The demand price of oil
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Could energy shortages be a trigger for economic upheaval in 2006? Europe has already experienced gas shortages this winter, giving Russia a good feel for its new power. Iran is sensing it can afford to be defiant because the West cannot afford the drop in supply; Chavez is using energy to forge a new South America. Demand continues to increase and there is no significant new supply. Oil is becoming a clear and present source of political power, and it's hard to beat it. Military action is largely ineffective, as it will invariably cut the supply in the near term. You cannot run an oil economy by force, as the infrastructure is simply too vulnerable to sabotage. This raises the question of the demand price of oil -- the price people would be willing to pay at the limit.
globalpublicmedia.com
"If 2005 was the year Americans discovered the high price of gasoline, heating oil and propane, 2006 (or 2007) will be the year they discover oil product shortages. Chavez is a reluctant supplier. China has made a competing deal for Saudi oil. Nigerian production is questionable. Iraq is a mess. Iran's Ahmadinejad wants to hurt the infidel."
There's a rational case for higher prices. As Matt Simmons argues (http://www.simmonsco-intl.com/files/Chilton%20Club.pdf), oil is still much cheaper than bottled water and should cost way more to encourage rational use. A gallon of gas is equivalent to about 500 hours of human labor -- a more concentrated and portable form of energy than any alternative (http://www.lifeaftertheoilcrash.net/Research.html). Most touted alternatives, such as ethanol and hydrogen, are really derivatives of oil -- they require more energy to produce than they yield (http://www.lifeaftertheoilcrash.net/SecondPage.html). The existing oil-consuming infrastructure represents a massive sunk investment that will keep oil valuable even above the level at which renewable sources of energy are in principle competitive. All of this means oil will be worth buying at prices several multiples above current prices. This is what is meant by "price inelasticity" -- and why a 5% shortage of gas made prices in California go up 400%. We're nowhere near the ceiling of this effect -- oil's intrinsic value is way more than what it's currently selling for. How much more?
In May 2004, Simmons argued that in order for demand to be appropriately controlled, the price of oil would have to reach $182 per barrel -- generating a price of $7 a gallon at the pump (http://news.bbc.co.uk/1/hi/business/3777413.stm).
Yet the real value of oil is arguably much higher still. If the price of apples goes up by a factor of ten, people quit cold buying apples. If the price of oil does, there will still be lots of customers, given the real costs of not having it -- including the cost of retooling society to alternatives, where they exist. In general, the amount of energy you have access to effectively determines the ceiling of your economic productivity. Given the existing infrastructure, oil at $600 a barrel might still be a steal. For $600 you would buy the equivalent of around 20,000 hours of agricultural labor in terms of pure energy expenditure. Since a great deal of expertise has already been built into production machinery, that equation means oil will remain a dominant determinant of productivity.
20,000 hours of labor for $600 is roughly a dollar a day for an able-bodied man. Economies unaided by oil today appear to generate incomes around this level. This line of thinking sets the ceiling of the price of oil in terms of the productivity of a human being in the previous regime, that of agricultural production.
Just as stone age hunters increased in numbers by killing large animals and burning wood to survive in cold climates, and agricultural societies increased by harnessing the energy of grains and domesticated animals, so our industrial civilization is at its base a product of our ability to extract energy from fossil fuels.
If we are going to successfully make a transition to a more sophisticated form of energy, we will need to devote our remaining productivity to this task. Once oil supply declines, it will be increasingly difficult to divert the resources required for this task. So far, most countries have not made a significant dent in this project, and the US is boldly blazing the trail of squandering our remaining resources by fighting over them. It is this path that most confidently will lead to a massive increase in the price of oil.
The price of oil is going to reflect its actual value to the economy -- that is to say, the price will be demand driven and not supply driven, as it has been up to now. Demand will drive the price up until it is on par with alternative sources of productivity. That price -- given its unmatched properties of extreme energy concentration and the sunk cost of the existing infrastructure -- is sky high above the current level. At $60 a barrel oil is still ludicrously underpriced.
In comparison, gold has no intrinsic value to the economy. The case for gold has to be based purely on psychology, to people's belief in and desire for an incorruptible form of money. Psychology is likely to trump reality for a while, but the real crisis is not fiscal, it is not even a generic one of natural resources, or commodities. It is starkly one-dimensional, a real oil crisis.
Kailash |
