Economist call it the income and substitution effect. We think the latter will dominate though..

Peak Oil And Demand For Substitutes

If those who project a rather imminently starting long term decline in world oil production are correct then I also expect to see a decline in demand for electric power in the short to medium term. Previously I believed that Peak Oil means bigger demand for substitutes – and that’s probably still true for liquid fuels substitutes if any can be made viable in time. But patterns in changes in energy demand in this recession have caused me to rethink my views about electric power demand. The recession has lowered the prices of oil, natural gas, coal, and even photovoltaic panels. Why? Lower economic activity lowers demand for a very wide range of goods and services.

Coal demand might go down overall post-peak as well. Coal demand for electricity generation, for steel plants, and for other industrial processes has plummeted in this recession. An oil supply decline will probably cause a long recession that will depress demand for steel and industrial products as well. So coal doesn’t look like a big winner post-peak either. Am I wrong about this?

A post oil peak environment will differ from today in one important respect. The prices of oil will be much higher than today and therefore demand for substitutes will be greater at the same level of economic activity. So a 3% decline in the economy in the current recession leads to less demand for substitutes than is the case when the price of oil is higher and the economy shrinks the same 3%. But our current level of economic activity even in a recession strikes me as higher than what we’ll see when oil production declines 3-4-5% per year for year after year. The economy can’t develop substitutes fast enough to allow economic growth or even economic stability during a period of declining oil supplies.

A post peak environment will eventually differ from today in another important respect: people will eventually know we’ve past Peak Oil. Longer term decisions about substitutes will factor in the expected yearly decline in oil availability. So, for example, oil burning heater sales will plummet much more than the economy shrinks. Why buy capital that is of declining usefulness. This will lead to greater demand for ground sink heat pumps and therefore more electric demand to operate those ground sink heat pumps. But I do not expect that new source of demand to make up for declines in demand coming from overall lower economic activity.

You can get an idea of how much electric power demand drops in a recession by looking at a new report by the North American Electric Reliability Corporation (NERC). NERC is the regulatory body for the combined electric power grid of the United States and Canada. NERC expects summer 2009 electric power demand in the US and Canada to be down 1.8%.

Decreased economic activity across North America is primarily responsible for a significant drop in peak-demand forecasts for the 2009 summer season (Figure 1). Compared to last year’s demand forecast, a North American-wide reduction of nearly 15 GW (1.8 percent) is projected. In addition, summer energy use is projected to decline by over 30 Terawatt hours (TWh), trending towards 2006 summer levels. While year-over-year reduction in electricity use is not uncommon — industrial use of electricity has declined in 10 of the past 60 years4, for example — it is critical that infrastructure development continues despite this decline. Based on the information provided as part of this assessment, most Regions have not yet experienced adverse impacts on infrastructure projects. However, WECC has indicated that some generation and transmission projects have been deferred or cancelled, in part due to overall economic factors.

My main point: I do not see supplies of electricity as the rate limiting factor for moving away from use of oil in a post-peak economic environment. I could be wrong on this point and I’m writing this post because I’d like to hear from you dear readers. I realize some of you do not think we are anywhere near the peak in world oil production. But can we just put that debate to the side for the sake of this discussion and consider a hypothetical? Here’s the hypothetical: world oil production starts an irrevocable decline some time in the next 5 years. What happens to electric power demand?

The reason I say the next 5 years is that electricity becomes more substituteable for oil the further into the future we go. Technological advances will lower the costs for nuclear, solar, and wind electricity while other technological advances (e.g. better batteries, better heat pumps for heating, even ways to use electricity to generate liquid fuels) enable electricity to get used in more places where oil gets used today. But in the short term substituting is more costly and takes longer to do.

Next question: If what I’m saying about electric power demand in a post-peak economy is true then what are the policy implications? I can see one big one: incentives for cleaner electric power sources are less important than incentives for shifting demand from oil to electricity. So tax credits or loan guarantees for wind, nuclear, and solar do less good than, say, tax credits for electrifying rail or putting in ground sink heat pumps or tax credits for shifting more quickly to pluggable hybrids.

Update: Global electric power consumption appears to be declining more than global economic activity.

In a report to be presented at a meeting in Rome, the International Energy Agency (IEA) will forecast a 3.5 per cent contraction in global power consumption this year, according to its chief economist, Dr Fatih Birol.

“This shows how deep a recession we are in,” Dr Birol said yesterday. “Oil demand has declined in the past due to oil price shocks and financial crisis, but electricity consumption has never decreased. If you want to measure the health of an economy, you look at the electricity consumption.”

I’ve read estimates for global economic decline of about 1.5% in 2009. So electric power consumption is declining more than economic activity? Why?

Update II The US Department of Energy’s Energy Information Administration does not expect total energy usage per capita to grow over the next 20 years due to regulations that require higher efficiency energy usage.

Growth in energy use is linked to population growth through increases in housing, commercial floorspace, transportation, manufacturing, and services. Since 1980, U.S. energy use per capita has remained relatively stable, between 310 and 360 million Btu per person. In periods of high energy prices (particularly, oil prices) energy consumption per capita has tended to be at the low end of the range, and in periods of low energy prices it has tended to move toward the high end. With the expectation that oil prices will remain high throughout the projection period, coupled with recent legislation enacted to increase energy efficiency, energy use per capita in the reference case drops below 310 million Btu in 2020 and continues a slow decline through 2030 (Figure 35).

Transportation is the hardest sector to shift away from oil usage since liquid fuels work so much better than competing energy sources in cars and trucks. Will rising transportation costs pull down the whole economy or will people rapidly shift to living closer to work and will rail expand quickly to substitute for trucks?

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We have a couple of remarks

• Plug-in hybrids are pretty far from being viable at the moment
• Natural gas is a natural substitute for oil. It has considerable advantages (cleaner and cheaper), but also disadvantages (difficult to store, needing a lot of infrastructure, although a cynic could argue here that’s good in a depressed world economy, it provides useful investment opportunities to revive demand ànd creating long-term benefits). Boone Pickens had a plan with natural gas, it even involves the transportation sector.
• Renewables are too small yet for any meaningful relieve
• See here for a primer on peak oil