I was an invited speaker at the “7th Biennial International Workshop ‘Advances in Energy Studies,’” in Barcelona, Spain in October 2010. Afterward, I wrote a peer-reviewed academic paper related to my talk called, “Oil Supply Limits and the Continuing Financial Crisis.” It now has been published in the January issue of Energy. It is available free at this link (probably temporarily).  The rest of the articles are also available free. A complete listing of articles in the January issue can be found here.

My article abstract is as follows:

Since 2005, (1) world oil supply has not increased, and (2) the world has undergone its most severe economic crisis since the Depression. In this paper, logical arguments and direct evidence are presented suggesting that a reduction in oil supply can be expected to reduce the ability of economies to use debt for leverage. The expected impact of reduced oil supply combined with this reduced leverage is similar to the actual impact of the 2008–2009 recession in OECD countries. If world oil supply should continue to remain generally flat, there appears to be a significant possibility that oil consumption in OECD countries will continue to decline, as emerging markets consume a greater share of the total oil that is available. If this should happen, based on these findings we can expect a continuing financial crisis similar to the 2008–2009 recession including significant debt defaults. The financial crisis may eventually worsen, to resemble a collapse situation as described by Joseph Tainter in The Collapse of Complex Societies (1990) or an adverse decline situation similar to adverse scenarios foreseen by Donella Meadows in Limits to Growth (1972).

Dinner with a group of attendees and speakers at the Barcelona conference. I am wearing the red jacket.

I was in Barcelona for an entire week, for the conference and for a related meeting with high school students. The meeting with high school students was in a large auditorium. Students were asked to submit questions in advance relating to oil limits and possible ways to deal with them. There was also time for some impromptu questions.

Gail Tverberg, Charles Hall, Mario Giampietro, and Joseph Tainter in auditorium in Barcelona, Spain. They would later answer questions from students from 11 high schools in the area. Translation from Catalan to English was provided by headphone.

Our Finite World

The Report of the High-level Panel on Global Sustainability, entitled Resilient People, Resilient Planet: A Future Worth Choosing, contains six sections in its entirety:

Section I – The Panel’s vision
Section II – Progress towards sustainable development
Section III – Empowering people to make sustainable choices
Section IV – Working towards a sustainable economy
Section V – Strengthening institutions
Section VI – Conclusion: A call for action.

This overview reproduces Section I from the Panel’s report. The Summary of Sections and the Call for Action are taken from the report’s Executive Summary. The Panel’s recommendations are reproduced in full.

[For the complete Overview, see here. The complete report is available online. ]

1. Today our planet and our world are experiencing the best of times, and the worst of times. The world is experiencing unprecedented prosperity, while the planet is under unprecedented stress. Inequality between the world’s rich and poor is growing, and more than a billion people still live in poverty. In many countries, there are rising waves of protest reflecting universal aspirations for a more prosperous, just and sustainable world.

2. Every day, millions of choices are made by individuals, businesses and governments. Our common future lies in all those choices. Because of the array of overlapping challenges the world faces, it is more urgent than ever that we take action to embrace the principles of the sustainable development agenda. It is time that genuine global action is taken to enable people, markets and governments to make sustainable choices.

3. The need to integrate the economic, social and environmental dimensions of development so as to achieve sustainability was clearly defined a quarter of a century ago. It is time to make it happen. The opportunities for change are vast. We are not passive, helpless victims of the impersonal, determinist forces of history. And the exciting thing is that we can choose our future.

4. The challenges we face are great, but so too are the new possibilities that appear when we look at old problems with new and fresh eyes. These possibilities include technologies capable of pulling us back from the planetary brink; new markets, new growth and new jobs emanating from game-changing products and services; and new approaches to public and private finance that can truly lift people out of the poverty trap.

5. The truth is that sustainable development is fundamentally a question of people’s opportunities to influence their future, claim their rights and voice their concerns. Democratic governance and full respect for human rights are key prerequisites for empowering people to make sustainable choices. The peoples of the world will simply not tolerate continued environmental devastation or the persistent inequality which offends deeply held universal principles of social justice. Citizens will no longer accept governments and corporations breaching their compact with them as custodians of a sustainable future for all. More generally, international, national and local governance across the world must fully embrace the requirements of a sustainable development future, as must civil society and the private sector. At the same time, local communities must be encouraged to participate actively and consistently in conceptualizing, planning and executing sustainability policies. Central to this is including young people in society, in politics and in the economy.

6. Therefore, the long-term vision of the High-level Panel on Global Sustainability is to eradicate poverty, reduce inequality and make growth inclusive, and production and consumption more sustainable, while combating climate change and respecting a range of other planetary boundaries. This reaffirms the landmark 1987 report by the World Commission on Environment and Development, “Our Common Future” (United Nations document A/42/427, annex), known to all as the Brundtland report.

7. But what, then, is to be done if we are to make a real difference for the world’s people and the planet? We must grasp the dimensions of the challenge. We must recognize that the drivers of that challenge include unsustainable lifestyles, production and consumption patterns and the impact of population growth. As the global population grows from 7 billion to almost 9 billion by 2040, and the number of middle-class consumers increases by 3 billion over the next 20 years, the demand for resources will rise exponentially. By 2030, the world will need at least 50 per cent more food, 45 per cent more energy and 30 per cent more water — all at a time when environmental boundaries are throwing up new limits to supply. This is true not least for climate change, which affects all aspects of human and planetary health.

8. The current global development model is unsustainable. We can no longer assume that our collective actions will not trigger tipping points as environmental thresholds are breached, risking irreversible damage to both ecosystems and human communities. At the same time, such thresholds should not be used to impose arbitrary growth ceilings on developing countries seeking to lift their people out of poverty. Indeed, if we fail to resolve the sustainable development dilemma, we run the risk of condemning up to 3 billion members of our human family to a life of endemic poverty. Neither of these outcomes is acceptable, and we must find a new way forward.

9. A quarter of a century ago, the Brundtland report introduced the concept of sustainable development to the international community as a new paradigm for economic growth, social equality and environmental sustainability. The report argued that sustainable development could be achieved by an integrated policy framework embracing all three of those pillars. The Brundtland report was right then, and it remains right today. The problem is that, 25 years later, sustainable development remains a generally agreed concept, rather than a day-to-day, on-the-ground, practical reality. The Panel has asked itself why this is the case, and what can now be done to change that.

10. The Panel has concluded that there are two possible answers. They are both correct, and they are interrelated. Sustainable development has undoubtedly suffered from a failure of political will. It is difficult to argue against the principle of sustainable development, but there are few incentives to put it into practice when our policies, politics and institutions disproportionately reward the short term. In other words, the policy dividend is long-term, often intergenerational, but the political challenge is often immediate.

11. There is another answer to this question of why sustainable development has not been put into practice. It is an answer that we argue with real passion: the concept of sustainable development has not yet been incorporated into the mainstream national and international economic policy debate. Most economic decision makers still regard sustainable development as extraneous to their core responsibilities for macroeconomic management and other branches of economic policy. Yet integrating environmental and social issues into economic decisions is vital to success.

12. For too long, economists, social activists and environmental scientists have simply talked past each other — almost speaking different languages, or at least different dialects. The time has come to unify the disciplines, to develop a common language for sustainable development that transcends the warring camps; in other words, to bring the sustainable development paradigm into mainstream economics. That way, politicians and policymakers will find it much harder to ignore.

13. That is why the Panel argues that the international community needs what some have called “a new political economy” for sustainable development. This means, for example:

radically improving the interface between environmental science and policy;

recognizing that in certain environmental domains, such as climate change, there is “market failure”, which requires both regulation and what the economists would recognize as the pricing of“environmental externalities”, while making explicit the economic, social and environmental costs of action and inaction;

recognizing the importance of innovation, new technologies, international cooperation and investments responding to these problems and generating further prosperity;

recognizing that an approach should be agreed to quantify the economic cost of sustained social exclusion — for example, the cost of excluding women from the workforce;

recognizing that private markets alone may be incapable of generating at the scale necessary to bring about a proper response to the food security crisis;

and requiring international agencies, national Governments and private corporations to report on their annual sustainable development performance against agreed sustainability measures.

We must also recognize that this is a core challenge for politics itself. Unless the political process is equally capable of embracing the sustainable development paradigm, there can be no progress.

14. The scale of investment, innovation, technological development and employment creation required for sustainable development and poverty eradication is beyond the range of the public sector. The Panel therefore argues for using the power of the economy to forge inclusive and sustainable growth and create value beyond narrow concepts of wealth. Markets and entrepreneurship will be a prime driver of decision-making and economic change. And the Panel lays down a challenge for our Governments and international institutions: to work better together in solving common problems and advancing shared interests. Quantum change is possible when willing actors join hands in forward-looking coalitions and take the lead in contributing to sustainable development.

15. The Panel argues that by embracing a new approach to the political economy of sustainable development, we will bring the sustainable development paradigm from the margins to the mainstream of the global economic debate. Thus, both the cost of action and the cost of inaction will become transparent. Only then will the political process be able to summon both the arguments and the political will necessary to act for a sustainable future.

16. The Panel calls for this new approach to the political economy of sustainable development so as to address the sustainable development challenge in a fresh and operational way. That sustainable development is right is self-evident. Our challenge is to demonstrate that it is also rational — and that the cost of inaction far outweighs the cost of action.

17. The Panel’s report makes a range of concrete recommendations to take forward our vision for a sustainable planet, a just society and a growing economy:

a. It is critical that we embrace a new nexus between food, water and energy rather than treating them in different “silos”. All three need to be fully integrated, not treated separately if we are to deal with the global food security crisis. It is time to embrace a second green revolution — an “ever-green revolution” — that doubles yields but builds on sustainability principles;

b. It is time for bold global efforts, including launching a major global scientific initiative, to strengthen the interface between science and policy. We must define, through science, what scientists refer to as “planetary boundaries”, “environmental thresholds” and “tipping points”. Priority should be given to challenges now facing the marine environment and the “blue economy”;

c. Most goods and services sold today fail to bear the full environmental and social cost of production and consumption. Based on the science, we need to reach consensus, over time, on methodologies to price them properly. Costing environmental externalities could open new opportunities for green growth and green jobs;

d. Addressing social exclusion and widening social inequity, too, requires measuring them, costing them and taking responsibility for them. The next step is exploring how we can deal with these critical issues to bring about better outcomes for all;

e. Equity needs to be at the forefront. Developing countries need time, as well as financial and technological support, to transition to sustainable development. We must empower all of society — especially women, young people, the unemployed and the most vulnerable and weakest sections of society. Properly reaping the demographic dividend calls on us to include young people in society, in politics, in the labour market and in business development;

f. Any serious shift towards sustainable development requires gender equality. Half of humankind’s collective intelligence and capacity is a resource we must nurture and
develop, for the sake of multiple generations to come. The next increment of global growth could well come from the full economic empowerment of women;

g. Many argue that if it cannot be measured, it cannot be managed. The international community should measure development beyond gross domestic product (GDP) and
develop a new sustainable development index or set of indicators;

h. Financing sustainable development requires vast new sources of capital from both private and public sources. It requires both mobilizing more public funds and using global and national capital to leverage global private capital through the development of incentives. Official development assistance will also remain critical for the sustainable development needs of low-income countries;

i. Governments at all levels must move from a silo mentality to integrated thinking and policymaking. They must bring sustainable development to the forefront of their agendas
and budgets and look at innovative models of international cooperation. Cities and local communities have a major role to play in advancing a real sustainable development agenda on the ground;

j. International institutions have a critical role. International governance for sustainable development must be strengthened by using existing institutions more dynamically and by considering the creation of a global sustainable development council and the adoption
of sustainable development goals;

k. Governments and international organizations should increase the resources allocated to adaptation and disaster risk reduction and integrate resilience planning into their development budgets and strategies;

l. Governments, markets and people need to look beyond short-term transactional agendas and short-term political cycles. Incentives that currently favour short-termism in decisionmaking should be changed. Sustainable choices often have higher up-front costs than business as usual. They need to become more easily available, affordable and attractive to both poor consumers and low-income countries.

18. This Panel believes it is within the wit and will of our common humanity to choose for the future. This Panel therefore is on the side of hope. All great achievements in human history began as a vision before becoming a reality. The vision for global sustainability, producing both a resilient people and a resilient planet, is no different.

19. In 2030, a child born in 2012 — the year our report is published — will turn 18. Will we have done enough in the intervening years to give her the sustainable, fair and resilient future that all of our children deserve? This report is an effort to give her an answer.

[For the complete Overview, see here. The complete report is available online. ]

United Nations

The US dollar is fast losing out its reserve currency status with China aggressively replacing the dollar with the Yuan as a currency for bi-lateral trade. The latest is an agreement signed between the China and the United Arab Emirates (UAE), which will use the Yuan for oil trade.

The deal is worth around $5.5 billion dollars and the Chinese central bank said that the deal aims at “strengthening bilateral financial cooperation, promoting trade and investments and jointly safeguarding regional financial stability”

Earlier, Russia and Iran had decided to use Rubles as a means of currency. With both China and Russia converting their bi-lateral trades into non-US dollar deals, the greenback is now under threat of losing out its status as the world reserve currency. And the impact of such a transition will essentially tip the balance of global power.

Commodity Online

The last ten years have brought a structural change to the world oil market, with changes in demand increasingly playing a role in maintaining the supply/demand balance.  These changes will come at an increasingly onerous cost to our economy unless we take steps to make our demand for oil more flexible.

We’re not running out of oil.  There’s still plenty of oil still in the ground.  Oil which was previously too expensive to exploit becomes economic with a rising oil price.  To the uncritical observer, it might seem as if there is nothing to worry about in the oil market.

Unfortunately, there is something to worry about, at least if we want a healthy economy.  The new oil reserves we’re now exploiting are not only more expensive to develop, but they also take much longer between the time the first well is drilled and the when the first oil is produced.  That means it takes longer for oil supply to respond to changes in price.

In economic terms, the oil supply is becoming less elastic as new oil supplies come increasingly from unconventional oil.  Elasticity is the term economists use to describe how much supply or demand responds to changes in price.  If a small change in price produces a large change in demand, demand is said to be elastic.  If a large change in price produces a small change in supply, then supply is said to be inelastic.

Elasticity of Demand

On the demand side, the elasticity of our demand for oil reflects the options we have to using oil for our daily needs. At a personal level, we can quickly cut our demand for oil a little bit by combining car trips, keeping our tires properly inflated, etc.  But the ability to make such reductions is often limited, and even such simple measures come at a cost of time or convenience, which is why we’re not doing them already.  If we live in an area without good public transport (as most of us do) we can’t stop driving to work without losing our job, so we keep driving to work, and paying more for the gas to get there.

Over the longer term, our personal options to cut oil consumption increase.  We can move closer to work, or to somewhere where we can walk or use public transport to get to our job. This is why the most fuel-efficient vehicle is a moving van.

Replacing a car with a more fuel efficient vehicle is an option for those who have money or credit, but the people who are under the most pressure from high fuel prices are unlikely to be able to afford such options.  If they can’t resort to ride sharing or public transport, they may simply lose their jobs because they can’t afford to get there.

The reduction in fuel use that comes from people losing their jobs and no longer commuting to work also contributes to the elasticity of demand, and I mention it to highlight the point that while reductions in fuel use can be benign (properly inflated tires, for instance), they can also be harmful to the economy.  Reductions in demand due to high prices are often called demand destruction, and it’s just as unpleasant as it sounds.

Elasticity of Supply

Since our options for reducing oil demand in response to rising prices range from inconvenient to expensive, to downright painful, it’s clear why the media and politicians focus so much attention on the other half of the equation: When supply adapts to changes in demand, voters don’t have to make uncomfortable choices.

But there are also limits to the ability of oil supply to adjust.  Most OPEC nations, including Saudi Arabia, need at least a $100/bbl for oil to keep their budgets in balance, so why would they increase production to reduce the price below that?  In fact, as (subsidized and hence inelastic) OPEC domestic consumption continues to increase faster than supply, OPEC net exports will continue to fall, further raising the price needed to balance exporters’ budgets.

While fiscal issues constrain OPEC’s elasticity of supply, geology and politics constrain oil supply elsewhere.  Brazil’s giant pre-salt fields, like deep water discoveries in the Gulf of Mexico and elsewhere, are much more expensive and slow to develop than were past discoveries.  Canada’s tar sands are large mining operations, and are similarly slow and expensive to develop.

Put simply, if the oil were quick and easy to get at, we’d have gotten it already.  All these factors mean that the elasticity of oil supply is falling, so oil demand has to adjust more in response to changes in price than in the past.

Data

Since there is little reason to assume that the elasticity of oil demand has changed significantly (do we have more options for doing without oil than we did ten or twenty years ago?) while the elasticity of oil supply has fallen, we have to expect that overall oil price elasticity has fallen as well, and these changes should show up in oil market data.

Using oil annual supply, price and consumption data from the EIA and IEA, and making some back-of the envelope adjustments to account for the difference between their different definitions of what constitutes oil, I made some estimates of the price elasticity of oil supply and demand.

Since neither demand nor supply can respond instantly to changes in price, I first had to estimate the average reaction time.  To do this, I looked at the correlation between changes in the oil price and changes in supply and demand with various lags.  I used price and volume changes over a period of three years because three year changes gave me the strongest results, although one and two year changes were similar.

Below you can see the correlations between three year changes US and worldwide supply and demand with three year changes in US oil prices (WTI) and world oil prices (Brent), after various lags:

Note that we’re looking for negative correlation between price and demand (we use less oil when we have to pay more for it), and positive correlation between price and supply (companies produce more oil if they can get more money for it.)

From the chart, we can see that world oil supply has historically taken about one year to respond to changes in world prices (the blue line peaks at 40% correlation with a one year lag), while domestic US oil production (supply) has typically taken about four years to respond to changes in the oil price, but that response is much stronger than the response of world supply.

The difference between the response between US and world oil supply makes sense because domestic oil production operates in a much freer market than world oil supply, where changes are mostly dominated by political decisions in a few OPEC nations.  Political decisions are quicker than drilling new wells (one year as opposed to four), but they are only about half as responsive to changes in price.

On the demand side, we see very little response to changes in price at all.  The correlation between demand and price is always positive, showing that changes in supply have accounted for virtually all of the market response to oil price changes over the period.

Changes Over Time

To test my hypothesis that supply is becoming less elastic, I split my data set into two periods, one from 1987 to 2000, and one from 2001 to 2010.  If the hypothesis is correct, we will see less supply and more demand price response in the later period than in the earlier one.

The graphs which follow show significant changes in how both supply and demand respond to changes in price.  Perhaps the most significant change is that we now see a response in the demand for oil to the oil price.

In the early period, only US demand for oil shows a small response to price, with a slight negative correlation (-30%) between three year changes in US demand and changes in price.  World oil demand still shows no measurable price response.   I take this to indicate that at the end of the last century, Americans responded to changes in the oil price by using the relatively easy options such as eliminating discretionary trips when oil prices rose, but price was not an important factor for determining world oil consumption.

In the later period, the US demand no longer shows a short-term response to rises in the oil price, perhaps because the easy reductions in oil use have already been made, but we now see a relatively strong response to higher oil prices (with a -90% correlation) over a period of four years for both US and world oil demand.  This probably corresponds to such changes as purchasing more efficient vehicles, and minimizing commutes by moving closer to work or working more from home.

Confirmation

World oil demand’s very significant response to changes in the oil price implies that demand is now playing a much bigger role in the adjustments the oil market makes to changes in price than it has in the past.

Because oil supply has become less elastic and less responsive to changes in price, oil prices have become much more volatile in order to force market adjustments.

The chart below shows that while the magnitude (either up or down) of annual changes in supply and consumption have been in the 3% to 7% range for the last quarter of a century, the magnitude of oil price changes has been rising relentlessly.  In the 1990s, oil prices usually changed by an average of 25% or less per year, while they now typically change by three or four times that amount in any given year.

If the price elasticity of the oil market had not been falling over time, the increasing magnitude of changes in oil prices would have produced a similar increase in the magnitude changes in oil supply and demand.

As the Market For Oil Becomes Less Flexible, We Should Make the Market for Transportation Services More Flexible to Compensate

If what we care about are the effects on the economy, it does not matter how much oil is in the ground.  Over the last ten years, we have see a structural change in the oil market which will continue to have far-reaching effects on the economy even if we manage to increase the amount of oil produced.

Before 2000, oil supply did the heavy lifting when it came to balancing supply and demand in the oil market.  That is no longer the case, and the oil price signal has grown significantly stronger in order to elicit a response in demand.

With 2% of the world’s oil reserves, changes in the US supply of oil will remain insignificant in the world oil supply demand picture, developments in the Bakken shale and cheer leading from political leaders notwithstanding.  On the other hand, as the consumer of a quarter of the world’s oil supply, we can have a significant effect on the world oil market by making sure that our economy can adjust quickly and easily to changes in the oil price.

What measures can we take to increase the elasticity of oil demand, and reduce the pain of demand destruction?  Measures which increase our citizen’s options for reducing oil use.

• Increased investment in alternative modes of transport, such as mass transit (both buses and rail), bike lanes, bike and car sharing, and walking improvements to allow many more workers the option of getting to their jobs without the use of a personal car.
• Improvements in our nation’s rail system to allow more freight to be shifted from truck to rail.
• Increasing gas taxes slowly and predictably over time to both fund the above improvements, and to signal to consumers that they need to prepare for long term higher prices by purchasing more efficient vehicles and changing where they live so that they have the ability to reduce their driving.
• The use of road congestion pricing, pay as you drive insurance, and other price signals that give people the right market signals and enhance the most efficient use of our nation’s roadways.
• Encouraging the electrification of transport (including the alternative transport options mentioned above) to provide transport options which are not dependent on oil.

In short, we need to make the market for transportation services more efficient by encouraging new entrants (mass transit, bikes, trains) and competition with the incumbent car/internal combustion engine infrastructure.  Competition within the car infrastructure should also be encouraged by sending price signals such as the slowly and predictably increasing gas tax mentioned above to better reflect the dangers to our economy posed by the new oil market regime.

Forbes

Since 2005, European oil consumption has fallen by 1.5 million barrels a day. And, in the same period, US oil consumption has fallen by 2 million barrels a day. If oil was priced at $60 a barrel, rather than $100 a barrel, then a fair portion of that lost demand might return. Instead, since 2005, global crude oil production has been bumping up against a ceiling around 74 million barrels a day. Thus, the tremendous growth in oil demand which emanates from the developing world, in Asia primarily, has been supplied by the reduction of demand in Europe and the United States. Why doesn’t the world simply increase the production of oil to 77, or 78 million barrels a day? After all, that is precisely the history of global oil production: a continual increase in supply to capture the advantage of rising prices.

Today, in 2012, I observe that many analysts of global oil production—and the interaction between oil prices and the global economy—continue to engage in a guessing game about the future. But, frankly, the future has already arrived. And it is not a random future, but a future that was held to be improbable, if not impossible. For each extra barrel of oil produced over the past seven years from Russia, and Canada, there has been a loss of production from the North Sea, from Mexico, from Indonesia and elsewhere. And in the case of OPEC, there has been a stubborn flatlining of production growth, which, in the true spirit of argumentum ad ignorantium, has been taken as proof of OPEC’s hidden and secret supply. Thus, we are led to the newest and strangest meme of all: the failure of global oil production to grow over seven years, in the face of a phase transition in oil prices, is not even suggestive of peak oil. But rather, proof of oil’s imminent supply resurrection.