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Pricey Oil's Ugly Spillover


The digital road race could be slowed by fossil fuel scarcity

Niko Bellic, the main character in the best-selling video game Grand Theft Auto IV, spends a lot of time driving around the virtual world of Liberty City—but he never has to stop to buy gas. That, in a nutshell, is the difference between the digital economy and the oil economy.

The digital economy is a culture of abundance. It's virtually costless to duplicate something online, whether it be music, software, or even news. Google (GOOG), Microsoft (MSFT), Facebook, and MySpace (NWS) all vie to attract customers to their plentiful free offerings. By comparison, the oil economy embodies the culture of scarcity, wherein traders try to figure just how much petroleum is left in the world and just how high the price of oil can go.

Digital Substitutions

Until recently, the digital and oil economies coexisted in peace. Oil prices were low enough that total spending on crude paled next to the economy's expenditures on technology. For example, at the bottom of the tech bust in 2002, U.S. businesses spent $400 billion on information processing equipment and software. That same year, U.S. refineries spent only $131 billion acquiring crude oil. Between 1995 and 2002, the acquisition cost of crude oil averaged only 30% of spending on tech.

But that has changed, and the oil economy has caught up with the digital economy. By BusinessWeek's calculations, in the first quarter of 2008, U.S. refineries bought up crude oil at an astonishing $504 billion annual pace. That comes close to the $534 billion annual pace of U.S. business spending on information technology.

The U.S. has reached an important turning point in the development of the digital economy. If oil prices remain high, we will see whether the culture of abundance can survive an encounter with the culture of scarcity.

One possibility is that the high cost of oil actually accelerates the shift into the virtual world, as people and businesses substitute digital connections for physical interactions. Managers will rely on videoconferencing instead of flying across the country or the world to meet in person. Newspapers, faced with rising energy costs for production and delivery, will make the big decision to drop their print versions and go completely online. Socializing will shift increasingly to the Web from pricey evenings out. And teenagers will do more of their driving online rather than spend $40 to fill the tank of the family car.

Purchasing Slowdown

Alternatively, the culture of abundance could falter under the weight of energy costs. The data centers underpinning the digital economy are prodigious users of electricity. If oil prices stay high, electricity prices should soon follow—and how long will it be before the data centers become expensive drains on corporate profits?

Anticipating this problem, Google and other major tech companies have built some of their data centers in areas such as the Pacific Northwest, where cheap hydropower is available. Nevertheless, most of their digital infrastructure around the world has no such immunity from rising energy costs.

Similarly, we've grown used to spending relatively small sums to purchase sophisticated routers, laptops, and smartphones. But this cornucopia of cheap electronics is based in part on making the gear 10,000 miles away in Asia and shipping it to the U.S. However, the price of inbound air freight has risen by 15% over the past year. If transport costs continue to rise, will the price of tech equipment have to rise as well?

These questions can't be answered until we know whether oil prices are going to fall or soar to even higher levels. But here's one thing we do know: Unlike Niko Bellic, we do have to stop for gas sometime.

Links

Weighing in on bubbles and shortages, and the possible rise of Brazil as a leading producer

SOROS SAYS THE B-WORD

A May 26 article in London's The Daily Telegraph quoted George Soros as saying that "a weak dollar, ebbing Middle Eastern supply, and record Chinese demand could explain some of the increase in energy prices" but that "the price of oil has this parabolic shape which is characteristic of bubbles." However, the billionaire investor doesn't see a steep correction in oil prices until the U.S. and Britain fall into recession--a scenario he also predicts.

FALLING CRUDE SUPPLIES?

Crude-oil supplies over the next couple of decades are likely to be far tighter than previously forecast, according to a May 22 report in The Wall Street Journal. The Paris-based International Energy Agency is expected to significantly lower its oil-supply forecast. Previously the IEA had predicted that supplies of crude and other fuels would stay roughly in alignment with demand through 2030. Instead, a production gap could emerge in the middle of the next decade.

BRAZIL IS ANGLING FOR OPEC

Brazilian President Luiz Inácio Lula da Silva is thinking big. In a May 9 interview with Der Spiegel, the German newsweekly, Lula indicated that Brazil is interested in joining the cartel. Last year a huge oil reserve was discovered off the coast of Rio de Janeiro that the government believes could eventually boost the country's oil reserves by 40%. If so, Brazil could emerge as a top-10 petroleum-producing nation during the next 10 years or so.

Mandel is chief economist for BusinessWeek .

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