishing returns makes workers less efficient. This happens because of the need to work around problems (such as digging deeper wells and removing more extraneous material from ores). For many years, technological changes may offset the effects of diminishing returns, but at some point, technological gains can no longer keep up. When this happens, instead of wages rising, they tend to stagnate, or even decline. Figure 3 shows that per capita wages have tended to grow in the United States when oil was below about $40 or $50 barrel, but have tended to stagnate when prices are above that level.

Figure 3. Average wages in 2012$ compared to Brent oil price, also in 2012$. Average wages are total wages based on BEA data adjusted by the CPI-Urban, divided total population. Thus, they reflect changes in the proportion of population employed as well as wage levels.

Figure 3. Average wages in 2012$ compared to Brent oil price, also in 2012$. Average wages are total wages based on BEA data adjusted by the CPI-Urban, divided total population. Thus, they reflect changes in the proportion of population employed as well as wage levels.

What Effects Should We Be Expecting from Diminishing Returns With Respect to Oil Supply?

There are several expected effects of diminishing returns:

  1. Rising cost of extraction for oil and for other commodities subject to diminishing returns.
  2. Stagnating or falling wages of all except the most elite workers.
  3. Ultra low interest rates to try to make goods more affordable for workers stressed by stagnating wages and high prices.
  4. Rising governmental debt, in an attempt to stimulate the economy and in order to provide programs for the many workers without good-paying jobs.
  5. Increasing concern about debt defaults, as the amount of debt outstanding becomes increasingly absurd relative to wages of workers, and as all of the stimulus debt runs its course, in countries such as China.
  6. A two way problem with the price of oil. On one side is recession, when oil prices rise to unaffordable levels. Economist James Hamilton has shown that 10 out of 11 post-World War II recession were associated with oil price spikes. He has also shown that there is good reason to expect that the Great Recession was related to the run-up in oil prices prior to 2007. I have written a related paper–Oil Supply Limits and the Continuing Financial Crisis.
  7. The second problem with the price of oil is the reverse–price of oil too low relative to the cost of extraction, because wages are not high enough to permit workers to afford the full cost of goods made with high-priced oil. This is really a problem with inadequate affordability (called inadequate demand by economists).
  8. Eventual collapse of whole system.

There have been many studies of collapses of past economies. These collapses tended to occur when the economies hit diminishing returns after a long period of growth. The problems were often similar to ones we are seeing today: stagnating wages of common workers and growing debt. There were more and more demands on governments to fix the problems of workers, but governments found it increasingly difficult to collect enough taxes for all the needed programs.

Eventually, the economic systems have tended to collapse, over a period of years. The shape of resource use in collapses was definitely not symmetric. Figure 4 shows my view of the typical shape of the collapses in non-fossil fuel economies, based on the work of Peter Turchin and Surgey Nefedof.

Figure 4. Shape of typical Secular Cycle, based on work of Peter Turkin and Sergey Nefedov in Secular Cycles.

Figure 4. Shape of typical Secular Cycle, based on work of Peter Turchin and Sergey Nefedov in Secular Cycles.

In my view, the date of the drop in oil supply will be determined by what appear to on-lookers to be financial problems. One possible cause is that the oil price will be too low for producers (a condition that is occurring now). Governments will find it unpopular to raise oil prices, but at the same time, will be powerless to stop the adverse impacts the fall in price has on world oil supply.

Falling oil prices have especially adverse effects on oil exporters, because they depend on revenues from oil to fund their programs. We are already seeing this now, with the increased warfare in the Middle East, Russia’s increased belligerence, and the problems of Venezuela. These issues will tend to reduce globalization, leading to less world growth, and a greater tendency for the world economy to shrink.

Unfortunately, there are no obvious ways of fixing our problems. High-priced substitutes for oil (that is, substitutes costing more than $40 or $50 barrel) are likely to have as adverse an impact on the economy as high-priced oil. The idea that energy prices can rise and the economy can adapt to them is based on wishful thinking.

Our networked economy cannot shrink; it tends to break instead. Even well-intentioned attempts to reduce oil usage are likely to backfire because they tend to reduce oil prices and have other unintended effects. Furthermore, a use of oil that one person would consider frivolous (such as a vacation in Greece) represents a needed job to another person.

Should Peak Oilers Be Blamed for Missing the “Real” Oil Limits Story?

No! Peak oilers have made an important contribution, in calling the general problem of diminishing returns in oil supply to our attention. One of their big difficulties was that they started out working with a story of the economy that was very distorted. They understood how to fix parts of the story, but fixing the whole story was beyond their ability. The following chart shows a summary of some ways their views and my views differ:

Figure 5. Author's summary of some differences in views.

Figure 5. Author’s summary of some differences in views.

One of the areas that Peak Oilers tended to miss was the fact that an oil substitute needs to be a perfect substitute–that is, be available in huge quantity, cheaply, without major substitution costs–in order not to adversely affect the economy and in order to permit the slow decline rate suggested by Hubbert’s models. Otherwise, the problems with diminishing returns remain, leading to declining wages and rising costs of making goods and services.

One temptation for Peak Oilers has been to jump on the academic bandwagon, looking for substitutes for oil. As long as Peak Oilers don’t make too many demands on substitutes–only EROEI comparisons–wind and solar PV look like they have promise. But once a person realizes that our true need is to keep a networked economy growing, it becomes clear that such “solutions” are woefully inadequate. We need a way of overcoming diminishing returns to keep the whole system operating. In other words, we need a way to make wages rise and the price of finished goods fall relative to wages; there is no chance that wind and solar PV are going to do this for us. We have a much more basic problem than “new renewables” can solve. If we can’t figure out a solution, our economy is likely to reach what looks like financial collapse in the near term. Of course, the real reason is diminishing returns from oil, and from other resources as well.

Gail Tverberg's picture

Thank Gail for the Post!

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Discussions

Hops Gegangen's picture
Hops Gegangen on Oct 10, 2014 3:29 pm GMT

 

Where does all the incredible waste of energy fit into this equation? It seems like the flip side of EROI must be more like happiness per unit of energy input. 

Everywhere I look, I just see waste waste waste. I have neighbors who leave an outdoor incandesent flood light on 24X7, and another who fires up the hot tub when it’s below freezing outdoors. Then on the road outside my subdivision there is a constant flow of traffic consisting of huge SUVs with one passenger going to the mall to buy stuff shipped from China for eventual trucking to  a landfill.

I think we could cut a lot of waste and be just as happy, if not happier. Personally, I managed to arrange to work at home instead of commuting all the time, and I am much happier despite using a lot less fuel.

 

Max Kennedy's picture
Max Kennedy on Oct 10, 2014 4:25 pm GMT

Hello Gail, Well written and easily understood.  There is one statement towards the end that I will, however, disagree with.  “But once a person realizes that our true need is to keep a networked economy growing”.  The fallacy of continuous growth is one of the fundamental lies of neoclassical economics that is part of the “wrong version of how our economy works”.  We need to prepare for an economy not of growth but of maintenance with periods of growth due to change.  The changes may be in tecnology, realisation of new resources etc… however if we predicate an economic system on growth we will inevitably reach the end of a era and see a bust.  We need an economic model that will prepare us for the end of a particular growth cycle, maintain us through an era of constancy and prepare us to grow again when conditions warrant.  this would slow growth when change occures because the economy would be looking at the long term and what the new sustainable end point would be.  If we wish to avoid the continuing cycles of civilisation collapse this is what we MUST achieve and is the real NEED!

Joris van Dorp's picture
Joris van Dorp on Oct 12, 2014 11:58 am GMT

Hops, its foolhardy to expect that lifestyle changes (Enforced?) will save the environment. It wont happen. I see the same thing you write above: Hot tubs in winter, lights on all the time, etc. Particulary, I see households living in recently built – very efficient – homes who then go and install hot tubs outside, infra red heaters outside, etc. *because* they noticed that their energy bills are lower due to living in an efficient house!

We must ensure the provision of abundant, cheap, clean energy, and then try our best(!) – through political negotiation – to institute an efficient(!) framework of energy taxation that will stimulate reasonable(!) efficiency improvements and prevent pointless(!) waste. Exclamation marks are there to point out that all these elements require very careful design, to prevent social inequality, ‘carbon leakage’, lack of (international) competitiveness, etc.etc. etc.

We cannot risk our common future on the expectation of massive lifestyle changes alone, even though we might philosophically conclude that lifestyel changes are “necessary”. That is just abstract thought! It doesn’t work in the real world. So we cannot stake the future on it. We need to enable cheap, clean, abundant energy to replace our current dirty energy, and that can only be nuclear power.

Wilmot McCutchen's picture
Wilmot McCutchen on Oct 12, 2014 9:29 pm GMT

Shale oil has become so cheap in the US that peak oil fears now seem to have been groundless.  And natural gas is now so abundant that in North Dakota it just gets flared into the atmosphere.  Water is lavishly consumed and polluted by fracking and oil sands extraction, despite the Drought.  So it would seem that something like the loaves and fishes is going on with what we of little faith used to believe were finite natural resources.

The money supply, too, expands by accrual of compound interest without limit.  So does the debt of students  reduced to peonage by compound interest on debts they will never be able to pay or discharge in bankruptcy.  Evidently the Jubilee has been repealed, as well as the laws of nature.  Party on, 1%!

Thanks, Gail, for your lucid dissent.  Recent news might explain weak oil prices: the Rossi reactor.  http://www.extremetech.com/extreme/191754-cold-fusion-reactor-verified-by-third-party-researchers-seems-to-have-1-million-times-the-energy-density-of-gasoline

Gail Tverberg's picture
Gail Tverberg on Oct 13, 2014 1:50 am GMT

There is a big difference between (1) expanding money supply and (2) expanding the supply of goods that money might buy. The government is good at expanding money supply. It is a lot less good at expanding the goods that that money might buy.

For example, all of the debt given to students so that they can go to school increases the money supply, since it is paid to university professors and used to buy books. Whether the debt will really be paid back depends on whether the young people incurring the debt actualy get high-enough paying jobs to pay back the debt. The young poeple who drop out wihtout finishing are likely to be especially hard-pressed to repay their loans. But these loans are part of government balance sheets. They are counting on having control of the goods that his money will buy.

Gail Tverberg's picture
Gail Tverberg on Oct 13, 2014 2:07 am GMT

I agree that in a finite world, an economy cannot grow forever. We reach diminishing returns. 

The problem we have is a catch-22 type problem.  Because of diminishing returns, we need to keep growing our use of energy, just to stay even. This is related to our using the cheapest to extract resources first. We are forced to move on to the more expensive to extract resources.

When it comes to metals, recycling is at best a very partical solution, because of the energy required and losses involved in all recycling. Quite a few people believe a “circular economy” is possible, but this is not really the case, because there are always energy losses. 

There is also the issue of all species reproducing at greater than the needed level to replace the parents. We need to spend energy (birth control pills, education, coersion) to try to keep populatoin down. Otherwise, we have problem of more mouths to feed. This doesn’t work on level resource use.

Gail Tverberg's picture
Gail Tverberg on Oct 13, 2014 2:14 am GMT

“Waste” is what helps keep oil prices high enough so that businesses can afford to extract the oil. It also pays wages for people (for example, making the SUVs). So it is not as simple as you say. Your waste is someone else’s job.

A big part of what the high base EROEI pays for is the things that make our system possible, but arne’t direcly measured: government, education, roads, pipeliness, electricity transmission lines, banks, a system of airlines and boats, factories, and other things needed to keep our system operating. We can’t get rid of these.

 

Max Kennedy's picture
Max Kennedy on Oct 13, 2014 2:49 am GMT

Nature seems to do quite well with a circular economy using the energy input of the sun to actually increase diversity and wealth.  So what is to prevent us from doing the same instead of the current rape, pilliage and dump?  2 things really.  The first is an expanding population that takes more and more and the second is the attitude it cannot be done.  Part of a circular economy is reducing population to a sustainable level, less than a 3rd of what it currently is.  The other is throwing out the idea of growth and controlling our desire for more.  If we don’t, like all civilisations before us, we will collapse!  An ethical maturity not currently in evidence is needed to progress from here.

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