Pricey Oil's Ugly Spillover
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.
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.
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.