Peak-Oil Economics Unscrambled

History shows that the world economy did not collapse when oil supply peaked sharply in 1979, so where have the peak-oil geologists gone wrong in their thinking? Peak-oil’s Mad Max economics assumes markets work like this:

Confused economics: The demand for oil increases as wealth and population increase. The supply of oil will fall after peak oil. Therefore supply will not meet demand, and a crisis will destroy the world economy.

Basic economics says that unless the government interferes, markets will work like this:

Basic economics: The demand for oil increases as wealth and population increase. The supply of oil will fall after peak oil. Falling supply will cause the price to rise, and that will cause people to use less. Demand (oil use) will fall until it equals supply.

That is what happened in the early 1980s. Deffeyes, the Princeton geologist, almost succeeds in putting the two together. First he tells us,

For the first time since the Industrial Revolution, the geological supply of an essential resource will not meet the demand. —Deffeyes, Beyond Oil

This is partly right. Markets have worked for all essential resources. But Deffeyes is worried that the law of supply and demand is about to break down for the first time in 250 years. Other peak-oil proponents blame this breakdown on markets, but Deffeyes, remembers the real reason: “Virtually all economists visualize it as price increases that bring supply and demand into a new equilibrium.” Exactly. By equilibrium he just means supply equals demand. But after remembering the reason, he rejects it.

“That outlook is widespread;” Deffeyes says, “it must be something that Gerber puts in baby food.” He doesn’t believe that price will do the job. Instead, he has another theory, and gives two examples from history:

• “Historically, President Nixon regulated the oil price.”

• “President Roosevelt had us carrying little red and blue gasoline ration coupons.”

Deffeyes is right that, if the government intervenes, it can break the market and then demand will fail to equal supply. According to Deffeyes this is why, after 250 years, the market for oil will break down when oil production peaks.

Deffeyes argues that the government will intervene because “When the situation gets serious, there will be immense political pressure to ‘do something.’” But Deffeyes overlooks what happened after Nixon regulated the price of oil. By the end of the OPEC crisis, virtually the entire elaborate system of oil-price controls, gasoline-price controls, and quantity rationing had been eliminated. This took immense political wrangling, but eventually there was widespread agreement. The country learned something back then, and I don’t think it’s about to forget it and cause the collapse of the American economy—or the world economy.