I just read an interview with an oil industry analyst named Steve Kopits. He’s the guy who pointed out that 4 of our last 5 recessions happened just after our national expenditures on oil reached 4% of GDP.
Kopits talks about a concept that is new to me – peak oil price.
When we think about supply and demand, we generally think in terms of a simple relationship with price. All other things being equal, if supply goes down, price goes up. When price goes up, demand goes down. Of course, there is such a thing as price elasticity. That is, if you are truly dependent upon something a 10% price rise won’t result in a 10% fall in consumption.
Oil has shown itself to have a very elastic price. Oil cost $25 a barrel back in 2000. Now it costs more than four times that much (Brent price $110), but you don’t see a drastic drop in consumption.
Enter the marginal consumer, the marginal barrel, and carrying capacity. The marginal barrel is that highest priced barrel of oil that blends in with the rest of the world supply and holds up the world average price. The marginal consumer is the world’s poorest consumer, or the consumer for whom there is a less appealing but plausible alternative to oil waiting for use. Carrying capacity, in Steve Kopys’ thinking, is the maximum price that a particular country will tolerate before cutting back on consumption.
According to Kopits, the U.S., Europe, and other western industrialized nations hit carrying capacity at around $110 a barrel. China has another $10 or so to go before it starts losing its taste for the stuff. Some poorer countries have hit their limits already.
The upshot is that although supply is constrained, the price has hit a wall. Enough people, countries, and industries will grudgingly conserve or switch to prevent oil prices from rising drastically. Here in the U.S. gasoline consumption is down 3% from last year. This could be partly due to the recession, but partly because we have hit our carrying capacity.
By Kopitz’s estimation, just as world oil production has hit a bumpy plateau, so too has the price of oil. It will come to rest north of $110, but this will make more consumers retreat from the market.
Nota Bene: Increasing wealth, increasing efficiency, and inflation will all tend to raise the nominal carrying price of oil. The price will creep up along with our efforts to be more efficient, simply because a mile of driving or a day of 68F in a house will cost the same.
This is when, paradoxically, the most energy efficient economies become the greatest users of oil. (The formal term is Jevon’s Paradox) It is a huge advantage. Oil is an unparalleled commodity, as both energy and chemical feedstock. The city, state, or nation with the highest efficiency, and therefore cost tolerance for oil, will be able to take advantage of its conveniences after other entities have been forced to use lower quality compromises. The same holds true for any other energy source.
I’d like to see my home state of Vermont put more emphasis on energy efficiency. Right now we are the fifth most energy efficient state in the U.S. I’d like to see us beat out Massachusetts for the top spot. Then I’d like to see us pour it on and open up an unbeatable lead. It would put us in an enviable economic position as all energy sources approach their limits.
(Just in case you are interested, I now have a Twitter account, @MinorHeretic. Nothing serious, just photos of the natural world and minor absurdities. A break from all the grim stuff.)