Peak Oil + Autonomous Cars = Traffic Nightmare

Originally posted at willmartin.com.

How you’re going to feel once peak oil and automated cars make traffic a nightmare

Autonomous Cars
For a number of years now, high-end luxury cars have had autonomous cruise control systems that use lasers or radar to maintain a set distance to the car ahead. Earlier this month Teslarolled out an autonomous driving mode in its electric cars that takes this a step further. Teslas will now drive themselves on a freeway, accelerate and decelerate on their own and maintain a set distance to the car in front. However, unlike other cars with autonomous cruse control, they will now also change lanes – if you click the turn signal the car will automatically check your blind spot and execute a lane change. This is just one more step toward a fully autonomous car that consumers can buy.

Some of the world’s largest tech companies are working on autonomous vehicles. Google has driven their autonomous prototype cars over a million miles, which have been completely accident-free, except for other human drivers crashing into them. Apple has also been hard at work on an autonomous, possibly electric, car of their own. In all, over 25 companies are currently developing autonomous cars.

Most industry experts believe that fully autonomous cars will be mainstream in just 5 years. Others predict that in 20 years most cars won’t have a steering wheel or pedals and in 25 yearsmost people won’t need a drivers license.

Speed Records
Recently Alex Roy teamed up with Carl Reese and Deena Mastracci to complete a cross-country speed record in a Tesla with the new autonomous control upgrade. Roy is best known for breaking the Cannonball Run record by driving across the United States in 32 hours and 7 minutes in a BMW M5. (This record was most recently bested by Ed Bolian in 28 hours 7 minutes with a Mercedes CL55 AMG.) Reese and Mastracci are known for previously driving the Cannonball Run route in an electric car in just 58 Hours and 55 Minutes. Using Tesla’s new autonomous mode, the trio completed the route in 57 hours, 48 minutes – over an hour faster than their previous electric car record, but still about 30 hours slower than the petroleum-powered record. For reasons I will describe below, Bolian’s record may stand for eternity as the fastest transcontinental automobile crossing. In the future, traffic may simply become so bad that no one will be able to achieve such a feat again.

The Promise of Autonomous Cars Ending Traffic
Cornucopian futurists have suggested that increased adoption of autonomous cars could bring an end to our traffic congestion woes. One MIT researcher thinks they could reduce traffic by80%. The Brookings Institute says that autonomous cars will “reduce much of the congestion and delays that make road travel so onerous.” They could even eliminate traffic in Los Angeles– arguably the world’s most car dependent city. It will be “An End to Traffic Jams Forever!”

The idea is that unlike human drivers, autonomous cars have perfect reaction times. They can follow the car in front of them with very little braking distance, matching speeds perfectly. If a group of autonomous cars gets together on the freeway they could form a “train” – all traveling in unison just inches from each other’s bumpers. It has been theorized that having just a few autonomous cars on the road could greatly reduce traffic congestion for everyone else.

The appeal of this is obvious. The average suburbanite is desperate for any news that allows them to think they can continue their “suburban, car-dependent, happy motoring living arrangement.” Driverless cars seem to offer the ability to continue living in a quiet suburban cul-de-sac miles from the nearest workplace or shop. You’d simply sit back, play around on your phone and let your robot car whisk you away to your destination dozens of miles away. “Super-commuters” (those who commute more than 50 miles to work) wouldn’t need to change a thing – they could just catch up on some shut-eye while their robot car drives them to and from work.

Peak Oil and Climate Change Legislation
Peak Oil is the point at which global oil production reaches a maximum rate and begins a permanent decline. Oil is a finite resource, so peak oil will happen – it’s just a mathematical fact. The controversy around peak oil isn’t about whether it will happen, but when, why and how it will happen: Is it happening now? Will it happen because oil gets too expensive to produce, restricting supply? Will it happen because oil gets too expensive to consume, restricting demand? How quickly will production decline after the peak? Will substitute forms of energy and transportation technologies offset the decline? No one can definitively answer any of these questions, but we do know that at some point in the future we will be faced with declining levels of global oil production. One possible outcome of peak oil is that we won’t have sufficient economic substitutes for oil and the price of oil rises significantly. Perhaps electric car production is limited by the high cost of extracting lithium for the batteries (especially since mining requires so much oil). Perhaps NIMBYism prevents us from increasing the walkabillity of our neighborhoods through the construction of public transportation routes and higher-density mixed-use buildings. In any case, in this scenario people would be stuck relying on their car, but oil prices would incentivize them to use as little fuel as possible.

Another source of higher energy prices is a potential global climate change agreement. Already 114 nations have signed the Copenhagen Accord, which states that the parties agree to limit global warming to 2 degrees Celsius above pre-industrial levels. The European Union has enacted climate change legislation. If all of the existing fossil fuel reserves that are on the books of the world’s oil, gas and coal companies were burned, it would generate more than 2.8 trillion tons of CO2 – well in excess of the 1 trillion ton “budget” that almost every country has agreed to. In order to keep that excess 1.8 trillion tons of carbon in the ground, a global climate change agreement would need to raise the cost of emitting carbon to a point where more than half of the remaining reserves are never burned. This could be accomplished through a global carbon tax or a global cap and trade program, but the result would be the same – far higher prices for gasoline at the pump. If a global climate change agreement  is reached, the average motorist will see rising fuel prices and will be incentivized to use as little fuel as possible.

The Eco Button
Many cars on the road today already have an “eco” button on the dash. The button doesn’t do very much today – it typically changes the throttle response, adjust the climate control and changes the fuel mapping a bit. In the future of automated cars, however, the “eco” button could do far more – it could pick the most efficient route to the destination (with the fewest hills and stops), it could drive at an optimal speed, and it could accelerate and decelerate at the optimal rates. Today the “eco” button gives drivers about 5-10% better fuel economy. In the future, self-driving cars could easily double your fuel economy at the simple push of an “eco” button. People today are used to hitting the “eco” button when they want to save a bit of fuel. In the future, if fuel prices are far higher and self-driving cars allow a far more impressive fuel economy improvement in “eco mode,” it seems obvious that more and more people will be pushing the “eco” button.

Hypermiling
As gasoline prices have gotten higher over the past two decades a group of fuel maximizing techniques know as “hypermiling” have become more popular. This can involve physically modifying a car by eliminating weight and improving aerodynamics. More commonly hypermiling is accomplished through driving techniques like optimal speed management and acceleration modulation to keep the internal combustion engine at optimal stoichiometric efficiency. Colloquially this is known as “driving like a grandma.”

Today hypermilers are able to achieve some amazing feats of fuel efficiency. Hypermilers areroutinely able to get double the “sticker” fuel economy of average cars. For example, hypermilers can get 127 MPG out of a Toyota Prius, which is rated by the EPA for 60 MPG. They can get 62 MPG out of a Toyota Corolla, a car rated for 35 MPG. Even with the king of fuel inefficiency, the Hummer, hypermilers are able to get 22 MPG in a truck that normally gets 10 MPG.

Pulse and Glide Driving and the Accordion Effect
Internal combustion engines are most efficient when they are under full load at low to medium RPMs. This means when you are driving up a hill you will consume less fuel to maintain the same speed if you use full throttle in a higher gear (at a lower RPM) than if you downshifted and used less throttle at higher a RPM. This becomes evident when one looks at the brake specific fuel consumption (BSFC) efficiency contour chart for a typical internal combustion engine:

A brake specific fuel consumption efficiency contour chart

Most internal combustion engine cars these days use electronic fuel injection; This allows the engine to consume zero fuel when you completely let off the throttle and coast. When driving on level ground this means the most efficient way to drive is to “pump” the throttle by accelerating at full throttle from 1500 to 2500 RPM and then coasting back down to 1500 RPM with no throttle. Hypermilers call this the “pulse and glide” technique. Unfortunately, as anyone whose been in a taxi recently can attest, this “throttle pumping” accelerator modulation is also the best way to make passengers carsick.

Besides making passengers carsick, the pulse and glide fuel saving technique also contributes to traffic through the “accordion effect.” When traffic is dense and a road is close to reaching its maximum capacity a single speed different can ripple through the crowd, causing stop-and-go traffic to pile up. This speed disruption can be as simple as someone looking down to check their phone; when they look back up the may realize they are following too closely and brake; the cars behind them see brake lights and they brake as well out of an abundance at caution; a mile back this ripple of brake lights brings traffic to a complete halt.

In the future, autonomous cars may be programmed to pulse and glide their accelerators to maximize fuel economy. As the autonomous cars coast down in speed, human drivers behind them will hit the brakes, causing stop-and-go traffic.

Speed Limits and Speed Minimums
If you asked the average person driving down the freeway to tell you the speed limit, chances are they would have a good idea. But if you asked the same people to tell you the minimum speed, I bet most would have a hard time coming up with it. In California most suburban freeways have a 70 mph speed limit and a 45 mph speed minimum. In reality this means that in the absence of traffic people in the left lane are driving 80 mph while people in the right lane are driving 65 mph. Anyone driving the speed minimum of 45 mph would be traveling at a 35 mph difference to other people on the road. Imagine standing on the side of a road and watching a car pass you at 35 mph – that’s a significant speed difference. Differences in speed cause traffic to pile up – as human drivers come up on an autonomous vehicle traveling significantly slower than they are the human drivers will hit their brakes which will cause everyone further back to hit their brakes, which will lead to the “accordion effect” of stop-and-go traffic.

If automated cars are put into “maximum economy mode” it is likely that the computer will poll its database for the minimum speed it can drive on any particular freeway and accelerate up to just that speed. Any police officer that pulled over an owner of an automated car driving the speed minimum would have hard time in court fighting a perfect computerized output of GPS coded data proving the car was following the letter of the law.

What this means in practice is that either politicians will have to raise the speed minimums of freeways or that we will have to live with traffic congestion caused by automated cars driving the minimum highway speed. My money says that very few politicians will want to go to bat for increased speed minimums.

Electric cars and “Range Maximization”
In a post-peak oil future with global climate change legislation, carbon-based fuels may be more expensive, but elections may not. If an electric car owner charges their car with electrons from solar panels on their home’s roof, they may not care as much about the cost of the electrons. But unless there is a major breakthrough in the energy density of electric car batteries, owners of electric cars will still have a major incentive to drive in a way that maximized the range of their vehicles. Importantly, the techniques used to maximize fuel economy in an internal combustion car are very similar to the techniques used to maximize the range in an electric car.

Just as internal combustion cars have an optimal speed for minimizing fuel economy, so too do electric cars have an optimal speed for maximizing range. Worryingly, the optimal speed for achieving maximum range in electric vehicles is far slower than the optimal speed for achieving maximum fuel economy in gasoline cars. According to Tesla, the range-maximizing speed for their Model S sedan is just 25 miles per hour! The current world electric car range record was set in a Tesla P85D. The drivers achieved 452.8 miles of range on a single charge by driving an average speed of 24.2 mph. If drivers push the “eco” button in an automated electric car like a Tesla, it is possible that the software would choose a route that allows it to maintain an average speed of 25 MPH. This would necessitate the car to avoid highways and use roads with lower speed limits. Most city streets, however, have speed limits of 35 MPH. Rural roads often have speed limits of 45 MPH. On many of these roads people are used to driving 5 to 10 MPH over the posted speed limit. A hypermiling automated electric car could easily be driving at 20 or 30 MPH below the average traffic speed. On a two-lane road, where it is difficult to pass, traffic would quickly back up behind such a slow car.

Tesla Range vs Speed Chart

The other main difference between electric cars and internal combustion cars is the acceleration efficiency. While internal combustion cars are most fuel efficient when accelerating at full throttle, electric cars are most energy efficient when accelerating very slowly. When trying to optimize the energy efficiency (and maximize the range) of an electric car, the best technique is to accelerate slowly (like there is an egg beneath the accelerator pedal) and to decelerate slowly by leaving plenty of stopping distance and letting the motor’s regenerative braking bring you to a halt. In fact, a driver who is truly optimizing the efficiency of their electric car would almost never need to use the brake pedal. Needless to say, this form of driving – with extremely slow acceleration and leaving many car lengths of following distance to allow for slow deceleration by the regenerative brakes – can easily case traffic to pile up.

Due to the low energy density of current electric car batteries, the easiest way to maximize the range of the car is to add as many batteries as possible to the car. Unfortunately adding more batteries adds more mass. As race car teams know very well, added mass is multiplicative – it snowballs. When you add an extra thousand pounds of batteries, you need to add an extra hundred pounds to the chassis to support the batteries; a heavier chassis requires beefier suspension arms, wheels and tires; a larger overall mass requires bigger breaks to stop, which further increases the mass of the wheels, tires and suspension; and on and on. Once the car has been designed with all of the safety and comfort requirements plus the structure to hold such a large amount of batteries it can tip the scales at astronomical values. The curb weight for the new Tesla Model X SUV, for example, is 5441 lbs – that is 741 lbs heaver than the Hummer H3! What’s worse, every pound added to the car increases the amount of raw materials needed to build and increases the complexity of assembling the car; thus the current top-of-the-lineTesla costs 78% of the median home price in the United States.

Self-driving cars offer an alternative way for electric cars to have long range without breaking the bank. Instead of loading up a car with more and more batteries, a self-driving car could have fewer batteries but be able to achieve an impressive range when put in “range maximization mode.” The average American drives 37 miles per day. Currently the cheapest electric car on the market is the Mitsubishi i-MiEV, which has a 62 miles range and costs just $15,495 after rebates. Amazingly that’s just $500 more expensive than the cheapest internal combustion engine car for sale today (the Chevy Sonic). 62 miles of range is almost 70% more than the average person drives in a day. In the near future, automated car technology could become so inexpensive that even a car like the i-MiEV could become totally driverless.

Volkswagen recently got in trouble for cheating on emissions testing by designing the software of their vehicles to adjust the fuel mapping to lower emissions when the vehicle sensed it was being tested on a dyno. In much the same way, it is plausible that in the future electric car companies could design their software maximize to the range of their vehicles when they sensed they were being tested. An inexpensive electric car like the i-MiEV may be able to achieve over 100 miles of range by accelerating and decelerating slowly and capping its top speed. The car may simply engage its “eco” mode when it senses it is being tested. But of course “your mileage may vary.” In the real world, ranges would be far less – but as long as the range under normal driving conditions remained above the daily driving needs of the average American, most people wouldn’t complain. For longer trips, drivers could put it in self-driving “eco mode” and just sit back and read a book while the car putters along at 25 MPH with dozens of cars piled up in traffic behind them.

Traffic Today, Traffic Tomorrow
Too many Americans drive too much every day. Many “super commuters” travel over 50 miles each way to their jobs every day day. Heading out of their suburban and exurban homes they must contend with drowsy drivers, drunk drivers, distracted drivers texting away, and, increasingly, horrendous traffic jams. Urban sprawl has pushed people from the suburbs into theexurbs. In many places around the world individual cities have sprawled so far that they have begun to merge into megalopolises.

Autonomous cars seem to offer the perfect solution to our driving problems. Robots have perfect reaction times – no more “accordion effect” of stop-and-go freeway jams caused by drivers slamming on their brakes. Robots never get distracted – no more accidents from texting while driving; no more idiots driving too slowly and swerving out fo their lane because they’re not paying attention.

Unfortunately, the promise of a traffic-free future is a probably a mirage. Peak oil and global climate change legislation will raise the price of transportation fuels. Barring a major breakthrough, affordable electric cars will only be able to achieve long ranges through economical driving. As more and more people hit the “eco” button on their autonomous cars, roads will become increasingly jammed up by robotic cars driving like grandpa on his way home from the blue plate special. As the cost of living in walkable neighborhoods continues to rise more people may consider moving to car-dependent suburbs. Autonomous cars may make suburban commutes look attractive, but reality will be different. As autonomous car software allows more people to hypermile their cars at the push of a button, suburban commutes could become unbearable. Rather than heading towards a traffic-free future we may be headed towards a traffic jam nightmare.

Chasing Yields

Baby boomers who are retired or close to retirement are finding themselves without a lot of options for "safe" income-generating investments these days. Over the past 60 years the classic 50%/50% stock/bond portfolio has yielded a combined annual income from dividends and bond coupons of about 4%. A retiree with a $1 million portfolio could look forward to a comfortable $41,000 a year in income before any drawdowns to their portfolio. Over the past 15 years, however, the situation has changed dramatically. Today, that same portfolio would yield just $19,800 per year - half what most retirees had been expecting. When the returns are charted out, it becomes blatantly obvious why retirees today are desperately chasing yields: 

The Bond Bubble

Thanks to the Federal Reserve's Zero Interest Rate Policy (ZIRP), treasury bonds are now returning their lowest yields in history. Bond prices and bond yields are inversely proportional. With interest rates having nowhere to go but up, bond prices have nowhere to go but down. Retirees holding a majority of their wealth in bonds could see their principle cut by a significant amount as interest rates rise. This bond bubble could continue on for years, but eventually it will burst.

The rise in bond rates could occur in a few ways. First, the Federal Reserve could raise rates if they believe that the economy is on a sustainable recovery. Fed Chairman Ben Bernanke's recent allusion to this caused bond rates to immediately surge.

A second way that bond rate could rise is through reduced confidence in the ability of the US government to pay their debt. On August 5, 2011, Standard & Poor's, one of the "big three" ratings firm, downgraded the US Government's credit rating for the first time in history. Ratings firm Egan-Jones has cut the US government's credit rating three times over the past few years over concerns with the Federal Reserve's quantitative easing.

A third way that bond rates could rise is if China decides to stop buying US debt. China is currently the largest foreign buyer of treasury securities and has $1.2 trillion in holdings. If China began cutting back on its purchases, or worse, began selling its existing holdings of US bonds, interest rates would rise significantly.

This combination of historically low interest rates and the inevitability of lower future bond prices has caused many analysis to begin calling US treasury bonds "return free risk" (a play on "risk free return" - the role that treasury bonds have historically played). Clearly it doesn't pay to be in bonds right now.

The Search for Yield

As treasury yields have plummeted to historic lows, investors have set out on a quest for higher yields in fixed income securities.

The first methods for finding higher yields is investing in longer maturity bonds. Instead of buying 10-year treasury bonds with a 2.25% interest rate, retirees may now be investing in 30-year treasury bonds with a 3.37% interest rate. The problem with this approach is that the prices of longer maturity bonds are more highly leveraged against interest rates. When interest rates rise, as they inevitably will, people holding 30-year bonds will get burned far worse than people holding 10-year bonds.

A second method of finding higher bond yields is to move into riskier bonds. Instead of buying treasury bonds, retirees may park their money in corporate bonds, municipal bonds or even junk bonds. While the yields of these bonds may be higher, the risk of default is higher as well. If the economy enters into another severe downturn, many companies and cities could enter bankruptcy, leaving bond holders with nothing.

A third path to higher bond yields it to look internationally. Just as with the other options, this one carries increased risk. Buying foreign bonds exposes the investor not only to the sovereign default risk of the country they are buying from but also to risk of currency fluctuations between their home currency and the currency that the bond is denominated in. Nevertheless, many investors are beginning to look overseas for increased bond yields. For investors worried about peak oil, it is possible to buy government bonds from 5 of the top 10 oil exporting nations: Russia, Nigeria, Venezuela, Norway, and Canada. As we pass peak oil and oil continues to get more expensive, government revenues should continue to increase for these countries, ensuring that they can avoid sovereign default while oil importing nations like Japan and the United States struggle. Buying Nigerian 10-year government bonds, for example, can land you a whopping 14.4% yield today. For investors simply wishing to reduce their exposure to US default risk, Canada and Norway 10-year bonds have about the same return as US treasury bonds but with arguably a much lower risk of default.

The Need for Yield

While the income from a typical 50/50 stock/bond portfolio has fallen by half over the past 20 years ago, many retirees are also finding that the cost of living in retirement has risen sharply over the same period. The price of gasoline, for example, has doubled over the past decade.

If you wanted to hedge against the cost of driving, you could buy 1300 shares of ExxonMobil stock and over the past 20 years the dividends you would have received would have almost perfectly offset the increases in the price of the gasoline you purchased each year. The problem is, it would have cost you just $12,000 in 1993 to buy 1300 shares of ExxonMobil stock, but in 2013 you'd have to spend nearly $110,000!

We may not be at peak oil yet, but we are certainly feeling the effects.

Food prices have also doubled over the past decade. Because each calorie of food we eat requires 10 calories of hydrocarbon energy to produce, it is no wonder that the rise in oil prices nearly is nearly perfectly correlated to the rise in food prices.

Combined with declining investment income, these rising costs of living are pushing retirees further in search of investment yields.

A Stock Bubble?

Without any good option in bonds, many investors have sought out yields in other asset classes, like annuities, royalty trusts, master limited partnerships and real estate investment trusts. All of these asset classes, however, usually carry increased risk of default and price volatility. In the case of annuities, investors face serious counter-party risks -- people holding Lehman Brothers annuities before the last crisis are lucky if they got anything following the bankruptcy.

This leaves investors with just one place left to go for increase yields: stocks. With retirees desperate for income and the value of treasury bonds certain to plunge at some point in the future, it is no wonder that investors are pouring their money into equities in the hope of receiving dividend income. By doing so, however, these investors are simply piling on more risk. Not only does the underlying value of stocks tend to swing far more wildly than bonds, but unlike the coupon of a bond, which you're guaranteed to get as long as the bond issuer doesn't default, continued high dividends from companies are far from a sure bet. If we enter another downturn, dividends could fall as companies try to shore up their balance sheets. 

Despite these risk, investors continue to pile into stocks in the quest for higher yields.  I believe that this reality helps explain why the stock market continues to hit record highs as the real economy continues to drag along with high unemployment and near zero real growth. I certainly don't have a crystal ball, but I do have an uneasy feeling about the current "recovery" here in the United States.

The Core Peak Oil Debate: Speed and Scale

I just got finished reading Ramez Naam's new book "The Infinite Resource." The first part of the book is a great overview of peak oil and climate change. He accurately describes the gigantic nature of a both problems and the potentially massive negative consequences we face as a society from them. He's clearly done his homework and gives a lot of examples of how these issues are affecting us all right now.

He also does a good job framing the climate change debate and walking through the real issues that are currently being debated (like whether peak oil will stop climate change and what level of atmospheric carbon dioxide we should consider "safe") while knocking down the "red herring" debating points (like whether humans are causing climate change).

On page 96 he finally gives us his main thesis: that we can solve the issues of peak oil and climate change with technology, innovation and substitution. He goes on to back up this assertion by showing many different ways in which technology is improving renewable energy, food production and sea water desalination.

On page 175 he finally addresses the main issue of the peak oil debate: Speed and Scale. His whole thesis (that the issues of peak oil and climate change will be solved by technology, innovation and substitution) is dependent on innovation improving renewable energy technology at a fast enough rate to allow us to offset the energy lost through fossil fuel depletion at a speed and scale necessary to avoid collapse. That is the core issue of the peak oil debate: will we be able to substitute renewable energy fast enough to make up for declining rates of fossil fuel production?

Naam is supremely confident that technological innovation in renewable energy will occur at a fast enough pace to allow us to both overcome the pace of fossil fuel depletion once we pass peak oil, peak gas and peak coal, but also that the rate of technological innovation will occur fast enough to allow renewable energy technologies to continue to ramp up to tremendous scale in the face of other limits like the limits of available "high potential" locations for wind and solar, the limits to speed and scale of the required electrical transportation infrastructure, the limits of available skilled manpower to build out that infrastructure at a fast enough pace, the depletion of required resources (peak rare earth metals, peak copper, peak silver) required to build out that infrastructure, the backlash of Jevon's Paradox to increases in efficiency, the potential decline in available capital should peak oil push us into another recession through another oil price spike and the potential social backlash (NIMBYism) to the massively ramped up scale of renewable energy infrastructure.

My argument is because of all of these limits, it is unlikely that we will be able to ramp up renewable energy generation and the electrification of transportation fast enough to offset the decline in available energy once we pass peak oil. The consequences of this shortfall are what worry me most. Naam's optimism that "technology" will solve the problems of peak oil and climate change by allowing us to seamlessly switch from from fossil fuels to renewables is, in my opinion, dangerous. Optimism breeds complacency. By telling readers that "innovation" will solve all of our problems, people can put down the book and go back to their normal lives without making the dramatic changes required to make themselves more resilient and to move us all towards a more sustainable future. This kind of optimism causes people to say "well this guy says there are some smart scientists out there working to fix the problem, so I guess I don't have to worry about peak oil and climate change."

Perhaps our difference in opinions comes from the fact that my professional experience is in the energy industry -- where projects take billions of dollars and years to ramp up to scale -- and Naam's professional experience is in the technology industry (specifically at Microsoft) -- where new software can be developed overnight on a shoestring budget and ramp up to infinite scale with little cost and few "real world" obstacles. Unfortunately, our global energy infrastructure isn't made out of bits and bytes, it's made out of iron and steel (and copper and rare earth metals). Energy projects can't be ramped up overnight. Engineering lead times for renewable energy projects can take a decade. We have trillions of dollars of capital stock (cars, airplanes, trains, farming machinery) locked up in technologies that are dependent on oil. Every car, every airplane, every train and every farm tractor has a usable life. In the case of a farm tractor, that usable life may be in the decades. Rolling over this multi-trillion-dollar capital stock is going to be an extremely slow process. It will take decades and trillions of dollars to switch our transportation infrastructure away from oil and on to renewable electricity and biofuels. Unfortunately, with peak oil staring us in the face, we do not have decades to solve the problem. With atmospheric carbon dioxide levels passing 400 ppm this month and with China now burning more coal than the rest of the world combined (making any carbon reduction the developed world does a moot point), we certainly don't have decades to fix our climate change problem. You can't simply wish away these problems with optimism about "innovation."

The consequences of this kind of unhinged optimism are perhaps more serious in the investing world. When deciding how to invest in the future of energy, we need to balance our optimism for technological innovation with our pessimism that the limits to innovation won't allow us to substitute away from fossil fuels fast enough to avoid collapse as we begin seeing a post peak oil decline. The key here is deciding how much optimism we should have. With most activities in life, it pays to be an optimist: sports, love, friendships, philanthropy, work, etc. But with investing, it arguably pays to be a pessimist, or at least to walk the line between pessimism and optimism. Optimists ignore investment risks and get burned. Pessimists see those investment risks, weigh them and decide to invest in ways that expose their portfolios to the upside while hedging the downside risk. In the world of peak oil, all of these risks will increase dramatically.

Global Oil Dashboard - Q1 2013

Introducing the "global oil dashboard."  I created this tool to help me track the key quantitative indicators of peak oil.  Oil is a finite resource and peak oil will happen eventually.  Because some experts, such as the Energy Watch Group, believe that peak oil is happening right now, I want to keep track of these indicators on a real-time basis to determine whether we are indeed passing peak oil.  I designed this dashboard to be mostly automated, in order to allow me to easily update it on a quarterly basis.  This dashboard also allows me to keep track of the performance of various "peak oil proof" investments to determine whether my investment hypotheses are correct.

Global Oil Dashboard - Q1 2013 - Will Martin - Peakoilproof.com

The Fourth Release of the Strategic Petroleum Reserve

Late last week the Obama administration announced that they would be releasing 30 million barrels of oil from the US Strategic Petroleum Reserve as part of a broader US-led release by the International Energy Agency of 60 million barrels of crude oil from member nations.  The move was unexpected and unprecedented.  This is only the fourth time in history that the Strategic Petroleum Reserve has been tapped.  The past three times were in 1991, during Operation Desert Storm, in 1996, when Bill Clinton used the reserve as a political tool to try to reduce the deficit and in 2005, after Hurricane Katrina knocked out 95% of Gulf of Mexico crude production.  The official reason given for the release of oil is to offset the lost Lybian oil production resulting from the Arab Spring-sparked civil war there.

Operation Desert Storm - one of four times the US used the Strategic Petroleum Reserve

In actuality, the release is probably designed to provide relief at the pump to American consumers as they enter the busiest part of the summer driving season.  With the QE2 stimulus ending on June 30th, the FED has planned to continue keeping interest rates low by using the proceeds from the maturing debt that was purchased during QE1 and QE2 to continue purchasing $25 billion worth of treasuries per month.  This continued quantitative easing would likely have an inflationary effect on oil prices, and this release of oil should partially offset this effect, at least for the next two months.  An economically-motivated drawdown of the Strategic Petroleum Reserve still has military consequences, leaving the US more vulnerable to supply disruptions, and as the US releases its stockpile of oil, China is rapidly filling its own strategic petroleum reserve.

After OPEC refused to raise production rates, many people expected Saudi Arabia to step in and raise their own production to offset the lost Lybian oil.  The fact that they haven't done so raises the specter that they may have in fact reached peak oil and are unable to raise their production rate any further.  Part of the problem is that the only additional oil that Saudi Arabia can quickly bring to market is heavy crude. Because it takes many months, many millions of dollars and numerous legal hurdles to upgrade refineries to be able to process heavy crude, heavy crude refining capacity remains tight, meaning the additional Saudi heavy crude capacity is unlikely to offset the lost light sweet crude production from Lybia.  This may continue to be a problem well into the future, as upgrading refineries for heavy crude and tar sands can cause their emissions per barrel to triple - making these upgrades difficult to justify politically.

With the world consuming over 86 million barrels of oil per day, the oil release is equivalent to a little more than 16 hours of global oil demand, meaning that the 5% drop in oil prices could be short-lived.  In fact, oil markets, which had been trading in backwardation since February, recently went into contango, signalling that supply shortages are just around the corner.  As a result, this short-sighted release of oil may present a buying opportunity for people wishing to profit from higher future oil prices.

Dollar Alternatives for a Peak Oil World

Some of the more alarmist peak oil writers have put forth the idea that once we reach peak oil, the world's fiat currencies will experience hyperinflation and currency collapse.  The general argument made by these authors, is that in the event of a rapid decline in world oil production, economies could suffer and governments may resort to printing money in order to prop up their economies (quantitative easing) or in order to purchase rapidly depleting resources.  This money printing could quickly get out of control, leading to hyperinflation and currency collapse.

Hyperinflation has happened a few dozen times before.  The most commonly cited cases are in Weimar Germany, which ultimately led to the rise of Adolf Hitler, and the recent 2004-2009 hyperinflation in Zimbabwe, which led to the government printing 100 trillion dollar bills that were so useless that they couldn't even buy a bus ticket.  Even in the United States, we experienced hyperinflation with the Continental Currency becoming so completely worthless through money printing that by 1778 the phrase "not worth a continental" entered our lexicon.

A Zimbabwe 100 trillion dollar bill

Personally, I think the risk of peak-oil-induced hyperinflation is relatively low, due to the fact that markets will, for the most part, properly allocate capital into energy alternatives and energy efficiency technologies.  Currently, the energy intensity (the amount of energy we use per unit of GDP created) of our world's economy is relatively low.  As we move from high net-energy oil (conventional oil with a high EROEI) to lower net-energy oil (tar sands, coal-to-liquids, etc.), the energy intensity of our economies will increase, but this will create an enormous financial incentive to increase our industrial energy efficiency and to develop renewable energy technologies.  To put it another way, oil will become more expensive, but we'll find ways to make the same amount of money with less oil, while at the same time, using oil alternatives that will become more and more affordable.  The change in world infrastructure may be massive and fraught with political and social pains, but inevitably, the world economy will continue chugging along as it always has.

Nevertheless, I find the topic to be fascinating (I even have a framed Zimbabwean $100 trillion bill on my wall), so let's take a look at various forms of alternative currencies that would theoretically save you from the "dollar apocalypse":

Other Fiat Currencies
There is a saying, that "everything is relative".  In the event of a currency collapse in one country, the currencies of other countries will gain relative strength.  During the hyperinflation crisis in Zimbabwe, locals began using the US Dollar and South African Rand in lieu of Zimbabwean Dollars.  Throughout history, some currencies have always been more stable than others.  The Swiss Franc, for example, has held its value extremely well while currencies around the world have fluctuated wildly.  Peak oil may cause the dollar to lose value if oil exporting countries lose faith in the dollar and begin to price oil in other currencies, such as Yen or Euros.  The world may abandon the US Dollar as a reserve currency and instead begin to use a basket of currencies for international trade.  In such a case, other currencies would gain on the dollar's loss.  As the world passes the peak of oil production, oil prices may skyrocket, benefiting the currencies of exporting countries, like the Russian Ruble.  If Saudi Arabia de-pegged its Riyal from the US Dollar, its value could skyrocket.  Fiat currencies from commodity-rich economies, like Australian Dollars, Canadian Dollars, and Norwegian Krone may also benefit in such a scenario.

Holding these currencies in a forex account or through currency ETFs may allow investors to benefit from changes in relative currency values, but using other countries currencies in day-to-day transactions is extremely difficult, as it may be impossible to get physical foreign currency during a crisis, and people may be unwilling to transact in currencies they are unfamiliar with.

Physical gold and silver
Commodity currencies, like gold and silver, our some of our oldest forms of currency and are even mentioned in the Bible, with Jesus referring to the Roman silver Denarius coins when he says "Render unto Caesar the things which are Caesar’s".  Throughout history, the purchasing power of precious metals has been surprisingly stable.  If you had an ounce of gold in 562 BC, during the time of the Babylon Empire, you would've been able to purchase about 350 loaves of bread.  Today, the same ounce would buy you about 500 loaves.  By comparison, a dollar would buy you twenty Hershey bars in 1954, but today it will only buy you one.  Clearly, physical metals are superior to fiat currencies in holding their value.

Unlike foreign currencies, people still have a general idea of how much a gold or silver coin is worth, due to the fact that so many people own gold and silver jewelry.  In the case of gold, because it never corrodes, it will remain in completely pristine condition forever.  It can be melted, combined and cast an infinite number of times, making it completely untraceable.  Gold and silver are relatively scarce and will likely remain so well into the future, due to the energy required to extract them from the ground.  Indeed, as peak oil makes energy more and more expensive, and as we move past all of the easily extractable gold, we could reach "peak gold" at some point in the future, and may have even reached it already.  Because well-recognized physical metals require absolutely no infrastructure to trade, they can be exchanged in the absence of electricity or even in the absence of government.  This advantage of gold was seen only a couple of years ago in Zimbabwe, when people began trading physical gold for food and other goods as the local currency collapsed.

Physical gold and silver, in the form of bars or coins, isn't easily divisible and has a relatively high value per unit, making it difficult to use in small transactions.  Instead of buying you a cup of coffee, for example, a silver coin might buy you twenty cups.  Coins are also subject to counterfeiting and coin clipping.  Verifying the authenticity of a coin may be extremely difficult and may require complex and expensive instruments.  Physical metals are also easy to detect and confiscate and can't easily be moved across boarders.  Finally, there is the problem with the physical security of precious metals.  Because they are so valuable, the risk of theft is high, and people may have to spend significant money simply to keep their physical metals safe.  Recent changes to the US tax code are also making it more difficult to transact in physical gold, as starting in 2012, all transactions valued over $600 (which includes most gold transactions) need to be reported on federal 1099 tax forms.  With the recent government raid on Liberty Dollars, it's also becoming more and more uncertain if it is legal for US citizens to use gold and silver coins as a currency.

Digital gold currency
Digital gold currencies have attempted to replace some of the shortcomings of physical gold by "digitizing" them.  Essentially, a digital gold service holds physical gold in a vault and allows its users to exchange gold amongst themselves online.  This solves the problem of divisibility, as digital gold can be divided into tiny fractions of an ounce.  It also partially solves the problems of authentication and physical security, as all parties agree to trust a central authority to hold real gold. 

While digital gold currencies may make it easier for people to conduct gold-denominated transactions, the risks are numerous.  The main drawback to digital gold currencies is that customers must put complete faith in the organization that holds the physical metals.  Customers must believe that the organization both holds real gold and that the organization isn't some "fly by night" operation that will take their money and run.  Electronic gold companies like "e-gold" have failed to reimburse customers after their accounts were hacked, and both e-gold and "e-bullion" have been shut down by the US government.

BitCoin
Bitcoin is the world's first decentralized digital currency.  Through the use of cryptography and a peer-to-peer distributed database, bitcoin allows people to exchange money online in an anonymous manner, similar to how we use cash today (think of it as an anonymous paypal that isn't controlled by anyone).  Because the money supply is finite and can't be adjusted by any central authority, bitcoin eliminates most of the problems that are created by the central banks that we have today.

For a good explanation of bitcoin, watch this video:

Because the number of bitcoins are finite, any banks that would use them would be less likely to practice risky forms of fractional reserve banking.  Unlike our banks today, if a "bitcoin bank" used the money multiplier effect to leverage up a $1,000 deposit into $10,000 in loans, it would then be at risk of a bank run.  Since there's no central bank to eliminate systemic risk through a mechanism like our FDIC, banks would need to use money multipliers that are lower than are currently used in order to limit their risk of a bank run.  A bitcoin bank could theoretically use a higher money multiplier and pay an insurance company to insure them against a bank run, but the result may be similar to what we saw when AIG, which insured against defaults of collateralized debt obligations by issuing credit default swaps, went bankrupt, causing a wave of bankruptcies that ended in the Great Recession.  In practice, if someone started a "bitcoin bank" it would most likely be a "full reserve bank" that would only allow people to store their money at the bank for a "safekeeping fee" or invest it by allowing the bank to loan it out in return for interest.  For deposit accounts, banks would need to compete against each other on the basis of which was the most solvent, rather than which can provide the most gimmicks like "free checking".

By eliminating the central bank, bitcoins also eliminate the "too big to fail" moral hazard problem with banking, whereby if banks do well, bankers are paid large bonuses, and if they fail, they get bailed out by the government and bankers are still paid large bonuses.  Such moral hazard, where there are no consequences for failure, cause bankers to take imprudent risks.  With bitcoins, since there is no central bank to print money and bail out failed banks, bankers would have to take more measured financial risks by using less leverage, which would make booms and busts smaller and less painful.  Without a central bank to control the money supply, inflation and deflation would be determined by the free market.

While bitcoins make hyperinflation impossible, one of the arguments against currencies with a finite money supply, like bitcoin and commodity currencies like gold, is that without continual inflation, the currency could be susceptible to a deflationary spiral whereby people horde the currency as goods and services become cheaper and cheaper.  Bitcoin has a built-in algorithm that causes near-term inflation that will gradually taper off into a finite amount of coins that are infinitely divisible.  As bitcoins become a finite currency, critics argue that they'll experience a deflationary spiral.  Arguments suggesting that currencies with a finite supply can cause a deflationary spiral are generally specious, as deflationary spirals aren't self-sustaining to infinity.  As deflation hits an economy, savers will hold out until the correction is at a point where the benefit of spending their savings outweighs the benefits of holding their currency any longer.  To put it another way, at some time during a deflationary spiral, there is an inflection point where the yield from investing the deflating money becomes higher than the yield from holding the money any longer.  At this point, the correction ends, the economy stabilizes, and everyone continues on their merry way.  Because humans have a time preference discount rate that favors consumption in the present over consumption in the future, there will always be a point at which people will want to stop hording a currency and start spending it.  There is a good deal of academic research that shows that deflation doesn't cause recessions, and can, in the case of a gold-backed currency, even be good for the economy.

Bitcoins eliminate the problem with currency debasement.  Throughout history, governments that have used commodity-based currencies have debased their value by gradually lowering the quantity or quality of the underlying asset.  In Roman times, the government debased the silver Denarius coins by reducing their size and lowering the fineness of the silver in them.  Beginning in the 1100's, the British Pound was backed by a pound of sterling silver.  In 1971, the pound was de-linked from silver and free-floated against other currencies.  The British pound that would buy you a full pound of sterling silver in the 1100's will buy you only 0.003 pounds of sterling silver today.  Rather than debasing the currency by physically altering the metal, the government debased the currency by simply changing the law.  Because bitcoins float freely against all of the world's currencies and because no government law can alter their supply, it is impossible for a government to debase the currency.

Bitcoins could theoretically eliminate a government's ability to hamper free enterprise by confiscating hard money and enacting price controls and rationing measures.  In 1933, Franklin Delano Roosevelt ordered the confiscation of all privately-held gold through Executive Order 6102.  Since bitcoins are virtual and decentralized, it is impossible for any government authority to confiscate them or freeze people's assets.  In the Soviet Union, for example, the government enacted price controls and rationing schemes during periods of goods shortages.  These efforts merely distorted the markets and encouraged underground economies to spring up.  The ultimate solution to shortages is the free market, because by determining resource allocations based on the proper price of goods, it sends price signals to the market, thereby encouraging investment in production of whatever is in short supply, and helping to bring the market back to equilibrium.  With government interference, these price signals are warped and resources may be easily misallocated.  If the economy used bitcoins, there would be no way for the government to restrict the underground economy, making price controls and rationing difficult or impossible to enforce.

If a government used bitcoins, rather than its own fiat currency, it would have to operate the way governments did under the gold standard.  Instead of printing money to pay for budget deficits, it would have to balance its budget or issue bonds.  If the government issued bonds, they would need to have an interest rate that compensated people for the risk of default.  Under the previous gold standard, the US government defaulted on gold-backed liberty bonds in the 1930's, leading to difficulties in selling further bonds.  The "inflation tax" that we all pay, but rarely notice, would be replaced by traditional taxes.  Without the inflation tax, there would be far more transparency in the way that we fund our government, and people would be less likely to allow the government to fund "pork barrel" projects or subsidies that benefit only a select few at the expense of the many.  People would be less likely to allow the government to fund wars without a clear idea of how the vast expense of wealth and human life would benefit the citizens back home.

The use of bitcoins by a government could also eliminate the iron triangle problem, as banks wouldn't be able to lobby a central bank to enact a loose monetary policy that would increase their profits and allow them to fund even more lobbying for even looser monetary policy.  This system would also eliminate the problem of political influence over central bank money printing.  For example, the incumbent political party wouldn't be able to create the appearance of a robust economy right before an election by pushing the central bank to enact loose monetary policy.  Politicians would have to get elected based on how their policies created actual economic prosperity, rather than perceived prosperity.

Governments could theoretically attempt to restrict bitcoins by declaring them illegal and prosecuting individual users, but because of the anonymity and decentralized nature of the currency, the government would have to expend enormous resources to find and prosecute people.  Short of catching someone in a sting operation, the anonymity of bitcoins, especially if they're run through an open wifi using nested VPNs and an anonymous protocol such as tor, could provide enough plausible deniability to make it impossible to prove guilt beyond a reasonable doubt in a court of law.  Since bitcoin is completely decentralized, the only way to shut down bitcoin would be to take down the entire internet.  As a result of the governments in Egypt, Libya, Tunisia and Bahrain shutting down their internet connectivity during the recent "Arab Spring" revolts, many smart technologists are looking into ways to make the internet more difficult for a single party to shut down.  Distributed infrastructure like the IEEE 802.11s standard for wireless mesh networking, is already being widely adopted throughout the developing world through the One Laptop Per Child program, which supports the standard.  These 2 million laptops can create a wireless mesh network where internet traffic can "hop" from laptop-to-laptop until it reaches one that is connected to the internet.  In the case of the Egyptian internet shutdown, journalists used satellite phones to connect to the internet and many people used old dialup modems to call international ISPs over land-lines to get back on to the internet.  The biggest current flaw to the resilience of the internet is the centralized nature of our domain name system.  As we saw recently with the US government's crackdown on internet poker sites, rather than shutting down the companies' servers, the government simply redirected their domain names.  Bitcoin has created a solution to this problem of internet centralization through the peer-to-peer domain name system called "namecoin" (to visit this blog over namecoin, simply use a namecoin-supporting DNS and go to http://will.bit/).  These domains, which end in ".bit", are completely decentralized and can't be shut down by any government authority.  There are other similar P2P DNS projects in the works, such as dot-p2p and MondoNet, but currently only namecoin is operational.  In theory, the combination of bitcoin and namecoin would allow an organization like Wikileaks to receive payments from supporters and operate a website which couldn't be shut down by any government.  The implications of these combined technologies on government transparency are enormous.

Clearly, bitcoin is a game-changer.  It has all of the advantages of traditional "hard money" like gold, all of the advantages of a digital currency and all of the advantages of cash.  When compared to fiat currencies, its drawbacks are few, if any.  It is a relatively rare occurrence when a new currency comes on to the scene and solves so many problems at once, which is why I and some of my friends here at Cornell are justifiably excited about this new currency.  Most of the hypothetical scenarios I previously laid out are simply designed to give a sense for how beneficial the widespread adoption of bitcoins could be.  At the very least, it is a superior alternative to the world's fiat currencies for online transactions, and it could be used in the event of hyperinflation or currency collapse.

Local Currencies
Finally, I want to discuss local currencies as an alternative for central-government fiat currencies.  Local currencies allow people to barter their goods and services within their own communities without the use of national fiat currencies like the US Dollar.  There are many examples of local currencies, from Detroit Cheers in Detroit, Michigan to BerkShares in the Berkshires region of Massachusetts.  Many cities have set up Local Exchange Trading Systems that allow people to trade their local currencies online.  Ithaca Hours, our local currency, is the oldest and largest community currency in America.  Each Ithaca Hour is valued at 10 US Dollars or 1 hour of labor and can be exchanged only within Ithaca, New York.  The benefits of Ithaca Hours are numerous. They keep wealth circulating within, rather than leaving the community, they encourage people to purchase locally produced goods and services and they provide community entrepreneurs with opportunities to generate wealth.  Dozens of other community currencies have sprung up since the creation of Ithaca Hours, and many have followed the Ithaca Hours model.  Currently over 500 local businesses accept Ithaca Hours, from our local grocery co-op to our local credit union.  Around the world, the Transition Towns Movement, which is bringing people together to prepare their communities for the dual challenges of climate change and peak oil, actively encourages local currencies.

1/8th of an Ithaca Hour

I've recently spearheaded the "Ithaca Hours Revitalization Initiative" here in Ithaca to increase the awareness and adoption of the currency around town.  This year is the currency's 20th anniversary and over the next year I and my team will be working with the Ithaca Hours organization to make it easier for Ithacans to use Ithaca Hours.  We're currently exploring the idea of digitizing the currency, and we're hoping to incorporate some of the ideas from bitcoin into America's oldest and largest local currency.

Conclusion
Once again, no matter how fascinating I find this topic to be, I personally believe that the chance that peak oil will lead to hyperinflation or a currency collapse is quite low.  Rather, I believe that markets will act accordingly to allocate capital into the extraction of ever more scarce resources until these sources of energy become more expensive than their sustainable alternatives.  The transition to these sustainable energy sources, however, may not be entirely smooth, and it therefore may be prudent for investors to consider moving some portion of their wealth into dollar alternatives.