Have We Already Passed World Peak Oil And World Peak Coal?

Most people expect that our signal of an impending reduction in world oil or coal production will be high prices. Looking at historical data (for example, this post and this post), this is precisely the opposite of the correct price signal. Oil and coal supplies decline because prices fall too low for producers. These producers make voluntary cutbacks because the prices they receive fall below their cost of production. There often are supply gluts at the same time.

This strange situation arises because prices must be high enough for the producers at the same time that goods and services made by oil (and other energy products) are inexpensive enough for consumers to afford. There is a two-way battle taking place:

(1) Prices producers require tend to rise over time, because of depletion. The easiest to extract a portion of any resource (such as oil, coal, copper, or lithium) tends to be removed first. What is left tends to be deeper, lower quality, or otherwise more difficult to extract cheaply.

(2) Prices consumers can afford for discretionary goods (such as cell phones and automobiles) tend to fall for a combination of reasons:

  • Wages of many workers fall because of competition from lower cost labor in other countries.
  • Some jobs are eliminated through the use of computers or robots.
  • Young people are increasingly being required to pay for higher education (beyond that which is provided free), leaving many with loans to repay, reducing their discretionary income.
  • Changes to US healthcare law (mostly starting January 1, 2014) lead to required health insurance premiums. While some citizens find cost savings in this approach, healthy young people often experience cutbacks in discretionary income as a result.
  • Rents and home prices keep rising faster than incomes.

When the discretionary income of the many non-elite workers of the world falls, they buy fewer finished goods and services. Finished goods and services are manufactured using commodities of many kinds, including oil, coal, copper, iron ore, and fresh water. When discretionary demand falls, commodity prices tend to fall. This is the problem we are encountering now. It tends to cause the prices of many commodities to fall below the cost of production. Eventually, producers decide to quit because production is no longer profitable. This is the issue that leads to peak oil, coal or copper.

Figure 1. Illustration showing why falling affordability creates a conflict between supply and demand.

If the Affordability Price Clash Mostly Affects Non-Elite Workers, Does it Matter?

When I talk about non-elite workers, I am talking about workers who are in the bottom 90% of the wage distribution. Elite workers will always have enough income for the necessities of life. There are so many non-elite workers in the world that they, indeed, do make a difference.

Also, the forces that adversely affect non-elite workers tend to have several effects:

  1. They tend to send a larger share of wages to elite workers, as the economy becomes more complex and more specialized.
  2. They tend to send more unearned income to elite workers, through capital appreciation, because elite workers can afford to buy shares of stock and expensive homes.
  3. The wealthy tend to spend their income differently from non-elite workers. Non-elite workers tend to spend the bulk of their discretionary income on devices made using commodities, such as cell phones and automobiles. The wealthy are likely to spend their discretionary income in less energy-intensive ways, such as investing in shares of stock and buying services such as private college education for their children.

History shows that economies tend to collapse when wage and wealth disparity becomes too great. Collapse can take various forms including revolutions by the disgruntled underclass, increased susceptibility to epidemics, or the financial collapse of governments. Wars become more likely, as one country tries to aid its citizens at the expense of citizens of other countries.

The world today seems to be approaching a crisis point with respect to wage and wealth disparity. Young people, in particular, are adversely affected. Figure 2 shows a chart indicating that wage disparity seems to be back to the level it was at the time of the Great Depression of the 1930s. This was also a time of low commodity prices and gluts of food and oil.

Figure 2. U. S. Income Shares of Top 1% and Top 0.1%, Wikipedia exhibit by Piketty and Saez.

Gluts tend to occur because commodity prices rise to a level where devices made with these commodities (such as cell phones and automobiles) become too expensive for non-elite workers to afford. Elite workers can still afford the devices, but there are not enough elite workers to make up for the shortfall in non-elite buyers of these devices, so industrial output per capita tends to fall.

Figure 3 shows the important role that the wages of non-elite workers play in generating adequate demand. If their wages are high enough, they can buy enough goods and services made with commodities to keep commodity prices high. With sufficiently high commodity prices, production can continue.

Figure 3: Chart showing the important role that the wages of non-elite workers play in maintaining energy demand. With adequate demand, prices can remain high enough for production to continue.

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Comments

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Gary Anderson 7 months ago Contributor's comment

Sobering, yet fascinating read. I suppose subsidies for energy producers, subsidies for energy buyers, or even helicopter money would be needed if the decline continues. Even lightweight cars with durable protection could reduce the energy needs of many.