The Paradox of Production

One of the things that makes the challenge of peak oil so insidious, and so resistant to quick fixes, is the way in which many things that seem like ingredients of a solution are actually part of the problem. Petroleum provides so much of the energy and so many of the raw materials we take for granted today that the impacts of declining oil production extend much further than a first glance would suggest.

Read through discussions of the energy future of industrial society from a few years back, for example, and you’ll find that many of them treat the price of coal and the price of oil as independent variables, linked only by the market forces that turn price increases in one into an excuse for bidding up the price of the other. What these analyses missed, of course, is that the machinery used to mine coal and the trains used to transport it are powered by diesel oil. When the price of diesel goes up, the cost of coal mining goes up; when supplies of diesel run short in coal-producing countries – as they have in China in recent months – the supply of coal runs into unexpected hiccups as well.

I’ve pointed out in previous posts here that every other energy source currently used in modern societies gets a substantial “energy subsidy” from oil. Thus, to continue the example, oil contains about three times as much useful energy per unit weight as coal does, and oil also takes a lot less energy to extract from the ground, process, and transport to the end user than coal does. Modern coal production benefits from these efficiencies. If coal had to be mined, processed, and shipped using coal-burning equipment, those efficiencies would be lost, and a sizeable fraction of total coal production would have to go to meet the energy costs of the coal industry.

The same thing, of course, is true of every other alternative energy source to a greater or lesser degree: the energy used in uranium mining and reactor construction, for example, comes from diesel rather than nuclear power, just as sunlight doesn’t make solar panels. What rarely seems to have been noticed, however, is the way these “energy subsidies” intersect with the challenges of declining petroleum production to boobytrap the future of energy production in industrial societies. The boobytrap in question is an effect I’ve named the paradox of production.

It’s crucial to understand that the problem with our society’s reliance on petroleum is not simply that petroleum will become scarce in the future, and will have to be replaced by less concentrated or less abundant fuels. It’s that a huge proportion of industrial society’s capital plant – the collection of tools, artifacts, trained personnel, social structures, information resources, and human geography that provide the productive basis for society – was designed and built to use petroleum-derived fuels, and only petroleum-derived fuels. Converting that capital plant to anything else involves much more than just providing another energy source.

Consider the difficulties that would be involved in building the sort of hydrogen economy so often touted as the solution to our approaching energy crisis. We’ll grant for the moment that the massive amounts of electricity needed to turn seawater into hydrogen gas in sufficient volume to matter turn out to be available somehow, despite the severe challenges facing every option proposed so far. Getting the electricity to make the hydrogen, though, is only the first of a series of tasks with huge price tags in money, energy, raw materials, labor, and time.

Hydrogen, after all, can’t be poured into the gas tank of a gasoline-powered car. For that matter, it can’t be dispensed from today’s gas pumps, or stored in the tanks at today’s filling stations, or shipped there by the pipelines and tanker trucks currently used to get gasoline and diesel fuel to the point of sale. Every motor vehicle on the roads, along with the vast infrastructure built up over a century to fuel them with petroleum products, would have to be replaced in order to use hydrogen as a transport fuel.

The same challenge, in one form or another, faces nearly every other energy source proposed as a replacement for petroleum. It’s not enough to come up with a new source of energy. Unless that new source can be used just like petroleum, the petroleum-powered machines we use today will have to be replaced by machines using the new energy source. Furthermore, unless the new energy source can be distributed through existing channels – whether that amounts to the pipelines and tanker trucks used to transport petroleum fuels today, or some other established infrastructure, such as the electric power grid – a new distribution infrastructure will have to be built. Either task would add massive costs to the price tag for a new energy source; put both of them together – as in the case of hydrogen – and the costs of the new infrastructure could easily dwarf the cost of bringing the new energy source online in the first place.

Factor the impact of declining oil production into this equation and the true scale of the challenge before us becomes a little clearer. Building a hydrogen infrastructure – from power plants and hydrogen generation facilities, through pipelines and distribution systems, to hydrogen filling stations and hundreds of millions of hydrogen-powered cars and trucks – will, among many other things, take a very large amount of oil. Some of the oil will be used directly, by construction equipment, trucks hauling parts to the new plants, and the like; much more will be used indirectly, since nearly every commodity and service for sale in the industrial world today relies on petroleum in one way or another. Until a substantial portion of the hydrogen system is in place, it won’t be possible to use hydrogen to supplement dwindling petroleum production, which is already coming under worldwide strain as demand pushes up against the limits of supply. Instead, the fuel costs of building the hydrogen economy add an additional source of demand, pushing fuel prices higher and making scarce fuel even less available for other uses.

The same thing is true of any other alternative energy system that attempts to replace petroleum in its current uses. The costs differ, depending on how much of the existing infrastructure has to be replaced, but there’s always a price tag – and a large portion of the energy needed will have to come from petroleum, because that’s the energy source our society uses for a great many of its crucial needs. If the new energy source can be produced and used by existing infrastructure with minimal modification, this effect may well be small enough to discount, but it is always there.

The advantage of energy sources that can use existing infrastructure is one of the reasons why ethanol and biodiesel have entered the energy stream in amounts large enough to affect total liquid fuel numbers, and have helped drive grain prices to stratospheric levels into the bargain, while so many other alternative fuels languish on the drawing boards and the imaginations of peak oil optimists. Both of these can be distributed and used as though they were petroleum products. Neither one is a viable response to the broader problem, of course; stark limits get in the way of fueling an industrial economy by pouring our food supply into our fuel tanks. All the arable land on the planet is not enough to produce more than a small fraction of the liquid fuels we get from petroleum today, and long before even that inadequate point was reached, mass starvation or violent revolution would cut the process short.

All other proposed replacements for petroleum, however, require much larger investments of money, energy, and raw materials for new infrastructure. The production of energy and raw materials depends on petroleum nowadays; so does the global economy which gives money its value – and conventional petroleum production worldwide is almost three years into what is most likely an irreversible decline.

At this point the paradox of production can be easily defined. If energy prices are high because supplies are limited, the obvious solution is to increase the supply by producing more energy. If this requires replacing one energy resource with another that cannot be produced, distributed or consumed using the identical infrastructure, though, the immediate impact of such a replacement will be to raise energy prices, not lower them. The direct and indirect energy costs of building the new energy system become a source of additional demand that, intersecting with limited supply, drive prices up even further than they otherwise would rise.

If the new energy source turns out to be more abundant, more concentrated, and more easily extracted than the source that it’s replacing, this effect is temporary; if the new source can be distributed and used, at least at first, via old technology, the effect is minimized; if the new source is introduced a little at a time, in an economy reliant on many other sources of energy, the effect can easily be lost in the static of ordinary price fluctuations. All three of these were true of petroleum in its early days. It started as a replacement for whale oil in lamps, and was distributed and consumed in existing technology; decades later, it found a niche as a transportation fuel, and relied on the old lamp-oil distribution system until a new one could be constructed on the basis of existing revenues; its other uses evolved gradually from there over more than half a century, until by 1950 it was the world’s dominant energy source

None of the proposed replacements for petroleum, though, have those advantages. None of them yield as much net energy as crude oil under natural pressure, and none combine petroleum’s unique mix of abundance, concentration, ease of production and distribution, and fitness for a world of machinery designed and built for petroleum-based fuels. The fuel they need to replace remains by far the most important energy source in the world today. Nor do we have half a century to ramp up a new energy system for the industrial economy; conventional petroleum production is already declining steadily, and the most reasonable projections of future production show it dropping off a cliff within the next decade or so.

At the very least, then, trying to solve the energy crisis on the downside of Hubbert’s peak by bringing new energy sources online will drive up the cost of petroleum further than it would rise on its own, since the direct and indirect energy costs of the new source and its infrastructure have to be met from existing sources. That poses the same political test faced, and failed, by the nations of the industrial world in the late 1970s, when promising steps toward sustainability went into the dumpster because their immediate costs hadf more political impact than their long-term benefits.

It also risks potentially fatal damage to the industrial economy itself, which will face severe strains already as the age of cheap abundant energy comes to an end. Pursued with enough misplaced enthusiasm, a crash program to bring some new energy source online in a hurry could drain enough energy, raw materials, labor, and money out of an already fragile system to drive it over the edge into economic and political collapse.

Fortunately, this is not the whole story. There is at least one proven way to counter the paradox of production, exert downward pressure on energy prices, and free up resources and time that can be used to respond constructively to our predicament. I’ll discuss it in next week’s post.

A Milestone In The Dust

Earlier this month, according to several peak oil bloggers, the world passed a milestone worth noting: the point at which oil, in constant dollars, became more expensive than ever before in history. Plenty of us in the peak oil community have been expecting that milestone any time now, and the surge that pushed one widely watched price marker past $112 a barrel last week turned the expectation into reality.

Profit-taking and a flurry of margin calls driven by the wider economic crisis brought oil prices back down at the beginning of this week, at least for the moment. Meanwhile, though, the higher cost of oil is already starting to trickle down to the consumer level. Diesel fuel is up over $4 a gallon in many US markets, while gasoline, heating oil, and other petroleum products are following the same curve. Speculation, in several senses of the word, has begun to focus on the upcoming summer driving season and the likelihood of soaring prices at the pump.

Just now, however, it may be worth taking the long view. When Goldman Sachs suggested, not so long ago, that oil prices might rise above $110 a barrel, their analysts thought that it would take a crisis threatening some significant fraction of world oil production to drive such a “superspike.” (That warning was widely and, I think, correctly interpreted as an attempt by New York financial interests to talk the cowboys in Washington D.C. out of launching a war with Iran.) The crisis has so far failed to materialize, but the superspike showed up anyway.

Like any other economic phenomenon in the real world, that unexpected event had numerous causes. One factor not often given sufficient weight, at least in the peak oil community, is the role of speculation. The global economy these days is dominated by flows of speculative money that pour into any investment promising an above average rate of return. Just now, commodities – fossil fuels, grains, metals, and the like – yield better returns than most other investments, and so that’s where the money goes.

Monday’s events demonstrated that. The drastic declines in most stock markets that day resulted in a bumper crop of margin calls. For those of my readers who don’t follow the markets, a margin call is what happens when investments bought with borrowed money lose enough value that the lender demands more collateral for the loan. Since few speculators keep large amounts of ready cash on hand, that usually means that other investments have to be turned into cash in a hurry; this is one of the ways financial panics spread from market to market.

Hit with margin calls in the stock market, speculators unwound positions in the commodities market, and most commodities dropped sharply in Monday’s trading. Oil slumped from $111 to $106 in a matter of hours. They rallied after that, but today’s ticker shows another dive, with oil futures down near $104 a barrel as I write these words. With stock markets sliding again, further declines are tolerably likely. None of this ought to come as any kind of surprise; the role of speculation as a source of whipsaw motions in energy prices has been discussed here on The Archdruid Report, and elsewhere across the peak oil blogosphere.

Still, speculation is only one part of the picture. Another part, hard to miss just now, is the plunging value of the dollar. Since oil, like most commodities, is priced in US dollars – a circumstance that has given the United States some notable advantages – a portion of the price increases that have roiled commodities markets and startled American consumers in recent months are simply readjustments by which commodities retain their value against the measure of a weakening currency.

There are good reasons for the dollar to shed value just now, of course, but I sometimes wonder if deliberate policy may play a role as well. After a quarter century of reckless deficit spending, the United States is insolvent by any reasonable measure, saddled with debts it will never be able to pay off. Unlike other countries that have recently landed in the same bind, though, it has a notable advantage – all those debts are payable in a currency it controls. The other day, US Treasury Secretary Henry Paulson made the usual ritual noises about upholding a strong dollar policy, but I suspect it has crossed his mind that the national debt would be a good deal less intimidating if the dollar were to slide to 5% of its current value over the next ten years or so. It’s hard to think of another policy, in fact, that will keep the United States from having to default on its sovereign debt sooner or later.

Whether or not this is on the official agenda, though, some such readjustment is inevitable. The imperial economics that enabled the five percent of the world’s population who are Americans to monopolize a third of the world’s resources have begun to unravel, with predictable results. Pundits who denounce “resource nationalism” and laud the alleged benefits of free trade have conveniently forgotten that America built the largest industrial economy in the world in the shelter of protective tariffs, and used its own natural resources as a political weapon whenever it had the chance – for example, against Japan in the years before the Second World War. We may not enjoy seeing the tables turned, but it’s not as though we have grounds for complaint.

Behind the wild swings of speculative excess and the tidal forces set in motion by a collapsing US dollar, in turn, lies a third factor – from a peak oil perspective, the signal half-hidden by a great deal of economic noise. This is the failure of world petroleum production to break out of the plateau it has occupied since 2004. Those who have been following the peak oil scene for more than a year or so will recall any number of confident predictions concerning improved secondary recovery, new discoveries, or alternative fuels, that would enable oil production to continue on its upward path once prices rose enough to make them economical.

That hasn’t happened. Instead, world oil production has continued to bump along at roughly the same level, while prices have soared through the skylight. The latest news from the International Energy Agency (IEA) shows that with ethanol, biodiesel, and every other source of liquid fuels added in, world production of petroleum and equivalents nudged just slightly over the records set in 2006, while production of conventional petroleum continues to wobble downward from its May 2005 peak. Demand remains strong and prices have soared, but supply has barely budged – and plenty of technologies and energy sources supposedly poised to surge onto the market once oil broke $30, or $40, or $50 a barrel are still pie in the sky.

What this implies is that for all practical purposes, peak oil has arrived. Pinpointing the peak precisely in time quickly becomes an exercise in quibbling over definitions; petroleum is not a single thing but a diverse assemblage of chemically related resources, extracted in many ways and traded in a baroque diversity of markets. Should tar sand extractives, which require huge energy inputs to bring to market, be counted alongside light sweet crude, which requires little? What about ethanol from American corn, cultivated by energy-intensive methods that burn more fuel than the corn itself yields? Should the ethanol and the oil used to produce it both be included in total production, even though this amounts to counting the same energy twice?

Still, there’s another way to think about peak oil that’s less difficult to define: the point along the curve of petroleum production at which geology trumps market forces, and all the price adjustments in the world can’t make supply increase to meet the potential demand. Set aside the whipsaw motions of speculative excess and the impact of a disintegrating currency, and this is what the rising price of petroleum seems to be telling us. Unless events in the very near future offer a different message, it’s fair to suggest that the milestone of record oil prices fading into the dust behind us may mark the end of the age of cheap abundant energy, and the coming of a new world of limits and scarcities for which most of us are hopelessly unprepared.