Ceteris Paribus

A common phrase in economics is ceteris paribus, a Latin phrase that essentially translates into “holding all else constant.”  In modeling economic analysis, extraneous factors are abundant.  However, in order to achieve relevance from the resulting conclusions, limitations on the factors must be in place.  By only allowing one factor to change, the direction correlation between the factor and the corresponding output is easily observed.  However, such a clear cut relationship is not always the case in economy.

One of the most overlooked and underplayed factor driving the economy is human will.  Explaining human behavior continues to be a century old challenge.  While the general assumption when studying economics is to either maximize profit or minimize cost, analysis becomes difficult when the parties no longer react in such a rational way. 

Female shoppers have long since been criticized for their compulsion for shoe shopping. Their male counterparts receive equal criticism for their desire for faster, louder cars, snowmobiles, jet skis, or essentially, anything fast and loud.  Simple assumptions do not account for this “irrational” behavior. Neither do these assumptions correctly summarize the entire male and female shopping populations.

But why is this important?  Most of the blog entries so far have focused on renewable energy sources in some facet.  But in reality, the entries have only scratched the surface on entire picture of adjusting from depleteable fossil fuels to cleaner, greener options.  Although graphs and models show an even line with a clear switch point, the reality of the transition will be much more obscure. 

What the entries, and most studies, do not account for is human will.  Although many US citizens support the idea of more environmentally friendly options, many are still not willing to change their consumption habits any times soon.  Eventually the price will be too high for the current energy sources, and price will continue to be an incentive to change behavior.

Caution is needed when using price as the only driving factor, however, in regards to changing behaviors.  Entrepreneurs are continuously looking for opportunities to profit, whether by tweaking current systems slightly, or developing entirely new concepts.  Human ingenuity will continue to play a large part in the transition towards more renewable energy use.  Just as cell phones and home computers where unheard of just a few decades ago, the potential leader in renewable energy may not be discovered yet, at least the technology necessary to efficiently harness our renewable sources. 

Forecasting helps provide insight into future outcomes, yet predicted scenarios do not always come to pass as anticipated.  Malthus argued that the world population would grow past its carry capacity and we could no longer feed our growing population.  As the population double, the farmland did not.  Interestingly enough, the amount of food production more than doubled during that same time, thanks to continuous innovation and technology.

Renewable energy may see a similar story.  Its adoption as the main source may be close in the future or still several decades off.  Whenever the transition, human will and ingenuity will continue to challenge the studies conducted under ceteris paribus.

United States' Energy Usage

After discussing options of renewable energy sources and the impact of oil in our economy, it was suggested to look into what the United States actually consumes energy for.  Residential, commercial, industrial, and transportation are all vital parts of our economy.  They are also markets demanding convenient and reliable energy sources.  But before claiming a new renewable energy source is the answer to less dependence on foreign oil and more environmental sustainably, the breakdown of the United States’ energy demand is necessary.

Surprisingly, the US consumed less energy in 2009 (94.6 quads) than any year since 1999 (97 quads), which was the first year of data the Lawrence Livermore National Laboratory had listed on their site.  The study used quads to measure the energy consumption, with one quad equally the energy produced from burning 36 million tons of coal.   

Even better news is the continued improvements in the renewable energy field.  In fact, according to studies by the Lawrence Livermore National Laboratory, 2009’s energy sources came from more renewable sources than in 2008.  . For example, solar energy increased in that time period from 0.09 quads to 0.11 quads.  Wind energy production also increased from 0.51 quads to 0.70 quads. Finally, the increase in geothermal energy rose from 0.35 quads to 0.37 quads in 2009.  

However, do not let the decreased energy consumption and increased renewable energy production mislead the true impacts of U.S. energy use.  The following chart is from the study conducted by the Lawrence Livermore National Laboratory and US Department of Energy reflecting the 2009 US Energy use.  The most revealing area of the chart is the total amount of energy that is wasted because of inefficiencies.  Theses inefficiencies range from light bulbs, to vehicles, to power plants’ waste heat.  This “rejected energy” counts for almost 55% of the total energy that is produced. 

Overall the United States’ energy efficiency is 42%.  Also, only 1.2% of our total energy consumption comes from solar, wind, and geothermal energy, despite the improvements in these areas.  With petroleum making up 37% of our energy sources, natural gas at 25%, and coal at 21%, the United States is still heavily dependent on exhaustible, nonrenewable sources.  

Incidentally, the largest sector that consumes energy is transportation, almost 40% of all energy consumed.   Residential, commercial, and industrial sectors are around 80% efficient, wasting on 20% of their energy.  Concurrently, the transportation sector is only 25% efficient, wasting 75% of the total energy consume.  The sobering reality is that solar panels and geothermal can help with the energy demands in the residential, commercial, and industrial sectors, but there has been limited progress in developing alternatives for fueling transportation.  

Bike paths, ethanol plants, and flex-fuel vehicles have all attempted to decrease the amount of pollution and nonrenewable energy use throughout the transportation sector.  However, more work is needed, especially in rural areas, extreme weather climates, or sprawling suburbs, where peddling over 50 miles to the nearest grocery store is not a feasible or desirable option.  The path to increased renewable energy will continue to be one of innovation and adaptation.

Oil Influences

A century has passed since the Standard Oil conglomerate was abolished under the Sherman Antitrust Act.  Incidentally, America’s economy uses a variety of sources to fill its energy quota.  However, even with a push for more renewable energy, the US economy is still driven by oil.  Cotton may have been king in the South, but the price of oil remains a dominating factor in many sectors of our economy.  

Agricultural producers are extremely sensitive to any rise in the price of oil.  Although their demand does not decrease from the spike, higher oil prices translate into tighter margins.  In an industry that already operates at near the margin levels, a rise in oil could mean the difference between making a profit and barely breaking even.  Equipment has to run to get the crops planted in the spring, harvested in the fall, and finally, shipped to market.  Incidentally, all of this takes fuel, and fuel prices have continued to rise. 

Oil is a traded commodity, similar to our agricultural products, and is subject to similar market volatility from supply and demand forces.  What makes oil unique from other commodities are the organizations involved in monitoring and even limiting production.

The key player in oil is no longer the infamous Standard Oil, but the Organization of Petroleum Exporting Countries, commonly referred to as OPEC.  Founded in 1960, OPEC consists of leading oil producing countries: Algeria, Qatar, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia and United Arab Emirates, Venezuela.  However, it was not until 1971 that OPEC realized its power in controlling world oil production. 

Up until then, the pricing power laid in the US, mainly with the Texas Railroad Commission.  When the Texas Railroad Commission allowed 100% production, producers in Texas, Oklahoma, and Louisiana were no longer restricted in their output.  Restricted output means less supply, which translates into higher prices.  Higher prices translate into higher profits when the commodities demand is relatively inelastic.  And there are only few substitutes in the market for oil. 

The following charts from WRTG Economics “Oil Price History and Analysis” provide a visual guide behind some of the volatility in oil prices.

Note that the Texas Railroad Commission and OPEC are not the only factors driving the price of oil.  Also, OPEC has not always been successful in controlling market prices. Unless there are methods to enforce guidelines, individual countries have an incentive to cheat, producing more than their quota and then capturing higher returns.  However, if every countries overproduces, the supply will increase, lowering price, and likewise, lowering returns. Because of the incentive to cheat, OPEC has experienced varied success in controlling oil prices.  

As rising oil prices continue to influence the market, and concerns on oil scarcity grow, the demand for other energy sources will also grow.  The current energy consumption is an intricate combination of various sources; time will tell how long the combination will use oil as the main component.