Friday, December 19, 2008

Energy Positive Feedback

One of the "fundamentals" of oil prices (and other commodities) is the thought that the cost of extraction ought to be fixed or stable for a given geography, related to how difficult or involved the process. Changes in cost due to demand and supply is explained away to profit margin over fixed costs, costs of exploration and costs of increasing capacity etc.

The truth is, with such increasing automation of providing supplies, one of the larger marginal cost of energy supply is the cost of the energy used to provide that supply. Thus as the expectation of costs incease, prices will increase in a magnified way, as the feedback of energy costs increasing will increase the associated cost of extraction. There will be correlation between increases in one energy commodity and a range of other energy commodities and commodities that require a lot of energy to produce( eg. Aluminium, Iron), or that can produce alternative fuels (eg. silicon for solar panels, or sugar for ethanol etc.).

Similarly if expectations of prices start to decrease, and there was a considerable margin to start with, there can be a positive feedback which reduces the price and also the baseline cost of extraction as well through the correlated energy rich commodities. This snowballing downward will still leave some producers with profit margin, even if there would have been a considerable loss at those prices with input costs the way they were.

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