I’ve seen weirder news days than today, but not many and not by much.

To recap the highlights:

• GM’s June sales dropped 8.3 percent vs. June 2007, and that was so much better than the expected drop (-19%) as well as the results from Ford (-19%) and Toyota (-12%), that the company’s stock spiked by 15%. Of course, it would be impolite to compare their results with Honda’s (+14%).[1]
• Oil is up again, thanks to yet another gloomy outlook report–this one from the wacky funsters at the IEA (the Medium-Term Oil Market Report), plus growing fears that Israel will attack Iran, which would cause Iran to attempt to close shipping through the most critical oil shipping lane in the world, the Strait of Hormuz.
• The Alliance of Automobile Manufacturers issued a 77-page report saying that the new US CAFE standards are too costly to implement, as they would require a corporate fleet average of 35MPG in 2020. Um, not to put too fine a point on it, but do these people think that by 2020 they’ll be able to give away any vehicle that gets less than 35MPG?
• The Wall Street Journal is saying that the IEA’s Medium-Term Oil Market Report shows they’re joining the peak oil crowd. I haven’t read the report yet, but the summaries I’ve seen strongly suggest this is a reasonable interpretation, at least until the 2013 time frame.[2]

Dizzy yet? If not, hang on–you will be soon enough.

[1] Because some news outlets report sales trends based on “daily sales rate” and some just go by raw monthly totals, the measures of how well each car company did will vary a lot, as June 2008 had three fewer selling days than June 2007.

[2] I qualify this because I believe the IEA is talking about the oil market remaining extremely tight until then, and I’m not sure if that’s the end of their projection or if they’re saying the market will loosen up afterwards.

Jeff Rubin and Behjamin Tal of CIBC World Markets, Inc. have issued a short paper addressing what will happen in the US if we see $200/barrel oil and $7/gallon gasoline by 2010, as their analysis says is possible.

The paper is Getting Off the Road: Adjusting to $7 per Gallon Gas in America [5 page PDF], and it describes massive change (emphasis added, although hardly needed):

We stand at a turning point for US transport. Real gasoline prices have already surpassed the peak levels that followed the second OPEC oil shocks, and even when adjusted for potential fuel efficiency improvements, have increased to the point where they will dramatically change driving behaviour in America.

The some 57 million Americans who own a car and have direct access to public transportation will start to act more and more like Europeans, who have long paid much higher gasoline prices. By 2012, average miles driven will have shrunk by more than 15%. SUV and other light truck sales, which until 2006 accounted for almost 60% of total motor vehicles, will plummet to less than half that level, reversing the last fifteen years growth in market share.

More fundamentally, the freeways are about to get less congested. Not only will the number of vehicle registrations in the United States not grow over the next four years, but by 2012 there should be roughly 10 million fewer vehicles on the road in America than there are today.

For the past half century, America has spent the bulk of its infrastructure money on building highways—only to see that soon, $7 per gallon gasoline prices will lead to fewer and fewer people using them.

Gasoline prices in America have risen from around $1.80 in 2004 to the current $4 per gallon mark. The most recent surge in pump prices has, in inflation-adjusted dollars, already taken pump prices to a buck a gallon above the record prices seen in 1981 (Chart 1). And in percentage terms, the latest increase is almost twice the increase in oil prices that followed on the heels of supply disruptions after the Iranian Revolution.

Yet as daunting as these price increases have been, there is much more to come. Our updated oil price forecast of $200 per barrel oil by 2010 points to Americans paying as much as $7 per gallon for gasoline within the next two years.

Even the temporary 1979-1981 oil shock led to huge changes in driving behaviour. The prospect of a permanent price regime of $200 per barrel oil should trigger changes that will dwarf the adjustment we saw nearly thirty years ago.

See the paper for all the details of fewer cars, escalating transportation costs, people seeking public transportation, etc.

I won’t offer an opinion on the $200 oil/$7 gasoline projection, as talking about such pinpoint numbers (or even ranges) is the equivalent of trying to hit the bull’s eye on a dartboard while on a boat in very rough seas. But the ensuing analysis of what such prices, if they were to happen, would mean seem to be on the mark, with one glaring exception: There’s no discussion of the electrification of personal transportation.

Given that this paper is only talking about the years 2010 to 2012, for the most part, this seems reasonable–EV’s and PHEV’s will account for an infinitesimal share of the vehicles on the road in that time frame. But we’re very likely to see an “adjustment to the adjustment” once several mainstream companies have such cars in their showrooms (around 2009/2010) and production ramps up (likely by 2012). The per-mile cost of fueling an EV or PHEV is so much less than putting gasoline into even a Prius that they will be an economic game-changer all by themselves. Add in the virtually certain government support for residential solar PV panels, and suddenly you have many people in single-family homes (i.e. those with control over their own roof) using solar power from government subsidized hardware to partially offset the cost of recharging their plug-in Prius or Volt or iMiEV or whatever.

If there is an accelerated rate of retirement of gas guzzlers (like my Scion xA, as perceived in 2012 or 2015), combined with the people who have the longest drives flocking to EV’s and PHEV’s, we could see a higher than expected portion of vehicle miles fueled with electrons instead of hydrocarbons. And that, in turn, will reduce the incentive to make sweeping societal level changes.

In other words, we’re headed for not one major wrenching change, but a long, interrelated cascade of them, all triggered by much higher oil prices, that will pull different consumers, businesses, and institutions in different directions at various times.

And for the record, I wouldn’t bet against $7/gallon US gasoline in two years.

Here we go again–another article about economists measuring uncomfortable things like the value of human life in trying to figure out what our policy priorities should be. This time around, I have more than the usual objection to what my fellow economists have cooked up.

The article is Fixing the world — by the numbers:

Cutting our carbon emissions to reduce global warming? Not a top priority.

Combating terrorism? Not even on the list of priorities.

Zinc distribution, making school cheaper, and preventing heart attacks? Much more important on a global scale.

If the world decided to fund such efforts, the benefits we’d see would be far greater than what we put into climate change and terrorism, which are central to the anxieties of the First World, and dominate its media coverage.

At least, that’s according to some of the world’s greatest economic minds.

The scholars, including Nobel laureates, are part of an exercise in practicality called the Copenhagen Consensus. They’ve ranked 30 solutions to world policy challenges according to the strict criteria that economics provides: costs versus benefits.

While that might seem like a cold instrument to wield, bereft of human emotion, economists say it’s extremely rational and provides an unencumbered view of just what will give us the biggest bang for the buck.

…

After all, the reality is that not everything can be funded. Choices must be made. The Consensus hypothesizes the spending of $75 billion over four years on solutions for those choices.

What would these experts do first with the money? After listening to Horton’s passionate arguments at the Consensus conference, which wrapped up at the end of May, the panel agreed that providing zinc, along with vitamin A, to children who lack them in the developing world, should be the highest priority.

…

Spending just $60 million per year on this program would yield more than $1 billion in economic benefits, Horton argues, in the form of better health, fewer deaths and increased future earnings. Put another way, for each dollar spent on this solution, we’d get $17 back.

…

Benefit-cost analyses, free from emotion, can also lead to some controversial results.

For instance, the Nobel panel didn’t place solutions to terrorism on their list at all. Economists say the costs incurred in trying to stop terrorists are simply far higher than the benefits.

Another issue that is top of mind for many is global warming. But not for economists. Here again, the costs to mitigate climate change outweigh the benefits. Besides, those benefits won’t be accrued until well into the future, a strike against any solution.

“Think about it rationally,” Horton says. “Because our impacts on the environment are so slow to occur, many of us aren’t as avid about undertaking them as we ought to be.”

The panel ranked it at the bottom of the list.

Chris Green, who teaches a course on the economics of climate change at McGill University, has warned in his work that tackling climate change will be much more costly than most of us think.

Green, who participated in the Consensus, says that while climate change is an extremely serious long-term problem, “My view is that we don’t have the means to deal with it, in any meaningful way, without major technology breakthroughs.” He wants to see an “energy technology race” started.

The panel agreed, and placed the development of low-carbon technologies, whatever they may be, at number 14 on the list.

Economists know that their work can appear as nothing more than cold calculations. Even Green concedes, “I’m not sure you want to frame policy directly on” benefit-cost ratios. And Jha warns of listening to expert panels. “They’re only right half the time,” he cautions.

If anything, the Copenhagen Consensus exercise helps us think differently about the problems of the world: That is, what we may think is important may not have the biggest impact on its most vulnerable people.

The article, which I suggest you read in its entirety, also points out other health- and education-related efforts they recommended.

OK, let me deconstruct this just a bit, taking things in (generally) increasing order of friction-causing potential:

• The basic idea of cost-benefit analysis is sound, and is the only rational way to approach these issues. We have limited resources and we need to figure out how best to use them–that’s the textbook definition of economics.
• When you’re talking about human life, things get very uncomfortable very quickly. People go nuts about assigning a monetary figure to a human life, but there is no other choice. We have to measure the cost of the broad palette of steps we must choose from as well as the benefits. That means we have to use a common unit. So whether we measure things in terms of money or some fabricated unit (which then requires us to convert the money costs of things like public policies into quatloos or whatever we arbitrarily decide to use), we’re still measuring human life. It’s extremely distasteful, and economists don’t like it any more than anyone else; we’re just used to thinking in such terms.
• Even more problematic is measuring human life in the future. How much are you willing to pay today to make a better life for people who won’t even be born in the next 25 or 50 or 100 years?
• The basic conclusion of the economists in this article, that global warming isn’t a high priority, is riddled with assumptions that I think are wildly incorrect and serve as a perfect example of how easily such exercises can turn in unintentional GIGO (garbage in, garbage out) demonstrations.

A quick aside: I can almost bet my keyboard that Joe Romm will jump all over the assertion that we need major technological breakthroughs to deal with global warming. Joe has pointed out many times over on Climate Progress that the number one hurdle in the short to mid term is policy, not technology. I agree, even if I don’t match his intensity in hammering the point home.

Back to those assumptions. Clearly they are assuming that either [1] global warming “won’t be that bad”, or [2] if it is, we can delay action now and fix it later. Anyone who thinks inaction on global warming won’t be a catastrophe just isn’t paying attention and should be ignored. I strongly suspect that the economists involved believe global warming will be bad, but that we can deal with it later and spend resources on more immediate problems now. This is a horrible misreading of the situation, in my opinion, since it completely ignores the mounting evidence that not only is global warming progressing much quicker than any science-based assessment predicted, but we could well be at or beyond the atmospheric CO2 concentration needed to trigger reinforcing feedbacks–the tipping point that leads to a runaway effect that we can’t stop.

Even if you don’t think we’re flirting with a runaway disaster, something that I believe no one knows with absolute certainty, despite the growing evidence, it’s even more likely that if we delay action now and it’s still possible to fix this mess later it will likely be far more expensive than if we start now (or started when Al Gore and others started screaming about this, roughly 20 years ago). We will have to take more drastic measures, some with a higher risk of going horribly wrong (i.e. almost any of the geoengineering proposals), and we will have to spend far more to mitigate the growing effects of global warming.

Finally, let me make a public request: Those of you, including many in the peak oil community, who like to treat all economists like your personal punching bags, please stop it and grow up. Lumping everyone into one narrow, negative stereotype like that is something we all should have been taught not to do in childhood. (Do I really have to trot out some cringe-inducing examples of racial, ethnic, religious, and gender stereotyping to make my point?) If nothing else, remember that there are economists out here–including your host on this site–who understand at the DNA level what global warming and peak oil mean, and we’re doing our best to fight the good fight.

And for those who don’t know the background of “dismal science”…

The dismal science is a derogatory alternative name for economics devised by the Victorian historian Thomas Carlyle in the 19th century. The term is an inversion of the phrase “gay science,” meaning “life-enhancing knowledge.” This was a familiar expression at the time, and was later adopted as the title of a book by Nietzsche (see The Gay Science).

It is often stated that Carlyle gave economics the nickname “dismal science” as a response to the late 18th century writings of The Reverend Thomas Robert Malthus, who grimly predicted that starvation would result as projected population growth exceeded the rate of increase in the food supply. Carlyle did indeed use the word ‘dismal’ in relation to Malthus’ theory in his essay Chartism (1839):

“The controversies on Malthus and the ‘Population Principle’, ‘Preventative Check’ and so forth, with which the public ear has been deafened for a long while, are indeed sufficiently mournful. Dreary, stolid, dismal, without hope for this world or the next, is all that of the preventative check and the denial of the preventative check.”

However the full phrase “dismal science” first occurs in Carlyle’s 1849 tract entitled Occasional Discourse on the Negro Question, in which he was arguing for the reintroduction of slavery as a means to regulate the labor market in the West Indies:

“Not a ‘gay science,’ I should say, like some we have heard of; no, a dreary, desolate and, indeed, quite abject and distressing one; what we might call, by way of eminence, the dismal science”

Developing a deliberately paradoxical position, Carlyle argued that slavery was actually morally superior to the market forces of supply and demand promoted by economists, since, in his view, the freeing up of the labor market by the liberation of slaves had actually led to a moral and economic decline in the lives of the former slaves themselves.

Carlyle’s view was attacked by John Stuart Mill and other liberal economists.

So the next time you want to deride economists, please remember that it was an historian who coined the term while arguing in favor of slavery.

Michael T. Klare, did a 45-minute interview with Jim Puplava and the Financial Sense Newshour, and you should go listen to it.

Klare is the author of several books on the international ramifications of resource competition, most recently Rising Powers, Shrinking Planet: The New Geopolitics of Energy. In this interview he talks with the host, Jim Puplava, about a lot of resource issues, most related to the growing consumer class in China and India, with a particular emphasis on oil.

The interview is the second hour from the June 21, 2008 edition, and you can download or stream the interview in various ways, or just get it here [12MB mp3].

This post isn’t going to win me any friends in the blogosphere, but I’ve donned my Kevlar underoos in anticipation of the response, and it has to be said: Economics trumps energy.

What am I talking about? Simple: There’s this obsession, bordering on a fetish, in some circles with the concept of EROEI (energy return on energy investment). Basically, the idea is that you have to expend energy to extract, process, and deliver it in a useful form. E.g. you have to pull oil out of the ground somewhere, transport it to a refinery, refine it, and then typically transport it at least once more before a customer can actually purchase and consume the final product. That all takes energy, obviously, so you can calculate a return on the investment–you spend X kWh of energy in turning oil in the ground to a usable product at your local gas station, and every gallon of gasoline provides you with Y kWh of energy, so your absolute net energy gain is (Y - X) kWh, and the percentage gain is (Y - X)/X. Simple stuff.

The problem isn’t the math, it’s the way people fall into orbit around the concept. A good example is the post currently up at EcoGeek, Water Powered Car Will Never Work, which focuses exclusively on the physics of the situation. While I agree with the assessment of the energy flows, and I find it hard to see how anyone couldn’t, it misses the point:

We decide which things to do based on economic considerations, not energy flows.

Economics, I will remind you all for perhaps the 48 gazillionth time, is the study of the allocation of scarce resources. But everything is measured in money, and those valuations are intimately tied to how much individual consumers value the things they purchase–in econo-geek speak, their utility functions. Using energy flows as a proxy for valuations only works in those situations when they just happen to agree on the relative cost of various alternatives.

Need a specific example? OK, imagine this: Oil is getting pretty scarce, and therefore very expensive. The cost of gasoline is pushed up by the cost of oil to much higher levels than we’re seeing today. We can cook oil out of the sands and shales in the US and Canadian Rockies, but only by using a lot of some other form of energy. In our scenario the economy is shifting away from oil use, but not nearly fast enough (we have all those old cars still on the road, for example), so the market, reflecting the demand of all those individual consumers, values a kWh of energy in oil much higher than it does a kWh of energy in natural gas (or nuclear power or wind power or…). Therefore, we’ll use one of those non-oil energy sources to cook oil out of the ground because the oil is worth more than the cost to produce it, including all that natural gas or whatever. The net energy gain could well be negative, but until the price of the other energy source rises enough we’ll keep doing it.

Need a more immediate example? Batteries. Not the fancy lithium ion cells in your laptop or the NiMh cells in your Prius, but the penlight cells in your camera or the 17 remote controls on your coffee table. How much energy do you think it takes to make one of those penlight cells, even with the enormous economies of scale from making the immense number we manufacture every year? And do you think the whisper of electrons an AA battery produces is anywhere near that up-front energy input? Of course not. Yet we make and use batteries by the barge load simply because we value what they can do for us more than we have to pay to acquire them. Energy flows don’t come into the picture at all.[1]

You can make an argument that this is yet another reason why public policy is so important. Via public policy we change the relative cost of alternatives and modify behavior in a way that’s in the best interest of society at large. We could (and hopefully will, some day) institute a feebate system to encourage the purchase of more fuel efficient vehicle and discourage the sale of gas guzzlers, for example. Ditto for using some mechanism to put a price on CO2 emissions, and end to the biggest, most destructive single negative externality in the e+e arena. That’s the basic process we use to make the connection between what we collectively think we “should” do and what we “will” do–public policy using the price mechanism to tilt the competitive landscape to everyone’s benefit.

My point is not to beat up EcoGeek, a site I have in my RSS feed reader app and read every day (as should you), or anyone else for that matter. Consider this a plea to remember when you’re reading and thinking about energy, environmental, and economics issues that large groups of people do things based on economic calculations, which means money. Assuming anything else, whether based on optimism that we’ll do the right thing purely because it’s the right thing, or for any other reason, can quickly lead to wrong conclusions.

[1] If you’re going to comment here or e-mail and scold me about not using rechargeable batteries, save your keystrokes. I’m a big fan of them, and I’ve been using them for a long time. I don’t know how much money and environmental impact I’ve saved by not using disposable batteries, but I’m sure it’s a lot. And yes, you should use them, too.

As the dual problems of global warming and peak oil become so pressing that even US politicians can no longer ignore them, they, and all Americans, will face a daunting series of public policy questions. In one way or another, all the questions raised by the need to rein in CO2 emissions and accelerate our transition away from oil as a primary energy source share one thing in common: An implicit decision about the “proper” roles of government and free markets in achieving these goals. It’s quickly becoming clear that the first of these painfully difficult decision points is already upon us, namely: What can and should the US government do about the imploding airline sector?

This is the question posed by the report “Oil Prices and the Looming U.S. Aviation
Industry Catastrophe: A Hole In The Transport Grid”[8-page, 94KB PDF], written by the Business Travel Coalition and AirlineForecasts, LLC. The report paints an stark picture, by any measure, as summarized in the press release (emphasis added):

At current oil prices, several large and small U.S. airlines will default on their obligations to creditors beginning at the end of 2008 and early 2009, according to a study issued today by AirlineForecasts, LLC and the Business Travel Coalition. The study shows that $130/barrel oil prices will increase yearly airline costs by $30 billion, while airlines will be able to generate only $4 billion in fare increases and incremental fees. The implication of this alarming trend is that several large and small airlines will ultimately end up in bankruptcy, and of those, some will be forced to liquidate.

…

“If oil prices stay anywhere near $130/barrel, all major legacy airlines will be in default on various debt covenants by the end of 2008 or early 2009,” the study conducted by AirlineForecasts for BTC states. “U.S. commercial aviation is in full blown crisis and heading toward a catastrophe.”

“Airlines are the primary source of inter-city transportation, critical to national and local economic development, the flow of human capital, movement of just-in-time parts for manufacturing, perishable food and other goods critical to our economy,” the study says. “With airlines gravely threatened, so is our economic well-being.”

Findings:

* The top 10 U.S. airlines will spend almost $25 billion in higher fuel costs this year over last year when jet fuel averaged $2.11 per gallon. Fuel hedge benefits could offset $5 to $6 billion of the increased fuel costs.

…

* Industry fares will have to increase at least 20% - across the board and on average - just to cover the dramatic gap-up in fuel costs from 2007. This is not possible given the level of uneconomic seat capacity in the system today.

* The upshot of higher fares is less traffic, and given a reasonable estimate of price elasticity, the industry will eventually be forced to shrink its seat capacity by 15% to 20%. However, there is no guarantee that a transition to a smaller, more expensive (for the consumer) airline industry would be successful and sustainable.

* Airlines have the ability to raise some cash, and moreover, suppliers such as aircraft manufacturers, leasing companies and travel management companies will have an incentive to support large airlines that provide a stream of value. Nevertheless, without a swift reduction in the price of fuel, the industry is headed toward a massive failure that will result in more bankruptcies, including liquidations.

“The U.S. airlines, and those who depend on them, are watching with growing alarm as their cash reserves fall precipitously toward zero as the price of oil, already at unsustainable levels, continuously spikes into uncharted territory,” the study says. “These airlines have never faced a darker future.”

“Brand name legacy carriers that we and American communities from coast to coast have depended upon for decades to provide us with affordable, frequent air service are running out of cash, and therefore, toward a date with bankruptcy and liquidation,” the report warns.

“Airlines can attempt to radically shrink the industry,” the study states. “But given the competitive situation they face, it’s highly unlikely that they will have the ability to reduce capacity to levels that will allow all of them to survive. Instead, absent direct policy intervention, the likelihood is several airlines will fail.”

“Stabilizing this ailing industry must become a national policy priority,” the report states. “Many Members of Congress, federal regulatory officials, state legislators and Governors have yet to fully appreciate the devastating impact an oil-crippled airline industry will wreak on our culture and our national and local economies.”

The report itself says (pages seven and eight):

To fully grasp the gravity of the current situation, it’s useful to reference some historic context. During the airline industry cyclical downturn in the early 1990s, the industry lost a cumulative $12 billion between the fourth quarter of 1990 and the first quarter of 1993. What followed were 6 years of profits
sufficient for airlines to repair damaged balance sheets. (US Airways even repurchased $2 billion of its stock.)

The most recent downturn in 2000 lasted until 2006 and reported net losses were over $44 billion. The industry only had one year of profitability, in 2007, at less than $4 billion, to begin the balance sheet repair work before it was plunged into deep losses again in 2008. Importantly, during this most recent downturn, significant costs were taken out of the industry, and for many airlines, virtually all assets were mortgaged. Most airlines have little flexibility now as they face both a slowing economy and record-setting jet fuel prices.

…

A catastrophic result for U.S. airlines can be averted if policymakers, particularly in the White House and Congress, step up purposefully to address this monumental challenge. There is still time to make a difference. This is important not only for airlines and their passengers, but also for every business that uses oil products.

In the weeks ahead, BTC will work with its allies to bring forward to Congress and the Administration some specific proposals that will help address the near and long-term implications of the aviation fuel crisis.

We urgently need a new energy policy that will give the airlines a fighting chance to survive and recover — and serve all members of the traveling public for many years to come.

Even if you want to apply a fudge factor to these claims–it’s a business sector claiming times are tough and asking for government help, not a condition that historically tends to result in understatement–it’s hard not to agree with the conclusions of this paper. We’ve already seen several airlines increasing fees, retiring less fuel efficient airplanes, laying off workers, and even flying slower. As I’ve pointed out in some detail (e.g. Airlines, Apocalypticons, and the rest of us), the essential problem is that airlines have no where to turn; they’re tied to the cost of jet fuel, with no substitutes in sight.

So, if you wake up tomorrow morning and find out you’re the US president (with far more time in office remaining than George Bush) or the Senate Majority Leader or Speaker of the House, say, what policy fixes for this quickly unfolding mess would you propose?[1] I’m not talking about blue sky, magic wand notion that we can talk about on a blog and then blithely ignore, but real world, honest-to-Orville-and-Wilbur solutions that must (1) pass through the legislative process intact, (2) actually address the problem to an acceptable degree, and (3) do so at an acceptable cost to the taxpayer at a time when the US Treasury is geysering red ink and the US has an astronomically high national debt.

The first step, clearly, is to define what “acceptable” in (2) above means. Do you try to save all airlines over a certain size? Or do you determine a minimal size for the overall airline sector and try to save just enough carriers to meet that level of service (meaning coverage and number of flights), regardless of which companies that means saving or throwing to the wolves of the marketplace? My gut feeling is that the latter is the best approach, since our goal is to save the country from the pain of an airline sector collapse, not save individual companies.

Once we have some sort of metric for “acceptable”, then what do we do? I think the only viable approaches are to subsidize tickets or subsidize fuel costs. Subsidizing tickets would quickly turn into a infinite mess, I suspect, as the sheer volume of tickets and the resulting logistics would outstrip the government’s management skills, especially in the short run. If we were to subsidize fuel, however, it would be orders of magnitude simpler to administrate and adjust the program, and we would be directly addressing the problem: Fuel costs.

So, we decide to subsidize all airlines to a set fuel cost. What’s the magic number, and how much does it cost? The above report has a table (page 5) that provides various oil prices and their effects on the airline industry. This table says oil at $130/barrel equates to jet fuel at $3.80/gallon, and $100 oil translates to jet fuel at $3.10/gallon. For the sake of example, assume we’re aiming for the $100/barrel oil, $3.10/gallon fuel price point, although I’m not sure that the airlines would agree that this is enough help.

The US uses about 1.6 million barrels of jet fuel/day, or 67.2 million gallons/day, according to the current TWIP report, and oil is just a bit over $130/barrel. So we’re talking about the government underwriting 70 cents of ever gallon of jet fuel, at a daily cost of about $47 million, which is $17.1 billion/year. Given that the US is spending about $12 billion every month in Iraq, an endeavor which should end sometime within the life of at least some people reading this, this doesn’t seem too bad.

There are some very serious issues here, obviously:

• How long do you subsidize jet fuel? Until oil prices come down on their own? Lots of luck on that front. Until airlines shrink enough that they can survive without subsidies, i.e. the conversion to a boutique industry that serves only the wealthy? That’s what we’re trying to avoid in the first place, so that’s out of the question unless your goal is merely to slow the collapse of the airlines enough to let the rest of the economy adjust and soften the shock.
• Lower fuel prices means you’ll have more people flying than if you hadn’t created the subsidies, so that means more oil diverted to jet fuel and less to gasoline, diesel fuel, and home heating oil, as well as more CO2 emissions that we have to deal with as part of that other growling monster under our bed.
• How do you pay for the subsidies? Do you generate some other revenue stream–windfall profits tax on oil companies, anyone?–or do you simply pile it on the mountain that is our yearly deficit?
• What do you do if the crazy people on the Internet, like, well, me, are right and we hit peak oil in just a few years and oil becomes much more expensive, pushing up the cost of your subsidies? Do you maintain your commitment to subsidize jet fuel at $X/gallon, or is your commitment to subsidize by Y cents per gallon? Even if you stick to the Y cents/gallon formula, how many other, equally dire demands on the government will materialize once we get into the age of truly expensive oil?

I often say that one of the things I’m thankful for on a daily basis when I wake up is that I’m not the president of the US, and this airline situation is a prime example why that observation is less amusing on some days than others. In light of the range of current and developing issues facing the US, all industrialized countries, and essentially the entire human race, I honestly have no idea what I would do about this.

See also:

• Airlines, Apocalypticons, and the rest of us
• Airline Armageddon
• Aviation articles on the TCOE discussion board

[1] I’m assuming that you agree that this is a very big problem that should be addressed if at all possible. If you think it’s either not a problem for the country to have the airline sector implode, or you think we should just let it “sort itself out” as the free marketeers like to say, then consider the rest of this post as an exercise in fantasy.

The EIA (Energy Information Administration), the statistical arm of the US Department of Energy, has suddenly changed its mind about what most energy prices will do across the years 2008 and 2009, and it’s not happy news.

The data below is from the STEO (Short Term Energy Outlook), which the EIA issues around the first week of each month. The home page for the STEO is here, while the archive of prior versions is here.

So, what do the numbers say?

First up is everyone’s favorite, oil:

In the May 2008 release, the EIA projected that crude oil would average $103.36/barrel in 2008, and then decline to $97.62/barrel in 2009.

But in the June release, which was posted yesterday, they upped their estimate for 2008 to $122.15/barrel (quite a jump from that $103 value in May, but not too surprising in light of the current $135+ price). Even more surprising is that they’re now projecting oil to average $126.00 in 2009, almost $4/barrel higher than in 2008.

From May to June, the projection for the 2008 average price rose 18.2%, and the projection for 2009 rose by 29.1%. The projected change from 2008 to 2009 went from a decline in the May report to an increase in the June report.

Gasoline (regular unleaded, retail price):

May: $3.52/gallon in 2008 declining to $3.44 in 2009

June: $3.78 in 2008 rising to $3.92 in 2009

From May to June, the projection for the 2008 average price rose 7.4%, and the projection for 2009 rose by 14.0%. The projected change from 2008 to 2009 went from a decline to an increase.

Diesel fuel (retail price):

May: $3.94/gallon in 2008 declining to $3.67 in 2009

June: $4.32 in 2008 and 2009

From May to June, the projection for the 2008 average price rose 9.6%, and the projection for 2009 rose by 17.7%. The projected change from 2008 to 2009 went from a decline to no change.

Natural gas (US average wellhead price):

May: $8.64/thousand cubic feet in 2008 declining to $8.52 in 2009

June: $9.82 in 2008 rising to $9.96 in 2009

From May to June, the projection for the 2008 average price rose 13.7%, and the projection for 2009 rose by 16.9%. The projected change from 2008 to 2009 went from a decline to an increase.

(Note that this is not the retail price of natural gas; that price is much higher, and is projected by the EIA to be about $15 for residential customers in 2008 and $17 in 2009, both very high numbers by historical standards.)

Coal:

May: $1.87/per million Btu in 2008 rising to $1.91 in 2009

June: $1.89 in 2008 rising to $1.96 in 2009

From May to June, the projection for the 2008 average price rose 1.1%, and the projection for 2009 rose by 2.6%. The projected change from 2008 to 2009 was an increase in both months.

Conclusions

First and foremost, don’t go nuts over price projections from the EIA or anyone else. As I so often point out here, the energy field is littered with predictions that didn’t exactly hit the mark. The EIA seems to have a particularly inaccurate dart board. That’s not to say that I think this revision of their numbers is wrong; if anything I think it’s conservative and overdue. In fact, it’s hard to look at this flip in projections–from generally downward (2008 to 2009) to generally upward–and not leap to the ever so slightly tin-foil-hatted conclusion that the EIA held out as long as they could before delivering the bad news. A month ago they were predicting an average price for oil in 2008 of only $103.36, for example. In those intervening four months did they suddenly notice (as they say in the STEO release for June):

The combination of rising consumption, further downward revisions in the supply outlook for countries outside of the Organization of the Petroleum Exporting Countries (OPEC), and low surplus production capacity reinforce the perception that supply is having a difficult time keeping up with demand growth, accounting for much of the upward trend in oil prices. Consumption in countries outside of the Organization for Economic Cooperation and Development (OECD) continues to grow rapidly, offsetting weaker consumption in OECD countries, especially the United States. Declining production in a number of non-OPEC nations, including Mexico, United Kingdom, and Norway, is largely offsetting increases in other countries. Slow growth in non-OPEC supply is coinciding with disruptions in supplies from some OPEC countries, such as Nigeria. Ongoing geopolitical concerns in several producing countries, including Venezuela and Iran, have contributed to oil price volatility.

The market remains concerned that the cushion of surplus production capacity of less than 2 million bbl/d (almost all located in Saudi Arabia) and/or stocks is insufficient to protect against possible changes in supply or consumption, especially as we enter the summer hurricane season. The absence of a Saudi commitment to add capacity beyond its current goal of 12.5 million bbl/d adds to the uncertainty about the adequacy of future supply capacity growth.

See the June STEO for the other stunning revelations behind these latest projections, revelations that absolutely no one (by which I mean practically everyone on the planet) has been talking about for a long time.

Combine this report, which I’m sure has a huge influence on commodity traders, with the big drop in US oil stockpiles released in today’s TWIP report (likewise), and you probably have all the explanation you need for why oil is up $6.29/barrel and gasoline is up over 17 cents/gallon on the NYMEX as I type this.

Whether or not there is a “creeping, belated awareness of peak oil” among US mainstream consumers and voters, as I wrote last Friday, there’s the more pragmatic issues of how consumers are reacting to the recent run-up in gasoline prices. Put another way, are we learning anything from this encounter with “high” oil prices, or are we just setting ourselves up to prove yet again that we can’t learn anything from a second mule kick, as the old saying goes?

This thought leapt to mind recently when I read the article, GM wakes up and plugs in. Now comes the hard part, which includes the following passage:

Going green is going to take more than a change in mindset. That, in itself, was monumental for GM, but it will likely end up being the easy part. Going green can save the Detroit Three only if they can quickly change their business model to one that generates profits from the sale of cars, instead of trucks and SUVs. And even then, only if they can develop the right environmental technologies that drivers - and North American governments - are demanding in an era of expensive gasoline.

Of course, even if they do all that right, they’ll still face Toyota and Honda on the other side, ready to steal even more market share. In fact, their Japanese rivals have already pulled ahead in the race to go green.

Unfortunately, the Detroit Three seem to take decisive action only when a gun is pointed at their heads.

“Sometimes the gun is at their temple and it takes three or four homicidal events for them to move,” a former GM executive quips.

Gasoline at $4 (U.S.) a gallon looks like the gun that is prompting them to try to save themselves. Whether they will won’t be known for several years.

I yield to no one in my criticism of the US car companies and how their management stuck their heads in the sand after the oil crises of the 1970’s/80’s, but they’re just part of the problem. If US consumers had demanded higher MPG cars, the Big Three would have found that all the testosterone-soaked ads for pickup trucks and SUV’s in the world wouldn’t have let them become as insanely over dependent on them as they are now. The car companies certainly had more than a little to do with the oily mess they and the entire US and even the world is in right now, but they just as clearly had some help from their customers who were all too willing to believe, even if only implicitly, that oil would be forever cheap.

Surely with gasoline at $4/gallon and the mainstream media outlets running a barrage of stories about how uncertain the future supply of oil is, they Get It this time, and they’ll finally do the energy equivalent of sitting up straight, eating their veggies, and flossing regularly, even if the price of gasoline dips for 6 or 12 or 18 months, right? All this pain they’re complaining about endlessly has taught them a fundamental lesson, hasn’t it?

I think the most accurate thing anyone can say is, “I hope so, but the evidence has yet to be seen.”

A lot of people are indeed making changes right now. The news sites are full of stories about people driving less and relying more on public transportation. (Even in the US?! The horror of it all!) In fact, a recent Ipsos/American Access poll asked people how they were responding to higher gasoline prices:

A new telephone survey of 1,000 Americans, conducted by Ipsos Public Affairs on behalf of Access America Travel Insurance and Assistance, has found that 67% have already changed their driving habits because of gas price increases.

…

As the price at the pump continues to rise, more and more Americans will be changing their driving habits: at $3.00 per gallon, 35% of Americans had changed their habits; by $4.00 per gallon — a reality in many parts of the U.S. already —, it will be 74%; and by $5.00 per gallon, 85% of all Americans will have changed their driving habits. However, one in ten Americans (9%) say they will never change their driving habits, regardless of the how high the price climbs.

…

In an effort to save on gas, Americans first tend to reduce non-essential driving. More than a quarter (26%) say that cutting back on travel or recreational driving is the first substantial change they made or will make due to rising gas prices. One in five (21%) say the first thing they did or will do is to consolidate or reduce errands (21%). Fewer Americans first look to alternate forms of transportation such as carpooling (7%), walking or biking when possible (6%), or using public transportation more often (4%). Only 3% say that the first thing they did or will do is buy a more fuel-economic car or a hybrid.

(Notice that using more public transportation is a measly 4%, which tells you how little we used it pre-price run-up when we have all those articles now talking about increases in ridership of 10, 20 or more percent.)

When I read those results, I wondered if the survey didn’t ask about hypermiling, or if they did and no one was doing it. When I e-mailed Ipsos, Aaron Amic, Vice President at Ipsos, responded:

The question was open ended so the respondents were free to give any response they liked. The responses were then grouped together to form response categories.

There were no direct mentions of hypermiling but a small percentage pointed to “driving slower” and a smaller (to small to code) percentage (<1%) said "not letting the car idle".

In a later e-mail he said, “I agree that if gas prices continue to increase, we may see more people use the techniques of hypermiling. However, the data suggests it is still a nascent activity among general population drivers on the roads today.”

This shouldn’t be a surprise; people will make adjustments according to how much of an impact they perceive those changes will have on their lives. In economics-geek terms, each person or family or organization has their own utility function, which defines the tradeoffs they’re willing to make. Right now, they’re doing the obvious things, as described above. If gasoline prices continue to inflict higher levels of pain, I expect that they’ll look for additional ways to reduce their fuel consumption. That will lead more people to learn about hypermiling and give it a try. And once they find out from personal experience that it won’t make their private parts stop working or fall off, they might decide it’s not nearly as bad as they feared. I like to tell people that for the average American driver (read: lead foot) it’s almost like a free conversion of their car to a hybrid.

(For an article about a similar survey, albeit with some very different results, see: Fearing $5 gas, Americans cut back)

But the big unknown is what will happen if gasoline prices retreat to, say, $3/gallon. That’s where I worry, because every vehicle put on the road now is one we’ll have to live with for at least a dozen years, normally longer, on average.

A small but very pessimistic sign is the number of people I know personally or have heard from who are blaming the faceless, all-powerful “They” for the current problems. And I’m not talking about just the people who think “there’s plenty of oil–the oil companies are screwing us again”[1], although that’s a sizable contingent. No, I mean the people who insist that “They” could make a car that gets 100MPG if “They” wanted to.

Even more disturbing is a note I got from an extremely well educated friend who said, “Honestly, I can’t believe in this day and age that we can have people living in space for months at a time but we can’t figure out a technology that doesn’t depend upon oil. (Although I have to say, I think the technology exists and that the government and car companies are keeping it hush hush).”

This is the kind of stuff that makes me nuts. I would love to know what incentive the government and the car companies would have to do something like that. As I pointed out to my friend, if I ran a car company and had this wonderful technology that was price competitive, I would use it and make billions.

I know from experience that when you press people on these kinds of comments, they inevitably fall back on how “They” want to control us or make more money from us (even though They would be better off doing something different) or who knows what absurdity. That’s as far as the conversations usually go, because I have to excuse myself, run outside, and scream at the sky for a minute or two.

(I’ve also never figured out why the heck They would want “total control” over us, anyway. I wouldn’t want any control at all over the “nice” people I know and associate with, let alone some of my, shall we say, more colorful fellow Americans.)

The point is that the level of reality denial among consumers, and the effect it can have on their real-world decisions, should not be underestimated. People who buy much larger and less fuel efficient vehicles than they need, or build a new home in a location that requires a hellishly long commute simply don’t want to admit that a lot of the financial pain they’re feeling right now is of their own making. Perhaps they didn’t pay enough attention to energy issues when they made those decisions to see that the rules of the game as they knew them their entire lives were about to change dramatically. Or perhaps they did know (or had a friend who gave them no choice but to know), and they wished it away as just another loopy Internet thing. Whatever the case, it would be in everyone’s best interest for those living inside their own, personal Reality Distortion Field to realize that they can do something to insulate themselves from future mule kicks, especially since the next one could well be the worldwide peak in oil production and far worse than anything we’ve seen to date.

[1] If you have the patience and the blood pressure points to spare, ask one of the “there’s plenty of oil” people for some hard stats–how much oil is in the ground, how quickly are we using it, which of the world’s major oil fields are in decline, which new fields are coming online, etc. When they just stare at you because they have no facts, ask them how they know that “we have plenty of oil”. That’s when you’re perilously close to ending a friendship, so tread carefully.

The American baseball legend Satchel Paige famously observed, “Don’t look back. Something might be gaining on you.” While that might good advice in some circumstances (it was one of his rules for staying young), in energy and environmental matters it’s painfully shortsighted and all too typical of how many of us do things, at least until very recently.

While I suffer from no delusions that my next trip to the local grocery store will reveal hordes of shoppers wearing peak oil-themed T shirts while they fondle the produce, or that every person in my neighborhood who owns a dinosaur on radials (i.e. an unnecessary SUV or pickup truck) will sell it for scrap and buy a Vectrix electric scooter or a bicycle, the signs are accumulating that the peak oil meme is spreading–slowly and inexorably–beyond our virtual clubhouses on the ‘net. It’s about freakin’ time.

Just to be clear, one thing that doesn’t necessarily point to this dawning awareness is the trickle of stories about surveys showing people expect higher gasoline prices, like this one from Gallup. Notice near the bottom of that page that Gallup asked people what was causing higher gasoline prices. “Peak oil” wasn’t an explicit option (but some similar options were offered), and the number one choice (34%) was “Oil/gas companies getting greedy and gouging the public”. So we have some work to do and it’s not quite time to shut down this site.

But we are seeing some mainstream discussion of peak oil, and even (gasp!) people explicitly using the term “peak oil” in a non-sarcastic or demeaning way, instead of simply describing the situation perfectly and then conveniently avoiding the term.[1] The latest example is the Reuters article, Cairn says peak oil fears may have fuelled rally[2], which says:

Oil’s spurt to a record above $135 last month from around $100 at the start of 2008 may have been influenced by a growing feeling that oil supplies might be peaking, the head of oil explorer Cairn Energy (CNE.L: Quote, Profile, Research) said.

Cairn’s Chief Executive Bill Gammell told the Reuters Global Energy Summit on Friday that there was growing awareness in the market about “peak oil”, a theory which says that global production is near an apex after which it will decline sharply.

“The move from $100 to $130 was actually a period when people started to look at and wonder more a bit about the peak oil theory,” Gammell said.

…

Cairn’s Gammell said it was a “struggle” to see where major production volumes would come from going forward, while demand for oil in Asia led by China and India was only “going to go one way”.

“Which leads me to suspect that prices are likely to remain firm … I would say that from a long term view, I would be bullish on oil prices. Where they will be I don’t know,” Gammell added.

Why is this a big deal? Because perception is reality, as they tell people in corporate communications classes and politics. Not literally, of course–what we think or say certainly won’t put more oil in the ground or instantly improve the efficiency of the massive infrastructure already in place in industrialized countries. But it does have a profound effect on our actions; we respond to our perception of the world, not the world itself.

If we buy the projections of the US Dept. of Energy (which really should be turned into a slapstick comedy routine), then it seems ridiculous for oil to be leaping off the charts as it is right now. (It’s up $11.14/barrel, with wholesale gasoline up 21.56 cents/gallon, on today’s trading. Stop and ponder those numbers for a moment.) And keep in mind, we didn’t have a hurricane or terrorist attack interrupt the oil supply, nor was there a sudden cut in oil shipments from Saudi Arabia or Russia or anyone else.[3] There’s clearly an element of speculation and exchange rate fluctuation involved, no sane person would deny that, but the core driver, I think, is nothing more complicated than the traders finally pulling their heads out of the sand. They’re just beginning to realize, right down to the DNA level, that a worldwide, permanent, inescapable peak in oil production is not some far-off, quasi-theoretical construct on a professor’s PowerPoint slide, but a terrifying occurrence that has been tightening its grip on us for a few years already, even if the peak itself is still technically a few years off. After being yelled at by the energy geeks for years, they’re finally recognizing the broad and deep and long-lived ramifications for modern industrial society of vastly more expensive oil. And they suddenly realize that even when you don’t look, something very big and very nasty could be gaining on you.

[1] I’ve commented on this phenomenon, the “peak oil by any other name” gambit, several times. I still believe that writers do this to avoid being lumped in with the doomers. This is why I think the Apocalypticons are doing more harm than the Cornucopians–they’re making it very easy for the newbies (which include the vast majority of consumers and voters) to dismiss the entire entire notion of peak oil as yet another Internet-fueled urban myth. And let’s face it–peak oil forces such a radical change to one’s world view that we’d all like to brush it off with no more regard than we give the crazies who claim we never landed on the moon or Elvis is alive and working in a Wal-Mart in Georgia.

[2] Yes, the speaker (or the author?) in the article takes some liberties with what peak oil means. I’m not about to pick nits here. Just the fact that he’s talking about it in this way and using the name will get a pass from me, at least this time. But he should consider himself on notice.

[3] Yes, there are those rumors lately that the US is getting ready to attack Iran any second now, the same rumors that have been floating around the ‘net for years in one form or another. I would be stunned if the oil traders suddenly decided those stories had enough credibility to make them risk millions of dollars on commodity options. Even I’m not convinced Bush is far enough out in foo-foo land to do it, and I’m one of the people who thinks he attacked Iraq largely to prevent other countries from monopolizing their oil and natural gas exports.

Since shortly after I wrote about the looming disaster in the airline industry (see Airline Armageddon), I’ve been engaged in an interesting discussion via e-mail with a reader that I thought worth writing about publicly.[1]

In essence, the questions raised by Airline Armageddon were: Have I joined the Apocalypticons? If so, why? If not, how can I write about the airline business in such stark terms and not be in that camp?

The first question is the easiest to answer: No, I haven’t joined the Apocalypticons.[2] I still believe, right down to my DNA, that for all the challenges humanity faces–peak oil and global warming being right at the top of the list–we will rise to the occasion. It won’t be fun, it won’t be cheap, and it will entail significant human pain. But it won’t trigger the end of modern industrialized civilization or any other Apocalypticon fantasy.

The second question is now moot, which brings us to question number three and the heart of the matter, not to mention my motivation for writing this blog entry.

Boiled down to its essence, the answer is that the unique circumstances of the airline industry make it a very special case that’s not representative of our overall peak oil dilemma; in other word, their goose is highly likely cooked[3], while that of humanity or modern industrialized civilization isn’t.

To help explain those special circumstance, let me very briefly detour into microeconomics. Two key concepts of micro theory are the price mechanism and substitute goods. The price mechanism is nothing more than a fancy term for how prices act as a signal throughout the economy, letting buyers and sellers make decisions in a way that (presumably) best serves their own interests. The critical balancing act that economies perform in terms of allocating scarce resources is built atop the foundation of the price mechanism working within the context of a reasonably open and free market.

A substitute good, as the name implies, is something you can use in place of something else. Just think of all the brands and models of consumer items, like appliances, audio/video equipment, clothes, etc. we’re used to seeing for sale, many of which offering very little or no significant difference from their competitors.

Combine the price mechanism and substitute goods in a free market and you have the basis for a very powerful system that works surprisingly well on autopilot. For example, you go to a sporting goods store to buy a tennis racquet, and find that the one you had planned on getting has increased in price, so you buy a different model or brand. This increases demand for the one you bought relative to the one you had planned to buy, and helps balance the prices, and therefore the allocation of resources to make them.

As far as airlines go, they have a problem: They were already under stress from ferocious competition, and then fuel costs rose dramatically in the last few years. In the usual abstract economics classroom discussion, Company X finds that resource Y needed to make widgets rises in price, so they stop buying Y and switch to resource W. When enough companies follow X’s lead, the price of W rises and that of Y falls until the amount they contribute to the cost of making a widget is equal, and then everyone goes home happy. The catch is that airlines don’t have a resource W to turn to–there is no short-term substitute for petroleum-based jet fuel.

But wait, you say–isn’t that that sneaky little “short-term” qualifier the loophole in the gloom and doom? There may not be a good substitute for petroleum-based jet fuel now, but once the rise in fuel prices creates a large enough incentive we’ll invent one, right? Isn’t that the classic economics view of the world. Yes, it is, and in this case the real world choose not to play by the rules of that quaint mental model.

Aside from shrinking the entire industry considerably, until it’s just big enough to serve those fliers willing to pay enough for a ticket to cover current (and likely much higher, in the coming years) fuel costs, what are airlines to do? There are efforts to make jet fuel from biological material, essentially the airplane equivalent of ethanol for cars. Similarly, there’s considerable work going on to make jet fuel from coal. Neither of these alternatives seems promising.

To begin with, consider the scale of the problem. The US alone uses 1.6 million barrels of jet fuel every day[4], that’s 67.2 million gallons/day, or 24,528 million gallons/year.

The biofuels option seems highly unlikely to scale to a useful level. A large ethanol plant produces about 100 million gallons per year. Replacing even half of US jet fuel consumption would therefore require 122 biofuel plants of that size. With the high and growing backlash against biofuels made from food, and the likely competition for arable land even if you’re using willow tress or switchgrass or who knows what, it’s ever more difficult to concoct a scenario in which this option works in the real world. Add in water issues, and it gets even nastier: Drought conditions mean we’ll have ever tougher decisions regarding the use of fresh water, and using more of it to grow biomass for airplane fuel and then even more to convert that biomass into usable fuel will be very tough to justify.

Converting coal into jet fuel looks like it’s technically workable, and the US Air Force is involved in developing this technology. The problem is that turning coal into jet fuel creates a lot of CO2, which we all know we can’t just dump into the atmosphere. So we’re stuck either trying to sequester it permanently underground or consuming it in some way, such as feeding it to greenhouse plants or algae farms and ensuring that a very high percentage of it is consumed. (The planes will make more CO2 when they burn the fuel, so this sequestration or consumption step handles only the emissions from the CTL processing.)

Even if you assume that we can cook up a zero-CO2 way to turn coal into jet fuel, something I find highly doubtful, we will still face enormous pressure to minimize air travel, which is currently responsible for over 240 million metric tons of CO2/year in the US[5] and offers virtually zero hope for CO2 capture and sequestration. Plus, there’s the delay factor–how long will it take to build out the infrastructure needed to convert coal into jet fuel (with no CO2 emissions) at a rate that will help the airline industry? And can the airlines possible hold their breath that long?

My conclusion from all this detail: If you assume that cheap oil isn’t returning, then the nature of the airlines’ business and the other pressures arising from global warming unavoidably leads you to one conclusion: The airlines will have to shrink, a lot, to stay alive, which is why I keep referring to that sector having a future as a “boutique business”. This is quite a contrast to the car makers, where electrified vehicles will be a mainstream alternative very soon and much can be done to increase the miles traveled on each gallon of oil even for plain old gasoline and non-plug-in hybrid models. Airlines have neither an escape hatch nor low hanging fruit to save them.[6]

I’m bringing all this up for a simple reason: I think it’s critical that each of us, when we’re making decisions about our own consumption or which public policies and politicians to support, avoids the error of reaching bad conclusions based on a too-broad analysis or, even worse, simply relying on a gut instinct or misapplied rule of thumb. Very often we can only find accurate answers by delving into the details. Yes, that’s a lot more work than simply assuming that “gasoline prices are high because the oil companies are screwing us”, for example. And yes, that exposes us to being lied to with numbers by people with all manner of hidden agendas, most of which don’t share our best interests. But with the peak oil and global warming situations becoming more urgent by the day, it’s never been more important that we do our homework so we can individually and collectively make the right decisions.

[1] For those who like to play blogger parlor games and will be tempted to guess who my correspondent is, don’t bother. The person isn’t even a registered member of the site or the discussion board, let alone one of the regular contributors. Even though I don’t understand the need for it, I’m keeping the person’s identity a secret by request.

[2] For those new to the site, “Apocalypticons” is a term I coined some time back to refer to the doomers who make ridiculous predictions, typically based on absurd, linear projections of current trends (or simply pulled from a particular body orifice which shall remain unnamed), with no (or virtually no) allowance for the dynamic nature of economic and political systems, not to mention humanity in general. (The opposite end of the spectrum is Cornucopians, the equally clueless fools who think we can achieve infinite growth on a finite planet.) A classic example of Apocalypticon thinking is the claim that after the peak in worldwide oil production we won’t be able to maintain wind farms because the necessary trucks and cranes run on petroleum-based fuels. I’ll leave the refutation of that gem as an exercise for the reader.

[3] Throughout this entry I will assume for that the price of oil will not make a major and long-lived retreat.

[4] It’s actually 1.624 million barrels/day in 2006, as reported in the latest Annual Energy Review, Table 5.11.

[5] It’s actually 243.8 million metric tons in 2005, as reported in the latest Annual Energy Review, Table 12.3.

[6] It should go without saying, but let me be painfully clear about this: If I’m wrong in this assessment of the airlines, please tell me. In fact, I would love to be wrong. I would be delighted to have someone point out that there’s a way for airlines to keep flying (and keep all their employees on the job) without continuing to contribute to CO2 emissions and/or making the biofuels debacle far worse. I’ve looked, and I can’t find that solution.

For a long time, the world oil market was pretty simple: World demand was lashed to US demand–part of that whole “the US uses 25% of the world’s oil” thing we hear all the time, and and Saudi Arabia had both the spare production capacity and the willingness to be the “swing producer”, the exporter that throttled its production up or down to keep the market relatively calm. But paradigm shift happens, and as I type this we’re just beginning to test drive the new energy world.

What makes this new world so new is far more than current oil prices, but a combination of perceptions and economic realities that could have profound effects on those prices and everyone who pays or is dependent on them, which is, well, almost everyone on the planet.

As I see it, the defining characteristics of the new energy world order are:

• OPEC’s shifting perception means it’s no longer both willing and able to be as compliant as it was in the past.
• New customers: The rise in oil consumption in China, India, and some oil exporting countries.

OPEC’s perception

You can find all the arguments you could possibly want online about whether OPEC (and in particular, Saudi Arabia) has any appreciable spare production capacity. Put another way, we don’t really know if their newfound resistance to calls for more oil, including visits from George Bush, hat in hand, is a reflection of their ability or their willingness to pump more oil. My blatant guess, which is just as blatant as anyone else’s regarding the enigma lasagna that is OPEC, is that they do have some spare capacity, perhaps two or three million barrels per day, but that they’ve had a significant shift in their perception of the market, which is making restraint far easier than it has been in the past.

What could suddenly influence OPEC in this way? Two things:

First, and of lesser importance, is the fact that the world’s largest oil importer (I’m looking at you, America) has not exactly been the most stable or friendly of neighbors for years, at least since about March 2003 when that whole “we have to blow the hell out of Iraq because they have WMD’s and unmanned drones that can reach the US” thing erupted onto the world stage, fully formed, from the fertile little minds of certain people. Honestly, if you had a dwindling resource that a vastly larger and more powerful country was painfully reliant upon, and that country was acting the way the US has, how much incentive would you feel to keep their oil bill and your revenues low by depleting that resource quicker than necessary?

Second, even OPEC doesn’t have an infinite amount of oil, and they have very likely reached a critical stage in the history of the oil market: They can restrict supply and let prices float to previously unimagined heights without fear that the US and other importers will wean themselves from the devil’s tears, as oil is called in parts of Asia. OPEC knows it will take the US years to transform its economy to one that uses vastly less oil, and once we are closer to the world peak of oil production than the US’s transformation time, there’s no point in being quite so compliant. Suddenly, OPEC has immense incentives to trim output and support much higher prices. They make far more money, they extend the production lifetime of their oil fields (which maximizes their power and earnings in the future when oil becomes truly scarce), and they can even tell themselves that they’re doing the importing countries a favor–higher prices pre-peak mean the transition away from oil starts sooner and reduces the risk of a major economic collapse (or yet another oil war), which would be bad for the importers as well as the exporters’ business. They get to enhance their position now and in the future, and they can tell themselves that they’re doing the whole world a favor. What could be better?

New customers

Looking at the BP Statistical Review of World Energy, we see that from 1996 to 2006 oil demand in China grew by 101% (3.702 million barrels/day to 7.445), India’s grew by 51% (1.700 to 2.575), and the entire Middle East’s grew by 35% (4.370 to 5.923). By comparison, oil consumption for all of Europe and Eurasia grew by 5% (19.555 to 20.482), and the US’s grew by 12% (18.309 to 20.589).

When domestic oil demand rises in an exporting country (often due to very high subsidies that make gasoline extremely cheap), that means less oil on the open market for importers to buy. A far bigger impact is emerging from China and India, however, for reasons that involves a little economics theory. (Don’t worry, it won’t hurt.)

China has a population of roughly 1.3 billion people, while India’s is about 1.1 billion. Large portions of those immense populations are just entering what most people would call a consumer or middle class society. As a result, they have more money than ever before, and they’re spending it on cell phones, more and better food, and, most pertinent for our purposes, their first cars. None of this is news to most people who follow energy and environmental issues, but there’s an economic subtlety that is almost never mentioned: Consumer surplus.

I’ll spare you the supply-and-demand graph, but basically consumer surplus says that if the overall market is willing to buy X units of some product at price Y, then a lot of people are getting bargains–they would be willing to buy as much (or very nearly so) as they do now at a price higher than Y, but they don’t have to because the market has settled on a price of only Y. These are the people who derive more utility/dollar from buying their share of those X units than other consumers do, so they’re willing to pay more. (Think about the classic “early adopters” who line up to buy the latest iPhone or PlayStation. They derive a lot of utility from not just using the item, but from being known as one of the first people to own it. Not only do they pay the day one price, before it has a chance to decline, but they also incur the cost of standing in line outside the Apple’s store all night.) These are the people buying their first cars in China and India. They will not be easily turned away from driving, and certainly not from car ownership, by a rise in gasoline prices.

Our brave new oil market

So, where does that leave us? The old paradigm would tell us that when the US goes into a recession, as it is in all but official pronouncement right now, and when gasoline prices contribute to a reduction in US driving, as it has already has, then world demand for oil declines, the price drops, and if the situation becomes extreme enough OPEC reduces output a bit.

This time we have an entirely different scenario unfolding. US demand drops, and those early adopters in China and India, plus the growing domestic consumption in some oil exporters and OPEC’s eagerness to keep the market tight as a drumhead, greatly reduce the odds of a major oil price correction in the short run. The slack created by reduced US demand will be taken up by other consumers around the world, to the extent that it survives changes in the supply of oil. In other words, the US is now at the economic mercy of other countries’ oil consumption, just as they have been influenced by ours, including the knock-on effects on our foreign policy, for decades.

How confident can we be that this new energy model accurately describes our world? Opinions are all over the map, no pun intended. You can find pundits and analysts claiming that the decline in US demand will have anywhere from a major to precisely no effect on oil prices, beyond localized blips like the drop yesterday and today. The rules of the game are changing before our eyes, and there’s more fundamental uncertainty in the world oil situation than at almost any time since World War II.

I’m sure of one thing, though: In the next year or so we’ll live through one hell of a market experiment and get a lot of answers, some of which might not be good news.

As I explained yesterday in The oil market falls into line, perfectly, the oil futures market is doing some decidedly weird things, at least measured by historical standards. Beyond the rapid run up in price–including a $4+ jump just yesterday–there’s this issue of the market being in a state of “continuous contango”, meaning that as you go further into the future the price of oil in various contracts rises.

The conventional wisdom is that contango can’t last with a non-perishable commodity like oil, since doing so would indicate that traders couldn’t simply delay selling it until the price rose, which would push up current prices (less is being consumed now) and bring them down in the future (when that supply becomes available). Checking the NYMEX oil prices just now, I see that while the market is generally still clearly in contango out to the furthest contract, dated December 2016, the pattern is no longer perfect, and a few very minor dips have shown up in the prices.

So, what’s going on here?

After having a little time to do some more reading and just sit and think about it, I’m convinced that we’re seeing a confluence of two factors, one “news” (at least to commodity traders who were behind the curve on peak oil), one not.

Factor 1: Surprise! Peak oil isn’t a myth!

The news is that peak oil is looking a lot more like a mainstream concept and an imminent phenomenon. No, the oil traders haven’t suddenly started flocking to this site or others talking about peak oil, but they very likely are aware of the stunning news that will be published by the IEA in November, according to The Wall Street Journal:

The world’s premier energy monitor is preparing a sharp downward revision of its oil-supply forecast, a shift that reflects deepening pessimism over whether oil companies can keep abreast of booming demand.

The Paris-based International Energy Agency is in the middle of its first attempt to comprehensively assess the condition of the world’s top 400 oil fields. Its findings won’t be released until November, but the bottom line is already clear: Future crude supplies could be far tighter than previously thought.

…

For several years, the IEA has predicted that supplies of crude and other liquid fuels will arc gently upward to keep pace with rising demand, topping 116 million barrels a day by 2030, up from around 87 million barrels a day currently. Now, the agency is worried that aging oil fields and diminished investment mean that companies could struggle to surpass 100 million barrels a day over the next two decades.

The decision to rigorously survey supply — instead of just demand, as in the past — reflects an increasing fear within the agency and elsewhere that oil-producing regions aren’t on track to meet future needs.

“The oil investments required may be much, much higher than what people assume,” said Fatih Birol, the IEA’s chief economist and the leader of the study, in an interview with The Wall Street Journal. “This is a dangerous situation.”

…

But the direction of the IEA’s work echoes the gathering supply-side gloom articulated by some Big Oil executives in recent months. A growing number of people in the industry are endorsing a version of the “peak-oil” theory: that oil production will plateau in coming years, as suppliers fail to replace depleted fields with enough fresh ones to boost overall output. All of that has prompted numerous upward revisions to long-term oil-price forecasts on Wall Street.

…

The IEA’s study marks a big change in the agency’s efforts to peer into the future. In the past, the IEA focused mainly on assessing future demand, and then looked at how much non-OPEC countries were likely to produce to meet that demand. Any gap, it was assumed, would then be met by big OPEC producers such as Saudi Arabia, Iran or Kuwait.

But the IEA’s pessimism over future supplies has been building for some time. Last summer, the agency warned that OPEC’s spare capacity could shrink “to minimal levels by 2012.” In November, it said its analysis of projects known to be in the works suggested that the world could face a shortfall by 2015 of as much as 12.5 million barrels a day, unless there was a sharp drop in expected demand. The current IEA work aims to tally the range of investments and projects under way to boost production from the fields in question to get a clearer sense of what to expect in production flows.

Think about this for a moment and you’ll probably agree that this is an enormous conceptual leap, the economic equivalent of Walter and Luis Alvarez figuring out that the dinosaurs were wiped out by a big rock falling out of the sky. It’s a true paradigm shift, and it raises some very uncomfortable questions.

Factor 2: No place for our stuff

As for the other factor, let me being with a snippet from one of Jeff Vail’s posts on The Oil Drum:

Contango could exist if a few circumstances were met: present rate of oil production would need to be effectively fixed, there would need to be a consensus that future rate of production will be lower and that demand will remain highly inelastic, and there must be some impediment to storing today’s oil to sell in the future. If all three of these came to pass, then the oil markets could be in significant contango and arbitrage would not be able to remedy the situation. Of course, it seems unlikely that these things (specifically the inability to store oil) will come to pass unless through some kind of political or regulatory move, but it is possible.

My contention is that there simply is no way to store enough oil to bring down future prices, if you assume that the IEA reassessment is accurate, which means that from the perspective of today’s traders, all of Jeff’s conditions are met. We’re on a production plateau; there is now a consensus that the future rate of production will be lower, at least relative to demand, which is what really matters; and we can’t store the oil.

Why can’t we store oil? We do it all the time, right? The problem is that we can’t store enough of it to make a difference over a period of years.

Assume, for example, that to loosen up the markets and drop the price substantially you have to come up with another 1 million barrels of oil per day. (We’re currently consuming about 85 million barrels/day, worldwide.) That means that over the 8.5-year period covered by the NYMEX contracts, you would need to store just over 3.1 billion barrels of oil, or all the world’s oil production for 36 consecutive days. That’s a lot of oil.

How much do we store now? The IEA’s figures for the OECD countries[1] show that in February 2008 their combined stockpiles of crude oil, NGL, and refinery feedstocks were 2.3 billion barrels. (See Table 9.2 of this spreadsheet (1MB XLS file).)

So, where would we put 1.35 times as much unrefined oil as the entire 30-nation OECD currently stores? We can’t put that 3.1 billion barrels on supertankers, as that would take a fleet of about 1,000 ships, assuming they’re all the largest ones currently in existence, with a capacity of 3.1 million barrels each, of which we currently have four.

The entire US SPR (strategic petroleum reserve), which is the largest such reserve in the world and stores oil in underground salt domes, is “only” 700 million barrels, just 23% of our target 3.1 billion barrels.

You can come up with your own scenarios about how long it would take to build up that large an oil stockpile, and how insane the market would go if we tried.

Conclusion

I’m convinced that we’re seeing an awakening of the broader market to the breadth and depth of our worldwide oil mess. A crucial segment of the economy, the money people, are finally figuring out that those of us who have been obsessed with this topic for years weren’t all crazy. My guess is that there was no single event that triggered their change of mind, but a rising tide of information and opinion gently lifting their conceptual boat: We’ve had numerous statements in recent months from oil companies about the difficulty of meeting future demand, plus a growing list of ever more dire predictions from the investment and securities firms. But the news that the IEA is doing their own megafields project, ala Chirs Skrebowski’s (which is the most reliable methodology, in my opinion, and concludes we’re headed for a 2011/2012 peak), and that it will show a dramatically lower peak probably contributed the last ripple needed. (And I have to wonder about the IEA leaking this news six months in advance of the report’s official release. That’s as transparent an attempt to soften the blow of bad news as one could imagine. Even with continual leaks, I expect to see a knee jerk reaction when the final report is released.)

The market likely will oscillate between contango and backwardation, with few eyebrow-raising events like the continuous contango we saw two days ago. But barring any unforeseen surprise, like a dramatic drop in worldwide oil demand or someone discovering how to turn sea water into regular unleaded at $1/gallon, we’ll see continued “high” and generally rising prices, even without any other factors, like a new war or terrorist attack, launching the market into low-Earth orbit.

In short, during the last 48 hours the energy world dramatically changed shape, with vast implications for almost everything we do in our daily lives.

[1] The OECD countries are: Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States