Kate Mackenzie Economists deliver a sturdy smackdown of peak oil demand

Whether or not you agree with peak oil, a new paper by two economists, Joyce Dargay of University of Leeds and Dermot Gately of New York University, draws some rather dramatic conclusions.

Unlike some economists, the pair do not buy the ‘peak demand’ idea. In fact they believe the IEA, EIA and Opec have all seriously underestimated future demand growth – by almost a third:

If annual per-capita oil demand growth rates to 2030 were assumed to be held zero in the OECD, 1% in the FSU, and at its 1971-2008 historical rate (2.54% annually) in the rest of the world, total oil demand will be 138 mbd in 2030 – about 30 mbd greater than what is projected by DOE, IEA, and OPEC.

And in large part it comes down to cars and other transport needs. 

The problem with the IEA, EIA and Opec forecasts, Dargay and Gately write, is that they believe that the per-capita growth rate of oil consumption will slow. But this is based on past experiences of responses to price rises – which the authors believe are misunderstood.

A key reason, they argue, is that ‘demand destruction’ – permanently switching away from oil in response to high prices – was much stronger in the past than it will be now.  Dargay and Gately write that OECD achieved its past oil demand declines through targeting the ‘low-hanging-fruit’ of heating and residual oil, while former Soviet Union states saw their demand fall when their economies collapsed – neither of which are repeatable.

To illustrate the difficulty of reducing demand, compare two decades in which the price of crude oil has quintupled: 1973-84 and 1998-2008. After the price increases of the 1970’s, per-capita demand fell by 19% for the OECD and by 13% for the world as a whole. In the past decade, with oil price increases similar to those of the 1970’s, per-capita demand fell only 3% in the OECD; worldwide it actually increased, by 4%.

The paper, among other things, attempts to disaggregate demand for specific oil products and analyse crude oil demand relative to income.

Much of the reduction in oil demand, they find, was from heating oil and residual oil: overall demand for these fuels has fallen by a third since 1971, while demand for transport and other oil doubled.

As they helpfully point out, the 30m barrels per day difference in their 2030 crude forecast is equivalent to more than double Saudi’ Arabia’s capacity.

Dargay and Gateley do not seem especially optimistic about the possibility for electric vehicles to solve the problem of ever-growing transport fuel demand – at least, we could find no mention of this in the paper. And Dargay, we note, is a professor of transport econometrics.

In fact, the final paragraph of their conclusion has a interesting kicker, particularly for economists (emphasis ours):

Hence this imbalance would have to be rectified by some combination of higher real oil prices, much more rapid and aggressive penetration of alternative technologies for producing liquids, much tighter oil-saving policies and standards adopted by multiple countries, and slower world economic growth.

Something in that for everyone, then.

Update: Paul Kedrosky doesn’t believe that the persistence of transport fuel demand seen in the past will translate to future crude oil price spikes:

As I said in my TED talk this year, we will more likely see multiple fuel spikes much higher, perhaps $150 or more, which will have very different shock & awe effects than steady increases due to inelastic liquid fuel demand in developed countries. That doesn’t make the situation more palatable, of course, but the non-linearities in the system are the key to understanding that it won’t happen the way it is being econometrically modeled.

[H/T James Hamilton - the economist who last year published a very interesting paper finding that the 2007-08 run-up in oil prices might have contributed to the US recession.]

Related links:

Peak demand, going mainstream (FT Energy Source)
An ‘oil-less’ recovery (FT Energy Source)