Tuesday, July 15, 2008

Managing the risk of peak oil

My post on the CSIRO report [PDF] predicting that oil will be $10 / litre within a decade has drawn some adverse comment over at Kiwiblog. I agree with DPF that a scenario is not necessarily a prediction; the relevant question is which scenario we are heading towards. And on that, I refer again to the graph - oil prices are now far higher, far sooner even than CSIRO's "peak" scenario. DPF may wish to ignore that, but I think it is a warning we should pay attention to. While some of that price is due to short-term security concerns, no-one outside the White House seriously believes they're going to disappear anytime soon; Bush's legacy of instability in the Middle East will outlast his disastrous presidency. Meanwhile, with demand exceeding supply, a refining bottleneck, and production expected to start declining within the next decade, the long-term price trend is up. As for how high it ultimately goes, as the CSIRO pointed out, that depends in large part on how people respond. Which suggests we may want to start preparing now, in order to insulate ourselves from the worst effects.

What would those effects look like? If oil does get that high, or even remotely close, then our economy is going to be in big trouble. When people can't afford to get to work, things stop. When we can't afford to ship things around the country, things stop. And when tourists can't afford to fly here, our primary source of export income goes out the window.

(At this stage its worth pointing out that domestic petrol prices are already higher in real terms [PDF] than they were during the oil shocks of the 70's, when we had carless days, lower speed limits, and restrictions on sales. Scared yet?)

How can we manage this risk? The most obvious step is investing in public transport. Our biggest city, Auckland, has a pathetic commuter rail network. Wellington is better, but barely coping after a decade of private-sector neglect. Christchurch has good buses, but they too are struggling to keep up with the demand. As for our regional cities (e.g. Palmerston North), public transport is pretty much a joke. If we want our economy to keep working even in the face of much higher oil prices, we need to improve all of these services, and start looking at better urban design to make our communities less dependent on the car. There are significant co-benefits in this as well, for air pollution, climate change, and just making our cities nicer places to live, so at least some of it is worth doing regardless.

Secondly, we need to invest in alternative fuels, so we're not so exposed to oil and can keep stuff running regardless. The government is taking the first steps towards this, with its Biofuels Bill, which will create a market and thereby spur domestic production. This is a long game; we're really interested in encouraging domestic production of second-generation biofuels made from trees rather than the current ones based on food crops and waste, but they won't happen unless we create that market first.

Thirdly, we need an alternative transport infrastructure to the current one based around big, inefficient trucks hooning along the roads. Fortunately, the government has just done something about that as well...

Finally, we should pay for these preparations by redirecting resources away from infrastructure that is going to end up stranded. While we will still need roads in the future, we're unlikely to need too many more than at present. We plan our construction of schools and hospitals around perceived demand; we should do the same to roads (and using actual costs and a fair comparison with alternatives, rather than strapping the chicken as they do at present)

Unfortunately, there is nothing we can do about the tourism; we'll just have to cope with that as best we can.

If we invest early (and to their credit, the government is doing at least some of what is necessary), we can insulate ourselves against some of the risk of higher oil prices. The downside is that we may end up paying more than we would if we took an optimum path (that is, if we knew exactly what path oil prices would take in the future). But given the direction of the price trend, the fact that its mostly a question of "when", not "if", the investment timescales and the consequences of doing nothing, then I think its far better to be safe than sorry. That way, if we're wrong, then the worst that will happen is that we end up with some infrastructure that we arguably need anyway, and which will benefit New Zealand for generations to come. Whereas if we do nothing and we're wrong, we end up facing substantial economic costs, and being at the wrong end of a decade-long investment cycle to relieve them. And that simply doesn't seem prudent or rational to me.