Beginning of the End for Age of Oil

By David L. Brown

We have always contended that higher oil prices would translate into faster movement toward alternatives that use less gasoline or diesel fuel. The latest financial results at Union Pacific Railroad provide one piece of evidence that that is happening:

Union Pacific Net Jumps 38% on Higher Freight Revenue

Union Pacific reported a 38% jump in profit in the third quarter, beating analysts’ expectations.

The railroad company weighed in with profits $703 million, or $1.38 a share — up from the $532 million it earned in the same quarter last year.  Analysts polled by Thomson Reuters had expected the company to earn $1.30 in the third quarter.

“Union Pacific achieved record quarterly financial results despite a challenging economic environment and record-high diesel fuel prices,” said Jim Young, Union Pacific chairman and CEO.

The company saw its average freight revenues jump by 16%, led by big gains in agriculture and energy shipping. Average revenue per car also soared 22%, with broad gains in all categories.

Union Pacific says it is optimistic about the fourth quarter, despite the effects of the economic slowdown.

And why does this show the effects of higher oil prices? Simply because rail freight is far more efficient than over-the-road trucking. A single freight train can carry as much as 100 to 200 tractor-trailers, each requiring a driver and sucking a gallon of diesel fuel for nearly every five miles traveled.

This is just one example of why the paradigm is changing. Demand for oil has dropped worldwide due to the economic situation, and it isn’t likely to come back very soon, even though lower demand has brought prices back to the $70 range at present. OPEC is quite irate, because they had already gotten used to the $135 per barrel prices and thought they would go on forever.

Unfortunately for OPEC (and I say that with ironic intent), the world economy cannot sustain high oil prices. So when the oil minister of Iran says, as he did a couple of days ago, that “the end of cheap oil is over,” he may be right in a way, but in fact that statement could be edited to read a bit differently.

Try this version: “The age of cheap oil is over.” That’s more like it, because this is the end of the era of oil. There isn’t enough to fully satisfy demand except at high prices, and those high prices are not sustainable. The world economy was built not just on a foundation of oil, but of cheap oil. If that is no longer available (which it isn’t) then the economy will have to go in a different direction. And so it is. The age of oil is not truly over, but we are seeing the beginning of the end and that movement will only continue now that the oil peak has been passed and petroleum prices have reached levels that are not feasible for the world economy as it has existed.

It is too bad that the first phase of this landmark change probably must be a serious recession and likely a depression that might last for years. In fact, it is quite possible that the world economy will never fully recover from its long addiction to cheap oil. Certainly there will be many challenges to overcome, but it is at least encouraging to see a move in the right direction as signaled by such things as the move from truck to rail freight.

We have discussed the problem of an auto industry that was hellbent to keep churning out SUVs and pickup trucks forever, thus ducking the CAFE standards with a wink-wink nod from the government that was supposed to enforce them. Detroit is almost certainly doomed, and that is okay because we have an absolute glut of cars in the US. We don’t need any more new ones, and particularly as those millions who are driving leased cars turn in the keys and add even more to the unsold inventory of perhaps several tens of millions of unsold new and used vehicles. Detroit and its dealers are practically giving the things away just to get rid of them, so there will be plenty of cheap autos and trucks around for some time to come, long enough for somebody (if not Detroit) to begin to provide affordable and sustainable alternative vehicles such as all-electric models.

Meanwhile, Americans are driving less and the poor folks at OPEC (irony again) will discover that even if they lower production now, it will only offset the declining demand. They will have a hard time pushing oil prices back up because it is no longer a positive demand market as it has been in the past. Oil even at $70 is too expensive not  to cause demand to continue to decline, and in fact OPEC will need to drop production merely to keep from flooding the market and causing even further price declines.

Higher production costs also create a floor beneath which oil prices cannot fall, since no one will produce oil at a loss. That has been the problem with remaining reserves here in the U.S., which could not be developed at a profit when oil prices remained low.

Even at present prices, oil is priced too high to sustain the old economic model. Thus, change is inevitable and it is beginning to happen. There is a lot of bad news loose in the world, but this is one glimmer of good news.

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