This is a guest post by Philip Henshaw, known on The Oil Drum as pfhenshaw. Phil has a BS in physics and an MFA in architecture. He has been studying the physics of how natural systems change form for 40 years, first interested in the subject by college physics experiments in how all experiments misbehave. Phil's website is www.synapse9.com.

Economic theory is based on the observed regularities of the past. Some are considered as general principles, or “natural laws” that are expected to never change. From a systems view, though, such laws are emergent properties of the complex system they are regularities of, and prone to change as the system changes form.

Growth systems, for example, invariably change form when they climax, but the present laws of economics describe a complex system that has perpetual growth that never changes form. The question is partly how to tell when such changes might be appearing. Complex systems may vary a great deal without indicating a change in the form of the whole system. What would raise the question is finding events of kinds that are not supposed to occur at all. Present evidence points to depletion of necessary resources as the possible cause of the combined food and fuel price spiral of the past decade.

An example of one such economic law is that scarcities are temporary. In theory, self-interest drives people to either find substitutes, added supplies, or to reduce demand as prices rise, and in those ways scarcity is expected to resolve smoothly.

When none of those three things occurs, though, the economy experiences a continuing price spiral with no substitutes or added supplies being found for an extended period. It’s a primary indication that the physical system is at a point of inelasticity, and changing design in some way. Then the old “laws” become misinformation about regularities that no longer exist. This is a brief research note on one example, to raise questions.

This is the second (the first can be found here) in a series of guest posts by Robert Smithson, a portfolio manager at a London based investment fund.

Introduction

The world’s oil supplies are not unlimited. Unless the abiogenic theory of oil is correct, then reserves will one-day dwindle, and production will decline. New barrels cannot be “magic-ed” by some trick of economics. Extraction of any fossil fuel extraction is limited. Peak oil is inevitable. Of course, there is debate about when production hits its highs; it may have already happened, perhaps it will come in the next few years, and just possibly, it will be in 2020 or later. But make no mistake about it, we are not endowed with infinite amounts of the stuff.

Sceptics rightly point out that this bell has been rung before. In the mid 1980s, world oil reserves were forecast to last about 20 years; and yet here we are in 2007, with near record production levels. Historically, we have always found new sources of oil – in Alaska, in the North Sea, in the Gulf of Mexico, and off the coast of Africa – to satisfy our addiction. There are prospects in the future too: there may well be (very substantial) new discoveries in the Middle East, ultra-deepwater drilling holds promise, as does the development of new areas such as the South Atlantic, and increased enhanced oil recovery will certainly play a role. This misses the point: finding new oil reserves may push out peak production, but it does not invalidate the concept. Our planet does not contain an unlimited amount of oil.

Many – particularly on this site - argue that economics has little that is intelligent to say about peak oil. Yet the very definition of economics is the study of scarcity, and in particular, the study of the efficient allocation of scarce resources. What more relevant subject could there be for studying the effects of peak oil?