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Wednesday, July 23, 2008

Omelets without Eggs / Fuel without Oil

Over at the Freakonomics blog, Steven Dubner hints that we could be in the process of witnessing what Austrian economist Joseph Schumpeter called "Creative Destruction."

From his post "Don't Throw out Capitalism just yet."

The turbulence of the U.S. economy has lots of people railing against capitalism itself, and with good reason: capitalism is inherently turbulent. That’s why the legendary economist Joseph Schumpeter called it “creative destruction.” Not only must eggs be broken to make an omelet, but sometimes people may decide they want their omelets made with no eggs at all.

In business school my strategy processor often referred to Schumpeter's theory of creative description throughout our course on renewable strategy. Creative destruction happens when an established process or technology is displaced by newer, more efficient technologies. Think of the iPod replacing the walkman, or DVDs displacing VHS. Schumpeter was one of the earlier figures to discuss business cycles, and his classic book Capitalism, Democracy, and Socialism served as a rebuttal to Karl Marx, who said that capitalism's natural turbulence would eventually lead to it's collapse and it's replacement communism. Schumpeter's response was that, while Marx had a point that periods of capitalism will experience crisis (like we are with energy prices today), but that instead of a collapse of the capitalist system the crisis would motivate capitalists (like a T. Boone Pickens) and entrepreneurs (the Tesla Motors guys) which would lead to the old way of doing things being destroyed and replaced by new ways (wind / solar energy replacing coal and dirty electricity in the case of Pickens, electric cars replacing gasoline powered cars in the case of Tesla).

Periods of creative destruction aren't always as pretty as the iPod example. When an entire industry goes under there can be a lot of pain during the shakeout and transition to new technologies. If this were to happen to the petroleum fuel industry here in the US be negative consequences - jobs would be lost and shareholders would lose money, but in the big picture we would be much better off compared to what typically happens after these massive "gales of destruction." For one, since we would still have a need for petroleum based products such made from plastics and rubber, most of those 150 refineries who would still be in business producing petroleum derivatives including plastics and rubber. Additionally, since our fuels would be grown here domestically, through renewable fuels such as biodiesel or electricity, we would probably end up with a net creation of jobs for our economy.

Furthermore, there would be tremendous benefits to our economy. Our dependence on petroleum means sending upwards of $700 billion a year in oil revenues to foreign oil producing states, and that figure will only get higher the longer we wait to take serious actions to reduce our oil consumption. Sending all of those dollars overseas creates a huge trade imbalance, leading to downward pressure on the value of the dollar. Eliminating or drastically reducing our imports of oil would make the US much more competitive with the nations who have used their flush bank accounts to gobble up foreign corporations and natural resources.

So how likely are we to see creative destruction within the petroleum fuels industry here in the US? The longer oil and gasoline prices stay at these current levels, the more likely that investment into alternatives would increase to the point where we are technologically capable of replacing all of our petroleum based fuels with non-hydrocarbon sources. Creative destruction is a reason why oil states like Saudi Arabia have an incentive to keep oil prices low, and it is the reason why in the past US officials could press the Saudi Royal family into increasing their supply of oil to the marketplace, and once the Saudi's turned on the spigots, the price of crude oil would drop upon a moment's notice. However, this strategy is no longer effective. The Saudis, the largest producers of oil in the world, are now worried that their supplies may be diminishing. It has been documented that some of the largest Saudi Arabian oil fields are approaching their peak production. The Wall Street Journal's Environmental Capital blog had a post on the Saudi oil supply situation not too long ago and I encourage you to read it. Here is an excerpt from some of their interviews:

Even in Saudi Arabia, home to more than a quarter of the world’s known recoverable reserves, the age of cheap and easily pumped oil is over. To tap Khurais, Saudi Arabian Oil Co., known as Aramco, has embarked on the most complex earth- and water-moving project in its history. It is spending up to $15 billion on a vast network of pipes, oil-treatment facilities, deep horizontal wells and water-injection systems that it calls “one of the largest industrial projects being executed in the world today.”

Think Global Warming and the potential for catastrophic climate change is scary? What if top oilman from the largest producer of oil said that their oil was running out?

“Khurais and [offshore field] Manifa are the last two giants in Saudi Arabia,” says Sadad al-Husseini, a former Aramco vice president for oil exploration. “Sure, we will discover dozens of other smaller fields, but after these, we are chasing after smaller and smaller fish.”

After reading the books such as "Oil on the Brain" and following the great Oil Drum blog I'm more worried about us not quitting our dependence on oil before we reach the peak of global oil supply. The risk of a global economic collapse due to an insane increase in crude oil prices could easily result in the next world war if we're not ready to replace oil. This is more likely to happen during my lifetime or your lifetime any of the catastrophic event that are supposed to be a result of global climate change.

The looming crisis of global peak oil and the results of that crisis are why we need to embrace creative destruction by saying goodbye to gasoline powered vehicles and hello to the era of electric vehicles, hydrogen fuel cells, and other sources of renewable fuels. We can actually create more jobs here in the US by depending on home grown fuel sources, such as cellulosic ethanol, and clean electricity from solar, wind, and geothermal plants. Trying to drill for more oil domestically, which most Republicans are calling for, and now some Democrats are calling for, would only delay the inevitable, which is the absolute necessity that our society stops using petroleum for fuel.


Jeremy Sharpe said...

I never cease to be astounded by Marx' short-sightedness. He failed to see that there would always be some form of class system; in his the party class system simply replaced the economic class system.

In any event, economics is dialectical in its operation, as the phrase "Creative destruction" implies. Take the Ipod example: The Walkman Hardware acts as the Thesis, The Apple Software acts as the Antithesis, and in this case Ipod acts as the Synthesis (Rather than sublation or "overcoming" as Hegel posited). In a capitalistic system, especially one as robust as ours, innovation is encouraged. Whatever fills the needs or wants of the consumer most fully and efficently will win the day. When a competing good or service rises to challenge the dominance of an existing good or service a kind of "natural selection" takes place in which the fittest good or service survives (or at least comes to rule that particular niche. Capitalism works because it is the economic system that most closely mimics the natural order and gives the most free reign for the process that operates according to, which is a dialectical evolutionary process.

On a side note, we ought to keep in mind that this "Creative destruction" applies not only to products but to markets, economies, cultures, governments, societies, and civilizations. We (humanity) will overcome our dependence upon oil, but we may look strikingly different on the otherside of the shift. There is rarely growth without pain and as the term "creative destruction" implies, some things are lost along the way. If we (Americans) are slow to rise to the demands of change then we may become casualties of the DEP (Dialectical Evolutionary Process) and go the way of the Romans, while the rest of the world goes on without us.


Schultz said...

Well put! Your comments remind me a few books on the decline of societies; Jared Diamond's book Collapse comes to mind. Here is a snippet from Wikipedia, notice the last four that he mentions of present and future societies:

Diamond lists eight factors which have historically contributed to the collapse of past societies:

1. Deforestation and habitat destruction
2. Soil problems (erosion, salinization, and soil fertility losses)
3. Water management problems
4. Overhunting
5. Overfishing
6. Effects of introduced species on native species
7. Population growth
8. Increased per-capita impact of people

Further, he says four new factors may contribute to the weakening and collapse of present and future societies:

1. Human-caused climate change
2. Buildup of toxins in the environment
3. Energy shortages
4. Full human utilization of the Earth’s photosynthetic capacity