It’s a Crisis Now, But The Long View is What Matters
When the near term is hard to know, it’s useful to focus on the long term. Because in times like this the long term is more foreseeable than the short term.
Today we have an Iran crisis that is causing oil prices to spike for lots of very logical reasons. A major shipping route has been closed. Docks and refineries have been shut, damaged or destroyed. We have, at the moment, a cease fire. Maybe things will re-open and quickly return to normal. Maybe it will take longer. Maybe much longer.
The near term is really really hard to forecast now. There are lots of things that have gone wrong, and will continue to go wrong. When the near term is hard to know, it’s useful to focus on the long term. Because in times like this the long term is more foreseeable than the short term.
Lots of things have been set in motion that are now bound to happen. And these things are bound to happen no matter how the Iran war ends. Even if everyone agreed to pack up and live peacefully in Iran, the world now knows it can’t rely on that. The die is cast.
This is an energy crisis, but energy runs everything, so it has impacts far and wide. Petroleum and urea are impacted by the closure of the Hormuz Straight, and both of those are critical inputs to fertilizer, which is required in agriculture. If we use less fertilizer, or no fertilizer, crop yields will plummet, affecting food costs. We need petroleum to run manufacturing of every kind. Planes require petroleum. There are no electric 747s in the near future.
Most countries have had a wake up call about their need to have a Strategic Petroleum Reserve. SPRs will have to be refilled later. And countries that didn’t have a SPR will be adding them, and those new SPRs will also need to be filled. All that demand will put upward pressure on prices.
If oil prices look like they will stay high, that starts another predictable series of events. Companies that produce oil will have every incentive to drill more and produce more. If they have operations that weren’t profitable when oil was $60 a barrel, those operations will begin to look very attractive. It takes a long time to re-open closed operations and pursue new ones, so the effect will be delayed, but it is certain to happen. And once those things are put into motion, they won’t easily be stopped. In fact, the reliable history of oil production is a pattern of swinging from producing way too little to producing way too much. As producers swing all the way to “way too much”, that will actually put downward pressure on prices.
The distribution of oil will be revolutionized. Nobody will want to be constrained by a single chokepoint like the Hormuz Strait ever again. Pipelines will be built. New overland routes will be created. Oil that has to pass through choke points may eventually be priced lower than oil that has no constraints, since everyone will be well aware of the risks. If that happens, oil producers will be incentivized to focus on sources that don’t have that penalty, pulling investment away from the risky locations.
Alternative energy is going to look like an increasingly good investment. The higher oil prices are, the more you can profitably spend on the production of oil alternatives. Wind turbines, solar panels, and uranium aren’t shipped in oil tankers that must traverse the Hormuz Strait. Hundreds or thousands of solar panels and wind turbines create a distributed infrastructure far less subject to terrorism than a few huge power plants. Potential new technologies like geothermal power will be worth exploring. Alternative energy investments of all kinds are bound to take on a new life.
We are re-learning old lessons about supply and demand. We had a taste of this in the pandemic. The pandemic was temporary, and we returned to normal life afterwards. In this case, it’s harder to ignore and I’m not sure we’ll go back.
One thing that predictably happens when prices are high is that there is demand destruction. People don’t just pay the price, no matter how high. They start to change their behavior. They do temporary things to use less, like take fewer trips. If high prices persist, they do permanent things to use less, like switching to an electric car. Once they make permanent changes, it won’t be easy to go back.
We’ve talked about how high prices might get. I’ve heard less discussion about what happens if there is not enough supply, at any price. If there’s not enough oil for everyone, who gets it? Does it go to anyone willing to pay any price? That would certainly drive the price up. But that can’t be the result. There are some users that must have priority. Will that priority mean government users get oil? What about hospitals? If there’s not enough for everyone, some will have to do without.
We had rationing in WWII. There are very few people still alive who lived through that, but we may have to learn how to manage shortages. Just as we learned in the pandemic that just-in-time manufacturing might not work when supply chains are threatened, we may have to learn how to prioritize energy and critical materials with rationing.
I discussed in my last post the various types of power that supply the electric grid. If we have a shortage of any of those power sources, we might have to ration electricity use. And any shortage will affect the cost of electricity. It’s impossible to know if electricity will become a scarce resource, but it certainly has become a possibility.
Data centers are huge users of electricity. If we have to ration electricity, data centers running AI may have to take a back seat to keeping hospitals online. Bloomberg News reported earlier this month that “Almost half of the US data centers planned for this year are expected to be delayed or canceled.” That’s just due to shortages of electrical equipment, let alone what would happen if they had constraints on electricity usage. Limits like this on data centers could have important ramifications for the future of AI.
The die is cast. The system we have now will have to be restructured. The short term is impossible to know, but the long term is bound to go in new directions.
Photo by Timothy Dykes on Unsplash