Arnold Kling  

Basic Oil Economics

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The Great Depression... Doubts about Planning...

Holman Jenkins makes some useful points.


nowadays U.S. consumption of Persian Gulf oil totals about $18 billion a year, less than we spend on computer parts from Asia. The price mechanism works: Oil would flow in greater volume from higher-cost sources in the unlikely event of a catastrophic disruption of supplies from the Gulf. Canada, for instance, has 180 billion barrels in oil sands that are producible, judging by a new Shell project, at $15 a barrel.

Yet so ingrained are the false assumptions of energy insecurity that many pundits and politicians continue to insist that the U.S. has been remiss in failing to impose monumental costs on itself in pursuit of "energy independence."


Jenkins is saying that the U.S. consumption of oil from the Middle East is neither large relative to our economy nor inelastic with respect to price.

For Discussion. Compare the benefits of achieving self-sufficiency in energy with the benefits of achieving self-sufficiency in computer parts or some other large industry. What would have to be sacrificed in order to achieve self-sufficiency in either industry?


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COMMENTS (23 to date)
Newt writes:

Well, there is no other import (other than illicit drugs) which is the primary funding mechanism for a global terror movement, so that is one unique point.

We could achieve North American oil independence entirely by choosing to drive smaller, more efficent cars. In a seven to ten year period the vast majority of the motorcar supply turns over, so a simple tax on gasoline from Eastern Hemisphere oil would make us independent. $1.60 per gallon should be enough, phased in by 20 cents a year for eight years should do it.

Most likely, Japan and Europe would soon fully fund Middle Eastern terror by buying the supplies we stopped buying, though. So the positive effect is likely to be ephemeral.

Eric Krieg writes:

>>We could achieve North American oil independence entirely by choosing to drive smaller, more efficent cars.

Really? Correct me if I'm wrong, but we DID THAT in the late 1970s (check out the difference between a 1973 Chevy Impala and a 1978 one. There's a 1000 lb difference!)

Carmakers raised fuel efficiency by downsizing cars, in reaction to high gas prices, CAFE stadards, and Japanese competition.

But it didn't make us energy independent.

Boonton writes:

Self sufficiency, independence sound like good things but as economic goals they have been the cause of much folly. Nations that trade a lot tend to do very well, those that attept to be 'self-sufficient' are not so impressive.

Also, Middle Eastern terrorism is not, IMO, increased or decreased by oil money. 9/11, suicide bombers etc. are funded with a very tiny portion of Arab nations GDP. In fact, there is an argument that oil money can be used to 'buy off' terrorists. The chances of a US embassy getting blown up in oil poor Pakistan does seem smaller than in oil rich Kuwait or Saudi Arabia.

Regardless, energy 'independence' is a unrealistic goal. Moving beyond oil, though, is not a unreasonable goal.

Eric Krieg writes:

Being an auto enthusiast, it grates me when people who don't know beans about cars start laying into SUVs (people like Araiana Huffington).

I mean, if energy independence is going to be our number one priority, we need to examine every aspect of our lives, not just the vehciles we drive.

The amount of oil used for transportation is a function of average fuel economy times average miles driven times number of drivers.

It seems to me that the variable with the biggest impact is the number of drivers.

What can we do to reduce the number of drivers?

Easy. Seal the borders, and throw out all the illegal immigrants. That will reduce the number of drivers by millions.

Second, pull a Taliban and make it illegal for women to work. That will get half the people off of the road, at least during commuting hours.

And speaking of commuting, sprawl has as much of an impact as SUVs. All you people commuting 20, 30 or more miles each way consume way too many resources. People should be forced to live in the town that they work in. Outlaw commutes of more than 5 miles each way.

As you can see, these ideas are preposterous, and JUST a bit fascist. But no more so than the focus on SUVs.

Bernard Yomtov writes:

The issues here are political, not economic. Nobody is going to claim that we should be self-sufficient in oil, or reduce our imports, for economic reasons.

Political questions are another matter. Lots of oil-producing nations are unstable, and have populations that are hostile to the US. The market is largely controlled by a cartel.

The reason we don't worry about semiconductor imports is that we assume that the producers are going to define their self-interest in economic terms - that they will continue to produce and sell semi-conductors as long as it is profitable to do so. But this assumption may not be valid for oil. Producers may act in a way that conflicts with their economic interest, but benefits them politically. Hence there is greater reason for concern.

And by the way, someone should explain supply and demand to Jenkins. Does he seriously think that if there is a "catastrophic disruption of supplies from the Gulf," Canadian oil will be available at anything near today's prices?

Eric Krieg writes:

>>The reason we don't worry about semiconductor imports is that we assume that the producers are going to define their self-interest in economic terms

Some would say that this is not a valid assumption with regards to China. The Chinese military is very interested in "dual-use" technology. There are scenarios where our Chinese investment comes back to bite us.

In some ways the Chinese are similar to the Islamists. The Chinese Communist Party believes in territorial conquest, as evidenced by their assimilation of Tibet and their lobbing missiles at the slightest sign of Taiwanese independence. There can be no independent, majority Chinese nations other than Red China, according to their ideology.

Don't forget 2001, when the Chinese military forced one of our spyplanes down in their territoy. Juse because relations between the US and China are okay now doesn't mean that they will always be.

Bernard Yomtov writes:

Even if China did decide to cut off semi-conductor exports - wildly unlikely I think - the market is competitive and other producers would be happy to fill the gap.

And there is the major difference that, unlike oil, sem-conductors don't become increasingly expensive to make as you increase production.

Eric Krieg writes:

>>Even if China did decide to cut off semi-conductor exports - wildly unlikely I think - the market is competitive and other producers would be happy to fill the gap.

I'm not so worried about them cutting off exports (although the Chinese military, knowing that they cannot now take on the US head to head, is very interested in warfare "by other means", including economic).

I'm more worried about dual use technology. You know, Weh Ho Lee stole enough information from us for the Chinese to get a good idea how to build a neutron bomb. Now, with cheap, Chinese made computers, they can finish the job. Maybe even improve upon it.

And that's just one example of what I mean when I say that our investment in China could come back to bite us.

The Chinese are not our enemies (not in the way that the Islamists are, or even the Soviet Union was), but they're not our allies either. They have their own strategic interests (just like the Saudis do). We would be foolish not to be cognizant of that.

Eric Krieg writes:

>>And there is the major difference that, unlike oil, sem-conductors don't become increasingly expensive to make as you increase production.

Are we talking about getting oil out of the ground, or refining it into useful products?

As far as pumping it out of the ground, new oil supplies have been found much faster than has been needed in, say, the last 20 years. Logic tells you that this can't be done indefinately. But in the short term, supply is not going to be restrained by much of anything. Even if the Saudis took their fields out of production, there is a lot of supply out there. As we saw with the Iraq war, supply disruptions cause only short term price increases.

Boonton writes:

"As you can see, these ideas are preposterous, and JUST a bit fascist. But no more so than the focus on SUVs."

The most logical answer is to impose a 'homeland security' tax on fuel. Someone with 6 people in the family will find it more efficient to pack everyone into an SUV rather than buy 2 or 3 small cars. The individual driver would balance their desire for large SUV's against the cost of fuel. In effect the SUV lovers would end up financing those who bite the bullet & drive a smaller efficient car.

This most logical answer, though, is not politically viable so the 2nd best solution is to push all cars and SUV's to gradually improve their mileage.

Bernard Yomtov writes:

Eric,

The problem is not the physical supply of oil. It is the cost of extracting it. I don't doubt that there is plenty at $100/bbl. But at those, or even much lower, prices, we would be in a serious mess.

Eric Krieg writes:

>>The individual driver would balance their desire for large SUV's against the cost of fuel.

How is this any different than what happens today?

SUVs are popular for one and only one reason: Americans are rich. We are so filthy, stinking rich that we can afford to drive vehicles that get 14 mpg when gas is $1.50 per gallon.

My experience with SUVs is that, at least for the really big ones, the people who own them are people with kids. I don't see many single people driving Tahoes. So, the paradigm that SUV drivers switched out of cars is incorrect. They substituted SUVs for minivans.

Now I ask you, how much gas would be saved if people switched back to minivans? They get a little better gas mileage, but not much.

And one way that automakers are making minivans more attractive to SUV drivers is by making them more powerful. The Japanese minivans all make over 230hp, for example. That horsepower comes at the expense of mileage.

Eric Krieg writes:

>>The problem is not the physical supply of oil. It is the cost of extracting it. I don't doubt that there is plenty at $100/bbl. But at those, or even much lower, prices, we would be in a serious mess.

Yes and no. Yes, we will never find more oil supplies that are as easy to extract as Kuwaiti oil. But enough new production has come on line at reasonable extraction costs, from such places as Siberia and the west coast of Africa, that the world is still awash in oil, at least with the world economy limping along as it is.

I don't doubt that at some point the price of extracting oil is going to cause us problems. I just don't think it is going to happen anytime soon, say in the next twenty years.

Lawrance George Lux writes:

I will return to the original question. The Oil question is both economic and enviornmental. We are taking thousands of years of fossilized Carbon from the ground, and burning it in the atmosphere. The cost of Oil extraction, at least from the point of American importation, makes the possibility of synthetic fuel make from surface Carbon sources more viable. Conversion of Oceon algae for base Carbon could be concentrated and refined; at what cost, it depends on method. Conversion of Sewage and Garbage, more difficult and thereby, more expensive. The need for artificial fuel with a surface Carbon base is immense.

Importation of semi-conductors from Asia takes American jobs, and will eventually lose American the current technilogical superiority we have, as Production experience is vital to development of proper R&D. Some degree of Trade is always necessary, but are We not cutting off Our own tail in foreign outsourcing? lgl

Eric Krieg writes:

>>The need for artificial fuel with a surface Carbon base is immense.

I have one word for you: biotech.

We may be able to genetically engineer microbes to optimize ethanol production. Perhaps we could get an order of magnitude decrease in ethanol cost, which would make it competitive with gasoline as an automotive fuel.

Jim Glass writes:

"The problem is not the physical supply of oil. "

True.

"It is the cost of extracting it. I don't doubt that there is plenty at $100/bbl...."

Actually there are limitless supplies available at around $35 barrel, the level where it becomes generally ecomomic to covert stocks other than "pumped light oil" into oil products -- those other stocks being the likes of heavy oil, coal, gas, tar sands, shale, etc., which exist in quantities vasty greater than humanity will ever use.

The $35 estimate is from several years ago, of course it declines gradually over time as technology advances. And as it does these sources already are gradually coming on line.

E.g., Canadian firms currently are rapidly expanding commerical extraction of oil from the Athasbasca Oil Sands Deposit in Alberta -- which by itself holds five times all the known oil of Saudi Arabia (!) -- at a production cost of about $15/b.

The $35/b cost for such unlimited supply isn't so much -- by contrast, oil was over $50 in today's money during the 1980s boom years.

And running a modern economy on oil from tar sands and such is no dream -- one may remember that Germany largely fought WWII using oil-from-coal made with 1930s technology. Nobody at the time thought it was greatly handicapped by doing so (until we bombed the oil factories). South Africa also ran its economy largely on oil-from-coal during the embargo years. So it's not merely true that it can be done, it has been done.

The limitation on it happening today on a larger scale is that oil-from-other-stuff factories require great up-front capital investment, and companies aren't going to make that investment unless they are sure of getting their $35/b over the long run (though as the Canadians show this price is declining).

As long as OPEC -- that is the Saudis -- have the power to run the price of oil way down below that level by opening the taps on oil with a $5/b production cost, those companies aren't going to invest. But OTOH, the Saudis know they can't run the real price of oil back up to anywhere near where it was in the 1980s either. That's why they target a top price of oil at about $30b, to prevent these alternative sources from accelerating development. And over time the price of even OPEC oil must gradually decline, as it has since the 1980s.

The oil market is very anamolous because *so much* oil that can be produced *so cheaply* is sitting in such a small area under the control of a single family of former nomads.

For information purposes, here's the "USGS World Petroleum Assessment 2000" is at http://www.usgs.gov/public/press/public_affairs/press_releases/pr1183m.html

Basically it says there's maybe most of a hundred years worth of regular pumped oil available -- though that period will be lengthed as sources like Athasbasca increasingly come on line over time.

But in any event, way before that hundred years is up solar and other sources will become fully competitive with oil and we'll shift to them for their various advantages. The solar people say about 30 years.

In the late 19th Century serious British economists were really worried that there was only a finite amount of coal available to fuel the Industrial Revolution in Britain, and that when the coal ran out it would be "the end". Today there's more coal sitting in the ground literally worthless over there than they even knew they had at the time.

I'd bet that in the 22nd Century the same story will be largely true of oil.

Ray Gardner writes:

Imposing taxes on Eastern oil or adding more regulation to the auto industry is reactionary and verifiably inefficient. CAFE standards, for example, have had disastrous affects on auto safety. Econ 101 teaches us the differences between the best of intentions and real world results.

Any attempts at self-sufficiency should logically start with our own supply; namely why aren’t we making more efficient use of our own sources already and how do we correct this situation.

From there we could affect the oil trade of other countries with our own supply, even if that supply were relatively more expensive to extract. For example, if we opened up a new oil supply that was going to cost us some minimum dollar amount that was still slightly more expensive than the going rate, it would effectively cap the foreign oil prices with the mere threat of a sizeable increase in the global oil supply. And this doesn’t include hair brained ideas of timed releases of any strategic oil reserves, those do not qualify as a ‘sizeable’ increase in the global trade.

Ray Gardner writes:

And the importation of semi-conductors from Asia does not cost Americans jobs. What causes manufacturers to shift their production to Asia in the first place? Our labor is over priced for the job. So the cause of this supposed job loss is our higher standard of living and over regulated labor market.

And R&D does not suffer from this kind of foreign manufacturing, at least not necessarily. America produces more goods than ever before through the manufacturing sector, only we do it so much more efficiently now that we employ far fewer people to accomplish the job. The actual innovation is still taking place by large, technologically advanced firms seeking to increase their productivity while the literal cutting edge of innovation still happens with the micro manufacturing outfits. Machine shops employing a dozen or so people still operate in huge numbers because they are geographically closer to those that need them. They produce and begin to refine the products and subsequent components that are eventually shifted to Asia for higher level mass production.

Sam writes:

When I was working in semiconductors (at a design house, not in manufacturing) I did worry that much of the semiconductor manufacturing was overseas. Back in the mid-90s (I just googled it to March 1996), China caused some serious tensions by test firing missiles toward Taiwan, which I recall caused some minor but noticable price spikes for chips. If China actually invaded Taiwan, they could control a very large fraction of the worldwide semiconductor fab capacity.

I believe most semiconductor manufacturing moved overseas for reasons more complex than cheap labor. Probably environmental regulation was a signficant factor.

Albert Cheng writes:

Re: Driving more fuel efficient vehicles as a mwans to reduce demand for oil

Yes, you can improve the gas mileage of vehicles in two ways: (a) improve the design of the engine to make it more efficient; (b) reduce the weight of the vehicle. For option (b), there is a trade-off involved. Lighter cars are less safe. But how much more dangerous? I don't know. The question that has to be considered is - are people prepared to accept the price-higher deaths in the name of securing oil independence?

Eric Krieg writes:

>>The question that has to be considered is - are people prepared to accept the price-higher deaths in the name of securing oil independence?

I've seen estimates that the downsizing of American cars in the 1970s in response to CAFE standards caused 4000 deaths PER YEAR. Now, I ask you, is Middle East Oil funded terrorism causing that many deaths per year?

It's simply physics. A heavier car is a safer car, all other things being equal. The Insurance Institute for Highway Safety just came out with numbers showing that the most dangerous cars on the road are subcompacts like the Honda Civic and the Toyota Corrola.

As for more efficient engines, engines are becoming about 1% more efficient per year. But there is no market for increased fuel efficiency in America, so automakers are using the efficiency to raise horsepower. This is how you can get a Honda Accord, perhaps the most boring car ever made, with a 240 hp engine. You can get a Toyota Camry with a 230 hp engine. My favorite car, the Chevy Impala, is available with 240 hp. These cars get highway mileage in the high twenties, which is nothing to be impressed with.

Eric Krieg writes:

http://www.cei.org/gencon/025,01631.cfm

Fuel economy standards cost lives. Over time, the death toll eclipses that of terrorism (although perhaps in not so spectacular a fashion, and the WTC death toll could have easily been 10 times as much).

We need to be proactive, and wipe the terrorists off the face of the earth, not reacting to terrorism by driving Yugos.

Ernest McCray writes:

I would like to draw everyones attention to www.dieoff.com . We have about 50 years worth of fossil fuels to squander, then what happens?? Oil production will start to decline within the next 3 or 4 years. What do we replace it with? Tar sands won´t do it, I worked on one plant and it would take 10 to replace 1 MM bbls per day of crude oil.
Hydrogen must be produced from natural gas or oil or coal. We use about 78 MM bpd of crude, by 2020 50 MM bpd will be available.

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