The last century can rightly be called the Age of (Inexpensive or ‘Cheap’) Oil as world oil consumption grew from about 20 million tons per year in 1900 to just under 400 million tons per year in 2005. Since 2005, however, world oil consumption has been nearly constant despite high demand and record high oil prices, which indicates that we simply cannot produce oil any faster. And since oil is not renewable, eventually the production (and therefore the consumption) of oil must decline.
Declining oil production will be an extremely painful reality for the U.S. because not only does the rate of energy use strongly affects national wealth, health and education levels, but the American economy is built on two largely unspoken assumptions about oil: First, we assumed we could have all the oil we wanted, and second, we assumed that oil prices would be relatively low ($20 per barrel) and stable. Neither one of those assumptions is true anymore, and as a result, U.S. society has entered into a painful transition, highlighted by much of the turmoil that we see around us – such as the rise and fall of places like Detroit, the 2008 financial crisis, and the reduced tax base for local and city governments and subsequent reduction in services.
As the oil age winds down even bigger problems will arise: High unemployment will follow a shift away from industrial and occupational hyper-specialization, high and volatile oil prices will wreak havoc on the food system, and national and international trade – particularly in commodities – will be in turmoil as prices and price volatility increase. Since trade has always been a catalyst for wealth creation, the buffeting of trade will likely reduce American and global wealth creation.
Perhaps the most far-reaching and transformative effect of the end of cheap oil, and the end of growth in oil consumption rates, will be a significant and long-lasting brake on economic growth. Increased rates of oil consumption over the last century led to greater economic activity, higher gross domestic product (GDP) levels and bigger tax receipts. Over the past decade, coinciding with the end of cheap oil, growth in real GDP has been very slow in the US and the developed world and thus tax receipts are stagnant or declining. What will happen to our social programs and entitlements that require continuing economic growth? I believe it will be a very painful period for the U.S. and other nations as we revisit and revise our social programs to account for lower economic growth.
If we are to make wise decisions about our future, we must understand and accommodate ourselves to this harsh fact: the age of cheap oil is over, and it will not return.
Do you agree with this analysis of the oil landscape? Please comment.
Read the original version of Dr. Bruce Dale’s editorial, first published in the journal Biofuels, Bioproducts & Biorefining, here: “The times they are a-changin’: the end of cheap oil and how it is changing our world.”
I very much agree with this analysis. I have written about this subject to a significant extent, including an article published in the journal Energy called, Oil Supply Limits and the Continuing Financial Crisis.
Beyond what you have said, I don’t think that people realize that limited oil supply can manifest itself in many ways. One of the more obvious ways is in cutbacks in discretionary demand, as consumers pay more for oil and for food (which uses oil for production and transport). This leads to layoffs in discretionary industries, such as restaurants and vacation travel, and also can lead to debt defaults and recession.
As governments attempt to fix the problem of high unemployment and failing banks, they are dragged into the mire as well. They find themselves with higher payouts for unemployment coverage, stimulus funds, and bank bailouts. At the same time, tax collections are lower, because of lower employment. The result is continually high deficit spending, that is not fixed as long as oil prices remain high and economic growth remains sluggish. If a government attempts to fix its debt problems, it has the potential to plunge the country back into recession.
I have been researching and writing about this issue since late 2005. I write on a blog called http://ourfiniteworld.com/ . A recent post that has been popular is Ten Reasons why High Oil Prices are a Problem.
I do think Dr Dale’s article neglects the impact of drilling for oil in shale…in hard to get at tight oil. While I do not believe that shale oil will make the U.S. like saudi arabia, I do believe it will increase supply. Although many factors affect price (eg. tension in middle east, global demand, likely manipulation and speculation, because tight oil is expensive to drill, on average, it will over time probably generate high costs of oil per barrel. Opening up vehicle fuel markets to competition from alternative fuels….a major public policy plus…would leaven oil costs and likely reduce costs of oil per barrel and gasoline at the pump. It could also impede drilling for oil in environmentally sensitive areas like the artic and monterey shale. If oil per barrel costs go below 70 dollars a barrel, oil producers will think twice about drilling, given high costs. We do need to think through a new definition of peak oil.
As a point of clarification, in Dr. Dale’s original editorial, he wrote this about ‘new’ oil:
“The ‘new’ oil (from deep-water drilling, enhanced oil recovery, tar sands, etc.) is much more expensive than conventional oil. The ‘new’ oil also yields much less useful energy for our society per unit of energy used to produce it than conventional or cheap oil.”
thanks for clarification…but really even with limitations to “new oil,” restricted gasoline markets plus the other factors mentioned in my comments above, assuming they occur, will grant emphasis to drill baby drill re. tight oil and because of the cost of drilling generate higher cost of gas at the pump. Opening up the fuel market to alternative transitional fuels would steady prices and probably cause a decline. The standard for an alternative fuel ought to be is it as safe , and environmentally better than gasoline. Then let the consumer chose.
I thank everyone for their comments. For those who may be interested, the full text of my editorial “The Times They Are A’ Changin…” from which Michael Spiak kindly extracted the condensed version above is found at:
http://onlinelibrary.wiley.com/doi/10.1002/bbb.1382/abstract
The editorial is available as a free download and represents several years of thinking and reading about our energy situation, particularly for liquid fuels. I think it is pretty good and recommend it to you.
While I agree that tight oil from shale formations and tar sands oil are needed, we must be very careful not to oversell them. There is a reason we didn’t pursue those resources first… they are much more costly and provide much less useful energy to run the rest of our society than conventional or “cheap” oil. It would be a serious error to think we can delay making serious decisions about our energy future because of temporary, costly tight oil and tar sands oil.
A lot is at stake here. If we do not use our remaining oil and other energy resources wisely to make a transition to sustainable, renewable energy resources, we may find ourselves in a few decades without the wealth needed to make that transition. We don’t have a lot of time left and so we must grow up.
Fuel choice at the pump is one means to a desired end, but it is not the end in itself. The end of our planning and thinking must be a stable, sustainable energy system that meets our needs, the needs of the planet and the needs of future generations. No other choice is moral or intelligent.
Pwc just issued a starkly contray report http://pwc.to/WKSWqB which is worth adding to this discussion (even if it is built off of a flawed assumption that conventional crude production will grow about 15% over the next 20 years). But there is certainly supporting commentary – here is Lou Gagliardi from this weeks echoing Bruce’s view http://bit.ly/ZcWJiU Fascinating that the range on the analysis can be this far apart.
Personal experience has made me skeptical of ‘peak oil’ prophecies like Dale’s.
I don’t know who Dale thinks “we” is, but his initial statement — “First, we assumed we could have all the oil we wanted, and second, we assumed that oil prices would be relatively low ($20 per barrel) and stable.” — is questionable.
At the AAAS annual conference in 1980, I chaired a panel of leading experts on the prospects for energy in the coming decade. They all agreed with the notion that the age of cheap oil was over and that oil prices would soar to $80/bbl or more in the next 10 years. One expert the other panelists had discouraged me from inviting — because his views were considered too unorthodox if not preposterous — was S. Fred Singer. Singer had publicly forecast that oil prices were about to begin a prolonged decline.
As it turned out subsequently, Singer was right and the other experts were wrong.
[See graph: http://bit.ly/15lKeBh
Dale’s argument might be more defensible if it were taking a very long term perspective. But he implies that the end of cheap oil is imminent, and its effects of the transition already present. At best, his argument seems shaky.
In the summary above, Dale blames the high cost of oil and gas for “much of the turmoil we see around us – such as the rise and fall of places like Detroit, the 2008 financial crisis, and the reduced tax base for local and city governments and subsequent reduction in services.”
But most economists would not share that view of either the cause or consequences of the Great Recession.
Detroit was damaged by the bankruptcy of General Motors and Chrysler. The latter were the result of a combination of poor management and excessive labor costs. Ford was better managed and did not require any bailout.
The financial implosion of 2008 also had little or nothing to do with the real cost of petroleum. Most government and other analyses concluded that the spike in oil prices in early 2008 was the result of financial speculation; especially via commodities future contracts that had become unhinged from actual delivery of oil or other commodities. That was one symptom of the broader malignancy of financial markets caused by the proliferation of derivative financial products — collateralized debt obligations, credit default swaps, etc. — combined with poor/nonexistent regulation.
In particular, most analysts attribute the cascade of financial failures — especially of institutions deemed “too big to fail” — to the explosion of synthetic securities spun out of shady ‘subprime’ mortgages. In what effectively was an ornate Ponzi scheme, these were contrived to inflate the real estate bubbles in the US and other countries until, as always, they inevitably went bust.
In the full version of his essay, Dale attributes the real estate collapse to oil prices:
“But when gas prices surged in the last decade, many people could not afford to keep up their mortgage payments and also drive to work. So to keep their jobs, they defaulted on their mortgages. Millions of these defaults helped to precipitate the financial crisis of 2008, the effects of which continue with us to this day. ”
That hypothesis does not seem to conform to history or the judgment of most economists. An inconvenient fact contrary to Dale’s version is that the housing bubble began to burst before the spike in oil prices.
National Association of Realtors chief economist David Lereah’s explanation, “What Happened”, from the 2006 NAR Leadership Conference:
>Boom ended in August 2005
>Mortgage rates rose almost one point
>Affordability conditions deteriorated
>Speculative investors pulled out
>Homebuyer confidence plunged
>Resort buyers went to sidelines
>Trade-up buyers went to sidelines
>First-time buyers priced out of market.
A 2008 paper by Frale and Gros showed that housing prices and the cost of oil (measured by purchasing power) had recently moved in opposite directions in several European countries as well as in the US. But the authors noted that “For most European economies there is no significant evidence of oil price impact on extreme GDP outcomes.” So the housing bust occurred in multiple countries at the same time, even in ones not particularly sensitive to oil prices.
If oil prices were so influential on economic conditions, one might have expected that the collapse of oil prices in late 2008 would have stimulated a rapid economic recovery. But that did not occur.
Gold and other commodity prices rose in parallel with oil prices. Yet Dale does not conclude that a scarcity of gold caused the housing bust and subsequent economic crash. It is at least equally plausible to conclude that investors rushed to shift money out of a bursting real estate bubble and into oil, gold, and other commodities — just as the collapse of the dot-com bubble c. 2000 led to an investor rush from tech stocks into what became an expanding real estate bubble.
Equally questionable is Dale’s broader conclusion: “High unemployment will follow a shift away from industrial and occupational hyper-specialization, high and volatile oil prices will wreak havoc on the food system, and national and international trade – particularly in commodities – will be in turmoil as prices and price volatility increase.”
First, much of the increase and persistence of unemployment in the past several years has been caused by technological innovation and structural factors having no direct connection to energy costs. Even as a growing abundance of domestic natural gas — which has become dramatically cheaper not more costly as Dale suggests — has sparked signs of a renaissance of manufacturing in the US, economists do not see or expect a significant increase of employment as a result. Corporations have become adept at increasing both business and profits substantially of late without hiring more workers.
Chronic and increasing unemployment, especially among the young, is a deeply worrisome problem in the emerging 21st century economy. But it is not significantly related to the costs of energy or other commodities.
The volatility of prices of energy, commodities, and other factors of production may have a greater chilling effect on economic performance, by stoking the uncertainty that still stymies recovery, than whether the prices are high or low. Consistently high prices prompt investment in the development of offsetting alternatives and innovations. But volatility and uncertainty discourage those investments.
Agriculture and food supply, on the other hand, are chronically vulnerable to the volatility of weather, disease, pests, market, geopolitical, and other factors. Futures markets, insurance, stockpiles, trade, and other mechanisms have long existed to buffer the effects of such variability. It is the lack of these mechanisms in many poor/developing economies that amplifies their vulnerability.
One energy policy that clearly has increased food insecurity is the diversion of agricultural production to biofuels.
Overall, it is unsurprising that other assessments, as Hinckley comments here, are so contrary to Dale’s.
I thank Dr. Perelman for his comment on my post “The End of Cheap Oil…”. I will try to be clear, and hopefully polite, in my response to his observations. Since the cost and availability of energy are crucial issues for our society, I hope I may be forgiven if I occasionally seem to step over the line of polite disagreement. It is much more important that our society be well-served by vigorous, fact-based disagreement, than it is whether or not Dr. Perelman or I have our feelings bruised.
As to who “we” is in my post, I mean modern industrial society, especially the U.S., but not just the U.S. If industrial society had ever seriously questioned the cost and availability of oil, then we would see it as a major theme of discourse. But it is not a pervasive theme. So I stand by my assertion. In the face of lots of evidence to the contrary, “we” (again, I mean modern industrial society, especially the U.S.) are assuming that we can “drive to WalMart forever” to quote a memorable phrase. We (including India and China and Malaysia, to name just a few places I have visited in the last few years) continue to build roads and bridges and parking lots and shopping malls as if the next hundred years will be dominated by the auto as the last hundred years have been.
I agree that we can question almost any assertion, including Dr. Perelman’s multiple assertions. So let’s deal with some facts instead of assertions. Here is an historical chart of the price of oil in constant 2010 dollars. There is a lot that can be learned from this chart, but I would like to focus on just a few things. First, crude oil prices were relatively stable at about $20 per barrel or less from 1880 through 1970. That time period corresponds to the build out of the modern U.S. we see around us…roads and shopping malls and suburbs everywhere. Then in the 1970’s, we experienced two oil price spikes and a really bad recession accompanied by high inflation. Sound at all like our current situation?
In the early 1980’s both the North Slope of Alaska and the North Sea oil fields came into full production. Oil prices fell back, not to earlier $20/barrel or less levels, but instead to higher prices consistent with the higher cost of oil production in those difficult drilling locations. (As Dr. Perelman correctly notes, predictions of peak oil at that time were wrong. More about the peak oil issue below.)
In the late 1990’s oil prices started to climb again, this time not because of political events as in the 1970s, but because of supply and demand. That multi-year run up in oil prices culminated in 2008 with the highest average oil prices since the beginning of the oil age in 1860. Oil peaked at almost $150 per barrel in the summer of 2008. And in 2008 we got the official start of the Great Recession. Oil prices are now higher on a sustained basis, in spite of a continuing deep recession, than they have been in over 150 years.
So, Dr. Perelman, with respect, the end of cheap oil is not “imminent” as you say that I imply. It is past history. The data show this conclusively. If you think we can return to the days of $20/barrel oil, kindly tell us how that miracle is to be achieved.
What is not so clear-cut is the cause of the recession. I agree that risky financial practices certainly played a role. (By the way, why are none of the perpetrators in jail? Not our subject today, I suppose.) But let me provide another perspective. I think high oil prices and the Great Recession are strongly linked through the effect of oil on all commodities. I believe oil is the “super commodity”. It is the only commodity required to first produce and then to transport essentially every other commodity on the planet: grain, steel, lumber, bauxite, coal and so on. If that is the case, then we might expect to see strong run ups in prices of other commodities caused by (or at least following) the run up in oil prices. I think we see exactly that. Here are a few illustrative figures. This figure tracks the constant dollar (2005 $) prices of a number of important commodities over the past two decades.
Note that crude oil prices started climbing in about 1998 and peaked in 2008 before crashing and then rising again. Every other commodity group in this group started rising after oil prices started to climb, peaked about the same time that oil peaked, crashed with oil prices and started rising again with rising oil prices post 2008…even though we are in this depressing recession. What is the link between prices of food, metals, minerals, rebar and urea? I think the link is oil.
At the risk of belaboring this point I will include a more detailed commodity price graph that includes oil, maize (corn) and composite food prices, again in constant 2005$. Here it is.
Again, note that oil prices started climbing in about 1998, but not much happened with food or maize prices until 2003 or so, when they started rising also. All of these peaked in about 2008, crashed and then started rising again, once again with oil leading the way. If oil prices tend to drive other commodity prices, then these are the patterns we would expect. And given the effect of high commodity prices on economic activity generally, wouldn’t we expect that high commodity prices would tend to cause economic distress? Sharp rises in oil prices have preceded 7 of the last 8 recessions in the U.S. The biggest oil price spike of all preceded the biggest recession of all; the one we are currently enjoying. Looks like pretty strong causation to me.
Dr. Perelman, when you say that “most economists” would not share my view of the causes or consequences of the recession, I don’t know of any polls that have been conducted asking that question. Please share such polls if you have them. Do “most economists” agree with each other, even if they don’t agree with me? I doubt it. Harry Truman’s famous request to “bring me a one-handed economist” rings true to me. So I have to say that such polls would probably not make much impact on me anyway. I am not too impressed with the performance of “most economists”. My question would be: who are these economists and what is their track record? Have they ever successfully, unequivocally explained any economic trends to the satisfaction of anyone but themselves?
There are many schools of economic thought and each school sees the world very differently. We are now running a massive Keynesian school experiment to see if creation of money (actually credit expansion) can stimulate the economy. Their results over the past few years are not very encouraging. If the Federal Reserve had the power to print barrels of oil, rather than pictures of dead presidents, perhaps we could test my hypothesis about the importance of oil, but essentially unlimited money creation doesn’t seem to be doing the trick.
In the meantime, please put me in the school of the “ecological economists”. The view of this school is that the economy is a wholly-owned subsidiary of the environment, and that environmental constraints ultimately constrain the human economy. Human creativity and innovation certainly matter, but there are still upper limits on human economic activity on a finite planet. In their view (and mine), the human economy uses energy to turn resources into wealth. (Basically this is the definition of the “work” function in the science of thermodynamics.) I think this thermodynamic approach is a much more reality-based view of economics than the one John Maynard Keynes gave us, and I have some evidence to support my view. Here is a small bit of the evidence.
If indeed human wealth is generated ultimately by the consumption of energy, then we ought to see a strong relationship between the rate of energy consumption (power consumption) and the rate of wealth generation. And indeed we do. The most generally accepted measure of wealth is annual GDP. Here is a graph of the per capita rate of energy consumption (power) versus the annual per capita GDP for the major regions of the world.
The correlation coefficient here is almost 93%, meaning that the rate of energy consumption explains 93% of the observed rate of wealth production. For those of my readers who took their last statistics class a long, long time ago, that is a very high correlation coefficient. In my laboratory, where conditions are very well controlled and the physical mechanisms are clear, we are delighted when we achieve correlations this high between our experimental variables. Bottom line: the relationship between energy consumption and wealth generation is both very strong and very real.
I have much more data that I am happy to show to support this point, if readers desire it. Or you can Google “energy consumption and GDP” and find it for yourself. There is some evidence against the idea, but lot more evidence, and a lot more convincing evidence for the concept. Read a couple of dozen papers on the subject, as I have, and it is likely you will also agree that energy consumption is a key predictor of wealth generation.
This comment is already very long, so let’s fast forward a bit. What happens when the rate of energy consumption falls? Do we see corresponding decreases in wealth generation? For example, what is the effect of increased gasoline prices (causing decreased gas consumption and thus less energy use) and economic activity? Since the effects of higher gas prices take a while to ripple through the economy, we might expect to see a delay between rising gas prices and economic activity. And indeed we do.
For a period of 35 years, the two lines on this graph track over each other very well. The unemployment rate (two years later) is a very good fit with the observed patterns of gas price increases and decreases. And when the unemployment rate goes up, what happens to mortgage defaults? The answer ought to be obvious. People tend to lose their homes when they lose their jobs. When enough people can’t pay their mortgages, then you have a financial crisis. Shoddy lending practices certainly contributed to the ongoing financial crisis of 2008, but first people lost their jobs, then they defaulted on their mortgages. And they lost their jobs in large measure because the cost of energy, for which gas prices are a proxy, increased so much.
If I am wrong, or incomplete in my understanding, I am happy to consider other points of view that are supported by data and facts. But opinion does not weigh very heavy in my scales and hype does not move the scales at all. I accept the Royal Society’s dictum on this issue: “Nullius in verba” (“take no man’s word for it”). I am not very interested in opinion…polls of economists or otherwise. Show me data and facts, please.
So let me end with a few key facts. The rate of oil production peaked (or plateaued if you don’t want to eat the whole enchilada right now) in about 2005. Dr. Kenneth S. Deffeyes predicted this date in his book, “Beyond Oil: The View from Hubbert’s Peak” (very much worth the reading). From the BP annual statistical report of world energy, we have compiled the stacked graph below showing the oil production from each of the major producing regions. As Deffeyes predicted, world oil production has been constant at about 4000 million metric tons per year (roughly 75 million barrels per day) since 2005.
So after increasing almost continuously since 1900 (except for the consumption reset due to the oil price spikes of the 1970s), world oil production has not varied much at all since 2005. OPEC production is politically-driven, and determined mostly by the need to maintain oil prices high enough to support internal social programs within OPEC countries. Thus the key issue that concerns us is what oil is available from non-OPEC sources. And that has been about 42 million barrels per day since 2005 (see below). The evidence is very strong that we are indeed at “peak oil”.
These data are reinforced by individual company data from the global multinational oil companies. In 2011, the last full year of data for Exxon Mobil, their extraction reached 2.3 million barrels per day of conventional crude. That is down 4.5% compared to 2010. It is down 11.6% compared to 2007. In 2007, Exxon drilled 971 new wells, then 1249 wells in 2010, and then 1606 wells in 2011. Thus well-drilling increased 65% over those four years, but their production of crude oil fell 11.6%. For the French company, Total, crude production declined 8.5% between 2010 and 2011, and it fell 18.8% between 2007 and 2011, even with big increases in their budgets for exploration and production.
These are patterns we would expect to see if global oil production had indeed peaked. Since oil represents about one-third of world energy consumption, then at least one-third of the driving force for global economic growth has been removed- if you accept the connection between energy consumption and economic output. Ouch!
I think this comment is probably much too long, but I hope it has been useful to those who have taken the trouble to read this far. I hope it generates more fact-based discussion and comments. I would love to be proven wrong about peak oil and about the connection between energy consumption and wealth…but I don’t think I am wrong. The consequences of those two linked ideas are very, very sobering. So I would like facts, please, and no hype about “Saudi America” that are not backed up with data.
I have a few comments in response to Dale’s rebuttal to my earlier critique of his essay.
1] First, Herschel Specter posted a similar argument recently linking petroleum scarcity to economic decline. I noted there that both his and Dale’s arguments here rest to a large extent on the common error of confusing correlation with causation. I presented charts showing that, by similar logic, one might argue that the sales of Rolling Stones’ records drive US oil production, or that Facebook usage caused the Greek debt crisis. Technically, this is the logical fallacy of Pro/Cum Hoc Ergo Propter Hoc.
So, for instance, in his rebuttal, Dale presents a chart showing an apparent connection between US gasoline price and US unemployment. Not only does that not prove causality, but the data are selective in a way that may be misleading.
If we looked at a different period of history, between the two World Wars from 1920 to 1940, we would see no evident connection between real gas prices and the immense wave of unemployment that occurred during the Great Depression:
2] Dale apparently rejects all economic science out of hand, which makes economic debate difficult. Dale prefers to view the economy as a thermodynamic machine rather than as a social system. That is essentially the same perspective taken by physicist Tim Garrett in a controversial and widely noted article published in the journal Climatic Science (after being rejected by many other journals). Analyzing the entire global economy as a single heat engine, Garrett concluded that the ratio of gross economic product to energy consumption has remained constant over time. Among the implications of Garrett’s thesis was that measures to increase energy efficiency would only serve to increase economic growth, not to reduce gross energy consumption.
A critique by Cullenward, Schipper, Sudarshan, and Howarth published in the same journal lists a number of problems with Garrett’s mechanistic approach. Their broad conclusion is that “the theoretical and empirical evidence supports the view that energy and economic systems are dynamic, and unlikely to be predictable via the application of simple rules.”
On his site, Garrett in turn claimed not only that they and other critics misinterpreted his analysis, but also that the journal editor had not handled the controversy fairly. [His complaint seems to have some merit, IMO.]
I’m not able to get into the details of that debate here. (The links should enable others to drill into it.) In general, I would say that many of the problems noted by Cullenward et al apply as well to arguments presented here by Dale and Specter.
I think there is something to Garrett’s thesis. Modern economies do seek to grow and seem inclined to exploit all available energy resources to do so. Going back to Jevons’ Paradox — based on the observation that increased technical efficiency in the use of coal led to increased not decreased consumption — I’m inclined to believe that there are likely to be ‘rebound effects’ as energy efficiency is improved.
But it’s a mistake to view the economy purely in the literally ‘inhuman’ framework of mechanics or what Dale considers environmental economics. While undoubtedly influenced by not only the quantity but qualities of its physical components, the behavior of economies is produced and governed overwhelmingly by multitudes of interacting human actions. As the mathematician/economist Nicholas Georgescu-Roegen counseled in his classic work, The Entropy Law and the Economic Process: “The true product of the economic process is an immaterial flux, the enjoyment of life, whose relation with the entropic transformation of matter-energy is still wrapped in mystery.” [My emphasis.]
Moreover, the central lesson of the emerging field of behavioral economics — in contrast to the assumptions of neoclassical and other idealized economic theories — is that the human behaviors which drive economic performance are more often irrational than they are rational.
The immensely complex, even chaotic character of the ornate web of interactions among billions of human (as well as increasingly human-automated) actions makes the problem of economic explanation fiendishly difficult. It similarly makes the task of economic forecasting vexing. But better solutions will come from better social and behavioral research, not from a wholesale rejection of economics itself.
3] To further illustrate the flaws in Dale’s argument, he presents another chart seeming to show a linear relationship between GDP and energy consumption. But the oversimplified chart chart masks some contrary realities.
One is that the “energy intensity” — the amount of energy used to create a dollar of GDP — of national economies varies considerably among countries:
Another is that there has been a broad historic trend for the energy intensity of many national economies to decline in recent decades:
4] Common to “peak” arguments like those of Dale and Specter — and the neo-Malthusian prophecies of increasing hardship they seem to project — is the flaw of treating “resources” as finite, purely physical inventories.
But resources per se do not really exist in the natural world. Whether and to what extent a material stock is a “resource” is determined by human perceptions, attitudes, and technologies. As the latter continually change and evolve, so too does the value attached to various resources.
Anne Korin and Gal Luft point out in their book, “Turning Oil Into Salt,” that until about a century ago, salt (sodium chloride) was one of the most strategically precious resources throughout most of the preceding history of civilizations. What made people prize salt was the substance’s unique ability to preserve food. Salt was important enough for people to fight wars over. The word salary derives from the Latin term for the wages paid to Roman soldiers — in salt.
The invention of refrigeration and other food-preservation technologies transformed the status of salt as a resource. Today, about the only threat associated with salt may be the health hazard posed by over-consumption.
In a commentary about 15 months ago, Stephen Brown of Resources for the Future noted that advanced technology — fracking, horizontal drilling, etc. — had greatly changed the picture of U.S. natural gas resources in just a few years: “Estimates of conventional natural gas resources remained steady while estimates of shale gas resources more than doubled from 2007 to 2009. Moreover, the cost of producing these shale gas resources has also dropped considerably.”
A sub-head in that article makes the key point: “Advances in Technology Yield Greater Availability.”
At the same time, advances in technology, other innovations, or changing market fashions can make a particular resource seem scarce when demand shifts in its direction. How people perceive and respond to scarcity or abundance also depends on variable social and behavioral factors.
Behavioral economics is key to understanding why the way energy (or other) resources are valued and used often seems irrational. That is underscored in another, recent paper from Resources for the Future by Karen Palmer and Kenneth Gillingham, “Bridging the Energy Efficiency Gap: Insights for Policy from Economic Theory and Empirical Analysis.”
In an insightful 1978 article in Science, historian Charles Berg observed that through most of the period in the late 19th century when coal progressively replaced wood as a primary industrial fuel, coal generally cost more than wood did. Human factors rather than just scarcity or price drove the transition. As Berg explained, coal won the contest because “coal had on its side the focused intelligence of the world’s most talented scientists, engineers, inventors, and entrepreneurs….” who were drawn to work on coal because it was perceived, as we would say today, to be the wave of the future, the “next big thing.”
There are still a number of points in my response to Dr. Perelman’s initial post on my article to consider – beyond the “correlation is not causation” argument – such as the growing body of data that support peak oil, the fact that oil prices are higher than they have ever been and rising again, even during a recession, or the fact that other commodity prices are strongly linked to oil prices.
I still reject Dr. Perelman’s claim that “Most economists would not share [Dr. Bruce Dale’s] view of either the cause or consequences of the Great Recession.” But I’m interested in any polls that have been conducted asking economists their view of the causes or consequences of the 2008 recession that prove otherwise. I do not “reject all economic science out of hand”, as I think supply and demand is a well-established principle, for example, and my first post implicitly accepts supply and demand.
Yes, I tend to be skeptical about economic projections. But we are engaged in this discussion to persuade each other based on evidence. So please persuade me by the evidence why a major cause of the recession of 2008 was not linked to the highest oil prices we had ever experienced. In the meantime, I offer one economist’s (Dr. James Hamilton of the U. of San Diego) analysis of the link between oil prices and the recession. If you don’t want to read the whole Hamilton paper, the following summary of his findings is shorter and well done.
Several economists at the St. Louis Federal Reserve also associate oil price shocks with increased likelihood of entering into recession. Here is their paper.
Finally, I offer one more very well done piece by Gail Tverberg, who commented early on my first post. Ms. Tverberg draws together a number of lines of reasoning and evidence to show that oil prices do matter to the economy—they matter a lot.
Understanding the concept of correlation and causation is important, as Dr. Perelman points out in his second post (Rolling Stones’ record sales driving US oil production—good grief!). I have a good background in statistics, painfully acquired, and therefore do not look for correlation between events that have no physical linkage. But if two events for which we can establish a physical linkage are correlated, then we are completely justified in saying that one event “caused” the other. For example, the physical act of childbirth is strongly correlated with another physical act some 9 months previous. Correlation is causation in that case. Ocean tides are strongly correlated with the relative positions of the sun, moon and earth in their orbits, another physical fact. Once again, correlation is causation. Sometimes, post hoc is propter hoc.
Hamilton notes that 10 of 11 post war recessions were preceded by oil price spikes. He does not say that all recessions are caused by oil price spikes, but that every time we have had an oil price spike, a recession has followed. The probability that those two facts are not connected is much less than one percent. Likewise, the fact that energy consumption and GDP are highly correlated (see my first post) for hundreds of countries is highly significant statistically. There is less than 0.1% probability that GDP is not largely (93%) determined by energy consumption. Herschel Specter thinks we are headed toward recession again in large measure because of the current oil price increase.
Energy is defined as the ability to do work. For most of human history, we have been limited to the energy provided by our own muscles, the muscles of domesticated animals harnessed to work for us, or the kinetic energy of wind to move our ships, or the energy in wind or water to turn our mills. About 200 years ago we started using fossil energy to make machines work for us, and an explosion of wealth occurred. That was the beginning of the Industrial Revolution. Fossil energy was increasingly used by machines to turn resources into wealth. This has been abundantly documented.
The most useful of all fossil energy sources is oil, which is now worth about 5 times as much as coal on an equal energy (per gigajoule) basis. If we are facing a future of declining oil supplies and rising oil prices then that fact is going to ripple through our entire economy and social system with fairly predictable, and drastic results. That was what my original post described and what I hope we can discuss. For example, I would love to see actual evidence that we are not at “peak oil”, but the evidence seems to point in the other direction.
While I think this debate has largely run its course, I have a few points to offer regarding Dale’s latest response….
1. >>I still reject Dr. Perelman’s claim that “Most economists would not share [Dr. Bruce Dale’s] view of either the cause or consequences of the Great Recession.” But I’m interested in any polls that have been conducted asking economists their view of the causes or consequences of the 2008 recession that prove otherwise.<<
Fair enough. I would be too. My Google search did not turn up any such polls per se. The National Assoc. of Business Economists regularly surveys its members, but chiefly for forecasts; not for post mortems it seems. However, the literature I did find bears out the impression I had from my own wide reading about economics.
In particular Jacob Weisenberg’s article in Slate on “The 15 best explanations for the Great Recession” summarizes the views of numerous economists from diverse schools of thought:
“There are no strong candidates for what logicians call a sufficient condition—a single factor that would have caused the crisis in the absence of any others. There are, however, a number of plausible necessary conditions—factors without which the crisis would not have occurred.”
The several factors Weisenberg proceeds to list do not include an oil price spike, or any mention of oil at all.
Among the key conclusions of a paper by Verick and Islam was: “…there were complex and interlinked factors behind the emergence of the crisis in 2007, namely loose monetary policy, global imbalances, misperception of risk and lax financial regulation.”
A paper by Roger Farmer of UCLA “argues that the stock market crash of 2008, triggered by a collapse in house prices, caused the Great Recession.”
A summary of another paper by Hurd and Rohwedder concludes: “The economic problems leading to the recession began with a housing price bubble in many parts of the country and a coincident stock market bubble. These problems evolved into the financial crisis.”
None of this is to say that skepticism about the reliability of economists’ judgment is unwarranted. A number of articles I found criticize the economic profession both for largely failing to anticipate the Great Recession or to learn its lessons.
Simon Potter of the New York Federal Reserve Bank discusses the economic forecasts preceding the Great Recession and identifies three main failures: (1) misunderstanding the housing boom; (2) poor understanding of new forms of mortgage finance; (3) inability to “connect the dots” of feedback between finance and the real economy.
Economics columnist Robert Samuelson criticized economists for ignoring what he viewed as “the real cause” of the Great Recession:
“It’s true that Wall Street took too many risks while government regulators watched passively; it’s also true that the government’s aggressive promotion of homeownership contributed to real estate speculation. But the fact that these theories are not mutually exclusive suggests that both were consequences of some larger cause. Just so. What ultimately explains the financial crisis and Great Recession is an old-fashioned boom and bust, of which the housing collapse was merely a part.“
Finally, writing in The Chronicle, Todd Gitlin of Columbia critically observed that the work of the relatively few economists who seemed to understand and/or anticipate the causes of the Great Recession was entirely absent from the curricula of academic economics departments. He concluded: “The academy is busy protecting itself.”
Among all the diverse views on the causes of the Great Recession across this body of literature, none points to or even mentions oil prices. So I conclude again that the claims by Dale and Spencer that an oil price spike was the cause is highly unorthodox compared to the judgment of most economists.
For reasons I stated at length earlier, I believe the claims are erroneous.
2. While claiming to understand the fallacy of equating correlation to causation, Dale proceeds to assert it again: “…every time we have had an oil price spike, a recession has followed.”
In this he persists in ignoring the possibility that oil prices and recessions are coincidentally driven by other causative factors.
As common experience indicates, there is high correlation between the initial experience of a sore throat and the subsequent experience of a head cold. There is also an obvious biomechanical connection between the throat and the nose and sinuses. But sore throats do not in fact cause colds. Both are symptoms of a viral infection that happen to unfold sequentially.
Economists have clustered metrics into leading, concurrent, and lagging indicators of economic waves. The leading indicators provide signals of where the wave may be headed. Yet even though they are functionally connected with other economic elements that may be concurrent with a boom or bust, they are not necessarily causal factors simply because they often precede other events.
Economists may be spotty at best at forecasting and explaining economic trends. But I would be surprised if Dale could present evidence that chemical engineers are more skilled at that task. If so, I’d say they are not earning as much income as they could.
3. Dale is evidently committed to viewing the complex social phenomena of economics within the simplified paradigm of elementary physics. While trained in physics myself, having been long immersed in the paradigm of social and behavioral sciences I see the issues very differently, for reasons I have expressed earlier.
Hence I conclude that this debate likely has run its course. As Thomas Kuhn noted about such paradigm clashes:
“Though each may hope to convert the other to his way of seeing science and its problems, neither may hope to prove his case. The competition between paradigms is not the sort of battle that can be resolved by proofs.”
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