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Sustainable Society:  A society that balances the environment, other life forms, and human interactions over an indefinite time period.

 

 

 

 

 


 

Peaking Of World Oil Production:

Impacts, Mitigation, & Risk Management

Hirsch, Bezdek, and Wendling

Part III. Why The Transition Will Be So Time Consuming
Part IV. Lessons And Implications From Previous Oil Supply Disruptions

 

Part III. Why The Transition Will Be So Time Consuming

 

A. Introduction

Use of petroleum is pervasive throughout the U.S. economy. It is directly linked to all market sectors because all depend on oil-consuming capital stock. Oil price shocks and supply constraints can often be mitigated by temporary decreases in consumption; however, long term price increases resulting from oil peaking will cause more serious impacts. Here we examine historical oil usage patterns by market sector, provide a summary of current consumption patterns, identify the most important markets, examine the relationship between oil and capital stock, and provide estimates of the time and costs required to transition to more energy efficient technologies that can play a role in mitigating the adverse effects of world oil peaking.

B. Historical U.S. Oil Consumption Patterns

After the two oil price shocks and supply disruptions in 1973-74 and 1979, oil consumption in the U.S. decreased 13 percent, declining from nearly 35 quads in 1973 to 30 quads in 1983. However, overall consumption continued to grow after the 1983 low and has continuously increased over the last 20 years, reaching over 39 quads in 2003, as shown in Figure III-1. Of particular note are changes in three U.S. market sectors: 1) Oil consumption in the residential sector declined from eight percent of total oil consumption in 1973 to four percent in 2003, a decrease of 50 percent; 2) Oil consumption in the commercial sector declined from five percent to two percent, decreasing 58 percent; and 3) Consumption in the electric power sector fell from 10 percent in 1973 to three percent in 2003, decreasing 70 percent. These three market sectors currently account for 1.3 quads of oil consumption annually, representing nine percent of U.S. oil demand in 2003.

Oil consumption in other market sectors did not decrease. A 140 percent growth in GDP over the 1973-2003 period made it difficult to decrease oil consumption in the industrial and transportation sectors.23 In particular, personal transportation grew significantly over the past three decades, and total vehicle miles traveled for cars and light trucks more than doubled over the period.24 From 1973 to 2003, consumption of oil in the industrial sector stayed relatively flat at just over nine quads, and the industrial sector’s share of total U.S. consumption remained between 24 and 26 percent. In sharp contrast to all other sectors, U.S. oil consumption for transportation purposes has increased steadily every year, rising from just over 17 quads in 1973 to 26 quads in 2003. By 2003, the transportation sector accounted for two-thirds of the oil consumed in the U.S.

Figure III-1. U.S. Petroleum Consumption by Sector, 1973-200325

 

C. Petroleum in the Current U.S. Economy

The 39 quad consumption of oil in the U.S. in 2003 is equivalent to 19.7 million barrels of oil per day (MM bpd), including almost 13.1 MM bpd consumed by the transportation sector and 4.9 MM bpd by the industrial sector, as shown in Table III-1. This table also shows the petroleum fuel types consumed by each sector.

Motor gasoline consumption accounted for 45 percent of U.S. daily petroleum consumption, nearly 9 MM bpd, almost all of which was used in autos and light trucks. Distillate fuel oil was the second-most consumed oil product at almost 3.8 MM bpd (19 percent of consumption), and most was used as diesel fuel for medium and heavy trucks. Finally, the third most consumed oil product was liquefied petroleum gases, at 2.2 MM bpd equivalent (11 percent of total consumption), most of which was used in the industrial sector as feedstock by the chemicals industry. Only two other consuming areas exceeded the 1 MM bpd level: kerosene and jet fuel in the transportation sector, primarily for airplanes, and "other petroleum" by the industrial sector, primarily petroleum feedstocks used to produce non-fuel products in the petroleum and chemical industries.

Table III-1.
Detailed Consumption of Petroleum in the U.S.
by Fuel Type and Sector -2003
26
(Thousands of barrels per day)

  Residential Commercial Industrial Transportation Electric
Power
Total
Motor Gasoline   20 159 8,655   8,844
Distillate Fuel Oil 421 236 603 2,455 51 3,766
LPG 429 76 1,648 10   2,163
Kerosene/Jet Fuel 27 9 7 1,608   1,651
Residual   30 87 250 291 658
Asphalt & Road Oil     513     513
Petroleum Coke     398   61 459
Lubricants     78 73   151
Aviation Gas       18   18
Other Petroleum     1,435     1,435
Total 877 371 4,928 13,079 403 19,658

 

D. Capital Stock Characteristics in the Largest Consuming Sectors

Energy efficiency improvements and technological changes are typically incorporated into products and services slowly, and their rate of market penetration is based on customer preferences and costs. In the 1974-1983 period, oil prices ratcheted up to newer, higher levels, which lead to significant energy efficiency improvements, energy fuel switching, and other more general technological changes. Some changes came about due to legislative mandates (corporate average fuel economy standards, CAFE) or subsidies (solar energy and energy efficiency tax credits), but many were the result of economic decisions to reduce long-term costs. Under a normal course of replacement based on historical trends, oil-consuming capital stock has been replaced in the U.S. over a period of 15 to 50 years and has cost consumers and businesses trillions of dollars, as discussed below.

Automobiles represent the largest single oil-consuming capital stock in the U.S. 130 million autos consume 4.9 MM bpd, or 25 percent of total consumption, as shown in Table III-2. Autos remain in the U.S. transportation fleet, or rolling stock, for a long time. While the financial-based current-cost, average age of autos is only 3.4 years, the average age of the stock is currently nine years.

Recent studies show that one half of the1990-model year cars will remain on the road 17 years later in 2007. At normal replacement rates, consumers will spend an estimated $1.3 trillion (constant 2003 dollars) over the next 10-15 years just to replace one-half the stock of automobiles.27

Table III-2. U.S. Capital Stock Profiles

  Autos Light Trucks Heavy Trucks Air Carriers
Oil consumption (MM bpd)28 4.9 3.6 3.0 1.1
   Share of the U.S. total 25% 18% 16% 6%
Current cost of net capital stock (billion $)29 $571 B $435 B $686 B $110 B
Fleet size30 130 MM 80 MM 7 MM 8,500
Number of annual purchases 8.5 MM 8.5 MM  500,000 400
Average age of stock (years) 9 7 9 13
    Median lifetime (years) 17 16 28 22

 
A similar situation exists with light trucks (vans, pick-ups, and SUVs), which consume 3.6 MM bpd of oil, accounting for 18 percent of total oil consumption. Light trucks are depreciated on a faster schedule, and their financial-based current-cost average age is 2.9 years. However, the average physical age of the rolling stock is seven years, and the median lifetime of light trucks is 16 years. At current replacement rates, one-half of the 80-million light trucks will be replaced in the next 9-14 years at a cost of $1 trillion.

Seven million heavy trucks (including buses, highway trucks, and off-highway trucks) represent the third largest consumer of oil at 3.0 MM bpd, 16 percent of total consumption. The current-cost average age of heavy trucks is 5.0 years, but the median lifetime of this equipment is 28 years. The disparity in the average age and the median lifetime estimates indicate that a significant number of vehicles are 40-60 years old. At normal replacement levels, one-half of the heavy truck stock will be replaced by businesses in the next 15-20 years at a cost of $1.5 trillion.

The fourth-largest consumer of oil is the airlines, which consume the equivalent of 1.1 MM bpd, representing six percent of U.S. consumption. The 8,500 aircraft have a current-cost average age of 9.1 years, and a median lifetime of 22 years. Airline deregulation and the events of September 11, 2001, have had significant effects on the industry, its ownership, and recent business decisions. At recent rates, airlines will replace one-half of their stock over the next 15-20 years at a cost of $250 billion.

These four capital stock categories cover most transportation modes and represent 65 percent of the consumption of oil in the U.S.31 The three largest categories of autos, light trucks, and heavy trucks all utilize the internal combustion engine, whether gasoline- or diesel-burning. Clearly, advancements in energy efficiency and replacement in this capital stock (for instance, electric hybrid engines) would help mitigate the economic impacts of rising oil prices caused by world oil peaking. However, as described, the normal replacement rates of this equipment will require 10-20 years and cost trillions of dollars. We cannot conceive of any affordable government-sponsored "crash program" to accelerate normal replacement schedules so as to incorporate higher energy efficiency technologies into the privately-owned transportation sector; significant improvements in energy efficiency will thus be inherently time-consuming (of the order of a decade or more).

When oil prices increase associated with oil peaking, consumers and businesses will attempt to reduce their exposure by substitution or by decreases in consumption. In the short run, there may be interest in the substitution of natural gas for oil in some applications, but the current outlook for natural gas availability and price is cloudy for a decade or more. An increase in demand for electricity in rail transportation would increase the need for more electric power plants. In the short run, much of the burden of adjustment will likely be borne by decreases in consumption from discretionary decisions, since 67 percent of personal automobile travel and nearly 50 percent of airplane travel are discretionary.32

E. Consumption Outside the U.S.

Oil consumption patterns differ in other countries. While two-thirds of U.S. oil use is in the transportation sector, worldwide that share is estimated about 55 percent. However, that difference is narrowing as world economic development is expanding transportation demands at an even faster pace. A portion of non-transportation oil consumption is switchable. As stated by EIA, “Oil’s importance in other end-use sectors is likely to decline where other fuels are competitive, such as natural gas, coal, and nuclear, in the electric sector, but currently there is no alternative energy sources that compete economically with oil in the transportation sector.”33 Because sector-by-sector oil consumption data for many counties is unavailable, a detailed analysis of world consumption was beyond the scope of this report. Nevertheless, it is clear that transportation is the primary market for oil worldwide.

F. Transition Conclusions

Any transition of liquid fueled, end-use equipment following oil peaking will be time consuming. The depreciated value of existing U.S. transportation capital stock is nearly $2 trillion and would normally require 25 – 30 years to replace. At that rate, significantly more energy efficient equipment will only be slowly phased into the marketplace as new capital stock gradually replaces existing stock. Oil peaking will likely accelerate replacement rates, but the transition will still require decades and cost trillions of dollars.

 

IV. Lessons And Implications From Previous Oil Supply Disruptions

A. Previous Oil Supply Shortfall and Disruptions

There have been over a dozen global oil supply disruptions34 over the past half century, as summarized in Figure IV-1.

Figure IV-1. Global Oil Supply Disruptions: 1954-2003


Briefly,

  • Disruptions ranged in duration from one to 44 months. Supply shortfalls were 0.3 - 4.6 MM bpd, and eight resulted in average gross supply shortfalls of at least 2 MM bpd.
     

  • Percentage supply shortfalls varied from roughly one percent to nearly 14 percent of world production.
     

  • The most traumatic disruption, 1973-74, was not the most severe, but it nevertheless lead to greatly increased oil prices and significant worldwide economic damage.
     

  • The second most traumatic disruption, 1979, was also neither the longest nor the most severe.

For purposes of this study, the 1973-74 and 1979 disruptions are taken as the most relevant, because they are believed to offer the best insights into what might occur when world oil production peaks.

B. Difficulties in Deriving Implications From Past Experience

Over the past 30 years, most economic studies of the impact of oil supply disruptions assumed that the interruptions were temporary and that each situation would shortly return to “normal.” Thus, the major focus of most studies was determination of the appropriate fiscal and monetary policies required to minimize negative economic impacts and the development of policies to help the economy and labor market adjust until the disruption ended.35 Few economists considered a situation where the oil supply shortfall may be long-lived (a decade or more).

Since 1970, most large oil price increases were eventually followed by oil price declines, and, since these cycles were expected to be repeated, it was generally felt that “the problem will take care of itself as long at the government does nothing and does not interfere.”36 The frequent and incorrect predictions of oil shortfalls have been often used to discredit future predictions of a longer-term problem and to discredit the need for appropriate long-term U.S. energy policies.

C. How Oil Supply Shortfalls Affect the Global Economy

Oil prices play a key role in the global economy, since the major impact of an oil supply disruption is higher oil prices.37 Oil price increases transfer income from oil importing to oil exporting countries, and the net impact on world economic growth is negative. For oil importing countries, increased oil prices reduce national income because spending on oil rises, and there is less available to spend on other goods and services.38 Not surprisingly, the larger the oil price increase and the longer higher prices are sustained, the more severe is the macroeconomic impact.

Higher oil prices result in increased costs for the production of goods and services, as well as inflation, unemployment, reduced demand for products other than oil, and lower capital investment. Tax revenues decline and budget deficits increase, driving up interest rates. These effects will be greater the more abrupt and severe the oil price increase and will be exacerbated by the impact on consumer and business confidence.

Government policies cannot eliminate the adverse impacts of sudden, severe oil disruptions, but they can minimize them. On the other hand, contradictory monetary and fiscal policies to control inflation can exacerbate recessionary income and unemployment effects. (See Appendix II for further discussion of past government actions).

D. The U.S. Experience

As illustrated in Figure IV-2, oil price increases have preceded most U.S. recessions since 1969, and virtually every serious oil price shock was followed by a recession. Thus, while oil price spikes may not be necessary to trigger a recession in the U.S., they have proven to be sufficient over the past 30 years.

E. The Experience of Other Countries

1. The Developed (OECD) Economies

Estimates of the damage caused by past oil price disruptions vary substantially, but without a doubt, the effects were significant. Economic growth decreased in most oil importing countries following the disruptions of 1973-74 and 1979-80, and the impact of the first oil shock was accentuated by inappropriate policy responses.39 Despite a decline in the ratio of oil consumption to GDP over the past three decades, oil remains vital, and there is considerable empirical evidence regarding the effects of oil price shocks:

Figure IV-2. Oil Prices and U.S. Recessions: 1969-200340

 

  • The loss suffered by the OECD countries in the 1974/-75 recession amounted to $350 billion (current dollars) / $1.1 trillion 2003 dollars, although part of this loss was related to factors other than oil price.41
     

  • The loss resulting from the 1979 oil disruption was about three percent of GDP ($350 billion in current dollars) in 1980 rising to 4.25 percent ($570 billion) in 1981, and accounted for much of the decline in economic growth and the increase in inflation and unemployment in the OECD in 1981-82.42
     

  • The effect of the 1990-91 oil price upsurge was more modest, because price increases were smaller; they did not persist; and oil intensity in OECD countries had declined.
     

  • Although oil intensity and the share of oil in total imports have declined in recent years, OECD economies remain vulnerable to higher oil prices, because of the “life blood” nature of liquid fuel use.

    2. Developing Countries

Developing countries suffer more than the developed countries from oil price increases because they generally use energy less efficiently and because energy-intensive manufacturing accounts for a larger share of their GDP. On average, developing countries use more than twice as much oil to produce a unit of output as developed countries, and oil intensity is increasing in developing countries as commercial fuels replace traditional fuels and industrialization/urbanization continues.43

The vulnerability of developing countries is exacerbated by their limited ability to switch to alternative fuels. In addition, an increase in oil import costs also can destabilize trade balances and increase inflation more in developing countries, where financial institutions and monetary authorities are often relatively unsophisticated. This problem is most pronounced for the poorest developing countries.

F. Implications

    1. The World Economy

A shortfall of oil supplies caused by world conventional oil production peaking will sharply increase oil prices and oil price volatility. As oil peaking is approached, relatively minor events will likely have more pronounced impacts on oil prices and futures markets.

Oil prices remain a key determinant of global economic performance, and world economic growth over the past 50 years has been negatively impacted in the wake of increased oil prices. The greater the supply shortfall, the higher the price increases; the longer the shortfall, the greater will be the adverse economic affects.

The long-run impact of sustained, significantly increased oil prices associated with oil peaking will be severe. Virtually certain are increases in inflation and unemployment, declines in the output of goods and services, and a degradation of living standards. Without timely mitigation, the long-run impact on the developed economies will almost certainly be extremely damaging, while many developing nations will likely be even worse off.44

The impact of oil price changes will likely be asymmetric. The negative economic effects of oil price increases are usually not offset by the economic stimulus resulting from a fall in oil prices. The increase in economic growth in oil exporting countries provided by higher oil prices has been less than the loss of economic growth in importing countries, and these effects will likely continue in the future.45

    2. The United States

For the U.S., each 50 percent sustained increase in the price of oil will lower real U.S. GDP by about 0.5 percent, and a doubling of oil prices would reduce GDP by a full percentage point. Depending on the U.S. economic growth rate at the time, this could be a sufficient negative impact to drive the country into recession. Thus, assuming an oil price in the $25 per barrel range —the 2002-2003 average, an increase of the price of oil to $50 per barrel would cost the economy a reduction in GDP of around $125 billion.

If the shortfall persisted or worsened (as is likely in the case of peaking), the economic impacts would be much greater. Oil supply disruptions over the past three decades have cost the U.S. economy about $4 trillion, so supply shortfalls associated with the approach of peaking could cost the U.S. as much as all of the oil supply disruptions since the early 1970s combined.

The effects of oil shortages on the U.S. are also likely to be asymmetric. Oil supply disruptions and oil price increases reduce economic activity, but oil price declines have a less beneficial impact.46 Oil shortfalls and price increases will cause larger responses in job destruction than job creation, and many more jobs may be lost in response to oil price increases than will be regained if oil prices were to decrease. These effects will be more pronounced when oil price volatility increases as peaking is approached. The repeated economic and job losses experienced during price spikes will not be replaced as prices decrease. As these cycles continue, the net economic and job losses will increase.

Sectoral shifts will likely be pronounced. Even moderate oil disruptions could cause shifts among sectors and industries of ten percent or more of the labor force.47 Continuing oil shortages will likely have disruptive inter-sectoral, inter-industry, and inter-regional effects, and the sectors that are (both directly and indirectly) oil-dependant could be severely impacted.48

Monetary policy is more effective in controlling the inflationary effects of a supply disruption than in averting related recessionary effects.49 Thus, while appropriate monetary policy may be successful in lessening the inflationary impacts of oil price increases, it may do so at the cost of recession and increased unemployment. Monetary policies tend to be used to increase interest rates to control inflation, and it is the high interest rates that cause most of the economic damage. As peaking is approached, devising appropriate offsetting fiscal, monetary, and energy policies will become more difficult. Economically, the decade following peaking may resemble the 1970s, only worse, with dramatic increases in inflation, long-term recession, high unemployment, and declining living standards.50

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Continue to Part V: Learning From the Natural Gas Experience & Part VI: Mitigation Options And Issues.
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