lewisabroad

Peak Oil's Bell Is Ringing

The author first describes a need for demand reduction and switching to localized production as a solution, and then describes a free market solution. Does he propose a free market solution as a way to implement the switch?S
Switching to localized production requires that once-outsourced manufacturing now needs to be done locally and manufacturing that was once done for a global market is now done for a local one. Businesses that were once profitable because of economies of scale and scope are no longer so, resulting in overall global economic loss. Producers for a local market are rarely able to achieve the efficiencies of a global producer, the result will be an overall increase in the cost of goods or decrease in quality, or both.

We experienced "peak oil" over the summer: a period when demand for a product with a highly inelastic price nearly exceeded supply. It's a good starting point to see if free markets will provide the necessary structure to prevent peak oil from affecting quality of life.

Over the summer price was also affected by hedge funds and other financial players speculating on the market. Prices plateued a bit when China and India decreased subsidies and then collapsed when speculators had to cover losses on unwinding positions when the commercial paper market collapsed. The speculative positions taken by non-market players may have caused prices to fluctuate more than they might have in a pure supply-demand market. My feeling is that the speculator's role may be overplayed however, as we saw a similar price spike in the 1970's when there were few players outside the market.

The idea that the market will solve this problem is a good one. As the margin between supply and demand grows thin prices rise. People then switch to other modes of transport or use other fuels, the price declines, and then people (perhaps) switch back, until a kind of equilibrium is reached.

There are a couple of problems with the free market model, however, that argue against a pure market solution. First, switching costs can be high, incur an initial investment cost, and take time. For example, switching to public transport from a car incurs a time cost of the customer and long-term will overload the public transit system resulting in a need for infrastructure investment. Switching to PHEVs requires a huge retooling investment from auto manufacturers and also requires time.

Second, because fuel prices are reflected in almost every product and service, fluctuation in fuel prices does not just affect the amount of driving we do but also the quantity and types of products we buy, resulting in a ripple effect across the entire economy. Price spikes in oil accompany periods of global economic growth, price collapses accompany periods of global recession.

Third, market policies are not determined globally; some countries implement subsidies while others allow market forces to rule. Subsidies distort the ability of supply signals to be sent to customers and modulate demand.

Lastly, since the price of oil is inelastic, prices fluctuate far out of proportion to the number fo marginal barrels of production out there. This results in dramatic price swings (both up and down) depending on the availability of oil. A drop in demand of less than 2% has led to oil prices dropping by roughly 50%.

We need policies that not only help us reduce demand, but also help dampen price spikes and troughs. It is nearly impossible to expect the market to be able to create technological solutions to high oil prices over the course of eight months. What happens instead is that demand for other goods and services is curtailed to free up consumers cash to fill up a tank, until consumer demand drops cause a recession.

In the case of petroleum, the answer is not "prices allocate their best use". the answer is "prices cause global economic instability and prevent long-term investment and decision-making" - at least on the part of consumers and producers.

My argument is that the only solution is to move away from oil to a diversified energy portfolio. Policies should be geared towards promoting electricity for transportation, whether through EVs or public transit, since electricity represents a diversified energy source. Let the utilities then decide which source is most efficient for them. If climate change is a concern, a general carbon tax would tilt economics in the favor of renewables and biofuels.