This article was originally published on ASPO-USA.

The facts are overwhelming. Oil prices described as ‘very high’ by many commentators have most certainly not ‘imploded’ or ‘cratered’ the world economy. In fact the economy and oil prices have grown together in remarkable symbiosis and interactivity since the most recent oil price low, in early 1999. Today, it is incredible to think that contracts for crude changed hands at 10 USD/barrel in 1999, but this was the case. Since then, and using nominal dollars (unadjusted for inflation), prices have grown about 575%.

Anyone who wants to can claim that there are ‘delays’ amongst economic agents and economic deciders, hampering or slowing ‘price-elastic adjustment’ of demand – that is a fall in oil demand due to high prices. In any case, fall in demand will or should mostly concern final consumers more than intermediate agents, like industrialists and manufacturers, who depend on energy-intensive and oil-intensive raw materials, and also use process energy, to produce goods.

Intermediate users, at least in copybook theory, tend to ‘pass on’ the energy price rises they suffer, often ‘anticipating’ inflation by increasing their final prices more than strictly justified by their raised energy costs. This further penalizes final users, causing faster or further economic downturn. The service sector, which is supposedly ‘energy-lean’ and therefore less affected by energy price rises, in fact has very high energy overheads or energy infrastructure requirements per employed person. Despite this reality, it is seen as a kind of ‘bulwark’ against high oil and energy prices, explaining the attraction of the ‘decoupling’ or ‘de-materialization’ myth in New Economy theory.

Continuing with classic or fairytale economic analysis, it is claimed that final consumers, as well as intermediate users of energy, will one day come to their senses and suddenly reduce their oil demand, because it is too expensive. At that time, the economy will ‘crater’, perhaps with inflation, perhaps without.

The most immediate question is why these economic agents will ‘come to their senses’ and use less oil. What will they do thereafter? Will they take up reading, philosophizing and musicmaking, before becoming unemployed vagabonds, we could ask. The fatuous unreality of ‘classical’ economics, regarding energy, is thrown into high relief by simple facts. The real economy isnt anything like its pastiche in fairytale economics. It is composed of millions of producers and consumers, and is obligatorily locked-on to energy utilization. The proof of this comes every hour, every day and every week.

Increasing energy demand is economic growth. In the exact same way, population growth is economic growth. The almost total absence of real, efficient, convenient or cheap alternatives to oil and gas explains why economic agents, that is everybody, goes on using them. Supposedly informed persons talk about the ‘energy transition’ from wood to coal, and then to oil: replacing 85 Million barrels/day of oil with wood may seem vaguely feasible in theory, but producing about 11 Billion tons of firewood each year would somewhat strain the already strained biosphere.

Getting back to the narrow question of why oil demand (and world gas demand now growing at around 5%-per-year) are much less than unaffected by rising prices, but are directly increased by higher oil and gas prices, we finally call on facts. We can use theory first, but finally we call on facts, because scientific theory is based on and comes from facts. The other way round is called economics – that is, bending facts to fit brokenback theories.

Price elasticity of anything has an underlying notion, hard to quantify, of ‘satisfaction’, and another of ‘substitution’. Neither of these have much place for the vast majority of oil and gas users. Nobody uses oil and gas ‘for the fun of it’, or at least very few persons. Equally, the famous ‘hi-tech emerging new energy’ substitutes and alternatives simply don’t exist. They may exist on the Nasdaq or in people’s heads and PCs, and in cute business video presentations, but not in the real economy.

So the simple fact that oil and gas demand is increasing much, much faster than during the cheap energy 1990s, with much, much higher oil and gas prices should at least allow us to accept reality, and find or develop theories that fit. When we go back to economic theory notions of ‘elasticity’, as mentioned above, we soon see that they don’t apply in large measure, or any convincing way to explaining what is happening. The bottom line is however very simple: until and unless interest rates are sharply raised, to double-digit annual rates, oil and gas prices can go on crawling ever up. With the ever surer approach of Peak Oil, they will in any case have no other direction to move.

© 2006 Andrew McKillop. All Rights Reserved.
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Andrew McKillop is a former Expert-Policy and Programming consultant, Division A-Policy, DG XVII-Energy, with the European Commission, Brussels. He writes and consults about the impact of oil prices on the economy and currently advises the ECOHABITAT sustainable housing and property development project near the French, Belgium and Luxemburg borders.