Brief Economic Explanation of Peak Oil

For a number of years there has been an arid debate between economists and geologists about Peak Oil. The geologists maintain that Peak Oil (maximal production) is a geological imperative imposed because reserves are finite even if their exact magnitude is not, and cannot be, known.

In contrast many economists maintain prices will resolve any sustained supply shortfalls by providing incentives to develop more expensive sources or substitutes. The more sanguine economists do concede that the adaptation may be slow, uncomfortable and economically disruptive.

The reality, I believe, is that both groups have part of the answer but that Peak Oil is, in fact, a complex but largely an economically driven phenomenon that is caused because the point is reached when: The cost of incremental supply exceeds the price economies can pay without destroying growth at a given point in time. While hard to definitively prove, there is considerable circumstantial evidence that there is an oil price economies cannot afford without severe negative impacts.

The current failure of most western economies to achieve anything more than minimal growth this year (2011) is most likely because oil prices are already at levels that severely inhibit growth. Indeed, research by energy consultants Douglas-Westwood concludes that oil price spikes of the magnitude seen this year correlate one-for-one with recessions.

The corollary is that if oil prices fall back to and sustain levels that do not inhibit growth, then economic growth will resume, with both recoveries and downturns lagging oil price changes by 1-6 months.

Read the rest at An brief economic explanation of Peak Oil

The post agrees with Warren Mosler's contention that the Saudis as the swing producers are the price setters: "As Saudi Arabia is the only oil producer with significant reported spare capacity, its policies effectively set the world selling price for oil."

This is a very provocative post. I recommend reading it all.