Wednesday, November 25, 2015

CO2 Reduction: Potential Economic Disaster?

The IPCC has warned we must reduce the consumption of fossil fuels in order to save the planet from the consequences of global warming. Although most of what the UN has said or written about global warming is “factually challenged’, our world leaders are making a politically expedient pretense of reducing CO2 emissions. This, of course, translates into burning less coal, oil and natural gas. But are these pledges realistic?

Absolutely not.

The following table shows the estimated potential economic growth of each geographic region from 2015 through 2035. Assuming no disruption from war, violence, disease, famine, and other assorted human chaos, most of the nations of the Asia Pacific region would like to triple their economic base by 2035, followed by a doubling of economic activity in the Middle East, South America, Central America, and Africa. Because they have a larger base to start with, the percentage growth of the North American and European-Eurasian regions will be somewhat less. (Note 1)

Projected Economic Growth
2015 - 2035

Asia Pacific
North America
Europe and Eurasia
Middle East
South and Central America

Source: TCE

Although for various social and political reasons it is unlikely these economic goals will be met, national leaders are firmly committed to programs of economic growth. Most national governments are fully aware that their continued political power depends on delivering economic well-being. Failure is not an option. And that creates a problem for those who think we should burn less coal, oil and natural gas. Economic growth takes energy. Until the 19th century, slavery was a primary source of commercial energy. Slavery was largely replaced in the 20th century by machines which either burn fuels, or are driven by electricity generated by the consumption of fuels. As a result, there is a close correlation of economic activity and fossil fuel consumption. The modern State cannot exist unless it consumes an ever increasing quantity of energy, and that fact is never going to change.

Let’s consider the implications for oil. The President of the United States, without consulting Congress, has committed America to reducing its emissions of CO2 in 2025 by 26 percent less than they were in 2005. That commitment is not without consequences for both the United States and for the world oil market. In 2014, America consumed roughly 20 percent of world oil production. Reducing consumption by any amount means a surplus of oil will be placed on the market, depressing oil prices, and encouraging other nations to consume more of this lower priced oil. It also will endanger the American economy.

The Ten Percent Reduction Scenario
Let’s look at a scenario where America reduces its oil consumption by just 10 percent by 2025. The consumption results can be seen in the following graph. North American oil consumption (remember – North America includes Canada and Mexico) declines by 3.4 percent from 2014 to 2025, and then continues to decline slightly each year. The European Union has made a totally impractical CO2 emissions reduction promise. Net immigration into Western Europe, along with increased consumption in the nations of the former Soviet Union, will put upward pressure on the Eurasian demand for oil. Our scenario assumptions project a net decrease of 2 percent by 2025. Oil consumption in the Asia Pacific region will have increased by 36 percent by 2025 and will continue to increase through (at least) 2029. Oil consumption within the nations tabulated as the Rest of the World (most notably the Middle East and South America) is projected in our scenario to grow by 25 percent by 2025, and will continue to increase thereafter. Given the assumptions used to create our scenario, it is likely available supply will exceed demand until ~ 2021, depressing gasoline and diesel prices all over the world. Cheap fuel prices stimulate increased demand. That means, any reduction of American oil consumption will have to be through the use of consumer coercion tactics – rationing gasoline and diesel fuels, increasing the tax per gallon of fuel, and so on. By 2025 however, our scenario model projects demand will begin to exceed supply, and world oil prices will increase. (Note 2)

As shown in the following graph, inflation within the United States would be relatively tame through 2021 and then higher oil prices, combined with the inflationary effects of restrictions on the consumption of gasoline, diesel, jet, and other fuels, would send the rate of inflation sharply higher. Although it is likely projected oil prices and the rate of inflation have been underestimated, it is – for purposes of analysis – sufficient to illustrate the results of our scenario.

North American oil consumption and GDP adjusted for inflation in 2015 dollars is, as shown in the following graph, quite volatile. Actual statistical data has been used 1970 through 2015. The estimated economic impact of a 10 percent reduction is shown for 2016 through 2035. One cannot rationally separate American oil consumption from “Real” GDP. After flirting with a recession in 2018, the American economy begins to slide into a long term recession in 2020.

Although there is a brief pause from economic malaise in 2022, the downturn trend would last for several years. Adjusted for inflation, American GDP increases through 2017, bounces a bit, and then declines. In 2030 real GDP is roughly the same as it was in 2014.

 A lethargic or declining economy causes higher levels of unemployment. Despite the feeling our scenario estimate may be too low; a chronic unemployment of 6 to 8 percent is consistent with prior periods of oil shortages.

One can question the timing and magnitude of these projections, but according to historical data, they are consistent with past experience.

  • Oil shortages in 1974 led to a 252 percent increase in the price per barrel of oil (gasoline went up 37 percent), an inflation rate of 10.97 percent, and a Real GDP of (minus) – 2.47 percent. Unemployment, which tends to lag changes in GDP, jumped to more than 8 percent in 1975.
  • A war in the Middle East unsettled the oil markets enough in 1980 to cause a 167 percent increase in the price of oil (gasoline went up 39 percent), led to an inflation rate of 13.5 percent, and dumped Real GDP by a (minus) - 4.7 percent. By 1983 unemployment had climbed to 9.6 percent.
  • A 39 percent increase in the price of oil in 2008 helped to decrease Real GDP by minus – 1.63 percent, increased the price of gasoline by 37 percent, and was a cause of food riots in several nations (because the cost of fertilizer, soil amendments, and motor fuels made it impossible to sustain food production).
If anything, our two scenarios have probably underestimated unemployment, and overestimated Real GDP.

Three points: Economic growth takes energy. A commitment to reduce CO2 emissions could lead to an economic disaster. Do we believe our political establishment has sufficient knowledge to understand the implications?

And- do they care?

Note 1: Economic Growth
Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP.

Note 2: Scenarios
The insights presented in this report are based on the analysis of two scenarios. Scenarios are not predictions.  Rather, they permit us to make, and then test, a hypothesis. We will then be able to challenge the assumptions, encourage debate about the model, and profile the probable result of our analysis. Scenarios are tools that give our evaluations focus, permit us to deal with the unexpected, and characterize the results of dynamic circumstances.

These two scenarios were created using a very complex computer model of annual oil production and consumption by global region, other liquids and refinery gain, barrels of oil in transit or storage, the net difference between production and consumption, the price of oil per barrel, the price of gasoline per gallon, national rates of inflation, current dollar GDP, current dollar GDP adjusted for inflation, rates of unemployment, and actual demand versus natural demand. Actual data was used from 1970 through 2015. Data sources include the World Bank, the International Monetary Fund, the Energy Information Administration, the International Energy Agency, and BP.

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