"Crude Awakening: Behind the Surge in Oil Prices"

Stephen P. A. Brown, Raghav Virmani, and Richard Alm of the Dallas Fed look at why oil prices are so high, and whether the high prices are likely to continue. It's a more optimistic view than many. Their bottom line is "Absent supply disruptions, it will be difficult to sustain oil prices above $100 (in 2008 dollars) over the next 10 years" (comments at Real Time Economics and The Big Picture):

Crude Awakening: Behind the Surge in Oil Prices, by Stephen P. A. Brown, Raghav Virmani and Richard Alm, Economic Letter, Vol. 3, No. 5, May 2008, Federal Reserve Bank of Dallas: The first few months of 2008 saw crude oil prices breach one barrier after another. They topped $100 a barrel for the first time on Feb. 19, then rose past $103.76 about two weeks later, surpassing the previous inflation-adjusted peak, established in 1980. In April and early May, oil prices pushed past $110 and then $120 a barrel and beyond.[1]

These milestones reflect a new era in oil markets. After the tumult of the early 1980s, prices remained relatively tame for two decades—in both real and nominal terms (Chart 1). This long stretch of stability ended in 2004, when oil topped $40 a barrel for the first time, then embarked on a steep climb that continued into this year.

Modern economies run on oil, so it’s important to understand how recent years—with their surging prices—differ from the preceding two decades. A good starting point is strong demand, which has pushed world oil markets close to capacity. New supplies haven’t kept up with this demand, fueling expectations that oil markets will remain tight for the foreseeable future. A weakening dollar has put upward pressure on the price of a commodity that trades in the U.S. currency. And because a large share of oil production takes place in politically unstable regions, fears of supply disruptions loom over markets.

These factors have fed the steady, sometimes swift rise of oil prices in recent years. Their persistence suggests the days of relatively cheap oil are over and the global economy faces a future of high energy prices. How they play out will shape oil markets—and determine prices—for years to come.

Supply and Demand
As incomes rise, economies use more energy for transport, heating and cooling and producing goods and services. A broad cross section of nearly 180 countries shows that doubling per capita income more than doubles per capita oil consumption (Chart 2). How much each country contributes to increases in global energy demand depends on its population and rate of income growth. Big nations moving quickly up the income ladder have huge implications for oil markets.

China and India, two giants with a combined population of nearly 2.4 billion, shook themselves out of a long economic slumber and began growing rapidly in the 1990s. Adjusted for inflation and purchasing power parity, China’s per capita GDP rose from $1,103 in 1990 to $4,088 in 2005; India’s went from $1,202 to $2,222. In this decade, new energy demand from China, India and other emerging countries has added to continued growth from the U.S., Europe and other parts of the world.

As economic activity in the U.S., the world’s largest oil consumer, began accelerating in 2003, markets began feeling the full force of the world’s increased appetite for oil. Global consumption rose from 82.6 million barrels a day in 2004 to 85.6 million in 2007. Since the beginning of the oil era, prices had ebbed and flowed around the U.S. economy’s ups and downs. Now, markets view demand increases as a fact of life that won’t be blunted much by a slowing U.S. economy.

With consumption on the rise, oil markets grew tighter as suppliers neared productive capacity. The Organization of Petroleum Exporting Countries (OPEC), a 13-member group that produces more than a third of the world’s oil, has maintained excess capacity of only 1 million to 2 million barrels a day since 2004, down from 4 million in 2001 and 5.6 million in 2002 (Chart 3).

Although OPEC’s excess capacity has rebounded from its 2005 low, the gains are largely in heavy crude oils that can only be processed in specialized refineries. Those facilities are running full bore, so the added supplies aren’t relieving a tight market. The latest evidence also suggests OPEC is now restraining its output.

While some warn that oil production has peaked—or will soon—most industry experts contend that oil resources are plentiful; it just takes time and money to get them out of the ground and into the market.

Higher prices have done what economics would predict—stimulated efforts to increase supply. Companies have expanded their exploration budgets. Oil-producing nations have announced new projects. Drilling activity is at a high level, both offshore and on land. Wages and oilfield services costs are being bid up, while shortages persist for some key skills and equipment.

So far, new supplies haven’t materialized quickly enough to keep up with growth in world demand, largely because various hurdles have slowed their development. Oil resources, for example, are concentrated in countries with state-run oil companies or little economic freedom. Where market signals aren’t allowed to work, incentives to boost production may be muted.[2]

Oil demand is inelastic in the short run—that is, it doesn’t react quickly to changing prices. Consumers adjust their spending to maintain consumption as prices rise, even if they have to pay more for it.[3] Most likely, this reflects businesses’ commitment to keep up production and individuals’ need to drive to work, run errands and heat homes.

When demand is inelastic, even modest tightening in markets translates into strong price movements. In recent years, this inelasticity has magnified tight markets’ impact on prices.

The Role of Expectations
The fundamentals of supply and demand not only led to higher crude oil prices but also fed expectations that world demand will continue to grow faster than supply. The result is escalated price expectations, which show up in futures markets. The anticipated price for 2011 crude oil has moved steadily upward—from around $60 in January 2007 to more than $120 in the first week of May 2008 (Chart 4).

Futures prices reveal oil traders’ expectations, but they also feed back into current prices. As a market efficiency condition, spot prices have to increase with futures prices to keep investors equally willing to hold or sell the marginal barrel of oil. If current and futures prices get out of sync, traders taking advantage of arbitrage opportunities bring prices back in line.

Forecasters offer another window on expectations. Their outlooks can provide additional information about possible price scenarios because they incorporate data beyond traders’ sentiments. Each year, the Energy Information Administration (EIA) presents a mainstream forecast, which incorporates projections on the supply and demand forces expected to shape the marketplace.

As the realities of higher oil prices have sunk in, EIA forecasts have marched steadily upward (Chart 5). The 2004 projection, for example, saw prices relatively flat in the $30 range through 2025. The latest forecast, issued in 2007, anticipates a price decline in upcoming years, with oil settling above $60 for the long haul out to 2030.

While $60 oil looks good in today’s markets, it’s worth noting that the EIA’s best guess for long-term prices doubled in just four years. It did so because the EIA decided its earlier demand projections were too low and supply projections were too high.

Consider the projected market for 2025 (Chart 6). It can be inferred that the EIA’s projected demand curve moved significantly to the right between 2003 and 2007, signaling the expectation that consumers will want more oil at all prices. It can also be inferred that the projected supply curve moved significantly to the left, reflecting a more pessimistic view about future production. The market-clearing price ends up considerably higher.

Dollar’s Weakening
Oil has long traded in U.S. dollars. Having a single-currency system lowers transaction costs for a commodity that trades globally. In recent years—while oil prices were rising on supply and demand fundamentals—the dollar has weakened against the currencies of the nation’s trading partners, particularly the European Union’s. The dollar has fallen 46 percent from its mid-2001 peak against the euro and 21 percent since 2004.

A declining dollar makes oil cheaper for Europeans and other foreign consumers, propping up their demand. A weakening U.S. currency also reduces the dollar-denominated supply from foreign producers. Together, these two factors exert additional upward pressure on prices. Daniel Yergin, chairman of Cambridge Energy Research Associates, adds a third element in arguing that some investors have used oil as a hedge against the dollar’s decline.

How much has the weakening dollar added to oil prices? If the U.S. currency had held its 2001 value against the euro, oil would have traded at about $80 a barrel in early 2008, about $21 below its actual price (Chart 7). Put another way, exchange rate movements accounted for roughly a third of the $60 increase in oil prices from 2003 to 2007.

Most of the dollar’s price impact occurred toward the end of the period. When it comes to adjustments in oil consumption and production, a declining dollar takes time to reshape crude oil prices because expectations don’t shift quickly. Factors that push up expectations of future prices, however, also put upward pressure on spot prices because markets will adjust until investors are indifferent between holding and selling the marginal barrel of crude oil on the spot market.

Would it matter if oil were priced in euros or a basket of consuming countries’ currencies? The headlines might be somewhat less alarming, but little would change in real terms. As the dollar’s value declined, U.S. consumers would still be paying more for oil. It would take more dollars to acquire the euros needed to buy oil. In a world where the dollar is weakening, the burden of higher oil prices would still fall more heavily on the U.S. than Europe.

Geopolitical Risks
The geopolitics of oil is a brew for sleepless nights. The Middle East sits atop two-thirds of the world’s reserves. The region pumps oil amid a war in Iraq, potential conflicts elsewhere and terrorists prowling for targets. Russia, a major non-OPEC producer, has expanded state control over the oil sector, pulling more of it into the realm of dicey internal politics tinged with nationalism. In recent years, violence has cut production by a quarter in Nigeria, Africa’s top oil producer. Venezuela, South America’s largest producer, is under the sway of the quixotic Hugo Chavez, who has threatened to cut off sales to the U.S.

Tight oil markets don’t have the luxury of spare capacity to offset supply interruptions resulting from trouble in important oil-producing countries or regions. Because oil demand is inelastic, even the temporary or partial loss of significant production capacity can strongly impact prices. Wars, political intervention or unexpected breakdowns send shock waves through oil markets. Just the fear of a supply disruption is itself enough to prompt price spikes.

Fears of disruptions are reflected more in short-term price movements than in longer-term ones. The increases can prove temporary, particularly when rumored troubles fail to materialize. However, the persistent threat from some disputes—for example, Iran’s long-simmering conflict with the U.S.—are likely to keep upward pressure on oil prices for longer periods.

Fear is hard to measure, but the futures market offers some help. We usually expect futures prices to slope upward from the spot price, a pattern the financial markets call “contango.” However, prices for future delivery sometimes dip below the spot prices, creating a phenomenon called “backwardation.” This can occur because of sudden shortages or a jolt of uncertainty.

It’s in this phenomenon that we find indirect evidence of fears of oil supply disruptions. When fear spreads, refiners bid aggressively for short-term oil supplies because they face extremely high costs for shutting down operations. Not enough oil can be brought to market quickly, and spot prices rise above futures prices, putting the market into backwardation.

Oil markets have been in the grip of backwardation lately, with futures prices declining. As spot prices climbed toward $120 a barrel in early 2008, for example, futures prices stood at $102 a year out and $100 two years out—a clear backwardation (Chart 8).

Oil Price Prospects
What happens with oil prices will be determined by the same four factors that have shaped the market in recent years—global demand, expectations about future market tightness, the value of the dollar and fear of supply interruptions. If these factors stay on their present course, prices are likely to be pushed higher. If one or more factors change, markets could see some easing of price pressures.

At first blush, crude oil demand doesn’t offer much hope for lower prices. It is likely to grow with an expanding world economy. Higher oil prices will prompt some conservation and take some of the edge off prices—but not much.

The past response of U.S. oil consumption to rising prices suggests the quadrupling of oil prices since 2003 might reduce U.S. consumption by 10 to 20 percent over the next decade. Europe might see similar declines. However, these reductions won’t be sufficient to relieve pressures on prices, given the projected demand growth from China, the Middle East, India and other rapidly expanding economies. Only a dramatic, worldwide move toward energy conservation or a much stronger U.S. and European response to higher oil prices could substantially alter the outlook.

Geopolitical factors affecting supply disruptions aren’t likely to change much, either. The Middle East’s heavy concentration of conventional oil resources suggests the region will become an even more important source of world oil production. Given the region’s historical instability, episodic fears of supply disruptions could remain part of oil pricing well into the future.

The dollar might offer some relief. Forecasting exchange rate movements is fraught with difficulty, but the currency is likely to strengthen with the U.S. economy. An appreciating dollar would lower oil prices for U.S. consumers. Further dollar weakening, however, would lead to higher prices.

Geopolitics and exchange rates aside, long-term oil prices will largely be set by supply and demand, which will affect prices directly and influence the expectations that shape futures markets. The key lies in how much new oil reaches markets. Four scenarios for conventional oil resources show a range of outcomes and impacts for the trajectory of prices:

• Oil production reaches a plateau or peak—prices likely to rise further.
• Oil nationalism continues to slow the development of new resources—prices likely to remain relatively high.
• In a shift of strategy, OPEC increases its output sharply—prices likely to fall.
• Aggressive exploration activities pay off with the quick development of significant new resources—prices likely to fall.

Both the futures markets and EIA forecasts currently anticipate some softening of oil prices over the next few years, suggesting markets expect supplies to gain ground on demand. International Strategy and Investment, an energy consulting business, has documented a substantial number of projects under way that would boost world oil supplies. The development of these resources could undermine the expectations underlying the higher oil price scenarios—even those of oil nationalism.

Supplies could be bolstered by nonconventional oil sources—tar sands, oil shale, coal-to-liquids. Industry experts regard these resources as plentiful, with development and production costs well below current oil prices. Tar sands and oil shale are already in production. Biofuels are too limited in scale and currently too costly to make much difference to crude oil pricing.

The substantial development of these nonconventional oil resources could mean downward pressure on crude oil prices in future years. Actual and expected costs of nonconventional resources suggest it might be difficult to sustain oil prices above $70 a barrel. However, the relatively high costs of these nonconventional oil sources could inhibit development because producers fear losses during a price collapse. The production and use of nonconventional resources would also generate more pollution, which could mean conventional oil could command a premium.

What’s the bottom line? Absent supply disruptions, it will be difficult to sustain oil prices above $100 (in 2008 dollars) over the next 10 years.

How High Are Oil Prices, Really? As oil prices rose to $50, $70 and $90 a barrel, analysts often pointed out that these prices hadn't yet breached the all-time high in real, or inflation-adjusted, terms. That barrier finally fell in early March, when prices topped the real 1980 peak. Looking beyond post–World War II or even 20th century oil prices presents a somewhat different picture. Real oil prices were nearly as high as they are today when North American oil production began before the Civil War in 1860. Oil prices can also be measured relative to changes in productivity and the level of technology, factors captured by manufacturing wages.[1] In the first quarter of this year, a typical factory worker needed slightly less than four hours to “earn” one barrel of oil. In 1980, it was just above five hours. Going further back in time, the number rises—to 6.4 hours in 1920, 7.9 in 1910 and an average of 15.4 in the 1870s. Technological advances have bolstered productivity, raised wages and made the work-time price of oil lower today than it was in the late 19th and early 20th centuries. Finally, it is important to note that—despite rising real prices and imports—oil siphons relatively less money out of the American economy than it did in the past. Expenditures on petroleum products today account for about 5 percent of all after-tax income earned in the United States, less than half of the 11.6 percent spent in 1980.[2] Notes “Natural Resource Scarcity and Technological Change,” by Stephen P. A. Brown and Daniel Wolk, Federal Reserve Bank of Dallas Economic and Financial Review, First Quarter 2000. Also see “What's Driving Gasoline Prices?” by Stephen P. A. Brown and Raghav Virmani, Federal Reserve Bank of Dallas Economic Letter, October 2007.

Notes

1. This article looks at oil prices through the first week of May and uses West Texas Intermediate as the reference price. Throughout the article, we've used a combination of daily, weekly, monthly, quarterly and annual data, which may alter the apparent timing of peaks and troughs in prices.
2. “Running on Empty? How Economic Freedom Affects Oil Supplies,” by Stephen P. A. Brown and Richard Alm, Federal Reserve Bank of Dallas Economic Letter, April 2006.
3. In some countries, government policies that maintain low prices interfere with the link between world oil prices and energy consumption. China, for example, hasn't fully passed price increases on to its consumers.

Comments

[James Killus]

"Absent supply disruptions...?"

This just in: sun rises in east.

[OhNoNotAgain]

"Absent supply disruptions...?"

No kidding, that's one hell of a big caveat.

[Bruce Wilder]

I thought the persistent use of the consumer frame was odd, as in this sentence: "As incomes rise, economies use more energy for transport, heating and cooling and producing goods and services." Or, "a typical factory worker needed slightly less than four hours to earn one barrel of oil."

I would think it more reasonable to think of petroleum as a key input to production and transportation. If the peak oil hypothesis is correct, and world (net useful) output is near its all-time peak, then future economic growth in income will have to be accomplished with no increase in oil consumption.

How long it takes a worker to "earn" a barrel of oil would seem less immediately relevant than how many barrels a worker consumes to produce or distribute X quantity of goods and services.

The implication of a hard ceiling on world oil output is a significant constraint on world economic growth, and, I would guess, on the shape of world "investment supply" (opportunities for productive investment).

In the late 19th century, the paramount fact of the developed world economy was that the leading countries were committed to the gold standard, and there was not enough gold to expand the money supply enough to accomodate potential economic growth. Every time the U.S. economy expanded, deflation soon enough set off financial panics or depression.

Now, we apparently face the prospect that oil will be a similar sort of hard constraint on world economic growth, only instead of monetary deflation, we have, instead, to fear periodic bouts of real (commodity) inflation.

[James Killus]

Just to emphasize the point, there has not been a ten year period without "supply disruptions" in the petroleum industry since whale oil went out of fashion.

[Winslow R.]

BW wrote: "Now, we apparently face the prospect that oil will be a similar sort of hard constraint on world economic growth, only instead of monetary deflation, we have, instead, to fear periodic bouts of real (commodity) inflation."

Interesting analogy I've not seen before. A few thoughts, gold was not even 'consumed' and still could not be supplied quickly enough to keep demand at a constant price. Hopefully there are readily available substitutes for oil just as there was paper money for gold.

The deflation equivalent with insufficient gold seems to be the search for increases in efficiency to relieve insufficient oil. Both are slow painful processes. Substitutes seem to be the better course of action.

[reason]

I like this:
The dollar might offer some relief. Forecasting exchange rate movements is fraught with difficulty, but the currency is likely to strengthen with the U.S. economy.
Well I beg to disagree. The rest of the world has started to notice that the US is bankrupt. The dollar will start to strengthen when the massive trade deficit disappears. And high oil prices make that very difficult. Catch-22.

[reason]

If I read the paper correctly, the sting is in the tail - it relies on NON-CONVENTIONAL Oil resources. It seems to me that the authors should be educated about EROEI (not to mention global warming).

[paine]

u folks caw like the ravens of doom

hard constraints .....

energy source innovation
was seriously retarded for 20 years
by cheap oil
key notions in piece

there's as much to fear from low oil prices ...

"the relatively high costs
of these nonconventional oil sources
could inhibit development
because producers fear losses
during a ...( crude oil ) ... price collapse"

---setting aside the cross current like chaos
of moment to moment flutters and spikes
in the towards backwardation or towards contango gig ---

since the producers/owners of oil are also
the speculators

they can boot strap prices
in a alibi filling
policy/event environment :

" Factors that push up expectations of future prices, however, also put upward pressure on spot prices because markets will adjust until investors are indifferent between holding and selling the marginal barrel of crude oil on the spot market"

[paine]

to me
the question that remains poorly answered

if the means to all these rents are structural
and availible to the oil boys
why not always go for rent max
why the long periods of deeply sub max pricing ???

and in that light
why are these BU/CH years
such lovely go for the max years

[paine]

"The rest of the world has started to notice that the US is bankrupt."

this metaphor posing as fact gets tedious

our debt to the world is in dollars
solvency remains so long as uncle produces the dollars

now the issuing of further credit might either require much higher rates of interest or non dollar borrowing
but the real problem if there is one

the trade gap

close it
we must
at some point

[reason]

Aha...
Paine notices the difference between nominal and real bankrupcy. The US can never pay back its real debt, but it doesn't have to. It borrowed oil and pays back paper. But in those circumstances, why should the world continue to lend to it?

[reason]

Paine...
as regards the rent maximisation - I'm 100% with you. That is the best evidence of real supply problems. But it could also be, that the club of exporters is getting smaller and so easier to predict.

[paine]

btw

the non commodity trade gap
is the key gap
combo of "real" services and products

roughly assume
our robustly productive ag sector
--- over the long haul----
can pay for our other commodity imports

as to current account bop

royalty and dividend payments etc

to me its only indirectly a misery
on its own
the class of pure exploiters
might as well be
more chinese and brazilian
less new york and californian

[reason]

Paine...
Re agriculture - the US will have to improve its water management massively though.

[paine]

reason
i always get good stuff from your comments
but not always stuff i agree with

here for example
i'm trying to suggest real supply limits are not the source of the price soar

no its not a tulip bubble
its a don't produce more
induced
profit gouge
the price is over high
because it can be
not because of a bubble created
by
the expected future market value
of the unpumped crude
has appreciating
in the minds of the specs
more then
events will prove true
ie
no ones in this game
playing the bigger fool
they all know
the real market play out
over time will not validate "spec-pec-tations"

in this case unlike gold bought at a thousand dopllars
there will be no old maid cards
that will be left in some one's hands

only oil left unpumped

in fact
today's oil consumers are the big losers
they got gouged

the answer is to set up a price system for domestic crude
that allows responsive pricing
but escrows the wind falls and wind loses
for later determination
as to the source of the oil price's
wind change effect
and the entailed (or entangled)
real future supply increasing/decreasing
" incentive " effect

[paine]

water subsidy for ag sec
may on the whole make sense
at sdome level or other

but first we need to price it properly
and end the crude jaw boning
"moral rationing" bull shit

the complex nexus of relevent
cross elasticties here is
to say the least ....daunting

my instinct is to let mexico grow
the labor intensive common garden crops

but growing nice green thick lawns
oughta be made far more expensive first

[hari]

I am still not sure if SWF are not (also) seriously speculating in the global commodity bubble, for example, Saudi Princes and Gulf Scheiks - who know not where to invest their mounting oil revenue.

[reason]

The US is mining its ground water resources and is in danger of salinating its deserts. These are serious problems. In speculating that the US can reverse its trade deficit via ag produce you are assuming that either the real price of ag produce will sore or there will be massive import substitution. All this against the trade winds of increasing payments for oil and the world getting sick of the US's intellectual property games.

[paine]

"the world getting sick of the US's intellectual property games"
count me in on that hoot

water management sounds like fun to me
better then say
a massive investment
in coal liquifaction

[paine]

hari
the producers are the specs
so yes the sovereign "funds" are
indirectly
bolstering
spot prices thru futures markets
its a case of
if they can
they will

worth a review

"the deal" made with the arab oilers
to sink crude prices in the mid 80's

[Alex Tolley]

Both OPEC and non-OPEC production has been falling. Whether this is because of peak oil or some game playing by the producers, it seems unlikely that oil production can grow that much further. This means that the sources of energy will have to change. Heating oil can be readily replaced by switching to electric heating off the grid. Oil consumption in US automobiles can be halved by significantly reducing the size of vehicles and improving efficiency. I fully expect high oil and gas prices to drive development of electric and hybrid vehicles. In the US, in the short term we can produce more electrical energy with coal fired plants at the cost of increased CO2 emissions. Hovever, we can also reduce demand by retrofitting houses to be more air-tight as we did in the 1970s and to shift energy production over to renewable sources such as solar and wind.

Personally I see high oil and gas prices as a much needed wake up call that will spur development of energy production that will mitigate global warming. If gas prices remain at $4+ /gal I would use that as the anchor for gas taxes should teh price decline again.

[hari]

Alex - you've a good point. There is no issue on that equation.

However what's troubling is how/who is manipulating not only the standard crude spot price but almost all other basic commodities including gold. It cannot be a simple market trend we're witnessing right now....

That's why when I saw Reuters headline investigation of storage facilities in south, it's manifestly speculative bubble which is taking place and it has to be exposed and punished by the Chicago Board dealing with Commodities or Mercantile Exchange.

[Alex Tolley]

hari: "That's why when I saw Reuters headline investigation of storage facilities in south, it's manifestly speculative bubble which is taking place and it has to be exposed and punished by the Chicago Board dealing with Commodities or Mercantile Exchange".

The WSJ has an article on the CFTC investigation:

here

However I doubt it means much except at the margin. We know total oil production has declined in the last few years and that supplies are tight. Whether it is deliberate in some cases (e.g. the Saudis maybe stalling new production) or incompetence (e.g. Mexico's oil industry) the real manipulators are the producers, especially OPEC.

The Saudis are not stupid, they know that if oil prices get too high that it encourages a shift away from oil. But they may no longer be the dominant swing producer able to control prices.

[Unconventional]

If unconventional supplies do indeed come on-line in a reasonably timely fashion, oil prices will moderate. Traditional wells are not likely to expand production significantly, while demand is likely to increase over time due to developing nation demand.

The key is the pace of development of unconventional sources of oil.

[Alex Tolley]

Unconventional : What are you referring to regarding unconventional sources of oil

Oil shale is does not look like it will be a very efficient source of oil - much like biofuels from corn.

Tar sands: "The oil sand industry is one of the major GHG emitters in Canada and the entire process approximately doubles to triples the amount of CO2 released per barrel of petroleum used compared to conventional extraction.

source

Thus while tar sands in particular might be a viable substitute for oil, we will be facing increased CO2 emissions for its use, the extra emissions due to burning some part of the oil to create the heat to extract the oil from the sand.
After that, it will be, as you say, dependent on how fast the production of oil from these sources can be ramped up.

IMO, there is a shortsightedness in this approach. We are taking our eye off the longer term consequences of fossil fuels as energy sources to focus on how we might find and extract oil to reduce the current price caused by the putative supply shortfall. Yet we could reduce demand using technologies we already have, simply by providing the right incentives. In California, when water is short (the only potential option is to desalinate sea water, a costly approach), we quickly offer incentives to economize on water use, from rebating low flow toilets to recommending re-landscaping with xerophytes to replace water hogging lawns. In extremis water rates are raised significantly and bans are put in place for some uses of water. This seems to be the better solution even when applied to oil, and here we can substitute the commodity using non carbon based energy sources.

I concede, as a long term Prius owner, that my smug emissions may be high, but I would really be interested to see how the US responds to $10/gal gasoline.

[Lafayette]

AT: but I would really be interested to see how the US responds to $10/gal gasoline.

Do you really mean that? It's an ugly sight.

Especially in a nation with so many guns at large.

[Lafayette]

Political motivations?

Inelastic petroleum pricing generally has two effects.

The first is on driver comportment, meaning more forethought in terms of usage and, in the US, downsizing cylindric capacity. The second is to displace discretionary income in the hierarchy of needs. Some items that were perceived needs no longer become all that necessary.

If responding to perceived needs determines "well-being" in a society, then the latter is considerably altered. For instance, those wishing for an urban or rural lifestyle, forgo it to remain close to their jobs. Or, the long vacations taken in cars is reduced or eliminated entirely. Or air travel successively surrenders market share to rail, which is more efficient.

In a country as mobile as the US, where the dependency on motor transport, is both real and pronounced, the change of lifestyle can be dramatic if ...

If prices maintain or they even rise. The above article notes all the permutations in factors, but settles on no one set specifically. Anything can and will happen.

I suspect that OPEC's reluctance to expand supply has political motivations directed specifically at the US. And, I'll bet adolescent Georgy Porgey was told as much by the Saudis during his recent visit there.

Georgy was playing with fire.

[radix]

I'm very concerned that the US will not start to pursue a rational energy policy quick enough and the energy scarcity and high price will join with the entitlement mess as the baby boomers retire. That scenario says simply a very long time of strapped govt, high taxes and a declining standard of living. The development in the economies of India, China and Russia means that the US is simply not as essential to the global economy. Once central banks switch their reserve currecy to the Euro (not a definite outcome but one that becomes more likely the longer the Fed goes without raising rates to stop inflation (Paul Volker!!! Your nation needs you! (clone? :) ))) the party will truly be over. Government debt will have to pay a crushing rate to be bought.

[Real Person from the Real World]

oil from plentiful non-conventional sources (tar sands, oil shale) - how viable are these really? While they may start to be economically attractive if regular crude oil hits some high, my understanding is that since it ain't that easy to get the oil out of the stuff, that is why we don't extract. If you have $10/gal gasoline from crude (based on speculation, "fear", et al), and $9.99 gas from "non-conventional" sources (based on production costs), what difference does it make?

Meanwhile, I am totally fed up with all the comments about how the US is pushing various wars to get oil, and how lily pure all these oil kingdom crooks and wheeler dealers are. They import what is essentially slave labor to do the actual work, while they build palaces, and indoor "ski slopes" out in the desert, and their elite export hate in the form of religious propaganda. Bottom line, oil has it's uses, and you have to sell it to someone who needs it to make money. The oil sheiks did not invent cars, and if there were no cars or planes and people rode in dirigibles and steam driven vehicles, the sheiks could not eat, wear, or build with it.

[Alex Tolley]

lafayette: Do you really mean that? It's an ugly sight.
Especially in a nation with so many guns at large.

I do. If the price of gasoline rises at say ~ $1/yr over the next 5 years or so, that it plenty of time for vehicle fleets to be replaced with more fuel efficient vehicles, for houses to be better insulated and commercial buildings to be refitted with more efficient heating and lighting (assumes heating oil and electricity will rise alongside increased oil and gasoline prices). It is not ideal, but it might put a serious fire under the complacency that currently is the US in this regard.

[Lafayette]

AT: It is not ideal, but it might put a serious fire under the complacency that currently is the US in this regard.

Perhaps not, but it will require not the "market solution" but federal incentives to do so.

Insulating homes will certainly save some heating costs, but tightening construction standards will save even more.

Then, there is the fundamental change that must be made from individual home heating, from fuel to either geothermal heating or solar. That can happen much quicker if tax reduction incentives are applied.

I built a house recently with geothermal floor heating because the French state gives a 50% tax rebate on the price. I'll never go back to oil or gas or electricity. The heat-pump does the job marvelously well.

That tendency has taken hold in European construction. Do you hear about it stateside. I doubt it. The US is still anchored in a 20th century mentality of energy usage. One that must change fundamentally.

And, for all that Al Gore has done to change mentalities, where's the beef? It took a European Nobel Prize to have recognized the importance of his effort. Wall Street didn't even blink an eye.

Because there was no eye to blink. (Bush will do nothing to affront the people who helped him get elected, BigOil. Back in Crawford, he's gonna have to live with them for the rest of his life.)

Business interests, and the Almighty Market Solution, are ruining America. Wake up. There are times when Public Interests prevail over Business Interests. Energy is (yet another) one of them.

[Real Person from the Real World]

Lafayette says:
"Business interests, and the Almighty Market Solution, are ruining America. Wake up. There are times when Public Interests prevail over Business Interests. Energy is (yet another) one of them."

AMEN!

[Alex Tolley]

lafayette: I built a house recently with geothermal floor heating because the French state gives a 50% tax rebate on the price. I'll never go back to oil or gas or electricity. The heat-pump does the job marvelously well.

1. Do you really mean geothermal energy or are you talking about a simple heat pump that extracts heat from the ground just below the surface? Geothermal energy in non-volcanic/hot spring regions means drilling a pipe down ~ 5km and injecting water to get steam for conventional turbines. Heat pumps are used in the US in some locations, but there is not tax subsidy for their use.

2. The US does provide tax incentives for solar PV - California is particularly strong in this regard.

No argument of the need for tax incentives when prices are not competitive or the upfront capital cost is high. OTOH, tax incentives are not needed for inexpensive equipment. A good example is solar thermal panels for pool heating. These cost around $3-7k to install, but they pay back within 12 months - with a lifetime of better than 10 years.