Will Oil Hit $300 A Barrel in 2010 Due To Mid-East Tensions?

03 Jan 2010 at 17:20

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Energy, Environment, Natural Gas, Nuclear Power, Oil, Oil and natural gas, Peak Oil, Technology, Wind power and energy

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http://www.gurufocus.com   by Jacob Wolinsky

While I am very reluctant to provide short term forecasts on area such as commodity prices or stock prices, I have a strong opinion about future oil prices. I am confident in my prediction because huge oil disruptions might occur due to tensions in the Middle East this coming year. I strongly believe that the media, politicians and investors do not realize the severity of situation. I think the coming year can see geo-political events that may cause the price of oil to skyrocket from current levels. While I think oil prices are currently over-priced, tensions in the Middle East could increase that will cause oil spikes this coming year. These Middle Eastern tensions are related to the current actions of the Iranian government. Continue reading →

Top 10 Energy Stories of 2009

31 Dec 2009 at 22:39

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Alternative Energy, Carbon Emmssions, Energy, Oil and natural gas, Peak Oil, Technology, Transportation

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http://www.theoildrum.com   The Oil Drum

Here are my choices for the Top 10 energy related stories of 2009. Previously I listed how I voted in Platt’s Top 10 poll, but my list is a bit different from theirs. I have a couple of stories here that they didn’t list, and I combined some topics. And don’t get too hung up on the relative rankings. You can make arguments that some stories should be higher than others, but I gave less consideration of whether 6 should be ahead of 7 (for example) than just making sure the important stories were listed.

1. Volatility in the oil markets

My top choice for this year is the same as my top choice from last year. While not as dramatic as last year’s action when oil prices ran from $100 to $147 and then collapsed back to $30, oil prices still more than doubled from where they began 2009. That happened without the benefit of an economic recovery, so I continue to wonder how long it will take to come out of recession when oil prices are at recession-inducing levels. Further, coming out of recession will spur demand, which will keep upward pressure on oil prices. That’s why I say we may be in The Long Recession. Continue reading →

Shale Gas and Climate Change

31 Dec 2009 at 22:32

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Natural Gas

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http://energyoutlook.blogspot.com

In Wednesday’s posting on the likely consequences of the latest version of greenhouse gas (GHG) cap & trade legislation, I hinted at an important option for electricity suppliers to reduce their emissions promptly. Today I’d like to elaborate on it. Although the power sector accounts for the largest share of US GHGs, its existing generating fleet already has the potential to reduce those emissions substantially by relying less on coal-burning plants and more on those that burn natural gas. That could be done with Continue reading →

To Bury CO2 or Recycle It

31 Dec 2009 at 22:27

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Carbon Emmssions, Energy, Technology

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http://energyoutlook.blogspot.com

While not the most powerful of the greenhouse gases produced by humanity, CO2 is certainly the most prevalent, if you don’t count water vapor. To a very large extent, addressing climate change depends on three main strategies for dealing with the excess CO2 our activities emit: avoiding its creation by switching to other energy sources, such as renewables or nuclear power; capturing and storing it in trees, other vegetation or underground; and recycling it into useful fuels and products. Most of the work to date on the Continue reading →

Talking Energy: carbon capture and storage

31 Dec 2009 at 22:19

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Carbon Emmssions, Technology

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http://www.telegraph.co.uk

Andrew Charlesworth

The UK is facing transformation of its energy generating system. The closure of end-of-life nuclear and coal power stations is coinciding with ambitious commitments to reduce carbon emissions and the demise of North Sea gas.

Whatever we replace our current generating capacity with has to provide affordable, reliable and lowcarbon power – an energy Continue reading →

The Peak Oil Crisis: Accusations

18 Nov 2009 at 16:05

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Alternative Energy, Economy, Energy, Peak Oil

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http://www.fcnp.com Tom Whipple

Not many years from now, there will be a huge uproar over who missed the coming of peak oil. There will be Congressional hearings and much finger pointing and protestations that the peaking of world oil production was impossible to predict.

It will all sound much like current discussions of whether our great recession was foreseeable. The uproar will come amidst very high gasoline prices and still greater economic difficulties and, hopefully, widespread understanding that the final energy crisis has begun.

Last week we had an early insight into the recriminations when the UK’s Guardian newspaper (formerly the Manchester Guardian) published an exposé on how the world’s official keeper-of-the-books on energy matters, the International Energy Agency (IEA), has been manipulating its forecasts. Two senior IEA officials, one active and one retired, were the sources of the story which was corroborated by others who have had close contact with the inner workings of the IEA in recent years.

The most damning part of the exposé was the allegation the manipulation of the oil production forecasts was done at the behest of the United States government which feared the consequences, should it become generally known and believed that oil soon would no longer be available in unlimited quantities. Oil products would become too expensive for many uses and the world would change forever. The IEA, of course, immediately denied that they were cooking the books to keep the Americans happy. They pointed out that for at least the last two years they have been warning of a near term supply crunch and that hundreds of outside experts reviewed their projections.

The evidence however that their projections were out of line with reality is very strong – whether American pressure was involved or not. Five years ago the IEA was projecting that world oil production would increase by another 35 million barrels per day (since reduced to 20) at a time when existing oil fields were depleting faster and faster. Every serious, unbiased, outside analyst that looked at the numbers said their projections were absurd as they required discovering and producing from new oil fields at a rate faster than had ever been achieved in the history of the oil age.

This, of course, would all be an interesting academic debate except that the fate of industrial civilization over the next century is at stake. Every one looking at the oil depletion problem has concluded it will cost trillions of dollars and take decades to effect a transition from oil to some other form of energy to keep civilization running in a recognizable form. Even then the chances of “success” are not that good. The longer we put off serious planning and implementing this transition to a post fossil fuel world, the worst the situation will get. However, to this day, almost no senior politician anywhere in the world has been willing to step forth and lay out the case that we almost certainly have one of the most serious problems of the 21st century just over the horizon.

We can probably give a pass on responsibility for ignoring peak oil to the Clinton administration. When the administration left office in January 2001 the proximity of peak oil was understood by only a handful of people, and peak production was still five years off. The Bush administration, however, is another matter. By Bush’s second term, the debate over peak oil was going hot and heavy, much research had already been published, and dedicated governmental energy research organizations such as the US’s EIA and OECD’s IEA certainly were aware of the likelihood that large increases in oil production could not continue much longer. Some are already holding the Director of the U.S.’s Energy Information Administration during the Bush Administration responsible for ignoring peak oil and for pressuring the International Energy Agency. For now however we can leave this up to the Congressional investigators.

While In its first ten months the Obama administration has made valiant efforts to stem carbon emissions, so far as is known, it has never mentioned the far more imminent problem of peak oil. Third parties report that Obama’s Energy Secretary Chu understands peak oil and its ramifications, but so far has remained silent as have the President and other senior officials.

The problem of course as we now have witnessed through two US administrations, and numerous foreign ones, is how does a government start to explain the phenomenon, peak oil, and more importantly the extreme sacrifices required to mitigate its occurrence to its citizens. Suppose the President gave a prime-time speech describing the evidence for the proximity of peak oil and laying out proposals to the Congress as to what needs to be done. It does not take a rocket scientist to deduce that there would be a huge political flare-up and likely a collapse of the equity markets. The President’s political opposition, which has yet to figure out just why polar ice caps are melting, would go completely berserk at the hint of restrictions either through taxes or other means on energy consumption.

There would be calls for impeachment and the likelihood that any legislation could be passed that might be helpful in preparing for or mitigating the consequences of global oil depletion for the time being are zilch. The reason of course is that the evidence for peak oil must first become so overwhelming that even the simplest amongst can understand that there is no cheap and easy way out of the problem

All this means that it is unlikely that our leaders will be taking the initiative to head off and attempt to mitigate the consequences of peak oil prior to its arrival. The political consequences of raising the issue in a polarized political world would almost certainly be seen as too uncertain and too severe.

http://www.fcnp.com/commentary/national/5301-the-peak-oil-crisis-accusations.html

Scientific American’s Path to Sustainability: Let’s Think about the Details

17 Nov 2009 at 14:11

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http://www.theoildrum.com

Scientific American presents “A Path to Sustainable Energy by 2030″ in its November issue. In many ways, it sounds good. But let’s think about the details: What would the end result look like? Would it really be sustainable? What would the costs really be? Is there any way we could afford to do what is proposed?

The authors of the article, Mark Jacobson and Mark Delucchi, propose substituting wind, water, and solar (WWS) energy for all other forms of energy by 2030, not for just the US, but for the world. The types of energy sources that would be eliminated include the following:

• Petroelum (including gasoline, diesel, propane, heating oil, etc.)
• Natural gas
• Coal
• Liquid biofuels, such as ethanol
• Wood and other biomass
• Nuclear

All that would remain would be wind, wave power, tidal energy, hydroelectric, geothermal, and solar. Because of the ambitious timeframe, the only techniques that can be used are ones that work at large scale today, or are very close to working.

What would we end up with?

Essentially, we would need to change all of the world’s infrastructure to use either electricity or solar or water power directly–by 2030. What might this mean?

• Airplanes. The authors propose that airplanes be powered by hydrogen powered fuel cells (with the hydrogen be made by hydrolysis using WWS energy sources). I understand that hydrogen is three times as bulky as gasoline,  and escapes fairly quickly from its holding tanks, making it difficult to store for very long. It seems like airplanes and helicopters would need to look more like blimps, to hold the necessary fuel.

 Ships. The authors don’t tell us how ships would be powered. Clearly sailing ships would meet the criteria, but would be quite slow. Because of their slow time for passage, we would need a lot more sailing ships than the types of ships we use now, because so many would be in transit at a given time. Barges could float down rivers, and if the current isn’t too strong, could perhaps be towed back in some way (boat with fuel cell?). Ships powered by hydrogen fuel cells might also work, but they would have the same issues as for airplanes. Because of their long trips, leakage would be more of an issue than on airplanes.

• Automobiles and Trucks. According to the authors, these would be powered by batteries or hydrogen powered fuel cells. There are several issues–the technology is only barely there for automobiles and trucks–for example, I don’t know of anyone working on battery-powered technology for long distance trucking. Fuel cell technology is very expensive. David Strahan in The Last Oil Shock says that the current cost is about $1 million dollars per car. He quotes the chief engineer at Honda as saying it would take 10 years to get the cost down to $100,000 a car.

Minerals shortages are also likely to be a problem for converting autos and trucks to batteries or to hydrogen fuel cells. The Scientific American article mentions following materials as being in short supply: rare-earth metals for electric motors, lithium for lithium-ion batteries and platinum for fuel cells. The article mentions recycling as a partial solution. Analyses published at The Oil Drum, such as this one, indicate that we would likely run out of rare materials fairly quickly, even with recycling.

• Farm equipment; bulldozers; cement mixers; and other heavy equipment. Would need to be converted to electric. It is not clear that the technology (or rare materials needed for the technology) exist to do so.

• Heating of buildings; heating for cooking and baking; hot water heating; commercial heating; heating of grains to remove excess moisture. Would need to be converted to electric, or in some cases solar. This would be true, even where heating is now done over wood or charcoal fires, such as in Africa or China.

• Mining and manufacturing. Would need to be converted to all electric. Presumably oil and natural gas extraction would continue, but at possibly lower rates, because of their uses for non-energy uses, such as textiles, asphalt, plastics and lubrication. Drilling for oil and gas would be converted to electric as well.

What steps would be needed to build all of these things?

It seems like we would first need to figure out what the end point would look like, and then work backwards.

We are told that the authors of the Scientific American article think we would need the following:

• 3.8 million large wind turbines

• 90,000 solar electricity generating plants

• “Numerous geothermal, tidal, and rooftop photovoltaic installations”

Besides these, we would need to build all of the new airplanes, ships, cars, trucks, heavy equipment, and new appliances that would be needed under the new regime. Individual homeowners would need to get their homes rewired for the larger amount of electricity they would use–especially if they are converting to electric home heating.

One thing we need to plan for is a greatly expanded and improved electrical grid. The Scientific American article indicates that the variability in generation would be mostly smoothed out by combining electrical transmission of many different types–wind, hydroelectric, solar, geothermal, and wave–over a wide geographical area. To do this will require considerable long distance transmission, often between different countries–including some that may not be friendly with each other. The grid will also need to be upgraded to be “smart,” so automobiles can draw electric power at the times of day when it is not needed elsewhere.

Once we have figured out what the new system will look like, we will need to figure out what kind of factories are needed to build all of the devices for the new system, and what raw materials the factories will need. Some of the raw materials can perhaps be obtained by recycling, and some factories can perhaps be obtained by converting other factories, but this won’t always be the case. It is likely that new factories will need to be built, and new mines opened, especially for the rare minerals.

By the time we start seeing many finished good produced, it is likely that we will be at least half way through the 20 year period. In part, this is because we are still working out technology details (for example, how to efficiently build a hydrogen fuel cell powered airplane). Also, once we get those details worked out, we need to build mines for raw materials and build the factories to make the new devices. It is only when we get those steps taken care of that we can build what we really want–the airplanes, the new ships, the wind turbines, the solar PV, and all of the rest.

When sizing the factories, we will need to size them not for “normal” production levels, but for converting the economy quickly to use the new power sources. For example, under normal circumstances, if earth-moving equipment is expected to last for 40 years, we would expect to need factories to make 1/40 of the world’s needed earth-moving equipment in a given year. But if we need to ramp up to replacement in 10 years, we will need 4 times as many factories. (What do we do with the excess factories at the end?)

How much would this all cost?

The authors tell us that they expect the cost of the new WWS energy generation equipment would be $100 trillion over 20 years. But that doesn’t include the cost of all the new infrastructure to go with it–the new airplanes and ships and cars and trucks, or the electrical transmission lines. In total, the cost will be far higher than $100 trillion–lets guess $200 trillion–to be paid for over the next 20 years.

The Scientific American article gives the impression that the costs will be low, because it looks only at the cost the new electricity generation, and assumes that cost of generation will go down with volume and with additional research. It also implicitly assumes that debt financing over a long period, such as 40 years, will be used, so we don’t have to pay for the cost of the new system before we start using it. But how realistic is that?

The cars, trucks, boats, airplanes, coal fired power plants, etc. we are currently using won’t have much trade-in value once power is generated by WWS, and the new equipment will likely be fairly expensive. So we will be faced with buying new high priced equipment, with little trade-in value from what we used previously. In many cases, businesses would not normally be replacing equipment this soon. The debt that was taken on to pay for all of our current equipment won’t magically go away either–it will still need to be paid.

So how will we pay for all of the new equipment? The governments of the world are pretty much maxed out for borrowing. Companies are not going to be able to take on a project of this magnitude either, especially since they already have debt to service. It seems to me that the only way a program such as the program of WWS fuels replacing other fuels can be financed is through increased taxes that would cover each year’s expenditures, as they are made.

So let’s think about how much this would cost. $200 trillion over 20 years amounts to $10 trillion a year, spread over world economies. The US share of this would be something around 21%, based on the ratio of US GDP to world GDP. So let’s say that the US would need to fund $2.1 trillion a year. Let’s compare this to current taxes. In 2008, US Federal, State, and Local taxes combined amounted to $4.1 trillion according to the US Bureau of Economic Analysis. In order to collect $2.1 trillion more, a tax increase equal to slightly more than 50% of all taxes currently paid would be required. If the additional tax were collected as a percentage of “personal income” (which includes wages, social security income, rents, dividends, etc.), it would amount to 17% of personal income. It seems unlikely that a tax of this magnitude, or even half of this magnitude, would be agreed to by tax payers.

If such a tax were passed, after a few years there would be benefits that would start offsetting its cost, and might lead to a lower tax, and after 2030, perhaps lower costs overall, because it is no longer necessary to purchase fossil fuels. The benefits that would start offsetting costs would be sales of electricity and other energy, and sales or leasing of vehicles and other goods produced. Many of the sales of goods would be going to replace automobiles that had worn out, factories beyond their useful life, and ships that no longer had value to the owners.

But there is a remaining issue. There will be a lot of assets which would still have considerable value in 2030, if it weren’t for the new law. For example, a new car with an internal combustion engine that was manufactured in 2028 will still have considerable value, and a gas fired stove a homeowner owns will still have value, even though he needs to replace it with an electric one. A coal fired power plant built in 1980 is likely to still have value, apart from this law, and so will all of the tankers used for international transport of oil, and all of the natural gas pipelines. Should the owners of these assets be compensated for value of their otherwise-useful assets? There is nothing built into the tax to do so.

It would seem to me that these owners should be compensated, even if it takes a higher tax to do so. In part, this compensation could come in the form of “trade in” value, if a new automobile or electric stove or other item is purchased. But suppose the assets that lose value belong to businesses, and aren’t easily traded in for corresponding asset–such as a coal fired power plant, or natural gas pipelines. I would argue that compensation for the remaining value of these is really needed as well.

The assets that will lose value because of the new law are typically owned by a company. The stocks and bonds of these companies will generally have a wide variety of owners–very often pension plans, insurance companies, endowment funds, and individuals saving for their retirements. If the otherwise-useful assets of these companies are taken without compensation, the companies are likely to default on their bonds, and the stocks of these companies will lose value. This will mean that some pension funds will not be able to pay their promised payments, and some life insurance policies will not pay as promised. If there is no compensation to these companies by a tax or some sort, the loss will flow through the system and hit others–with retirees likely hit the hardest. So there will be a loss to the system, one way or another.

How sustainable would this system be?

There are a number of weak areas in this system:

• There are not likely to be enough rare minerals (and even not-so-rare minerals), to make all of the desired high-tech end products. Recycling will help, but it is likely that the system will run into a bottleneck in not very many years.

• The system will use a huge number of electrical transmission lines. These transmission lines are subject to all kinds of disturbances–hurricane or other windstorm destruction, forest fires, land or snow slide, malicious destruction by those not happy for some reason (perhaps those unhappy by wealth disparities). Fixing lines that need repair will be challenging. We currently use helicopters and specialized equipment. These would need to be adequately adapted to a system without fossil fuels.

• If electricity is out in an area, pretty much all activity in an area will stop (except that powered by local PV), and there will be no back-up generators. Residents will not be able to recharge vehicles, so they will quickly become useless. Even vehicles coming into an area may get stranded for lack of recharge capability. Food deliveries and water may be a problem. The current system at least offers some options–back-up generators, and cars and trucks powered by petroleum that one can drive away.

• Operating the system will require a huge amount of international co-operation, because the transmission system will cross country lines. If one country becomes unable to pay its share, or fails to make repairs, it could be a problem.

• All of the high tech manufacturing will require considerable international co-operation and trade. This could be interrupted by debt defaults by major players, or by countries hoarding raw materials, or by difficulty in producing enough ships and airplanes to handle international trade.

• The system clearly can’t continue forever. It could be stopped by a lack of rare minerals, or international disputes, or lack of adequate international trade. The system doesn’t provide any natural transition to a truly sustainable future. For example, food production is likely to still be done using industrial agriculture, with the food that is produced shipped to consumers a long distance away. It will be difficult to transition to a system which is truly sustainable at the point the system stops working.

What would a reasonable timeframe for transition be?

It seems to me that a reasonable timeframe for a transition such as that discussed in the Scientific American article would be 50 years, rather than 20 years suggested in the Scientific American article. With such a timeframe, there will be a little more time to fine tune technology, so as to find cost-efficient solutions that scale well. We also have more time to use the factories that are built, so that we don’t have to overbuild, just to meet a deadline. Costs are likely to much easier to handle, since there will not be as much of an overlap issue. In addition, there will be much less problem of having to dispose of other-wise useful assets.

The problem is that we really don’t have 50 years to make a transition. We already are on the downslope. We should have started back in the 1960s with a project like this.

It seems to me that all we can do is a very much reduced version of an approach such as the one described in the Scientific American article. Given the timing, we may not even want to do an approach such as described in the article. The approach described assumes a high level of international trade continuing long-term. This is a fairly optimistic assumption, given the difficulty of air and ship transportation without fossil fuels.

 

Instead of the high tech approach advocated by Scientific American, we may want to find solutions that can be done locally, with local materials. For example, we may want to encourage local agriculture. For industry, we may want to look at solutions that have worked in the past, such as wind powered factories, as discussed in this recent post. These were built with local materials, and were used to power factories directly, without conversion to electricity. With such solutions, a transition to a truly sustainable future will be much more of a possibility.http://www.theoildrum.com/node/5939#more

Peak Oil Should Still Worry You: The Hot Air in New Natural Gas Estimates

17 Nov 2009 at 14:07

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Natural Gas, Oil and natural gas, Peak Oil

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http://www.examiner.com Seamus Ford

The Cavalry is not coming to the rescue us from our wasteful lifestyles

According to an article this week in the UK’s Guardian Newspaper  a whistleblower at the International Energy Agency said that the US pressured the agency to be complicit in underplaying the increasing decline of global oil reserves.

In light of this, recently revised estimates of Natural Gas reserves in North America should be taken with a grain of salt even thought they have some people calling the United States the Saudi Arabia of natural Gas. These excited comparisons are based on new techniques that allow natural gas to be extracted directly from Shale formations. Geologists have always known that natural gas exists in shale formations. (You can crack a chunk of shale and hold a match up to it and momentarily get a flame.)

The reason for the recent optimism is that newly developed technique called hydro-fracturing where horizontal drilling is combined with pressurized water to fracture the surrounding rock thus creating millions of cracks that allow the natural gas to seep into perforated pipe at the bottom of the well. There several things to consider when hearing such optimistic projections.

From an environmental standpoint, what is over looked are the thousands of already documented cases of ground water contamination. In the same way that the fracturing of the rock allows the gas to seep into the well it also can allow it to seep into the aquifer. For example, there are instances of towns in Texas where people have been able to hold a match to their tap water and ignite the natural gas that is in the water. People may need natural gas, but they need water more and this technique is dangerous to an already jeopardized water supply.

If somehow undertaken on the scale proposed in these optimistic projections it would almost certainly lead to a public backlash similar to that experienced by nuclear power after Three Mile Island.
The other aspect is the unproven energy economics of taping this resource. Setting certain environmental damage aside there is no certainty that this technique can be done on a wide enough scale to be able to replace oil in our transportation needs. Oils shale has shown to have a very quick depletion rate with many wells loosing 70% of their flow rate within one year. If natural gas is even to have a chance to replace oil in the It would require drilling on an almost unimaginable scale. Keep in mind that drilling a well (through perhaps mile or more of rock) can take up to two years. Quite simply the time required to drill a well, combined with the very high rate of decline in a shale gas well cannot be counted on to come to market fast enough to provide a reliable solution. To get an idea of the kind of drilling that would be required see this Quote from the R-Squared Energy Blog:

“The U.S. currently consumes 390 million gallons of gasoline per day. (Source: EIA). A gallon of gasoline contains about 115,000 BTUs. (Source: EPA). The energy content of this much gasoline is equivalent to 45 trillion BTUs per day. The energy content of natural gas is about 1,000 BTUs per standard cubic foot (scf). Therefore, to replace all gasoline consumption would require 45 billion scf per day, or 16.4 trillion scf per year. Current U.S. natural gas consumption is 23 trillion scf per year (Source: EIA). Therefore, replacing all gasoline consumption with natural gas would require a total usage of 39.4 trillion scf per year, an increase in natural gas consumption of 71% over present usage.”
 

Additionally, expanding our use of natural gas to remake our transportation fleet will drive the cost of natural gas up for our already existing uses. Additionally, according to www.greencar.com estimates on the cost of converting a vehicle to natural gas range from 12 to 22 thousand dollars. This makes a natural gas vehicle exceptionally expensive during a time when it is harder for more and more consumers to afford.

Other things to consider are:
Historically speaking, estimates of any energy reserve are almost always conflated. How long can Shale gas be expected to last? Extracting gas from these new locations will require the creation of new pipelines which will add to the cost of the gas and add to the time it will take to come to the market. Do we/will we have the resources to create a whole new infrastructure?

All this is to say that while natural gas will certainly be part of the future energy solution, it will not be a panacea that saves us from having to make significant changes to the way we live.

http://www.examiner.com/x-28586-Chicago-Environmental-News-Examiner~y2009m11d11-Peak-Oil-Should-Still-Worry-You-The-Hot-Air-in-New-Natural-Gas-Estimates

What Oil Price can America Really Afford?

17 Nov 2009 at 14:02

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Economy, Oil, Peak Oil

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http://www.thecuttingedgenews.com Steven Kopits

Saudi Oil Minister, al-Naimi, has warned that under-investment in oil capacity may lead to a return to $150/barrel oil, “or even worse.” The Paris-based IEA has also warned of price shocks due to resurgent demand and restricted investment. Will a high price environment truly emerge, or are price spikes followed by brutal recessions more likely, as experienced in the last year? And what is more important, the absolute price of oil or the rapidity of the price increases? A tour through the historical record may provide some insight.

The burden of oil consumption

In the last 37 years, the US has suffered six recessions. From the beginning, oil played a central role. As the period opened in 1972, Saudi Arabia was selling oil for about US$2.50/bbl – or about $13.50 in today’s prices. Oil had seen a decade of unprecedented growth. The US and Western Europe were finishing the process of motorization of their societies, and demand had soared from just over 20 MMbbl/d in 1960, to more than 50 MMbbl/d by 1972. At the same time, US oil production had peaked in 1970 and had begun to decline. The time was ripe for a shift of power to the up-and-coming OPEC producers, and it was not long in coming.

The fourth Arab-Israeli war broke out in October 1973, and the Arab Oil Embargo was imposed that same month. Within a month, the price of oil had doubled, and the US had plummeted into recession. Oil would double yet again within another two months, and by mid 1974 was trading at $15/bbl, about $55 in today’s prices, pushing the US deeper into the downturn. The US did eventually emerge from the recession, but the price of oil did not decline and remained in the $13-15 range until 1979. In the interim, the economy struggled with stagflation, a combination of high inflation and low growth, and the oil price was a primary cause.

The US economy has tended to grow well when oil consumption expenditures were less than 2 percent of GDP. In the early 1970s, for example, oil ranged from 1 percent to 2 percent of GDP. By contrast, from 1973 through 1978, oil consumption’s share of the economy peaked as high as 6.3 percent, never fell below 4 percent, and averaged 5.3 percent of GDP. In other words, oil expenditures represented a drag of about 3 percent of the economy throughout the period.

Many Americans remember the era as a depressing time, not only of economic difficulty, but also of political uncertainty as the country grappled with its military loss in Vietnam and the rise of communist regimes across the globe. The tide of history looked to be running against the United States. And it would get worse.

In January 1979, the Iranian Revolution broke out, and oil markets were savaged for the second time in a decade. Within a year, oil prices had doubled yet again to $30 ($90 in 2008 dollars), and the US was once again in recession. Oil consumption leapt from 5 percent of GDP to 8 percent and on to 9 percent (peaking at over $100/bbl in today’s dollars), in what would mark a recession that, for all purposes, would last the three years from 1980 to 1983.

The Federal Reserve Bank in the 1970s, under its Chairman Arthur Burns, had sought to counteract higher oil prices with an accommodative monetary policy in the hopes of maintaining “full employment.” This would prove unsuccessful, and inflation soared to 12 percent under his term, creating the malaise of stagflation. In 1979, Burns was succeeded by Paul Volcker, who brought monetary discipline to restore the foundations of the economy. Volcker raised interest rates and began to grind inflation out of the economy.

Without the cushion of inflation, the full effects of oil prices hit the consumer, and oil consumption was slowly crushed out of the economy. From 1978 to 1983, US oil consumption declined from 18.9 MMbbl/d to 15.2 MMbbl/d, a decline of 20 percent. Demand would not recover for nearly two decades. Indeed, the effects of OPEC’s pricing policy were felt globally. World demand peaked in 1979 and did not return to this level for a decade. For its part, Europe would never see its 1979 peak again.

However, the policies of Volcker and other central bankers would have their effect, and by 1983, oil consumption as a share of the economy had fallen dramatically. By 1986, it would fall sufficiently to break the will of OPEC, and Saudi Arabia would abandon its role as swing producer, never to return. The price of oil fell, and US oil consumption fell back to 2 percent of GDP. The “Great Moderation” had begun. Equities began their long bull run, inflation would remain tame, and the developed economies would begin a long period of prosperity.

But not without a few bumps in the road. In 1990, Iraqi strongman Saddam Hussein invaded Kuwait, prompting a military response from the US and a brief recession. Oil prices spiked only for a few months, but even this was enough to down the US economy, and the US suffered a shallow downturn which would bring Bill Clinton to the White House (“It’s the economy, stupid.”).

The US would also suffer one more recession before the current one, the bursting of the technology bubble in 2001. This recession is generally not linked to the price of oil, but even here, as we will see, oil may have played a role.

In every case when oil consumption breeched 4 percent of GDP, the US has suffered a recession, and indeed, the current US recession began within two months of oil hitting the 4 percent threshold, that is, when oil reached $80/bbl.

Oil price volatility

Are oil price levels the critical factor, or do rapid prices increases – price volatility – also matter? As it turns out, recessions also correlate well with sustained oil price increases. Whenever oil prices have increased by more than 50 percent year-on-year (trailing 12 month average divided by the previous 12 month average), a recession has followed shortly.

Curiously, oil prices doubled in the year preceding the technology-led recession of 2001, a recession not ordinarily associated with an oil prices shock, and a recession in which oil consumption did not reach 4 percent of GDP, suggesting oil may have be implicated here as well.

On the other hand, the 1991 recession associated with the first Gulf War did not result in a sustained price increase. But prices did, in fact, double for a period of about four months – not enough to cause a 50 percent annual increase, but enough to cause a recession. While the case for volatility remains somewhat circumstantial, in general, a sustained rise in the oil price of 50 percent or more has always been associated with recession, and this applies to the current recession as well.

The ‘shed rate’

When OPEC raised oil prices in 1973/74, and again in 1979, the cartel was operating under the belief that oil was a valuable commodity that deserved a higher price. And indeed, early prices increases did take hold. However, OPEC assumed that consuming nations would not react to higher prices at any level. This proved untrue.

After the first oil shock, the US economy shed oil consumption over a three year period starting in 1975, reducing oil’s share from 6 to 4 percent of GDP. After the 1979 oil crisis, the economy shed 5 percent of oil consumption in GDP over a six year period. High oil prices will draw a response, and in the case of the US, oil consumption as a share of GDP will tend to be compressed to below 4 percent of GDP, and perhaps lower, exhibiting mean reversion characteristics.

The maximum rate of adjustment for the economy appears to be about 0.8 percent of GDP per year. That is, the economy cannot shed oil consumption instantaneously; society needs time to adjust. When the economy is adjusting at full speed, it tends to struggle. Adjustment tends to be characterized by recession, inflation, or generally low GDP growth. For example, the period of adjustment from 1974 to 1979 was characterized by stagflation.

Three rules for policy

History then provides us three rules by which to avoid recession caused by oil prices, notably:

  1. Crude oil expenditures should not exceed 4 percent of GDP.
  2. Oil prices should not increase by more than 50 percent year-on-year.
  3. Oil price increases should not be so great that a potential demand adjustment should have to reach 0.8 percent of GDP on an annual basis, as shedding demand at this rate has generally been associated with recession.

The policy context
These rules can be applied to three alternative approaches to oil and climate policy, notably to:

  1. Prioritize climate policy with economic impacts secondary;
  2. Prioritize climate policy while taking a cautious approach to the economy; or
  3. Prioritize economic well-being, with climate policy secondary.

A climate focus

If indeed climate change represents “mankind’s greatest challenge,” then economic dislocation associated with CO2 reduction may be considered a necessary cost of achieving the goal. Indeed some articles have commented on the beneficial effects of the recession in prompting Europe’s declining carbon emissions in the last year. The US is no less commendable. Oil demand in the US has dropped 10 percent from its peak in November 2007. From a purely climate-centric perspective, this may be considered a success. Nevertheless, while de-constructing the economy will achieve climate goals, as a practical matter, few would endorse such a policy.

A balanced focus

If we allow that the economy matters, a more balanced approach would seek set climate policy to reduce US oil consumption at rates below those which would normally be thought to induce recession. This would involve a tax at an effective rate lower than the maximum “shed rate” of 0.8 percent of GDP which has consistently been associated with recession. For safety, one might wish to target a rate of perhaps half the maximum, perhaps 0.4 percent of GDP per annum, which would equal about $8/bbl per year, or equate to approximately 20 cents/gal at the pump (based on crude barrels). At this price, the economy would have ongoing pressure to adjust to higher oil prices, but the rate of change would be set to avoid unmanageable and excessively rapid price increases.

An annual increase of $8/bbl represents less than a 50 percent price increase from current levels and therefore should not create a level of volatility which would cause a downturn. However, this approach would not take into consideration levels of spending, that is, under such a program, oil consumption as a percentage of GDP could exceed the 4 percent threshold which has generally been associated with recession. As such, this policy would prioritize climate change over the economy, but would seek to apply sustained pressure without pushing the economy into the abyss of recession and would allow fine tuning of policy moving forward.

An economy focus

A third approach would take as its primary focus the economic health of the economy. Energy price volatility is the key consideration in this approach. In the last year, oil prices have varied not by 20 cent/gal, but by 10 times that amount, $2/gal, since last July. Since December, gasoline prices have increased by four times the rate which might represent a prudent carbon tax.

In short, the impact of inherent price volatility is likely to dwarf the magnitude of any carbon tax that a prudent policy maker might apply. For example, the recent collapse in oil consumption and dramatic reduction in US carbon emissions is unrelated to any carbon tax. Instead, it reflects oil price volatility and its impact on the US economy. Therefore, the greater issue – and the more profound driver of oil consumption – is oil price volatility, and this matters perhaps an order of magnitude more than a prudent carbon tax in whatever form.

A policy prioritizing the economy would be geared to minimizing volatility in oil prices and achieving steady oil price growth instead of the boom-bust cycle of the last two years. As a function of its primary objective, such a policy would explicitly consider the impact of any carbon tax in the context of both price volatility and overall cost burden.

For example, historical statistics indicate that a 50 cent/gal tax on $1.60/gal pump price would be relatively benign. Such a tax at $4.00/gal would be expected to prompt a six-month recession. Therefore, a suitable carbon policy would reflect a “flex tax” approach in which the tax would decrease as oil prices increase.

Moreover, such a policy would seek to sustain oil consumption during periods of high prices and promote oil production during periods of low prices in order to preclude recession. Climate policy would be explicitly subordinate to sustained economic stability, if not growth. This policy would not be anti-climate per se; however, it would seek to channel the transition from dependence on oil through a relatively controlled and gradual process, rather than through a series of spike-and-crash recessions, and the explicit emphasis would be on sustainable economic activity rather than on the climate.

Managing what matters

In the end, the administration has to decide whether climate change is the most important matter at hand, in which case any energy-induced recession is worth the price; or whether the health of the economy is of paramount importance, and any climate policy must be subordinate to that.

If the health of the economy matters, then the administration should take note that oil, at the time of writing, stands around $70 and that the recession threshold, by the books, is $80. Oil prices do not have to rally very much to reach unsustainable levels for the US economy.

In the longer term, the administration would do well to heed the forecasts and concerns of wide range of a mainstream analysts. Take for example, an oil forecast from an April report from the Commodities Research group at Macquarie, a leading natural resources investment bank:

“When looking out into 2011-12 and beyond, we see global spare capacity reduced to zero by 2013. Prices will again need to rise to accelerate upstream spending. We do not think, however, that production can be ratcheted higher fast enough. Oil prices could then rally to reflect scarcity, just like they did in 2Q of last year.”

Should oil return to $150/bbl, as Saudi Oil Minister, al-Naimi, has warned or as Macquarie implies above, the statistics are not ambiguous. When that happens, expect a recession, and a severe one at that.

http://www.thecuttingedgenews.com/index.php?article=11440

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