Thursday, May 19, 2011

Silver Lining in Climate Change Cloud

Economist John Quiggin opines that the apparent arrival of “peak gasoline” in in the U.S. in 2006, or the point when the U.S. consumption of gasoline began a gradual decline that has not rebounded, is a sign of responsiveness to the costs of climate change. By studying elasticity of demand, Quiggin argues that increasing gasoline prices combined with innovation in alternative fuels will ultimately drive down the need for oil, which needs to happen as the resource is eventually depleted. For more on this continue reading the following article from Economist’s View.

John Quiggin says the arrival of "peak gasoline" is good news:

Reasons to be cheerful, Part I, by John Quiggin: There are plenty of reasons to be gloomy about the prospects of stabilizing the global climate. ... But there’s also some striking good news. Most important is the arrival of ‘peak gasoline’ in the US. US gasoline consumption peaked in 2006 and was about 8 per cent below the peak in 2010. Consumption per person has fallen more than 10 per cent.

There are a couple of ways to look at this. One is in the standard economics terms of supply and demand. Given that oil production reached a plateau some time ago, and that demand from China and other developing countries is growing fast, equilibrium can only be reached if prices rise enough to limit the growth in Chinese consumption and generating an offsetting reduction in consumption elsewhere (I’m assuming little or no supply response, which seems consistent with the evidence).

We have of course seen oil prices rise substantially. The effect on demand depends on the percentage change in fuel prices and on the elasticity (a measure of responsiveness) of demand. Because the US has very low taxes on gasoline and other fuels a given change in oil prices produces a much larger percentage change in fuel price than in other developed countries. ... So, the US is the place to look for big price effects.

The big question is the elasticity of demand, that is the percentage change in demand arising from a 1 per cent change in price. In the short run, this elasticity is quite low, reflecting the fact that fuel is a small part of the running costs of a car. The short run elasticity (measured over periods less than a year) is relatively easy to estimate and is about -0.25, that is, a 1 per cent price increase will reduce demand by 0.25 per cent, and a 40 per cent increase will reduce demand by 10 per cent. That’s roughly in line with the observed outcome. However, given that factors such as income growth tend to raise demand, the observed reduction is a bit more than would have been expected with constant prices.

The long run elasticity is much higher, since in the long run people can change their driving habits, reduce their stock of cars, and choose more fuel-efficient cars. ... A sustained upward trend in prices will induce the development of energy-saving innovations... I suspect that the full long-run elasticity, including induced innovation, is near 1...

Finally, what does peak US gasoline imply about Peak Oil, which I’ll interpret as the point at which the current plateau in oil production turns into a clear, though gradual decline?

  • First, we won’t really notice it happening (except as it’s manifested as a further increase in oil prices). Rather, we’ll have to look back at the stats to identify when the decline began

  • Second, the adjustment will be a combination of many different processes (less travel altogether, less of that by car, more fuel-efficient cars) rather than one big shift

  • Third, given that oil accounts for something like a third of all CO2 emissions, the sooner Peak Oil arrives, the better.

  • Finally, oil output per person peaked in 1979. For most purposes, it’s output per person that matters. And the evidence is that, over the last 30 years, output of goods and services per person has risen substantially even as output of oil per person has fallen. That seems pretty conclusive as far as apocalyptic versions of the Peak Oil hypothesis are concerned.
See also "Good News on the Regulatory Front," by Robert Stavins. Good news or not, overall I remain pessimistic and hope that this type of thinking does not turn into an excuse to delay making the hard choices we will need to make to solve the climate change problem.

This post was republished with permission from The Economist's View.

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