What happens when we run out of oil?
This question, which comes up almost daily in the op-ed pages of this country’s newspapers, was recently raised by Gary Mason of the Globe and Mail. “If you believe the economy is structured in such a way that it needs to grow continually in order to survive, then it will take an endless supply of energy to feed it,” he begins. “How, then, does an economy grow exponentially forever if the one element it needs more than anything to flourish is contracting with time?” Statements like this represent a fundamental misunderstanding of resource economics, economic growth and the energy intensity of the economy.
Will we run out of oil? No. Surely it’s not that simple, you’ll say, but it is.
People will only be able to pay for a barrel of oil as long as that barrel performs valuable work, and so long as that same work could not be performed more cost-effectively using another source of energy. The price is capped not only by the product’s usefulness, but by the relative costs of substitutes. There will always be barrels of oil too deep to extract, or that we never discover because it’s not worth exploring areas that would be too costly to develop given the market for oil.
What about the next part: can we maintain our standard of living, or even enhance it, indefinitely while extracting finite resources? As Queen’s economist John Hartwick taught us years ago, the answer depends on three things: the amount of resource you have, the capacity for technological improvements and the cost of investing in those improvements.
Think of our economy as a computer running calculations. Think of economic output as the number of calculations it completes. Now, imagine the computer runs on a finite resource and that, at current rates of consumption, you’ll run out of the resource to run your computer in 30 years. It sounds dire, but it might not be.
If technology does not improve, your choice will be simple: reduce the amount you run your computer to smooth resources over time, or use them up and then starve. That’s how the Mason article portrays our oil situation. Now, imagine the computer technology improves such that its calculating efficiency increases each year. As long as that improvement is fast enough, you could have exponential economic growth while using fewer resources. As time goes on, your annual resource use would get closer and closer to zero, so while your resource is still finite, you can use it for a time period that limits to infinity as long as your rate of productivity improvement was sufficiently rapid. Our global economy is not just an energy economy, although we use energy in much of what we do. Capital and labour are much more important inputs to production than energy, and so small increases in labour or capital productivity lead to large increases in production per unit energy (or decreases in energy per unit produced).
What Hartwick proposed — now known as the Hartwick rule — was the degree of investment in capital required to maintain economic growth with dwindling resources. You can think of this, if you like, as investment in human capital and technology including the development of alternative energy sources. It’s not correct to say you can’t have infinite growth with a finite resource — you just need resource productivity to grow quickly to accomplish it. Hartwick didn’t say you could maintain any level of growth with a finite resource, or that any level of investment would be sufficient for consumption growth to go on forever, he just defined the conditions you’d have to meet to make it work.
But don’t we only have a few years worth of oil left? According to BP’s Statistical Review of World Energy, global oil reserves at the end of 2012 were 1.7 trillion barrels. Given that the world consumes about 86 million barrels of crude oil per day, it would be easy to conclude we’ll run out of oil in 55 years, or sooner if we increase
production consumption. This is where understanding what an oil reserve is important. The U.S. Geological Survey definition of an oil reserve is quantities of crude oil in discovered accumulations which can be legally, technically and economically extracted — oil reserves depend on discovery of new pools, but also on technology, prices and legal access to oil fields. This explains why oil reserves have been increasing, not decreasing, during the past 30 years, despite increasing oil extraction rates. Not only have reserves increased, but we’ve seldom had a lower rate of production out of global reserves than we have today.
So, what’s the bottom line? Are we going to run out of oil? No.
Are oil prices going to increase dramatically? They might, or they might not.
If we knew for sure what was going to happen, people would adjust production behavior accordingly. Can we have infinite, exponential growth with finite resources? Yes. Does that mean we don’t need to worry? No. Do we only have 55 years worth of oil left? No. Does that mean oil won’t get a lot more expensive soon? No, but it might also get a lot cheaper.
Saturday, February 1, 2014