The Long Recession

Sometimes people ask me what I think will happen as a result of peak oil. Well, it depends. We could see alternatives – natural gas, ethanol, GTL, CTL, etc. – fill the gap of falling oil supplies for a while. It just depends on how quickly production falls. But if the alternatives are not up to the task, then I think what we will see – borrowing terminology from The Long Emergency- is The Long Recession. Here’s how it would work.

As economies heat up, demand for oil increases. This puts upward pressure on oil prices, which can ultimately cause a recession such as the one we are in now. Historically, spiking oil prices tend to consume disposable income and lead to recessions. Jeff Rubin, whose new book I recently reviewed, has claimed that four of the past five recessions were caused by spiking oil prices.

In normal cycles, oil companies build up capacity when oil prices are high. A recession caused by high oil prices, combined with overcapacity built up during the price rise, can keep oil prices at bay for a long time. But what if oil capacity can’t be overbuilt, because oil production has peaked? In this situation, oil prices will start to recover just as soon as the economy starts to come out of recession. This may in turn “restall” the economy, leading to a long recession that just repeats the cycle every time the economy begins to recover.

It is hard to say that we are at that point. However, oil prices have recovered quite a bit of lost ground, and have now crossed $70/bbl:

$70 oil menaces budding recovery

At the end of May CNNMoney.com ran a story asking if $60 oil will kill any economic recovery. ‘No,” most analysts said – consumers could shoulder $60 crude, and analysts didn’t see prices going much higher.

Now oil is touching $70 a barrel. Goldman Sachs recently said it sees crude at $85 by the year’s end. With the economy still on life support, oil is drifting dangerously close to being the wet blanket at the recovery’s party.

Hmm. Sounds like what could be waiting on the other side of this recession is…a recession.

There are alternatives that start to become economical with oil at $70 or more. Oil sands, for one. Natural gas vehicles also start to look pretty good at those oil prices. Even GTL, CTL, and BTL stand a chance of being economical if oil prices hang around at lofty levels. But companies – especially oil companies – are pretty risk averse when it comes to predicting oil prices. I doubt any U.S. oil companies are basing future economics on the expectation of > $70 oil. If they were, you would see far greater investments into unconventional energy sources.