Sunday, September 11, 2005

Peak Oil, Freakonomics & Post-Katrina Oil Demand

Kunstler's recent guest-blogger Dmitry Podborits has an excellent critique of the "Freakonomis" critique of Peak Oil. Podborits points out that the traditional economics mantra of "the market will resolve supply and demand issues" works great. The market WILL resolve the Peak Oil problem...just maybe not in the "onward to Star Trek utopia" manner that we might like. Rising prices, even when confronted with inelastic demand, will eventually reduce that demand. But in light of the geological, chemical and physcial realities of energy, that reduction in demand may come in the form of war, die-off, fundamental restructuring of society, collapse of the global economy (a la Tainter), etc. After all, the market will find a way...

On another note, what will the long-term impact of Hurricane Katrina be on oil demand? Traditional "wisdom" tells us that it will cause a decrease in GDP growth--perhaps even a full-blown global recession--and therefore a decrease in global oil demand. Let's look at this another way: IF you accept the government provided inflation numbers, we produce about twice as much GDP per barrel of oil consumed today than we did in the '70s. That's largely because we now have a much more service and information orriented economy than we did 30 years ago. Here's the catch: in the aftermath of Katrina, there will be 100's of billions of dollars from government and private sources (largely credit-based) spent on manufacturing and construction--new homes, infrastrcuture, durable goods, etc. I contend that the aftermath of Katrina will result in an increase in economic spending, and that this spending will be on a 1970's level of GDP/barrel of oil. Katrina will increase short and mid-term oil demand just at the time that global supplies may begin to decrease... this really may be THE trigger event.


Anonymous said...

More a question than a comment...have you considered the opportunity cost of the rebuilding effort? The dollars spent to rebuild are dollars that would have been spent on something else. Therefore, what you term economic growth isn't "new" spending. It's spending that would have occured but on other things. Therefore, you're left with a wash in the end. It sounds like you're commiting Bastiat's Broken Window fallacy.

Jeff Vail said...

I agree that there is some opportunity cost here that mitigates some of the impact of the spending, but I think that there are a few important differences:

1. The spending on Katrina recovery will be on higher oil-intensity products than would have been the case with the opportunity cost alternative. The opportunity cost would likely have been spent on more information and service-sector goods, and this is why the spending on Katrina recovery will bolster crude demand.

2. Hurricane Katrina will be used as an excuse to spend more on credit than would have otherwise been the case (in the opportunity cost scenario). This would come back around in the long term, except that the resultant rise in oil price because of the increased deficit spending will be offset by the bouying of US currency as a result of higher demand for Us dollars to purchase dollar denominated oil. Sure, a "free market" wouldn't work this way, but this is anything but a free market.

It's like Bastiat's example, only the price of glass, suits, and the tailor's income and credit are all interrelated...

Eric and JJ Larson said...

Jeff, great to hang out with you and Julie over Labor Day. Many thanks.

Anyway, just one comment on the above topic. The problem with thinking about opportunity cost in this case is that buying on credit does not present an opportunity cost to most non-economists. It is buy now, buy now rather than buy now, pay later. The government is now working on the same principle. Besides, there seems to be very little choice in the matter. The opportunity cost in this case is lost votes for the administration rather than spending on other pet projects. It's not like this was a choice between 200 billion for the Iraq war and 200 billion for the Gulf Coast...the money will be spent for better or worse.

One other issue that probably needs more description is the exact nature of spending on disaster relief and rebuilding. Frankly speaking, with all that construction equipment moving rubble and moving building supplies into the NO / Gulf Coast area, oil demand will only increase more. Again, the market will probably correct for this, especially with the inelasticity of oil...increased demand for gas/diesel by construction companies will take away some of the supply that would be "extra" in the rest of the US market. In other words, even with refineries coming back on line and the price at the pump at new highs, we're still not going to curb our demand. Damned if you do, damned if you don't...

Anonymous said...


This is all very interesting but I belive you are way off base. The reason we have an oil shortage is because God is punishing us for working to hard. See all we really need is a bunch more dead dinosours, hey did you ever thing that today's humans is tomorrows dionosurs? We could be the next oil source... Hey now there is a thought.

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