Oil hit an 18-month high on Thursday, breaking up above previous trading ranges. Crude oil futures touched $85.37 a barrel, their highest level since October 2008.
The economics of peak oil are explicated using three indicative models: linear decline; oscillating decline; and systemic collapse.
In this model, constrained or declining oil production leads to an escalation in oil (plus other energy and food) prices. But economies cannot pay this price for a number of reasons. Firstly, it adds to energy and food price inflation, which are the most non-discretionary purchases. This means discretionary spending declines, from which follows job losses, business closures, and reduced purchasing power. The decline in economic activity leads to a fall in energy demand and a fall in its price. Secondly, for a country that is a net importer of energy, the money sent abroad to pay for energy is lost to the economy unless we export goods of equivalent value. This will drive deflation, cut production, and reduce energy demand and prices. Thirdly, it would increase the trade deficits of a country already struggling with growing indebtedness, and add to the cost of new debt and debt servicing.
Falling and volatile energy prices mean new production is harder to bring on stream, while the marginal cost of new energy rises and credit financing becomes more difficult. It would also mean that the cost of maintaining existing energy infrastructure (gas pipelines, refineries etc) would be higher, so laying the foundations for further reductions in production capability.
In such an energy constrained environment, one would also expect a rise in geo-political risks to supply. This could be bi-lateral arrangements between countries to secure oil (or food), so reducing oil on the open market. It would also increase in the inherent vulnerability to highly asymmetric price/supply shocks from state/