Sunday, April 7, 2013

Whatever happened to peak oil?

Remember when the phrase "peak oil" was everywhere and we were supposed be in a terminal decline in oil supplies, imminent doom approaching? A funny thing happened on the way to that catastrophe. It didn’t happen. 

The reason was a little bit of economic slowdown and a whole lot of fracking. It seems like fracking came out of nowhere in the last few years but it turns out it was invented in 1947 and has been used commercially ever since 1949. So sixty years in why is it such a big deal now?

The main reason is fracking costs a lot more than traditional oil recovery so you need guaranteed need high oil prices before you invest millions to do it. There are no guarantees in life, of course, but energy companies are pretty good at making long term zillion dollar bets. I don’t have any special insight into the board rooms of places like Exxon but my guess is the beancounter brigade ran their business models and said “If gas stays above $3 a gallon we can make money fracking.” It took them a little while to get confident with the $3 assumption. Once they did all frack broke loose. The U.S. is now on its way to be a net oil exporter thanks to fracking. It turns out this country had a lot of oil after all, it was just hidden.

Econ 101 predicts that, as the price of oil risese, new oil or substitutes enter the market. It’s the upward sloping supply curve you learn in class. Economists— and envirnomentalists, especially — however, thought that the new supply was going to be a substitute, hence the term peak oil. Everyone thought oil was over, they thought it would be bio-fuel or some other renewable resource. It wasn’t. The crummy thing about $3 a gallon gas is that, in spite of being a hisorically high average price, it's still not high enough to fund environmentally sustainable energy. Whatever you feel about fracking and its environmental effects there’s really no argument against the fact that burning gas to run cars is an environmental bad. I’m not sure where the price floor is for fuel cells or other clean car energy sources but I’m pretty sure it’s not $3 a gallon. It’s still way cheaper to buy a gas car, drive it for its lifetime, then bury it in the ground than it is to go hybrid or electric, let alone invent something new.

One more note about gas prices here at ZMO.

Last year at Zingerman’s Mail Order we spent over $4 million on food that we turned around and sold to our customers. Of that $4 million we paid less than $100K, or 2.5%, on direct freight to get it to us. Some freight was included in costs, too—some companies deliver for “free”—so that $100K doesn’t include all freight, just the ones who itemize it on their bill (which is most of them). But think about how low a  percent of the total 2.5% is. Even if it doubled it’d still count for less than a nickel of what we spend on food, let alone what we charged for it. Food is relatively heavy and relatively cheap, which means, overall, it has a high percent-of-total freight cost compared to things like computers or clothing.

The upshot is for many—and I’d say most—businesses in America, freight is no longer a huge part of our cost structure. The supply side oil shocks of the 1970’s woke up the logistics industry which rapidly adopted containerization. Technology improvements in trucking GPS and cell phones have kept trucks full, further lowering per pound charges. And freight trains are packed more than ever (that’s why Warren Buffet owns lots of them). Freight has become less of a cost for business over time, not more. That’s part of what makes the “buy local to save gas” argument fall apart. And it’s part of why peak oil didn’t stand a chance.

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