The Energy Futurist

High oil prices: Fortunately and unfortunately

High oil prices: Fortunately and unfortunately

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High oil prices are changing our world in many ways; some for the good, and some for the worse, columnist Chris Nelder writes.

High oil prices are changing our world in many ways; some for the good, and some for the worse.

Contemplating these changes, I'm reminded of a book I loved as a child, Fortunately, a tale of reversing fortunes:

Fortunately, Ned was invited to a surprise party.

Unfortunately, the party was a thousand miles away.

Fortunately, a friend loaned Ned an airplane.

Unfortunately, the motor exploded.

Fortunately, there was a parachute in the airplane.

Unfortunately, there was a hole in the parachute.

And so on. Such it is with high oil prices.

Mass transit

Last week, I wrote that drivers in the U.S. will be forced to simply hand over the keys to new drivers in developing countries as competition for oil increases. But there are other reasons too, like lower costs and less stress. Bus and train ridership increased by 2.3 percent in 2011 over 2010, according to new data from the American Public Transportation Association, reaching one of the highest levels America has seen since 1957, according to the Washington Post. Subway ridership was up 3.3 percent nationwide.

Intercity transportation is also moving away from air and rail and toward buses, according to research by the Chaddick Institute for Metropolitan Development at DePaul University in Chicago.

Bus service between cities has been growing steadily since 2006, and was the only form of intercity transportation to grow appreciably in 2011. Free wi-fi and power outlets, spacious seats, online ticketing, and convenient pickup locations have increased the appeal of what was once a disparaged mode of travel, even as air travel has become less convenient and more unpleasant.

Transit-hub based bus service enjoyed 6 percent growth in 2010, and 7.1 percent growth in 2011. Traffic on "curbside operators," which offer pickup at various locations aside from transit hubs, grew a whopping 32.1 percent in 2011. Big curbside operators BoltBus and Megabus posted the greatest growth, and appear to have now reached profitability. Megabus boasts 15 million cumulative passengers since it began operations in 2006. BoltBus, which opened in 2008 to some fanfare for its gimmick of selling one seat on each bus at random for just one dollar, is a comfortable and very cheap way to get between major cities in the Northeast. For example, one can book a trip from Boston to New York on BoltBus just two days in advance for between $17 and $25; on an airline, tickets for the same trip start at $360. Smaller operators offering more deluxe accommodations, such as Limoliner, Lux Bus America and New York Shuttle also expanded service in 2011.

Intercity bus service growth rates, 1960-2011. Source: Chaddick Institute for Metropolitan Development

The enthusiasm for comfortable and relatively low-cost bus service contrasts markedly with air and rail service. Scheduled airline departures shrank slightly in 2011 while passenger seat-miles increased a modest 1.5 percent. Rail passenger seat-miles rose just 1.2 percent but train-miles fell by 1.1 percent.

Estimated growth in passenger ridership, 2010-2011. Source: Chaddick Institute for Metropolitan Development

Interestingly, as I detailed in January ("The revolution will be bottom-up"), this is one of the many transformations under way in America which are forced by high oil prices but which aren't easily detected in official data. The researchers observe: "Accurate passenger traffic statistics are not available for the intercity bus sector due to the fact that no federal government agency compiles and audits such statistics, as is done for intercity rail and airplane travel."

Airlines

As ever, high oil prices hurt the airlines most of all. The last time global oil prices were this high was in the first half of 2008, when I detailed the carnage in the airline sector. By October of that year, when I heard airline industry expert Michael Boyd explain at an energy conference that every airline in the world is obsolete at $100 a barrel, 30 small carriers had gone bust.

Now we are seeing the next tranche of air carriers being wiped out by intolerably high fuel prices. Southwest Airlines, one of the few carriers who hedged their oil price risks properly in 2008 and avoided heavy losses, said yesterday that it will not earn a profit in the first quarter of this year.

But at today's oil prices, merely being unprofitable is doing very well indeed. Air France-KLM reported a $1 billion loss for 2011, saying that it had not been able to offset the rising cost of jet fuel. Australia's Qantas Airways reported last month that high fuel costs had halved its profit in the first half of 2011, and that it would cut 500 jobs in a bid to save the company. AirAsia X announced this week that it is suspending service to New Zealand due to unprofitability, as prices have increased more than 30 percent since it launched the route. Also this week, Israel's El Al Airlines announced higher fuel surcharges, eliminated its service to Brazil and iced its plan to expand service to the U.S. Of the six major airlines in India, only one is currently profitable, and the Indian airline industry as a whole is expected to realize a $2.5 to $3 billion loss for the 2011 fiscal year.

Worst of all, South Carolina-based public charter airline Direct Air suspended its operations yesterday without notice when it ran out of money to pay for fuel, stranding its customers without offering them alternative arrangements.

Unfortunately, there is little that the airlines can do to accommodate an era of permanently higher fuel prices, other than raising their own prices accordingly. Of necessity this will mean a shrinking industry and a gradual transition to buses and long-distance rail for overland transport, and an eventual return to seaborne transport for economy-class international travel. Looking 20 to 30 years into the future when the global supply of oil will be 30 percent or more lower than it is today, we can easily imagine air travel returning to its roots as a mode of travel that only the wealthy can afford. Indeed, Simon Fraser University urban studies professor Anthony Perl, the author of the 2008 book Transport Revolutions, predicts that no more than 25 airports will be functional worldwide by 2025.

Trucking and delivery services

Next to airlines, long-haul trucking companies are arguably the most vulnerable to fuel price shocks. With a single diesel fill-up costing up to $900 and very thin profit margins, most have no choice but to pass along their increased costs to customers.

"There's no way that the trucking industry can absorb fuel costs, it can't happen," trucking company owner Jim Ganduglia told ABC News. Where he operates in Fresno, California, diesel is running from $4.25 to $4.35 a gallon this week. "So there's a fuel surcharge and without that fuel surcharge we'd all be out of business."

Nowhere is the cost of trucking more evident to consumers than at the grocery store. Fresh produce and other perishables must be shipped promptly no matter what fuel prices are. Grocers, who also operate on razor-thin margins, must raise their rates in turn. So if you're wondering why a head of lettuce has jumped from $1.59 to $2.00, that's why.

Local drivers for repair services, florists, cleaning services, pizza shops, mobile food businesses, and so on are feeling the pinch even more. Many of them cannot pass their increased fuel costs along to customers without losing business, so they wind up eating the loss.

Operators of small fleets, like Phoenix-based HVAC repair shop George Brazil Services, try to maximize their fuel efficiency by switching to more efficient vehicles and increasing the size of their fleets so drivers don't have to travel as far on each call. With up to 2,000 house calls per week, they spend $10,000 to $20,000 on gasoline every 10 days, said owner Jim Probst.

Larger fleet operators are turning to logistics services to optimize their fleet activities, using GPS devices to track their drivers on a minute-by-minute basis. But such tools are generally beyond the reach of small businesses. So Google Green, take note: There's a hungry segment of small business owners who could really benefit from real-time guidance on avoiding slow roads, optimizing routes and shifting deliveries to less congested times of the day.

Optimizing the behavior of drivers is another fuel-reduction strategy advocated by companies like Dubai-based Dynamic Technical Training. By training drivers to shift strategically and avoid hard acceleration or hard braking, they have shown that fleet operators of 100 vehicles can save $31,500 annually in fuel costs. Larger fleets, in the 1200-vehicle range, could save $1.2 million per year.

For national delivery services like UPS who have already optimized their drivers' habits and engaged in a long campaign to upgrade the fuel economy of their fleets, the main recourse is to simply keep raising their fuel surcharges. One year ago, the surcharge was 5.5 percent. Now it's 7.5 percent, and it will be 8 percent by April according to the UPS surcharge schedule. Indeed, if diesel prices continue their current trajectory, UPS will have to issue a new schedule by summer because prices will have gone beyond its highest bracket of 9.5 percent.

Farmers

Farmers are being forced to find ways to conserve fuel as well. Although most consumers do not realize it, an estimated 7 to 10 calories of fossil fuel are embedded in every calorie of food that arrives on American tables, mostly from diesel used to power farm equipment and big rigs, and from natural gas used to make fertilizers. Fuel is an enormous part of the cost structure for farmers, but they are often forced to absorb fuel price increases because they can't pass them along to consumers.

So they have to be creative. Farmers are looking to no-till practices and switching to crops that require less tilling in order to save on fuel.

"We'll think of ways, maybe make less passes through the field with the tractor than we normally would have. Try to figure out ways by maybe using weed sprays instead of cultivation," farmer Greg Markarian told KFSN in Fresno.

This highlights a somewhat counterintuitive result of rising fuel prices. While it's true that organic farmers generally use less fuel than conventional farmers, the prices of organic foods may increase even more than that of their conventional counterparts if the farmers who grow that food are committed to using permaculture practices like cultivation instead of spraying herbicides to control weeds.

Creative as they may be, however, farming is an historically low-margin business, and it is likely that diesel prices remaining stubbornly over $4 a gallon will spell significant losses for many of today's farmers. At the same time, higher food prices should encourage more local food production and ultimately lead to the relocalization of American farming. As we progress into the era of expensive oil, we cannot continue having our food shipped an average 1,500 miles from the farm to our tables.

Supply chains

Another area in which relocalization is becoming attractive is in supply chain management. High oil prices and the North American recession are destroying the labor arbitrage that once made it attractive to offshore manufacturing to Asia, and have elevated transportation costs to a prime consideration.

One analyst who has predicted this for many years is former CIBC chief economist Jeff Rubin, author of the book Why Your World Is About To Get A Whole Lot Smaller: Oil and the End of Globalization. "Soaring transport costs suddenly change the entire economics of importing everything from cheap labour markets half way around the world," he writes, "So much so that triple digit oil prices will soon breathe new life into our hollowed-out rust belts, and, in the process, bring long-lost manufacturing jobs back home."

In 2008, MIT professor and supply chain expert Dr. David Simchi-Levi analyzed the historical impact of diesel prices on supply chains. He found that every $10 increase in the price of a barrel of crude added 4 cents per mile to transportation rates (against a $75 a barrel baseline price), and that when oil prices hit $150 a barrel, it begins to reverse offshoring prompted by labor costs. Philadelphia and Omaha suddenly become competitive with Juarez, Mexico.

In supply chain parlance, moving manufacturing back to North America is known as nearshoring. Logistics managers are increasingly considering it as a way to maintain profitability in the face of rising fuel costs. A new survey by Logistics Management magazine found that 38 percent of its readers are actively working on nearshoring strategies, and another 6 percent are considering it in the future. The magazine cited another recent survey of senior executives by Alix Partners, which found that 63 percent of the respondents were considering moving manufacturing operations slightly closer to home in Mexico, and that 19 percent want to bring operations back to the U.S.

Indeed, the repatriation of some manufacturing is already happening. CBS News recently featured a small bead manufacturing operation in Michigan, which found that making their product with domestic labor and parts delivered more profit and higher quality than its previous Chinese provider had. One in ten new manufacturing jobs in America are being created in the Michigan rust belt, CBS observed, and noted that everything from tractor parts to wind turbine components are now being made there.

So look sharp, America. Peak oil and the new era of higher oil prices may mean that you can't just flit off to Vegas for a weekend on the cheap anymore, but it also means that you can once again have a good job, and rebuild America's manufacturing base. Your world will be a whole lot smaller, but it might also be a whole lot better.

Photo: 11-year-old girl working in the Rhodes spinning factory, Lincolnton, North Carolina, 1908. (U.S. National Archives)

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Chris Nelder

Columnist (Energy)

Chris Nelder is an energy analyst and consultant who has written about energy and investing for more than a decade. He is the author of two books on energy and investing, Profit from the Peak and Investing in Renewable Energy, and has appeared on BBC TV, Fox Business, CNN national radio, Australian Broadcasting Corp., CBS radio and France 24. He is based in California. Follow him on Twitter. Disclosure