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Thursday, March 28, 2013

Too Low? Too High?

When I heard on the radio that Newfoundland and Labrador (NL) is proceeding with austerity measures, I wasn’t particularly shocked, since it seemed to ring true with much of what’s going on these days. But when the same radio story reminded me that NL had been anticipating great new prosperity thanks to its untapped offshore oil reserves, I paid a little closer attention. When finally it was explained that NL could not further pursue said prosperity because oil prices just aren’t high enough, I had to check to see if my ears were clogged.

It has been a while since I’ve heard the opinion that oil prices aren’t high enough – in fact, I’ve never heard that opinion in the mainstream media (MSM) before: it’s usually coming from the perspective of those who believe we should drastically reduce our consumption and, to the best of our abilities, leave the black stuff in the ground.
Of course the conventional wisdom is that in NL’s case, things would be so much better if only we could unlock the treasure trove of black gold in their back yard. But alas, the price of oil, at $95.00 per barrel does not make for profitable offshore operations. So projected growth has been shelved and the job cuts have already begun – not to mention the great many jobs that simply will not materialize down the road.
This story has peak oil written all over it.
As it happens, the enthusiastic economic projections that NL had been anticipating were based on predictions that the price of oil would have ratcheted up to about $125.00 per barrel by now. Back in 2007, when the price of oil spiked to $147.00, and all sorts of hell was breaking loose on the financial and economic stage of the world, a believable case was being made for such predictions: almost overnight, the unthinkable had become entirely plausible.
However, partly as a result of the general turmoil, and partly because of the spike itself (which was a bit of a speculative run, at least in part) a new economic phenomenon emerged. What is now generally accepted as “demand destruction.” It appears as though high oil prices have such a “wet blanket” effect on the economy, that there is effectively a ceiling against which the price bounces quite hard. So while some peak-oilers were predicting $200 to $300 per barrel in short order, it seems more realistic to expect the price to bounce between the recession-caused ceiling, and the more familiar supply shortfall that is pushing the price ever upward.
In other words, while the global economy servicing a population of 7 billion people tries to expand, but has trouble finding enough light sweet crude to do so, it resorts to more costly efforts such as tar sands, shale oil, and off-shore operations. However, with rising prices associated with these costs, the average citizen has less incentive to consume, effecting a recessionary influence.
This may well explain why the price of oil seems to dip occasionally, and rises to about $100.00 per barrel, without ever spiking to the record highs. Interestingly, the new lows which were around $60.00 a barrel are at least double what was considered high a mere decade ago.
And yet in NL (and elsewhere, I expect) even at $100 per barrel, offshore oil operations just aren’t profitable enough!
So the fanfare, which was considerable just a few short years ago, trumpeting NL’s future as an economic engine has faded away. It’s one more economic stumbling block for a province that has had its fair share over the decades. But it’s a trend that is becoming familiar in the energy industry all over the place. Welcome to the era of diminishing returns.
Similar hype and fanfare is currently being aired over the shale oil and shale gas phenomenon. The political leaders looking to make some quick “hay” along with their stenographers in the MSM are giddy about a new era of US energy independence. More scrutinizing analysts have identified the story for what it is: the next economic bubble to hit the already faltering economy (wait for it!... ).
Meanwhile, in Canada, we are experiencing a more protracted period of hype in the form of government propaganda (under the banner of “the economic action plan”). This is a veiled effort to convince the nation to support the government’s efforts to drive our economy on tar sands extraction. The tar sands story is also another chapter in the story of peak oil: it is dependent upon high prices that are caused by the depletion and exhaustion of conventional oilfields. But, as mentioned, the effect of “demand destruction” puts a ceiling on those prices. What’s more, when demand is being “destroyed” it’s because of recession – usually characterised by high unemployment.
In other words, the so-called good news of tar sands viability is dependent on the bad news of high oil prices which in turn invites recessionary trends.
So beware the fanfare Canada. The government may be claiming that tar sands can solve our economic woes (even if our energy predicament goes un-addressed), but there are a number of facts that go unstated, and a few assumptions that may not stand up to the test of time. Investing in this resource full tilt, as we have been doing may simply prove to be a case of over-reach, where we make commitments to a way of doing business that hasn’t got legs.
The facts are that tar-sands extraction is ridiculously costly, especially in terms of energy returned on energy invested (EROEI). So as the price of oil goes up (purportedly a good thing, remember?) the cost of extraction goes up along with it, keeping the margin of profit much closer to the ground than with conventional sources of oil. And of course the big assumption here is the lesson coming out of NL: the price of oil may simply not go where we want it to in a timely manner. And if it does, tar sands oil will surely keep it there.
Peak oil is indeed a real phenomenon that we all have to get used to. But it is easily misunderstood, and often mis-represented. Grappling with the implications peak oil has on the economy is serious business. Assuming that the rules have not changed is the first most common mistake made by economists. But this is another topic.
The best economic advice I can think of is to do a collective energy “gut check” and pare down our collective energy diet. Comprehensive energy conservation is the only way that we can guarantee that the availability of energy (for when we really need it) will manifest itself in lower prices. The first step though is to become energy-literate, and try to understand that when it comes to energy, we are like heavy drinkers on a wild binge, throwing caution to the wind…