April 12, 2007

The Foolish Economics of Conservation

Two of the silliest things that one can do in looking at the world is to assume that a particular factor is a variable when in reality it is a constant and vice versa. It is especially bad in the prediction business as Victor Davis Hanson shows in his recent analysis on oil. It's quite poor.

First the good:

What it does mean, though, is that the vast imported-petroleum needs of the West, India and China, and the resulting huge profits that pour into oil-exporting states, have super-sized the Middle East’s problems.

Currently, much of the Islamic world is struggling to come to grips with modernity and globalization. Yet while the West pays little attention to disenchanted Muslims in India, Indochina or Malaysia, we focus our attention on Iranian and Arab radicals. They alone, thanks to oil, have the cash to fund jihadists and hate-filled madrassas.

Then the bad:

If the United States could curb its voracious purchases of foreign oil by using conservation, additional petroleum production, nuclear power, alternate fuels, coal gasification and new technologies, the world price might return to below $40 a barrel.

That decline would dry up the oil profits of those in the Middle East who now so desperately use them to ensure that their own problems must also be the world’s.

The ugly truth is that the US is a mature economy and conservation is really only going to affect the marginal demand on petroleum. It might slow down the increase. But there are literally billions of new sources of demand in the form of the chinese and indian consumer out there and their basic needs for a high energy lifestyle have not been met. High petroleum prices have been and will continue to slow their entry into the market but conservation that lowers western consumption will allow marginal asian consumers to enter into the market and the demand overhang is huge. No reasonable level of conservation of 300 million americans will offset the demand of 2 billion indians and chinese (leaving off the vietnamese et al who are also coming on-line). High prices will remain until the overhang of consumers is settled.

Shifting to a multi-fuel economy where energy inputs like bio-fuels, petroleum, wind, solar, et al. go through an energy middleware transformation (electricity and hydrogen are the two major contenders) would have a much more profound effect as the barrier to entry of new producers all over the world would dilute OPEC producer power. The increase in possible energy sources and overall usable energy will reduce the potential consumer overhang much more rapidly than any possible conservation measures could.

But beyond speeding up the day when energy prices can start coming down again, enlarging the producer pie reduces OPEC influence by making the removal of any particular OPEC member from the markets a sustainable enterprise. Right now the Kingdom of Saudi Arabia produces so much of the world's transport energy that a regime change would be catastrophic. If the percentage of world supply satisfied by KSA drops below a certain level, they lose their "get out of jail free card" and their behavior in supporting terrorism through the madrassas they fund will end, one way or another.

Worldwide demand outside of the US is not a constant. It is a variable and one that is significantly changing year to year, mostly in Asia. The very good changes in India and the PRC, liberating the free market in both countries will put (in fact are already putting) huge pressure upwards on prices. All we can do is figure out how to increase the supply pie in like fashion. Conservation will simply not get us there.

Posted by TMLutas at April 12, 2007 04:56 PM