by Carrie
Fri Nov 17th, 2006 at 08:28:55 PM EST
Following on the footsteps of Colman's highly successful Probably incredibly unreadable modelling thread (June 12th, 2006)
In Thursday's open thread, starvid commented
Lately, I have been thinking about the economic impacts of Peak Oil, and tried to understand what industries will profit the most from it who'll lose the most.
and in the subsequent thread I demanded "a Leontieff matrix". When pressed, I explained what I wanted like this:
So Peak Oil is a phenomenon involving the Oil and Gas Extraction sector, namely its predicted inability to grow its output (in energy, not monetary units) or even maintain it, no matter what.
So, what are the inputs into Oil and Gas Extraction, and why is it that increasing any of the inputs won't increase the output?
Also, what sectors does the output from Oil and Gas Extraction feed into?
and managed to extract this
Inputs. Capital obviously. Plenty of that around. Skilled labor. We're seeing a shortage of that. Equipment. Most of it's old and rusty. New fields to exploit. This is the most important. Production can not grow without new fields. New technology only minimize decline rates and prolong high production and increase reserves (if they even do that, some people mean new technology only means the oil is sucked out of the ground faster). But it can only increase production in tired old fields, and it won't bring production back to it's old peak.
Where does the output go? I guess you mean where the product is used? Everywhere. In 99% of all transportation services. And everything is transported. The output also goes to heating and power generation where adequate alternatives exist and will supplant hydrocarbons in the long run. Another important use is in the petrochemical sector where alternatives are hard to see.
Who is this guy Leontieff, and why do I keep bringing his matrices up? The answer after the fold.
Wassily Leontief was a German-born Russian exile who won the 1973 Nobel Prize in Economics for his Input/Output model. According to Wikipedia,
The analytical apparatus is strictly empiricist and reducing bias in the analysis. For this reason, Leontief seems to have been just about the only economist who was equally honored by communist and capitalist economists.
I first encountered Leontief's model as an application of elementary linear algebra when I was a teaching assistant for freshman-level "Linear Algebra for Business" at an American university. Assisting math courses for Business majors was a rite of passage that every mathematics graduate student had to go through for at least (and hopefully at most) one quarter at the beginning of our studies. For the students this example (like most examples of applications in introductory maths textbooks that I encountered over the following 4 years) was a disaster: supposedly the Leontief model would help students understand linear algebra, but instead they were faced with the task of simultaneously getting their heads around matrices
and macroeconomics while having no experience or inclination for modelling. So much for trying to make math easier to teach by making it "relevant". </pedagogy rant>
Anyway, I think the Leontief model, painfully simple as it is, is quite useful and instructive. It is also quite limited, but that is mostly because of its linearity. It can easily be complicated beyond tractability, and that is just what I intend to do here. No, really, I'm just kidding.
So, keeping in mind Stephen Hawking's admonition that every equation reduces the number of your readers by half, I won't use any equations. Or not really. But, as you know from my previous writing, I don't like to do that anyway and it's your loss because an equation is worth 1000 words (just look at Archimedes).
The model
The basic building block of the model is a description of an "industry" in terms of one "output" and several "inputs". Like this (if you like chemistry you'll like this)
industry: (input 1) + ... + (input N) -> (output)
The model is parametrised by giving the amount of each input that is needed to produce one unit of each output. This is (the inverse of) the productivity of the given input. What makes this model more interesting than an enumeration of productivity numbers is the idea that every input must be the output of some other process, and conversely every output must be an input as well. This makes the system closed. The full model is obtained by allowing for consumption and trade of the products. It can be used to study the question of how changes in one sector of the economy will affect other sectors.
Leontieff formulated his model to study "general equilibrium", but the model can be used dynamically, and it can even be used as a framework in which "innovation" can be represented by adding new "products" or "industries" to the system, increasing the dimension of the input/output matrix. The possibilities are endless. The model is also great in that if emphasises that the economy contains cycles much like the enviromental cicles of carbon, water, etc, and allows one to study internal consumption, that is, what fraction f what is produced just goes to keep the machine going, as opposed to being enjoyed by the public.
Peak oil: the setup
So, what does this have to do with starvid's question on Peak Oil? Well, I think Leontief's framework allows one to systematically address the question of the effects of Peak oil on the economy.
Peak oil is a prediction that the output of the oil extraction industry cannot increase in the medium term and will likely start declining in the long term. So, we would start by writing an equation (like a chemical formula) for that industry...
oil extraction: (capital) + (skilled labour) + (machinery) + (oil fields) -> (crude oil)
A few questions immediately arise: 1) are "capital", "skilled labour", "machinery" and "oil fields" homogeneous enough, or do they have to be broken down further? 2) what processes and/or industries produce "capital", "skilled labour", "machinery" and "oil fields"? 3) aren't we forgetting waste products? How about the energy to power the machines? 4) how much of each of these inputs is necessary to produce one barrel of crude oil? Are there tradeoffs (e.g., can use more machinery and less labour)? 5) what processes/industries use "crude oil"?
Let's not get carried away into excessive complexity (there is always time to analyse entities into smaller ones and multiply the dimension of the problem) and instead concentrate on questions 2) and 5): where do the inputs come from and where does the output go? For the inputs, take "machinery" for instance
machinery: (capital) + (skilled labour) + (machinery) + (materials) -> (machinery)
and for outputs we have
oil refining: (capital) + (skilled labour) + (machinery) + (crude oil) -> (transportation fuel)
oil refining: (capital) + (skilled labour) + (machinery) + (crude oil) -> (heating oil)
oil refining: (capital) + (skilled labour) + (machinery) + (crude oil) -> (aviation fuel)
oil refining: (capital) + (skilled labour) + (machinery) + (crude oil) -> (petrochemicals)
We can play this game in as much or as little detail as we want (I recommend little detail) by adding new processes/industries as long as there are products that are unaccounted for as either inputs or outputs. At some point, every product will appear at least once as an input and once as an output and we will have achieved
closure. Then we can start analysing the impact that changes in one economic sector will have on another economic sector. In particular, for our purposes, we might be able to trace the impact of Peak Oil.
Peak oil: the answer
Questions? Thoughts? Rotten tomatoes?