Friday, February 10, 2012

The Economics of Peak Oil

James Hamilton, professor of economics at UCSD, runs the useful Econbrowser site providing links to a diverse set of resources dealing with the analysis of current economic conditions and policy.

He is also responsible for OIL PRICES, EXHAUSTIBLE RESOURCES, AND ECONOMIC GROWTH, an analysis of the implications of peak oil. Specifically, the paper analyzes data spanning the life of the oil industry in order to detail the phenomenal increase in global crude oil production over the last century and a half. The analysis demonstrates that a key feature of the growth in production has been exploitation of new geographic areas rather than application of better technology to existing sources, which suggests the end of that era could come soon. The paper then turns to an analysis of the history of temporary supply dislocations in an attempt to come to grips with the potential economic consequences of the peaking of conventional crude oil production.

One of the more interesting sections discusses the price elasticity of demand over the long run and whether or not the reductions in demand that accompanied the run up of oil prices during the 70's and 80's were historically unique.

Here one might take comfort from the observation that, given time, the adjustments of demand to the oil price increases of the 1970s were significant. For example, U.S. petroleum consumption declined 17% between 1978 and 1985 at the same time that U.S. real GDP increased by 21%. However, Dargay and Gately (2010) attributed much of this conservation to one-time effects, such as switching away from using oil for electricity generation and space heating, that would be difficult to repeat on an ongoing basis. Knittel (forthcoming) was more optimistic, noting that there has been ongoing technological improvement in engine and automobile design over time, with most of this historically being devoted to making cars larger and more powerful rather than more fuel-efficient. If the latter were to become everyone’s priority, significant reductions in oil consumption might come from this source.


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