A Parliamentary Research Paper from New Zealand, titled The Next Oil Shock?, succinctly summarizes the peak oil case, predicts that the economic consequences of peak oil will be a cycle of recession, fall in oil prices, recovery, oil price spike inducing recession, and so on, at ever decreasing levels of economic output as oil production exits the current plateau phase and starts to drop. The most interesting claim is that this cycle may have already began.

This may have been the first in a cycle of supply crunches and recessions following the same pattern: as demand rises faster than production capacity, the world’s oil supply buffer is whittled away. The supply crunch raises the price. Once the price reaches a certain level it tips economies into recession. This lowers demand, recreating the supply buffer, and results in a lower price. This enables economies to recover, which increases their oil demand, which decreases the supply buffer, and so on. Once production capacity starts to fall, rising demand will eat up the supply buffer at lower and lower levels.

Economists have spotted this effect in the past, explaining that an oil price shock which was not caused by strong growth in the domestic economy would act as a massive simultaneous tax on households and therefore it would be recessionary. This link has been empirically proven repeatedly. If anything some of these economists, who measured the value of oil imports to estimate the size of the tax, must have underestimated the magnitude of the tax since petroleum directly affects the cost of other imported products as well, most notably food. We discussed the “oil tax” in more economic detail on this blog, in Can Food Prices Rise During Deflation? The answer was that of course they can. The CPI as recorded in most countries is a poor indicator of underlying inflation.

The key insight is this: if we are at the cusp of global peak oil, meaning supply cannot rise in response to price, then it is likely that periods of excess oil supply capacity induced by episodes of falling demand will tend to become shorter and shallower, so there is little room to absorb the next episode of demand growth. This means that the interval between recessions induced by oil shocks will become shorter as the supply situation worsens. In the past the optimism/pessimism cycle was part of the business cycle, whereby pessimistic retrenchment led to saving and profits, which then led to optimistic investment and consumption and to the resumption of growth.

All our economic theories evolved to describe economic events observed during a period when the fossil energy subsidy acted as a constant accelerator for economic development. What economic theories would be appropriate for the Second Half of the Age of Oil? (After C. Hall, D. Murphy)

We accumulated a widespread, deeply entrenched bias to optimism thanks to 60 years of net economic expansion. But as the future episodes of recessions will be progressively longer than the shortening episodes of growth, total output per capita will ratchet down with each business cycle, unable to escape the constraint imposed by the falling crude oil net exports available to the oil importers. The existing bias to optimism will be under constant attack by this procession of recessions, slowly eroding consumers’ optimism and replacing it with hardening deflationary expectations.

Meanwhile, over here in Cyprus, septuagenarian business and political leaders are blissfully asleep, projecting their experiences of the last 50 years onto the next 50 years, and deluding themselves that this economic crisis will soon be over. Even if this recessionary phase “ends” soon, the “recovery” can only be short lived before energy issues force another recession. These leaders have either not heard about peak oil, or they have but are in denial, or they have not spent the time to understand the slow-motion train wreck that we are already living through.

The report first covers the supply side squeeze that lies behind the coming oil crunch. But also, interestingly, this research paper addresses demand-side contributory causes as well, in a paragraph with direct references to the same EIA data which I used to verify the Export Land Model in my post hosted at The Oil Drum:

Demand is rising particularly fast, outstripping increases in production, in many oil exporting countries. As a result, former exporters like China, Indonesia, and the United Kingdom are now net importers of oil, and exports from other producer nations are falling. Between 2000 and 2009, Middle East oil production rose by 0.9 mb/d while its oil consumption rose by 2.3 mb/d. The supply of oil available to satisfy demand from countries that are dependent on oil imports is being squeezed by domestic demand in oil producing nations. Between 2007 and 2009, oil exports fell 4.8 percent while world consumption fell only 1.8 percent.

The report also lists five recent expert analyses – four of them written in 2010 – which forecast that production capacity will fall or, at best, not grow as fast as demand in coming years. As a result, the supply buffer is diminishing and another supply crunch appears inevitable. The question is not if, but when:

The US Joint Forces Command forecasts that: “by 2012, surplus oil production capacity could entirely disappear, and as early as 2015, the shortfall in output could reach nearly 10mb/d.”

The UK Industry Task Force on Peak Oil and Energy Security predicts: “as early as 2012 to 2013 and no later than 2014 to 2015 oil prices are likely to spike, imperiling economic growth and causing economic dislocation.”

Lloyds of London says: “an oil crunch is likely in the short to medium term” and “appears likely around 2013.”

A German military report states: “some probability that peak oil will occur around the year 2010 and that the impact on security is expected to be felt 15 to 30 years later… [there will be] “partial or complete failure of markets… [including] shortages in the supply of vital goods could arise.. A restructuring of oil supplies will not be equally possible in all regions before the onset of peak oil.”

The IEA writes: “current global trends in energy supply and consumption are patently unsustainable…the era of cheap oil is over.”

This report can be counted as yet another pessimistic answer to the question I posted here on this blog, Is Peak Oil A Mortal Threat Or Just Another Inconvenience? This alert analyst in New Zealand’s parliament sees peak oil as a serious threat to our way of life.