Economics Backstop Technology/Sustainability Peak Oil

Econ 132
Energy Economics
Backstop Technology/Sustainability
Peak Oil
Oil Supply/Price Shocks
Role of Price Elasticities
Backstop Energy Source
• Energy source that at a sufficiently high price becomes
competitive with an existing source
• Examples
• As gasoline price rise, biofuels become competitive
• As natural gas price rise, solar becomes competitive
• Implications
• Fuel switching over time
• Shifts price of current fuel downward
• Provides an upper bound on price (for all substitutable uses)
• Hotelling rents still need to exist so whole time path shifts downward
• Lower price encourages more consumption
• Perverse incentives can exist to keep backstop technologies off market
Two Possible Backstop Paths
Motor Vehicle Fuel from Oil, Biofuels, and Coal
Relationship to Sustainability
• Sustainability is often loosely and ill-defined
• By some definitions, almost nothing we do is
sustainable
• More operational definitions are usually built on
formal ideas put forward by two economists: John
Hartwick and Robert Solow
• Basic notion is that sustainability ensures that
future generations are provided the resources to
ensure they can have as high a level of utility as
the current generation has
• Most common popular definition:
• Sustainable development is development that meets the
needs of the present without compromising the ability
of future generations to meet their own needs.
• Put forth by the Brundtland chaired World Commission
on Environment and Development (1987) report
entitled Our Common Future
• Few policymakers and almost none of the public
recognize what it takes to fulfill the Hartwick-Solow
condition of non-declining utility
• Technological progress faster then population growth
• Resource saving technological progress
• Invest the Hotelling resource rents into replicable capital
• Human capital or renewable resources
Review of Hotelling Model
• Owner of exhaustible resource (e.g., oil well, coal
mine) determines how much to extract each period
• Maximizes net present value with stock constrait
• Key principle is that discounted resource rent is the
same in all time periods
• At the margin owner must be indifferent to the period in
which the last unit of stock is extracted
• With constant price and cost function parameters,
basic model trades minimizing cost by equalizing
extraction across all time periods with net revenue
being worth less in later periods due to discounting
• The key feature is setting discounted net revenue
in each time period equal to λ
• This ties all the time periods together using r
• In a model with constant prices and zero marginal
cost price rises exponentially at rate r so that:
• pi=(1+r)ip0
• Simple versions of the model have the quantity
produced starting high and falling over time
• Price does the opposite
• More realistic version of the Hotelling model produce
very different patterns of production/price by allowing:
• Changes in demand over time
• Forms of industrial organization other the pure competition
and monopoly
• Changes in the cost function (technological change)
• New discoveries
• Backstop technologies (particularly if they vary over time)
• Various types of uncertainty
Inflation-adjusted price of crude oil
(West Texas Intermediate, 2008 dollars)
0
50
100
150
1945 1955 1965 1975 1985 1995 2005
Hubbert Peak Oil Theory
• Oil production in a particular region/country has a bell
shape distribution (normal/logistic)
• Result of lots of different exploration decisions with
production trailing 3+ decades
• Predicted peak for continental U.S. of around 1970
• Approximately correct peak annual production and cumulative
• Predicted peak for World around 2005
• Approximately correct for cumulative production
• Substantially under-predicted (32%) annual production
• Intense debate as to whether we are at peak oil production
• Implication if we are:
• Short term: dramatically higher gasoline prices
• Higher prices for oil intensive products (food, plastic)
• Long term: quicker substitution toward
• Higher gas mileage vehicles
• Alternative fuels
• Hubbert view of world oil production highly influential
• Follows from engineering not an economic perspective
• Does not logically follow from simple Hotelling theory
• But maybe consistent with it given some reasonable
assumptions about demand over time and technological change
• In particular, demand low initially and increases over time
• See Holland (2008) paper for more details
• Underlying mathematical model is usually given as:
• Q(t) = Q(Max)/(1 – αEXP(-βt)
• t(Max) = (1/β)ln(α)
• Variant of logistic growth function
• Surprising disagreements of statistical fitting of model
Hubbert’s 1956 Prediction
Peak Oil: Discovery and Production
Eventual Gross New Capacity from Projects Coming on Line in 2008
Global decline rate of 4%/year means need 3.4 mb/d in new gross capacity
every year to keep global production from falling
United States—Texas, Alaska, Total
Other Indicators of Change

Distribution of Primary Energy Use