The parable of the sperm whale

In the early 1800s, the main function of oil throughout Europe was illumination. Lamps were in every middle class home and to fire them up required oil from sperm whales hunted throughout the world's oceans.

But as whale numbers dwindled, the price of illumination increased, as did the determination of innovators to find a replacement for whale oil.

It was high prices that led to the stampede for alternatives, and plenty of alternatives were tried. Turpentine, gas distilled from coal, and kerosene were but a few. It may seem obvious today that oil would replace whale oil, but oil – then known to the world as 'rock oil' – was not widely considered to be a successor because it was difficult to extract.

It was only when individuals thought of drilling for oil, rather than digging it up, that large scale oil production became viable. It's hard to imagine that innovative breakthrough coming about in the absence of a strong profit incentive provided by high prices.

Whale oil producers did enjoy a short period of super profits. There were no doubt individuals who extrapolated high prices out many years. But high prices created the conditions for the birth of a new industry – rock oil – and the end of whale oil.

For those like me, who believe elevated energy prices are highly likely over the next few years, the parable of the sperm whale is an important one to keep in mind.

High prices aren't always the bonanza they appear to be. Sure, super profits can be earned in the short term, but as the threat from demand destruction and substitution – sometimes from unlikely sources – grows, legacy industries may be more likely to disappear than prosper. Higher prices alone are never an easy way to higher profits, at least not over the long term.