Oil - some crystal ball gazing

What do increasing oil prices mean for us? We need to separate out extreme claims, the economy, environmental concerns and the impacts on society.

Energy itself cannot be substituted, but crude oil has alternatives. At an expensive extreme, we could grow canola or mallee oil and we have coal for hundreds of years. Sure, there will be a crunch eventually - but further down the track. Oil can be both a provider of energy and an input to industry and coal can substitute in both situations.

Putting it very fundamentally, our way of life comes down to fertiliser, concrete, metal and transport.

Fertilisers are made from phosphorus and ammonia. Phosphorus extraction involves sulphuric acid, which is extracted more readily from oil. But it can be extracted from coal. You need hydrogen to make ammonia. Hydrogen is more readily extracted from gas and oil, but you can also extract it from coal and with sufficient energy, you can extract it from water.

The raw materials for concrete are plentiful. Iron ore is abundant, along with the coal to process it.

An important alternative to fertiliser from fossil fuel is biosolids recovered from sewage. There are processing and transport costs, but it may well become the cheapest option. At present, there is a health issue - it needs to be sterilised - which collides with issues of cost and sustainability - not to mention the inertia around fertilisers as we know them. But that may change. Perhaps irradiation will be an efficient means of sterilisation.

The "Hubbert curve" has oil production peaking and then declining. However, as noted in other articles in this feature, it's the pumping capacity, not the size of reserve, which determines the output. Rather than a "peak" we might have a "cliff", but the crunch will then be further off.

There's the energy profit ratio (EPR) - the energy required to extract the energy contained in a barrel of oil. In times past you could obtain about twenty five barrels of oil for the energy in one, and now it's down to about seven. It reduces the "size" of the reserve - if you need one barrel of oil to extract two, the size of the reserve is halved - for a ratio of seven, its reduced to 86 per cent of the original - and so on.

However, extraction energy is only one cost. There's infrastructure cost, exploration cost, ongoing maintenance and labour, and so on. Fabricating an oil platform takes energy, but for this you'd get a lot of energy out of the ground. It's still worthwhile to talk about the "value" of the oil rig in dollar terms separately to its energy cost. The "energy profit ratio" is not as significant as it advocates suggest. Oil is an important part of the economy, but not the only one.

Two important alternatives to current oil reserves are shale oil and tar sands. These have been criticised for having low EPRs but regardless, the EPR is positive. It's not clear whether the low EPR is the result of a thermodynamic limit or current technology. There are also issues of its environmental impact, but it is nevertheless likely to be important.

Even for low EPRs it is possible to extract the oil for industry, with the energy provided by sources which do not have alterative industrial uses.

If we replace oil with coal, we still generate CO2; but nuclear, tidal, solar and biofuels (for example, biodiesel and alcohol) do not generate CO2. Biofuels take CO2 out of the atmosphere as the plants grow; we put the CO2 back when we consume the fuel. Biofuels are CO2 neutral, as long as the fertiliser and energy used in their production do not themselves generate CO2.

CO2 production bears on the greenhouse effect, but it's separate to the market. We can worry about whether the price has increased as the result of "supply" (diminishing oil reserves) or "demand" (increasing world demand driving the price up). Regardless, it will have the same economic impact. But demand side increases do not reduce the total world oil consumption - we're just squabbling more vigorously over the same oil. Reduced supply would reduce global oil consumption.

If we use more nuclear power (either because we are forced to, or in pursuit of lower CO2 emissions), we could do this for about 100 years using current nuclear reactors, before fissionable uranium runs out. Fast breeder reactors would give us about 30,000 years. But breeder reactors produce nuclear weapon material. We'd probably have to change our global institutions dramatically, so that there was an international body contracted to individual nations to provide power. That's a dramatic change - but in a few decades our ideas could change significantly.

We'll continue to burn coal for a while. CO2 sequestration has been suggested to ameliorate the greenhouse effects. Sure, it will mean less energy for the same amount of coal burnt, with an associated economic impact. But, as long as it is a net positive in terms of energy extracted, it will be worthwhile.

It's meaningless to say that "demand exceeds supply". Demand always matches supply. The demand and supply curves can shift, but it makes no sense to say one exceeds the other.

But "price shocks" are still possible. In addition to fuel itself being more expensive, goods become more expensive, and people spend less on general consumer goods and accommodation as fuel absorbs more of their household budget.

So far, in Australia it seems that increasing oil prices have not caused other increases. But it may still happen, and if prices continue to rise, it must. As our oil reserves diminish relative to world oil reserves it will be a pressure on our balance of payments. Still, it is important to remember that some viable world economies have no native oil reserves - and the value of our coal exports might increase.

It's going to be painful. Still, the market will "respond" to the change. But, should we leave it to the market or intervene?

It's a long running conflict, which I can't settle decisively. Is there some pain which is irreducible, regardless of whether the market or something else sorts it out? Can we reduce the pain through intervention? The question is whether the market will be able to "read the future" and direct resources appropriately as the storm approaches - or whether reflection outside of the market is needed.

Environmentalists have encouraged us to use less oil and energy - because of the impacts of consumption. However, a side effect is becoming used to getting by on less oil on our own terms rather than being forced. But, are we tightening our belt before we need to? Or does some tightening the belt in advance mean less later on? The idea of changing our cities before the crunch - making them focused on public transport and bicycles like some European cites - may make sense.

What else might the future hold? Time for a little crystal-ball gazing ...

Oil companies see an "oil crisis" differently. They only need provide oil profitably. It's only a problem if:

1. alternatives mean the demand for oil drops to below their distribution capacity (even then, a “crisis” only takes place when it drops below the point of profitability); or
2. their supply of oil drops to below the point they can cover their fixed costs at market prices.

Oil companies may be able to move into alternatives. Coal, wood and electricity would be difficult to control - but biofuels and hydrogen are a possibility - with the oil companies taking advantage of their service stations and associated infrastructure.

Initially increasing oil prices would mean we use fewer (or no) private cars (by expanding car pooling; motorcycles would have an edge), with "individual" cars for emergency services only. Transport would be limited to pedestrian, cycle and public transport. (If we hadn't planned for it, the market would now force it on us.) Our old rail based transport system operating using coal might be revived.

If our economy can manage it, perhaps private transport will be possible - biofuels, hydrogen or electric vehicles through coal or nuclear power - with a significant changeover cost.

Liquid fuel is the only thing which cuts it for aircraft, and they use a lot. Air travel would again be the luxury it was in the sixties.

The price of food and other goods would increase. It's said that 7.5 calories of oil are embodied in every calorie of food produced by western industrial agriculture.

What about the country, where people need to travel more and car pooling is not feasible? Well, perhaps they'll be able to charge more for their produce to be able to afford some transport. Transportation relying on trucks would be replaced with a network with coal or electric trains as its backbone. But, yes, there would have to be some significant lifestyle changes.

But it's not clear how international trade will impact on the country and city. The price of international shipping must increase. But how will the price of domestic and imported goods compare? Much country produce is exported rather than directly sustaining Australian cities.

Supposedly the system will adjust, but you can't help thinking that oil prices will rise to the point where the economic activity of a city cannot sustain the required domestic and international food imports, or where the country shrivels up and dies, unable to sell anything, let alone being able to function.

I don't think this will happen. There are some fundamental limits, but they're far off.

In taking farm produce to the table, transport consumes about 40 per cent of the total energy in the process. The shopper's vehicle consumes about 10 per cent of the total energy. But, shopping uses only 2 per cent of the total fuel going into vehicles. It’s clear to see that for all this energy, society has a lot "up its sleeve" when we pare back to essentials. Food is more important that most of the other "add-ons" in our economy. If we can at least grow the food, human motive power can provide the transport, itself sustained by the food grown.

This is an extreme scenario. Some say the disruption will be relatively minor. A mere speed bump on the road of economic growth. Regardless, it seems to me that humanity will endure. And even if there's a lot of hurt, it's not in the ballpark of floods, famine, civil disorder (well, hopefully there won't be too much rioting), war or pandemics.

We could be in for a storm. But let's keep it in perspective.