Home > Economics - General > Two weeks behind the Zeitgeist

Two weeks behind the Zeitgeist

August 6th, 2007

I’ve been following the Peak Oil debate with a mildly sceptical eye for some time, and it struck me a while ago that despite high prices, global oil output hadn’t grown much, but hadn’t declined either. I came up with the innovative description of our current position as “Plateau Oil“. If I had bothered with Google, I would have noticed that the International Energy Agency had offered the same description two weeks earlier. And if I’d thought about for more than a couple of seconds, I would have realised that the supply of topographical metaphors is so limited as to make this a forced move (We Australians use “Tableland” to describe the same landform and there’s also “mesa”, but Mesa Oil is taken, and “Tableland Oil” sounds silly)

Anyway, why are we (apparently) observing Plateau Oil and what does it mean?

The standard economic theory of exhaustible resources says that, on average, the price of an exhaustible resource should rise at a rate equal to the owner’s marginal time discount rate. With constant prices, producers would prefer immediate sales (bringing the current price down and the future price up) and if prices were rising fast and expected to continue doing so, producers would reduce sales bringing about an immediate increase in prices and lowering the expected rate of increase in the future. This theory isn’t always applicable, but something like oil, where most of the major discoveries have apparently already been made, seems like a good case.

Applying this model it seems reasonable to project price increases of 5-10 per cent a year into the future. In the long run, this should more than offset growth in demand arising from population and income growth, so consumption of oil should gradually decline over time, just as Peak Oil theory says it should. But right now, thanks particularly to China, demand growth is strong enough to counterbalance the large price increases we’ve seen in the past five years or so.

There is no reason to be particularly alarmed about a gradually rising price for oil. As I’ve said before, our main problem with carbon-based fuels is too much not too little. And a gradual decline in oil consumption over the next few decades is not going to cause any real problems.

Of course, on a long enough timespan, the history of aggregate oil consumption is going to look like a sharp spike, rising from zero to current levels over 150 years, and then declining to zero again in the future. But the scale that matters to us is the rate at which we turn over our capital stock of motor vehicles and other oil-using capital, and this is measured in decades, not centuries.

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  1. August 8th, 2007 at 19:29 | #1

    Terje wrote:

    If your concern is Peak Oil I fail to see how making oil more expensive (presumably via a tax) is going to help.

    Well … it certainly seems to work in Europe. Europeans use far less oil per capita than Americans or Australians, and the only reason I can think of is the much higher fuel taxes in Europe.

    If we were facing a potential banana shortage whould you propose a banana tax? A selective oil tax is simply going to reduce investment in precisely the place where it is needed (ie in oil production).

    Ahh see there is fallacy. As Ernestine pointed out bananas are renewable resource, oil is not. Lets take oil exploration. Vast amounts of money are currently being invested in oil exploration, yet oil discovery peaked in the mid 1960s. The most oil found in one year was in 1948 (I believe) this is despite huge advances in oil exploration technology since then.

    So it really doesn’t matter how much we invest in oil discovery and exploration its not going to make more oil if its not in the rocks (economists may be shocked to learn this!)

    Our only options are to conserve and develop alternatives. A selective oil tax (where the alternatives are untaxed or lightly taxed) should achieve both those goals.

  2. August 8th, 2007 at 21:58 | #2

    Its not lower taxes that distort the market, its reducing one tax on one item (namely liquid fuels) and not reducing it on others that is the distortion.

    Yes but this is not what happened. If they had said no GST on petrol then you might have a point but they merely reduced fuel taxes. There is no fuel tax on horses or bicycles. So I can’t see how you could call such a decision a market distortion.

  3. August 8th, 2007 at 22:10 | #3

    Well … it certainly seems to work in Europe. Europeans use far less oil per capita than Americans or Australians, and the only reason I can think of is the much higher fuel taxes in Europe.

    Are you sure that it has nothing to do with the fact that Europeans live in concentrated population centres and that Europe is densily populated and invests heavily in public transport. The USA has many more people living outside cities. And Australians typically contend with larger distances in general even within our cities.

    It is obvious that if we tax oil harder then we will use it up slower. However that just brings forward the effective scarcity which is supposed to be the problem we are trying to avoid.

    So it really doesn’t matter how much we invest in oil discovery and exploration its not going to make more oil if its not in the rocks

    Sure. But how do you know it’s not in the rock if you don’t look. Do you have some magic crystal ball that says that there is no oil in the places where we have not looked?

  4. mugwump
    August 8th, 2007 at 22:28 | #4

    Ender, I don’t disagree that the Tesla is about twice as efficient as the average car. But given that it is a super-lightweight sports car – eg no good for family use – the efficiency starts to look a lot less impressive.

    Of course, it is wonderful for salving the conscience of Hollywood celebrities and Al Gore as they commute from their 200,000KWh mansions to their private jets.

  5. August 8th, 2007 at 23:29 | #5

    Terje – “Sure. But how do you know it’s not in the rock if you don’t look. Do you have some magic crystal ball that says that there is no oil in the places where we have not looked?”

    Most if not all the oil that we are using now was created during 2 times in the past when there were vast shallow seas that accumulated organic matter for millions of years that got turned into oil. The places that we find oil now are on the shores of these ancient seas. The places we have not looked are not explored for the very good reason that there is very unlikely that there is oil there.

    The crystal ball in this case is a solid knowledge of how oil formed and when and this gives geologists a pretty good idea of where to look. Apart from the time of formation oil bearing rock has to be just the right porosity and have just the right sort of trapping rock that prevents the oil from seeping away. Finally the organic matter has to be cooked for exactly the right time. Overdone and you get gas – underdone you get oil shale. The vast reserves that we are recklessly exploiting are really quite an unlikely occurence and once it is gone there is no more left.

  6. August 9th, 2007 at 08:16 | #6

    Yes but this is not what happened. If they had said no GST on petrol then you might have a point but they merely reduced fuel taxes.

    Honestly, which bit don’t you understand? If bread was a dollar loaf and we replaced the 10% GST with a 10c a loaf tax, but continued to tax everything else at 10% would that not be favourable tax treatment for bread, given that bread prices must inevitably rise?

    The GST proportion of fuel taxes was relatively small in 2001. Obviously it is growing because it is applied at 10% and not on a cents-per-litre basis, but that just proves my point!

    I’ll spell it out again:
    As petrol prices rise the percentage tax rate is falling. The percentage tax rate on all other items remains the same. How you can not see that as favourable tax treatment for petrol is completely and utterly beyond me.

    I will say no more on the subject.

  7. August 9th, 2007 at 08:22 | #7

    Are you sure that it has nothing to do with the fact that Europeans live in concentrated population centres and that Europe is densily populated and invests heavily in public transport.

    Obviously that is a factor, but its a chicken-and-the-egg argument. I would argue that European cities have developed as they have (post war) as a response to high fuel prices. In other words, the high fuel prices have delivered a favourable outcome whch is much more sustainable cities than the suburban sprawl seen in Australia and the U.S.

    But how do you know it’s not in the rock if you don’t look. Do you have some magic crystal ball that says that there is no oil in the places where we have not looked?

    Mate, oil is ~$75/barrel. They are looking, they’re just not finding any.

  8. August 9th, 2007 at 08:24 | #8

    Actually, I’m not sure whether bread is actually taxed under the fresh-food deal Howard did with the Dems when the GST was introduced … but you get the point (I hope!)

  9. August 9th, 2007 at 09:01 | #9

    Carbonsink,

    I don’t get the point. We have GST on pretty much every consumer good (except fresh food). To give one product a tax break (eg shoes) could arguably be called a market distorting reform because it creates a tax bias in favour of one product. However fuel tax is not broad based. It applies to fuel only. As such it is a market distorting policy (for better or for worse). Reducing fuel tax is hence a reduction in market distortion. You make out that all other products (besides fuel) are still suffering the burden of fuel tax, where in fact fuel has always had fuel tax as and added burden. You may be in favour of high fuel taxes and in favour of distorting markets, but you won’t get away with calling a cut in fuel taxes a “market distorting reform”. At least not on my watch.

    Regards,
    Terje.

  10. August 9th, 2007 at 11:16 | #10

    Ok, can we agree on this:

    The (politically motivated) move to freeze the fuel excise in 2001 has resulted in liquid fuels being taxed more lightly relative to the situation that existed previously? This has most probably resulted in higher fuel consumption than would have otherwise occured, and is dampening the effect of rising oil prices on the prices paid by Australian motorists at the pump.

    Changes to the tax system are all about relativites. Its the change from the pre-existing situation that moves markets. For example, the halving of the CGT and the reduction in company tax rates in 1999 provided a huge incentive for high income earners to capitalise and corporatise their income.

    If you think that reducing the tax on liquid fuels to 10% is a desirable outcome, then fine, that is effectively what is happening at the moment. When petrol is $20/L the 38c fuel excise will be insignificant.

    After all, the purity of the market is more important than the planet eh Terje?

  11. Ernestine Gross
    August 9th, 2007 at 11:39 | #11

    Regarding ‘fuel tax’: I understand there is still no fuel tax on international aviation and, it seems, Koyoto has overlooked this item.

    http://www.globalpolicy.org/socecon/glotax/aviation/index.htm

  12. August 9th, 2007 at 11:54 | #12

    Well you’re obviously bundling several statements into one package and asking if can agree on all of it. I’m happy to agree that taxing fuel more lightly will (all things being equal) lead to greater consumption.

    On whether market purity is more important than the planet I regard that as a loaded and hostile remark. Do you still beat your children frequently? Is your mother less important to you than fuel tax?

    My views about markets reflect a human centred perspective that says it’s not generally my business or your business to use coercion to tell people how to live their lives. I accept fully that liberty must be balanced against genuine arguments about utility, however I generally find the arguments offered to be weak, speculative or biased. Where such arguments are strong, well founded and without a biased agenda then I’m generally receptive. I make no bones about the fact that I believe in liberty and that in an analysis of any policy I place the burden of evidence on those that wish to curtail liberty. And I do that because in the great sweep of things the general body of evidence favours the utility of individual freedom over centralised control by either selfish or benovalent leaders. I certainly do not start out from a position of “how can we screw the planet”. If you infer otherwise I am somewhat saddened because it suggests a lack of faith in the goodwill of others.

  13. August 9th, 2007 at 12:30 | #13

    Ernestine – perhaps I’m being simplistic but I thought that Kyoto called for a cap and trade system not fuel taxes. My understanding is that we could in fact fully abolish all existing fuel taxes and be consistent with Kyoto so long as we implemented a cap and trade mechanism. Of course there are some ways in which such measures are economically equivalent. Not that I advocate cap and trade as better than a tax based pricing mechanism. In fact I think there is some sence in lowering the rate of fuel tax and at the same time broadening it to include coal. If the rate levied related to emissions it could be morphed into a more general carbon tax whilst also reducing some existing market distortion.

    In terms of taxing aviation fuel if it is applied in some nations and not others it may in fact encourage operators to overfuel in some locations and thus burn more fuel due to heavier fuel loads.

  14. Ernestine Gross
    August 9th, 2007 at 13:25 | #14

    Terje, you might be right regarding Kyoto. I am not an expert on the Kyoto protocol (hence the word “seems” in the second part of my sentence). Perhaps someone else can help on this one.

    There are two issues. One is the externality CO2. the other is non-renewable energy (oil).

  15. melanie
    August 9th, 2007 at 18:22 | #15

    JQ, It’s OK we don’t have to talk about ‘Tablelands oil’, we have the Balgowlah Plateau here in Sydney. So it’s officially an Australian word :)

  16. August 9th, 2007 at 18:25 | #16

    Getting back on-topic, Professor Cutler Cleveland from Boston University’s Center for Energy and Environmental Studies has a post up at TOD called Energy Transitions Past and Future.

    I must say I find this stuff much more convincing than ProfQ’s refrain of “its a myth that energy is crucial to the economy” and “have faith, the market will provide”.

    He actually looks at the character of the problem rather than taking the share of GDP that energy currently represents, multiplying by a fudge factor, and concluding it will cost nothing more than a cup of coffee in 2050. He even deals with “quibbles about supply variability” and I’m still waiting for my quibbles to be dealt with!

    Such intermittency means that wind and solar power are really not “dispatchable�—you can’t necessarily start them up when you most need them. Thus, when wind or solar power is first added to a region’s grid, they do not replace an equivalent amount of existing generating capacity—i.e. the thermal generators that already existed will not immediately be shut down. This is measured by capacity credit, which is the reduction of installed power capacity at thermal power stations enabled by the addition of wind or solar power in such a way that the probability of loss of load a peak times is not increased. So, for example, 1000 MW of installed wind power with a capacity credit of 30% can avoid a 300 MW investment in conventional dispatchable power. A recent survey of U.S. utilities reveals capacity credits given to wind power in the range of 3 to 40 percent of rated wind capacity, with many falling in the 20 to 30 percent range. A large geographical spread of wind or solar power is needed to reduce variability, increase predictability and decrease the occurrences of near zero or peak output.

    Quibbles indeed.

  17. August 12th, 2007 at 21:37 | #17

    Carbonsink,

    I’m not a huge fan of wind power or photovoltaics for grid based electricity generation. However I am keenly interested in the proposed alternative energy solutions offered by the likes of Enviromission (Solar Chimney) and Geodynamics (Hot Dry Rock). On paper at least both solutions offer a base load type output with dispatch qualities comparable to coal. And the projected energy cost from both is far more competitive than photovoltaics or wind farming.

    However this is not getting us back onto the peak-oil topic because in the domain of electricity generation coal is the most obvious substituted for oil and it is proven technology. Any real concerns about peak-oil surely relates only to transport, not electricity generation.

    Regards,
    Terje.

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