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What happens when oil does peak?

by Joel Bainerman

Peak oil is often referred to as "Hubberts Peak", a geophysicist who observed that oil well production followed a bell curve. According to the mainstream, convention view, peak oil is set to occur around 2006-2008. When peak oil occurs, production will decline approximately 3% per year at a time where global demand is increasing at 3% per year.

What will all this mean for you and me- the average folk? Which industries will suffer the most- and which will strengthen as the new situation takes hold?

If and when oil prices start to rise substantially, it will undoubtedly translate into strong commodity based inflation. Ultimately, as the price of oil rises it will cause a severe contraction in the world economy. Most observers of this occurrence agree that this will translate into higher prices all the way down the food chain- literally- right down to bread and fruit- as not only road and air transportation will be affected directly but the price of nearly ever commodity and product consumed in the world economy will be impacted indirectly.

When world petroleum production peaks, energy prices will go up dramatically. There will be a recession similar to the recessions that followed the energy price increases of 1974 and 1979, but with one difference: the US Federal Reserve Bank is much more active in setting economic policy than it was then, and its main focus is fighting inflation, so we can expect much lower inflation and much higher unemployment than in the 1970s. As interest rates soar, housing prices will fall and the stock market will suffer.

Eventually, the rest of the decline in oil production would have to be absorbed by a prolonged economic depression. Whenever energy prices soar, the Fed will raise interest rates until they have slowed the economy enough to stop inflation. To keep the demand for energy from exceeding the physical supply, they might have to reduce the GDP by 10 or 15 percent over 15 or 20 years. That could mean unemployment over 20 percent - about as high as it was during the worst years of the Great Depression.

Says David Petch of the Market Letters Digest newsletter:

"High oil prices around $160/barrel would eventually collapse to around $30/barrel. In 2012, should that occur, it would have a positive effect on agriculture, since food would be able to be produced cheaper. However, a decline in oil prices would signal a collapse in exploration, which would only add to energy crises in the future. A decline in oil to such a level would not be a permanent thing. It would likely return to the former level of $160/barrel and remain there, rising in price as it becomes more scarce. The wild fluctuations will hurt most, since it translates into oscillating inflation/deflation cycles"

Which industries will be affected most by the rising price of petroleum?

Food and agriculture industries

According to Matt Savinar, proprietor of lifeaftertheoilcrash:

Petrochemicals are key components to much more than just the gas in your car.

Geologist Dale Allen Pfeiffer points out that approximately 10 calories of fossil fuels are required to produce every 1 calorie of food eaten in the US. In the US, the average piece of food is transported 1,500 miles before it gets to your plate.

The size of this ratio stems from the fact that every step of modern food production is fossil fuel and petrochemical powered.

Vast amounts of oil and gas are used as raw materials and energy in the manufacture of fertilizers and pesticides, and as cheap and readily available energy at all stages of food production: from planting, irrigation, feeding and harvesting, through to processing, distribution and packaging. In addition, fossil fuels are essential in the construction and the repair of equipment and infrastructure needed to facilitate this industry, including farm machinery, processing facilities, storage, ships, trucks and roads. If the price of oil rises substantially- all of these sectors of the food industry will have to pass on the extra costs to the consumer.

Commercial food production is oil powered. Most pesticides are petroleum- (oil) based, and all commercial fertilizers are ammonia-based. Ammonia is produced from natural gas. Oil based agriculture is primarily responsible for the world's population exploding from 1 billion at the middle of the 19th century to 6.3 billion at the turn of the 21st Oil allowed for farming implements such as tractors, food storage systems such as refrigerators, and food transport systems such as trucks

According to Matt Savinar, proprietor of lifeaftertheoilcrash:

As oil production went up, so did food production. As food production went up, so did the population. As the population went up, the demand for food went up, which increased the demand for oil. Oil is also largely responsible for the advances in medicine that have been made in the last 150 years. Oil allowed for the mass production of pharmaceutical drugs, and the development of health care infrastructure such as hospitals, ambulances, roads, etc.

Colin J. Campbell, one of the world's leading oil industry analysts, claims:

“The world's economy has been driven by an abundant supply of cheap oil-based energy for the best part of this century. The coming oil crisis will accordingly be an economic and political discontinuity of historic proportions, as the world adjusts to a new energy environment."

We are now at a point where the demand for food/oil continues to rise, while our ability to produce it in an affordable fashion is about to drop. Within a few years of Peak Oil occurring, the price of food will skyrocket because the cost of fertilizer will soar. The cost of storing (electricity) and transporting (gasoline) the food that is produced will also rise starkly.

A sharp increase in the price of oil or a reduction of oil supplies could present a far more serious threat to food security and is likely to as oil enters its depletion phase. Food production and distribution, as they are organized today, would not be able to function. The alternatives, in the form of sustainable agriculture and local food supplies which minimize the use of crude oil, are currently unable to respond to increased demand due to low investment and capacity. Localising the food system will require significant diversification, research, and public investment.

According to financial analyst Norman Church, as a result, the contemporary food system may be inherently unsustainable.

According to Matt Savinar, proprietor of lifeaftertheoilcrash:

"Oil is required for a lot more than just food, medicine, and transportation, " he says. "It is also required for nearly every consumer item, water supply pumping, sewage disposal, garbage disposal, street/park maintenance, hospitals and health systems, police, fire services and national defence.

Church states part of the solution will be to localize the food system. Production needs to be located as near to the consumer as possible. When applied to food supply, local food systems in the form of home-delivery box schemes, farmers’ markets and shops selling local produce would replace imported and centrally distributed foodstuffs.

Some analysts predict that by 2030, the cost to transport fresh fruits and vegetables from foreign producers will become so burdensome that there will be a major resurgence in local agricultural production: e.g. truck gardening, community supported agriculture, and commercial greenhouses.

One sector of agriculture likely to benefit from the rise in the price of oil is organic farming. Organic gardeners, less reliant on expensive pesticide inputs, will become increasingly competitive at the local and regional level. A return to interest in canning and consumption of winter root crops can also be expected

Other industries to be affected by "Peak Oil"

According to Matt Savinar, proprietor of lifeaftertheoilcrash:

It's not just transportation and agriculture that are entirely dependent on abundant, cheap oil. Modern medicine, water distribution, and national defense are each entirely powered by oil and petroleum derived chemicals.

Most of the consumer goods we buy are made with plastic, which is derived from oil.

All manufacturing processes consume huge amounts of oil. For instance, the average car - including hybrids - consumes the energy contained in 25-50 barrels (or about 1,200-2,400 gallons) of oil during its construction, while the average computer consumes 10 times its weight in fossil fuels during its construction.

All electrical devices - including solar panels and windmills - make use of silver, copper, and/or platinum, all of which are discovered, extracted, transported, and fashioned using oil-powered machinery.

One industry likely to benefit from "Peak Oil" is the recycling markets for certain commodities. For instance, used materials that were energy intensive to produce, like ceramic sinks, aluminum canoes, stainless steel grilles, will become very cost effective to recycle.

New economy and technology companies

Although it sounds strange- an industry likely to feel the effects of the rise in the price of oil is the dot-com sector.

The oil shock could have adverse effects for new-economy companies. One

immediate concern is that delivery services FedEx and UPS will raise their rates

to cover higher fuel costs. Online retailers have built their reputations on cheap prices and fast delivery. Higher transportation costs could hurt their operations.

Some dot-com companies, however, may find good news in all this. Companies that

sell oil through online marketplaces such as Petroleum Electronic Pricing

Exchange (Pepex) and American Petroleum Exchange say business is up because high

prices mean buyers are looking for ways to cut costs.

"Larger buyers are seeking all kinds of alternatives to traditional buying

methods because they are faced with the higher cost of fuel, says Stephen Gloyd, senior VP for American Petroleum Exchange, a new b-to-b fuel exchange that counts FedEx, UPS and Wal-Mart as its customers. "They are doing everything they can to create some stabilization of prices and make sure they get enough product,"

Macro economic effects of "Peak Oil"

According to Matt Savinar, proprietor of lifeaftertheoilcrash:

Most people new to the idea of Peak Oil tend focus on finding alternatives to oil, while wholly ignoring the more fundamental issue: the ramifications of Peak Oil on our monetary system.

If the Federal Reserve raises interest rates, it could not only slow the whole economy but could also hamper investment in high technology.

"People often underestimate how cyclical tech spending and stocks are," says Martin Brookes, senior global economist at Goldman Sachs in London. "To the extent that high oil prices slow the U.S. economy, that will ripple through the technology sector as

well."

Brookes expects the rise in oil prices during the past 18 months will shave one-quarter to three-quarters of a percentage point off the growth of the world's major industrialized countries next year.

It's not enough to push the world into a recession. But it's enough to take the edge off quite robust growth.

Another less tangible consequence of higher oil prices is that they could depress consumer confidence. If people lose confidence, they start scaling back on purchases, and that is one way to get into a recession. Oil-price increases certainly have brought on recessions in the past and still have the potential to do so."

Binit Patel, an economist at Goldman Sachs, estimates that $50 oil would only add 1% to most western countries' consumer price index . However, it would have a bigger effect in the US, where CPI will rise 1.7%. This will undoubtedly mean the world will become a higher interest-rate place than it is today.

Patel estimates that after one year of oil prices at $50, G7 GDP would be 3% weaker than it otherwise might have been. Goldman Sachs equity strategists believe that each sustained 10% rise in oil prices knocks 8% off the value of European equities. US equities, meanwhile, are already falling in response to rising oil.

Although the initial effect of higher oil prices is inflationary, ultimately the result is deflation. Deflation in growth forecasts, deflation in stock prices and deflation in jobs. That means overall tax-take will be lower than he expected, which in turn means his budget deficit will remain high.

According to Matt Savinar, proprietor of lifeaftertheoilcrash:

Consequently, a declining supply of oil must be accompanied by either a declining supply of money or by hyperinflation. In either case, the result for the global banking system is the same: total collapse. This may be what led Stephen Roach, the chief economist for investment bank Morgan Stanley, to recently state,

"I fear modern day central banking is on the brink of systemic failure."

Within a few months of global oil production hitting its peak, it will become impossible to dismiss the decline in supply as a merely transitory event. Once this occurs, you can expect traders on Wall Street to quickly bid the price up to the $200 per barrel range as they realize the world is now in a state of permanent oil scarcity.

With oil at $200 per barrel, gas prices will hit about $10 per gallon virtually overnight. This will cause a rapid breakdown of trucking industries and transportation networks. Importation and distribution of food, medicine, and consumer goods will grind to a halt.

The collapse will be hastened by the fact that the US national debt will become completely unsustainable once the price of oil gets into the $100 range.

Once this mark is passed, the nations of the world will have no choice but to pull their investments out of the US while simultaneously switching from the dollar to the euro as the reserve currency for oil transactions. Along with the breakdown of domestic transportation networks, the global financial shift away from the dollar will wholly shatter the US economy.

Every dollar increase in the price of a barrel of imported oil increases the size of the U.S. trade deficit, which puts more pressure on the value of the U.S. dollar, which leads to a weaker dollar, which makes OPEC countries want to raise the dollar-denominated price of a barrel of oil to make up for the dollar’s fall, and so on.

Joel Bainerman

Joel Bainerman has been a writer on economic and Middle East issues since 1983. His published archive can be viewed on his website at www.joelbainerman.com

His new online, multi-lingual alternative newsmagazine for Europeans can be viewed at www.theotherside.org.uk