Oil Prices

Battleship

TriangleofDoomgc2reddit-logoOff the keyboard of Steve Ludlum

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Published on the Economic Undertow on May 2, 2016

 

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As JP Morgan famously remarked, markets fluctuate; its impossible at any particular moment to pick trends out of the background noise. Nobody can say for sure whether tops or bottoms are in. Trends only reveal themselves in the rear-view mirror, even as they are obscured by non-stop advertising campaigns and PR. By the time a trend is clear it is usually too late for investors — otherwise known as ‘fools in the market’ — to do anything about it, the free lunch is already eaten and the punch bowl taken away …

Triangle of Doom 042916

Figure 1: Is the bottom in? Chart by TFC Charts (click for big). Oil prices have been fluctuating higher in futures’ markets but nobody can be sure whether prices will rise from here or head back for the cellar.

With current prices at- or below the cost of extraction, drillers look to survive by reaching for the plastic, offering themselves and their properties as collateral. This is a medium-sized problem for drillers: along with all the other industries they have been borrowing from the beginning of time. In the good ol’ days they borrowed less, now they borrow more while praying for the trend change that brings that punch bowl back.

Ordinarily, the oil drillers’ customers step forward with their own borrowed funds to retire the drillers’ loans. Customers don’t simply sign over the money to the drillers, they over-pay for drillers’ products. This is what the term, ‘sustainable business model’ actually means; customers pay higher prices for successive rounds of cheaper-to-produce goods; the margin is used by firms for debt service and the retirement of maturing loans. Naturally, as each round of financing is rolled over the firms borrow more. Some of this money flows to executives, by way of this process CEOs become tycoons. Economists gain as well because every increase in borrowing represents GDP growth they can take credit for.

Fast-forward to the present: goods are unaffordably expensive to produce, emptied-out customers are no longer able to over-pay. They have nothing to offer as collateral for loans but their (near worthless) labor and frantic urge to Waste as seen on TV. Because the customers are unable to borrow, they cannot benefit the drillers, the drillers must borrow for themselves and pray …

Because the ‘waste as collateral’ concept is absurd/ridiculous, both the customers’ AND the drillers’ loans are effectively unsecured. This leaves a maturity mismatch between drillers and their customers. Firms are borrowing tens- of billions of dollars even as their customers are standing in line at the food bank. Customers cannot borrow => they cannot overpay => prices crash as drillers have no place to put unsold crude => whatever collateral the driller offers becomes worthless. The customers stiff their lenders => there is nothing for lenders to seize. At the end of the day, drillers, customers and lenders are all ruined … this dynamic is playing out in real time, right this minute, under everyone’s nose, all over our Great Round World.

This is perfect if unremarkable sense; conditions within oil industry finance must reflect resource depletion and it is clear that they do. The non-stop PR campaigns touting driller technology, efficiency and innovation are irrelevant, none of these things touch the customer. Losses cannot be made up with volume. Real returns, solvency and cash flows matter; when customers cannot gain the means to buy fuel industry products there is ultimately no more fuel industry. Redistribution, or giving customers the means to buy fuel is an immediate-term (non)solution. Some expensive time is borrowed until the customers’ financing is exhausted. Because resource waste offers no tangible returns to the waster; his credit will eventually run out, he will waste no more.

Meanwhile, the drillers must borrow or go out of business while lenders hold their noses and lend! The alternative is an output crash; we are caught between a looming crash and conditions that are pregnant with crash possibilities. Credit access becomes a matter of desperate necessity with every borrowed dollar lodged against the lenders’ deteriorating balance sheets. At the twilight of the petroleum age, drillers survive by cannibalizing their bankers who in turn are becoming the global economic link under the greatest strain.

Giant finance firms preserve the illusion of system sufficiency by lending to each other. Self-pleasure here is deadly; the lenders have become zombies rotten with non-performing loans. Growth is stagnating, economies are falling into deflation, turning Japanese. The zombification of the banks becomes both the reason for- and the consequence of extraordinary monetary quackery: the intent is to goad finance into squeezing out every possible loan, to kick that can one more day while hoping for a miracle. For business as usual, there is no alternative: interest rates fall to zero- then negative, currencies depreciate, pensions are looted and depositors bailed in … we must endure these abuses or else! Everywhere in the Westernized world useless industries and sectors are propped up regardless of consequences. Deflation results from the longer-term inability of billions of end-users to gain purchasing power or returns on capital from a mechanized regime that is designed from the ground up to annihilate capital.

No capital, no purchasing power, no problem; we’ve got iPhones, instead!

Blows are starting to rain down on the technology sector. Instead of saving our bacon as its promoters endlessly insist, the industry is having problems saving itself:

AAPL

Figure 2: It isn’t just the energy sector: looking at this pretty chart (Yahoo Finance, click for big): Apple’s decline looks to be part of a longer-running trend rather than a fluctuation. The firm reported earnings, which were terrible; the company is being punished for its customers’ misbehavior.

Rotten Apple: Stock plunges 8% on earnings, revenue miss

Everett Rosenfeld

Apple reported quarterly earnings and revenue that missed analysts’ estimates on Tuesday, and its guidance for the current quarter also fell shy of expectations.

The tech giant said it saw fiscal second-quarter earnings of $1.90 per diluted share on $50.56 billion in revenue. Wall Street expected Apple to report earnings of about $2 a share on $51.97 billion in revenue, according to a consensus estimate from Thomson Reuters.

That revenue figure was a roughly 13 percent decline against $58.01 billion in the comparable year-ago period — representing the first year-over-year quarterly sales drop since 2003.

Shares in the company fell more than 8 percent in after-hours trading, erasing more than $46 billion in market cap. That after-hours loss is greater than the market cap of 391 of the S&P 500 companies.

 

 

AAPL is not some disposable startup at the end of a cul-de-sac somewhere in suburbia, it is (or was) the world’s largest company by capitalization. It is the technology sector’s tech company. When people hear the word ‘progress’, chances are they think robots and iPhones. Yet, markets are becoming unfriendly for the behemoth: its shares presently lurk at a support level, that if breached, would indicate a decline to $55 or so … from $125 per share a little over a year ago. In other words, a slump that mimics the fuel price crash.

This is very serious business. Stockholders are a who’s who of finance: pension funds, sovereign wealth funds, central banks, private equity and hedge funds. Shares are collateral for billions in debt that has been used for stock buy-backs and mergers. The entire tech investment ecology is at risk. Damage from a sixty-percent-ish price decline would be severe. Leverage against the shares applied backward compounds the damage just as it expands returns on rising prices; this puts more pressure on the hapless lenders reeling from their debacle in the oil patch. It isn’t just the money: against a backdrop of hand-wringing and denial, the science fiction narrative of a future running on innovation (and sharp business practices) is falling apart.

Ironically, Apple is constrained by a cleverness shortage: successive iterations of iWhatevers have become predictable variations on now-familiar themes. Offering customers novelty in modest increments at stratospheric prices has consequences; buyers are skipping over the brand and buying cheaper look-alikes. Commodity ‘clone’ products represent the race to the price basement, they can’t generate the marginal returns or snazzy narratives that support inflated share prices. In this sense, Apple is a victim of its own success, it must either compete going forward with its imitators on price or invent the next great must-have-at-all-cost consumer product that will re-establish its position of leadership in the technology firmament.

This is what AAPL has come up with …

bmwi3-800x448

So much for redemptive innovation and technology … Apple aims to reinvent the Dodge Caravan. It turns out all roads lead to more and more roads. Why not battleships, instead?

Battleship1

HMS Dreadnought, a brilliant technological achievement in 1906, it was rendered obsolete before its keel was laid by the airplane.

Apple cannot be serious! In choosing the car, AAPL lurches in the direction of the hapless Japanese, who make brilliant cars (made brilliant battleships) but cannot return value to the cars’ users (neither do battleships). The auto (battleship) industry is a subsidy hog, it twists in the wind even as it is on life support. By way of its actions, APPL admits its customers can no longer subsidize the company and its lenders, it looks instead toward the government (just like battleship manufacturers), to gorge at the public trough.

ATSLA1

Figure 3: TSLA, another investors’ darling, (click for big). Strapped customers can afford the cars by bellying up to their friendly sub-prime auto lender for eight-year loans. Even this absurd financing is inadequate without billions in additional subsidies. These in turn can only come from finance, the same industry under so much solvency pressure from resource depletion … resulting from over-reliance on cars (battleships).

And all for what end? Nobody connects the big picture dots behind the empty gestures; battleships, Teslas and iPhones are status symbols, worth little- or nothing outside their self-generating, hubristic narratives. “In the long run,” said Keynes, “we are all dead”, it seems certain that we have to humiliate ourselves first.

US 2015 Oil Production and Future Oil Prices

youtube-Logo-4gc2reddit-logoOff the keyboard of Gail Tverberg

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Published on the Our Finite World on April 18, 2016

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Oil production can be confusing because there are various “pieces” that may or may not be included. In this analysis, I look at oil production of the United States broadly (including crude oil, natural gas plant liquids, and biofuels), because this is the way oil consumption is defined. I also provide some thoughts regarding the direction of future world oil prices.

Figure 1. US Liquid Fuels production by month based on EIA March 2016 Monthly Energy Review Reports.

 

 

Figure 1. US Liquid Fuels production by month based on EIA March 2016 Monthly Energy Review Reports.

US oil production clearly flattened out in 2015. If we look at changes relative to the same month, one-year prior, we see that as of December 2014, growth was very high, increasing by 18.0% relative to the prior year.

Figure 2. US Liquids Growth Over 12 Months Prior based on EIA's March 2016 Monthly Energy Review.

 

 

Figure 2. US Liquids Growth Over 12 Months Prior based on EIA’s March 2016 Monthly Energy Review.

By December 2015, growth over the prior year finally turned slightly negative, with production for the month down 0.2% relative to one year prior. It should be noted that in the above charts, amounts are on an “energy produced” or “British Thermal Units” (Btu) basis. Using this approach, ethanol and natural gas liquids get less credit than they would using a barrels-per-day approach. This reflects the fact that these products are less energy-dense.

Figure 3 shows the trend in month-by-month production.

Figure 3. US total liquids production since January 2013, based on EIA's March 2016 Monthly Energy Review.

 

 

Figure 3. US total liquids production since January 2013, based on EIA’s March 2016 Monthly Energy Review.

The high month for production was April 2015, and production has been down since then. The production of natural gas liquids and biofuels has tended to continue to rise, partially offsetting the fall in crude oil production. Production amounts for recent months include estimates, and actual amounts may differ from these estimates. As a result, updated EIA data may eventually show a somewhat different pattern.

Taking a longer view of US liquids production, this is what we see for the three categories separately:

Figure 4. US Liquid Fuel Production since 1949, based on EIA's March 2016 Monthly Energy Review.

 

 

Figure 4. US Liquid Fuel Production since 1949, based on EIA’s March 2016 Monthly Energy Review.

Growth in US liquid fuel production slowed in 2015. The increase in liquid fuels production in 2015 amounted to 1.96 quadrillion Btus (“quads”), or about 59% as much as the increase in production in 2014 of 3.34 quads. On a barrels-per-day (bpd) basis, this would equate to roughly a 1.0 million bpd increase in 2015, compared to a 1.68 million bpd increase in 2014.

The data in Figure 4 indicates that with all categories included, 2015 liquids exceeded the 1970 peak by 16%. Considering crude oil alone, 2015 production amounted to 98% of the 1970 peak.

Figure 5 shows an approximate breakdown of crude oil production since 1945 on a bpd basis. The big spike in production is from tight oil, which is another name for oil from shale.

Figure 5. Oil crude oil production separated into tight oil (from shale), oil from Alaska, and all other, based on EIA oil production data by state.

 

 

Figure 5. Oil crude oil production separated into tight oil (from shale), oil from Alaska, and all other, based on EIA oil production data by state.

Here again, US crude oil production in 2015 appears to amount to 98% of the 1970 crude oil peak. Thus, on a crude oil basis alone, we have not yet hit the 1970 peak.

Prospects for an Oil Price Rise

Most recent analyses of oil prices have focused on the amount of mismatch between supply and demand, and the need to craft a temporary agreement to reduce oil production. The thing that is missing in this discussion is an analysis of buying power of consumers. Is the problem a temporary problem, or a permanent one?

In order for oil product demand to keep rising, the buying power of consumers needs to keep rising. In other words, some combination of consumer wages and debt levels of consumers needs to keep rising. (Rising debt is helpful because, with more debt, it is often possible to buy goods that would not otherwise be affordable.)

We know that in many countries, wages for lower-level workers have stagnated for a number of reasons, including competition with wages in lower-wage countries, computerization, and the use of automation (Figure 6). Thus, we know that low wages for a large share of consumers may be a problem.

Figure 6. Chart comparing income gains by the top 10% to income gains by the bottom 90% by economist Emmanuel Saez. Based on an analysis IRS data, published in Forbes.

 

 

Figure 6. Chart comparing US income gains by the top 10% to income gains by the bottom 90% by economist Emmanuel Saez. Based on an analysis IRS data, published in Forbes.

Figure 7 shows that world debt has been falling since June 30, 2014. This is precisely the time when world oil prices started falling.

Figure 6. Total non-financial world debt based on Bank for International Settlements data and average Brent oil price for the quarter, based on EIA data.

 

 

Figure 7. Total non-financial world debt based on Bank for International Settlements data and average Brent oil price for the quarter, based on EIA data.

One reason for the fall in world debt, measured in US dollars, is the fact that the US dollar started rising relative to other currencies about this time. Oil is priced in dollars; if the US dollar rises relative to other currencies, it makes oil less affordable to those whose currencies have lower values. The big rise in the level of the dollar came when the US discontinued quantitative easing in 2014. World debt, as measured in US dollars, began to fall as the US dollar rose.

Figure 7. World Oil Supply (production including biofuels, natural gas liquids) and Brent monthly average spot prices, based on EIA data.

 

 

Figure 8. World Oil Supply (production including biofuels, natural gas liquids) and Brent monthly average spot prices, based on EIA data.

As long as the US dollar is high relative to other currencies, oil products remain less affordable, and demand tends to stay low.

Another issue that struck me in looking at world debt data is the way the growth in debt is distributed (Figure 9). Debt growth for households has been much lower than for businesses and governments.

Figure 8. World non-financial debt divided among debt of households, businesses, and governments, based on Bank for International Settlements data.

 

 

Figure 9. World non-financial debt divided among debt of households, businesses, and governments, based on Bank for International Settlements data.

Since March 31, 2008, non-financial debt of households has been close to flat. In fact, between June 30, 2014 and September 30, 2015,  it shrank by 6.3%. In contrast, non-financial debt of both businesses and governments has risen since March 31, 2008. Government debt has shrunk by 5.6% since June 30, 2014–almost as large a percentage drop as for household debt.

The issue that we need to be aware of is that consumers are the foundation of the economy. If their wages are not rising rapidly, and if their buying power (considering both debt and wages) is not rising by very much, they are not going to be buying very many new houses and cars–the big products that require oil consumption. Businesses may think that they can continue to grow without taking the consumer along, but very soon this growth proves to be a myth. Governments cannot grow without rising wages either, because the majority of their tax revenue comes from individuals, rather than corporations.

Today, there is a great deal of faith that oil prices will rise, if someone, somewhere, will reduce oil production. In fact, in order to bring oil demand back up to a level that commands a price over $100 per barrel, we need consumers who can afford to buy a growing quantity of goods made with oil products. To do this, we need to fix three related problems:

  • Low wages of many consumers
  • World debt that is no longer rising (especially for consumers)
  • A high dollar relative to other currencies

These problems are likely to be difficult to fix, so we should expect low oil prices, more or less indefinitely. Lack of oil supply may bring a temporary spike in oil prices, but it cannot fix a permanent problem with consumer spending around the world.

What’s Next for Oil: Whiplash

roller-coaster gc2smOff the keyboard of Thomas Lewis

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roller-coaster This is the closest we could come to a chart showing what is next for ojl and gas prices, and how it’s going to feel. (Photo by Patrick McGarvey)

Published on The Daily Impact on January 18, 2015


A savvy investor once told me that if you read something in the news, it is no longer true, if it ever was. I keep this in mind as I read over and over that the world is awash in 3 billion barrels of surplus oil. This glut — always and everywhere specified as 3 billion barrels — is present, the conventional wisdom (oxymoron alert) goes, because the crafty Saudis refused to cut production when the price of oil tanked (metaphor alert). They did this, it is said, to run the pesky American oil frackers out of business before they took over the world. This reminds me of the engraved plaque found in many Irish bars: “The Lord invented whiskey to keep the Irish from ruling the world.” An endearing sentiment, but probably not true.

[“The Saudis have won,” somebody said to me the other night. Really? They’re burning cash so fast that, despite having one of the world’s largest foreign-exchange reserves, they’re on course toward bankruptcy in four years. They have been forced to cut back on the subsidies that up to now have bought their subjects’ loyalty by providing them with cheap gas, electricity and water; gas prices alone have shot up 50% this year. When Iran tried that a few years ago, revolution appeared in the streets like a sudden flame, and the government reversed course immediately.

To suggest that the Middle East is a tinderbox is to understate the obvious; to say that it has become immeasurably more flammable since the Arab Spring, similarly goes without saying; and to conclude from the foregoing that this is hardly the time to thrust people more deeply into worse poverty with less hope, would not challenge the reasoning powers of a candidate for US president. The Saudi royal family is terrified and rightly so by existential threats from ISIS, Iran and increasingly its own people.]

But back to the 3 billion barrel glut. Question 1 is where did that number come from that everyone is using without qualification? Why, from the International Energy Agency (IEA), one of whose jobs is to keep track of world oil stocks. That’s oil that has been pulled from the ground but has not yet made it to a refinery: it’s in tankers, in pipelines, on rail cars and in tank farms. And it is true that IEA has just estimated those stocks at 3 billion barrels.  

BUT those stocks did not just appear because prices fell — or in order to make prices fall. If you go back ten years or more in IEA records, you find that there have always been around 2.7 billion barrels in the pipeline, so to speak. So the present number, far from representing a sudden tsunami of unwanted oil, represents an uptick of just 300 million barrels, a 10 per cent increase. It represents about a three day supply of oil at current global consumption rates.

Far from being a tsunami of excess oil swamping the world, this glut is hardly enough to get our shoes wet. There are two implications to putting this excess in its proper perspective:

  1. Any return to anything like normal demand will vaporize the glut in a matter of days. Which means that’s how long it will take for prices to head back toward $100 a barrel from the current under-$40.
  2. Although encouraged to ramp production back up by the return of high prices, the oil industry will not be able to. True, they can uncap sealed wells and re-erect mothballed rigs — although even doing that, which will require finding new sources of financing and hiring workers, will take a dismaying length of time. But virtually all the oil companies in the world have for years been cutting back on the money they spend looking for new oil fields. Before the price crash they were cutting back because it wasn’t working, they weren’t finding new oil no matter how much they spent. Since the price crash they’ve been cutting  back viciously because they can’t afford it. But the result is the same: there are precious few new oil wells to drill, even at a profit.

Thus the prospect of peak oil, far from having been disproved by current events, as some are gloating, hasn’t even been much delayed by current events. And if there is to be a recovery from the current doldrums of the oil industry it will be wrenching, recession-inducing recovery because we all know what economies do when oil prices spike.

On the other hand, if the economic news continues to be as bad as it is now, and the expected global depression locks most of the world’s people into long-term poverty, and their ability to buy anything continues to wither as it is withering now, why then we will be all right. With respect to peak oil.

As long as we can’t afford to buy gas, it will remain cheap. The minute we start buying it again, it will become expensive and scarce. And it will happen so fast that the thrill of victory and the agony of defeat will be simultaneous.


Thomas Lewis is a nationally recognized and reviewed author of six books, a broadcaster, public speaker and advocate of sustainable living. He also is Editor of The Daily Impact website, and former artist-in-residence at Frostburg State University. He has written several books about collapse issues, including Brace for Impact and Tribulation. Learn more about them here.

The Scariest News Story of 2016

saudiheaddressgc2reddit-logoOff the keyboard of Tom Lewis

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Published on the The Daily Impact on December 31, 2015

Arab Spring Yemen

This is what the Arab Spring looked like in Yemen, four years ago, when its people lost all hope. This is what Saudi Arabia, with diminishing prospects of success, is trying desperately to avoid. (Wikipedia Photo)

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Correct. The scariest news story of 2016 is already in. Saudi Arabia is starting to come apart, and when its unscheduled rapid disassembly is a little farther along, the Industrial Age will come to an end.

[TROLL: “Don’t you ever get tired of making predictions that never come true? You said exactly the same thing a year ago. And the year before that.” Actually, dear trolls, what you find here are not exactly predictions, rather they are analyses of trends and the likely outcomes of those trends. But even if you insist they are predictions, the fact is that virtually all of them are in the process of “coming true” — it’s just that people who have the historical horizons of a fruit fly assume that anything that doesn’t happen while they’re looking at it is never going to happen, and never happened before. In medicine that’s called amnesia.]

But back to Saudi Arabia, where the forces of disassembly have been in play for decades.  

It has been only eight decades since the country as we know it — a vast desert sparsely populated by nomadic tribes — was assembled as one kingdom under Ibn Saud, whose descendants still rule there. Six years later, in 1938, Standard Oil of California found oil under the sand. Found, as it turned out, that nearly 20% of all the oil on the planet was under Saudi Arabia.

Made wealthy beyond imagination, the House of Saud has been smart enough to bind together its hard-won alliance of fractious tribes, sects, clans and warlords with lavish bribes, otherwise known as subsidies. For years, Saudis have been filling their tanks with gasoline for a little over 60 cents a gallon. The government paid the difference between that and the cost of production. Similar subsidies kept the costs of electricity and water abnormally low, and the population unnaturally quiet under the lash of despotic rule, harsh justice and misogynistic customs.

Only three things could bring trouble to this paradise: the oil could run out; the price of oil could crash; or a burgeoning population could suck up so much cheap energy that it reduced the amount available for export, thus reducing the revenues needed to pay for all those subsidies.

The Saudis appear to have hit the negative trifecta. Despite nearly impenetrable secrecy and pervasive deception, it has become apparent that the Saudi oil fields have peaked (at a hair over 10 million barrels per day) and are beginning a slow but irreversible decline. Rapidly increasing domestic consumption of oil, now over three million bpd, is eating into the amount available for export. And the crash of oil prices during the past 18 months has placed an appalling drain on the Saudis’ cash reserves, which are huge but not infinite. The current Saudi annual deficit — the largest in its history —  is estimated by the International Monetary Fund to be $140 billion. At that burn rate, their formidable reserves would be exhausted in less than five years.

On Monday, the kingdom announced a wide array of “reforms” to stem the bleeding, including 50% higher prices for gasoline, electricity and water, and higher taxes. When such “reforms” have been attempted in the past, by the Saudis and by other petro-states with extravagant subsidies, the immediate result has been public protest, unrest, and a quick restoration of benefits. With this in mind, the Saudis have tried to increase prices on the richest first, but have also made it clear that more pain is on the way.

It seems clear that there is no road back to normal open to the Saudis. Even a sudden return of oil prices to their previous highs would not solve the problem of the depleted fields and growing domestic demand. In any case, the people of Saudi Arabia, already restive [SEE “The Worst News Story of 2015” and “The Worst News Story of 2015 Just Got Worse”] are unlikely to wait very long to see how these long term trends play out. And to the extent they destabilize Saudi Arabia, they destabilize the world.   

Total War in Yemen Totally Ignored Western Media

gc2smOff the keyboard of Anthony Cartalucci

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Published on New Eastern Outlook on August 27, 2015

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With almost a whimper, the Western media reported that the US-backed regimes of Saudi Arabia, the United Arab Emirates (UAE), and their auxiliary fighters drawn from Al Qaeda have begun carrying out what is the ground invasion of Yemen. Along with an ongoing naval blockade and months of bombing raids, the ground invasion adds a lethal new dimension to the conflict – for both sides.

Landing at the port city of Aden on Yemen’s southern tip, it is reported that an “armor brigade” consisting of between 1,000 – 3,000 troops primarily from the UAE are now moving north, their ultimate destination Sana’a, the capital of Yemen.

Columns of the UAE’s French-built Leclerc main battle tanks were seen moving out of the port city though their numbers are difficult to establish. Reports claiming that the UAE unit is brigade-sized might indicate as many as 100 tanks involved – a third of the UAE’s total armored force.

The bold move comes after months of frustrating failures for the two Arabian regimes. Their Yemeni proxies – loyalists of the ousted president Abd-Rabbu Mansour Hadi – have proven all but useless in fighting Houthi fighters across most of Yemen despite air superiority provided to them by their Arabian allies. And while it appears the well-equipped Arab forces are able to concentrate firepower, overwhelming Houthi fighters in pitched battles, the ability for Saudi, UAE, and Al Qaeda forces to actually hold territory they move through is questionable at best.

Opportunity 

The Roman Empire throughout much of its reign was feared as invincible. After suffering several major defeats, the veneer of invincibility began to peel and along with it crumbled inevitably their empire. Likewise, Western hegemony has been propped up by the illusion of military superiority on the battlefield. By carefully picking its battles and avoiding critical defeats, the West, and the US in particular, has maintained this illusion of military invincibility

As the US moves against nations with larger, better equipped and trained armies, it has elected to use proxies to fight on its behalf. Thus, any humiliating defeat could be compartmentalized.

However, by most accounts the war in Yemen is not only a proxy war between Iran and the Persian Gulf monarchies, it is one of several such conflicts raging regionally that constitutes a wider proxy war between the US and its regional allies on one side, and Iran, Syria, Russia, and even China on the other.

With the presence of Western main battle tanks in Yemen attempting to move north, the opportunity now presents itself to punch holes through this illusion of Western invincibility. Yemen as the graveyard for an alleged brigade of French-built Leclerc main battle tanks would be one such hole. It would also set the UAE’s extraterritorial military ambitions back, if not overturn them entirely, and finally, would leave whatever fighting was left in Yemen to the Saudis who have thus far proven incompetent.

Perhaps this is one of the many reasons the Western media has decided not to cover the events unfolding in Yemen.

Yemen Vs. Ukraine 

One might ask how – in the context of international law – it is possible for unelected absolute autocracies like Saudi Arabia and the UAE to intervene militarily in Yemen with naval blockades, aerial bombardments, and now an overt ground invasion including armor columns to restore an ousted regime. This is done with seemingly little concern from the United Nations and with the enthusiastic support both politically and militarily of the United States.

The answer to this question becomes more confounding still when considering Western condemnation of Russia for any attempt to support or defend the ousted government of Ukraine, a nation now overrun by NATO-backed Neo-Nazi militias who in turn are backing a criminal regime in Kiev which includes foreigners assigned to cabinet positions and even as governors. Saudi and UAE military aggression in Yemen makes it increasingly difficult for the West to maintain the illusion of moral superiority regarding Ukraine.

Russia’s relative restraint when compared to US-backed aggression on the Arabian Peninsula exposes once again the pervasive hypocrisy consuming Western legitimacy.

This may be yet another reason the Western media refuses to cover the events unfolding in Yemen.

Responsibility to Protect…? 

545353454After NATO’s attempt to invoke the “responsibility to protect” (R2P) as justification for the destruction of Libya, it became clear that NATO was merely hiding behind the principles of humanitarian concern, not upholding them. And while it may be difficult to believe, there are still those across the Western media and policy think-tanks attempting to use R2P to justify further military aggression against nations like Syria.

However, R2P is conveniently absent amid what little talk of Yemen that does take place in the Western media. US-backed blockades and months of aerial bombardments have tipped Yemen toward a humanitarian catastrophe. Not only does both the UN and the West fail to demand an end to the bombings and blockades, the West has continued to underwrite Saudi Arabia and the UAE’s military adventure in Yemen.

The carnage and injustice visited upon Yemen serves as yet another stark example of how the West and its institutions, including the United Nations, are the greatest dangers to global peace and stability, using the pretext of defending such ideals as a means to instead undo them.

Considering this, we discover yet another potential reason the Western media’s coverage of Yemen is muted.

It remains to be seen how the Houthi fighters react to the ground invasion of Yemen by Emirati troops. Dealing severe losses to the UAE’s armor while continuing to weather aerial bombardment may see the stalling or even the withdrawal of this latest incursion. Not unlike the 2006 Lebanon War where Hezbollah fighters expertly used terrain to negate Israeli advantages in airpower and armor, forcing an early end to the fighting, the Houthis may yet answer this latest move by US-backed proxies operating in Yemen.

Perhaps this possibility above all, is why the Western media would rather the general public knew little of what was going on in Yemen. It would represent yet another conventional Western-equipped proxy army defeated by irregular forces in yet another failed campaign fought in the interests of Wall Street and Washington. While the Western media refuses to cover the events unfolding in Yemen with the attention and honesty they deserve, the conflict is nonetheless pivotal, and may determine the outcome of other proxy wars raging across the Middle East and North Africa, and even beyond.

Tony Cartalucci, Bangkok-based geopolitical researcher and writer, especially for the online magazineNew Eastern Outlook”.   
First appeared: http://journal-neo.org/2015/08/27/total-war-in-yemen-totally-ignored-by-western-media/

Why EIA, IEA, and BP Oil Forecasts are Too High

Off the keyboard of Gail Tverberg

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Published on Our Finite World on June 9, 2015

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When forecasting how much oil will be available in future years, a standard approach seems to be the following:

  1. Figure out how much GDP growth the researcher hopes to have in the future.
  2. “Work backward” to see how much oil is needed, based on how much oil was used for a given level of GDP in the past. Adjust this amount for hoped-for efficiency gains and transfers to other fuel uses.
  3. Verify that there is actually enough oil available to support this level of growth in oil consumption.

In fact, this seems to be the approach used by most forecasting agencies, including EIA, IEA and BP. It seems to me that this approach has a fundamental flaw. It doesn’t consider the possibility of continued low oil prices and the impact that these low oil prices are likely to have on future oil production. Hoped-for future GDP growth may not be possible if oil prices, as well as other commodity prices, remain low.

Future Oil Resources Seem to Be More Than Adequate

It is easy to get the idea that we have a great deal of oil resources in the ground. For example, if we start with BP Statistical Review of World Energy, we see that reported oil reserves at the end of 2013 were 1,687.9 billion barrels. This corresponds to 53.3 years of oil production at 2013 production levels.

If we look at the United States Geological Services 2012 report for one big grouping–undiscovered conventional oil resources for the world excluding the United States–we get a “mean” estimate of 565 billion barrels. This corresponds to another 17.8 years of production at the 2013 level of oil production. Combining these two estimates gets us to a total of 71.1 years of future production. Furthermore, we haven’t even begun to consider oil that may be available by fracking that is not considered in current reserves. We also haven’t considered oil that might be available from very heavy oil deposits that is not in current reserves. These would theoretically add additional large amounts.

Given these large amounts of theoretically available oil, it is not surprising that forecasters use the approach they do. There appears to be no need to cut back forecasts to reflect inadequate future oil supply, as long as we can really extract oil that seems to be available.

Why We Can’t Count on Oil Prices Rising Indefinitely

There is clearly a huge amount of oil available with current technology, if high cost is no problem. Without cost constraints, fracking can be used in many more areas of the world than it is used today. If more water is needed for fracking than is available, and price is no object, we can desalinate seawater, or pump water uphill for hundreds of miles.

If high cost is no problem, we can extract very heavy oil in many deposits around the world using energy intensive heating approaches similar to those used in the Canadian oil sands. We can also create gasoline using a coal-to-liquids approach. Here again, we may need to work around water shortages using very high cost methods.

The amount of available future oil is likely to be much lower if real-world price constraints are considered. There are at least two reasons why oil prices can’t rise indefinitely:

  1. Any time oil prices rise, economies that use a high proportion of oil in their energy mix experience financial problems. For example, countries that get a lot of their revenue from tourism seem to be vulnerable to high oil prices, because high oil prices raise the cost of airline travel. Also, if any oil is used for making electricity, its high cost makes it expensive to manufacture goods for export.
  2. When oil prices rise, workers find that the cost of food tends to rise, as does the cost of commuting. To offset these rising expenses, workers cut back on discretionary spending, such as going to restaurants, going on long-distance vacations, and buying more expensive homes. These spending cutbacks adversely affect the economy.

The combination of these two effects tends to lead to recession, and recession tends to bring commodity prices in general down. The result is oil prices that cannot rise indefinitely. The oil extraction limit becomes a price limit related to recessionary impacts.

The cost of oil is currently in the $60 per barrel range. It is not even clear that oil prices can rise back to the $100 per barrel level without causing recession in many counties. In fact, the demand for many things is low, including labor and capital. Why should the price of oil rise, if the overall economy is not generating enough demand for goods of all kinds, including oil?

Oil Companies Can Report a Wide Range of Oil Prices Needed for Profitability

The discussion of required oil prices is confusing because there are many different ways to compute oil prices needed for profitability. Companies make use of this fact in choosing information to report to the press. They want to make their situations look as favorable as possible, because they do not want to frighten bondholders and prospective stock buyers. This usually means reporting as low a needed price for profitability as possible.

Oil prices can be computed on any of the following bases (arranged roughly from lowest to highest):

  • (a) The “going forward” cost of extracting oil from wells that are already in place, excluding fixed expenses that the company would incur anyhow. This cost is likely to be very low, likely less than $30 barrel.
  • (b) The cost of drilling new “infill” wells in existing fields, excluding the overhead expenses the company would incur anyhow.
  • (c) The cost of opening up a new oil field and drilling new wells, excluding the overhead expenses the company would incur anyhow.
  • (d) Add to (c), overhead expenses (but not including taxes paid to governments, dividends to policyholders, and interest on borrowed funds).
  • (e) Add to (d) amounts paid to government, dividends to policyholders, and interest on borrowed funds.
  • (f) The price required so that the oil company has sufficient cash flow so that it doesn’t need to keep taking on more debt. Instead, it can earn a reasonable profit (and from this pay dividends), and still have sufficient funds left for “Exploration & Development” of new fields to offset declines in production in existing fields. It can also pay governments the high taxes they require, and pay other ongoing expenses. Thus, the system can continue to operate, without assistance from other sources.

I would argue that if we actually want to extract a large share of technically recoverable oil, we need oil prices up at this top level–a level at which companies are making a reasonable profit on a cash flow basis, so that they don’t have to go further and further into debt. If they are getting less than they really need, they will send drilling rigs home. They will use available funds to buy back their own shares, rather than spending as much money as is required to develop new fields to offset declines in existing fields.

Required Oil Prices

Many people believe that low prices started in late-2014, when oil prices dropped below the $100 barrel level. If we look back, we find that there was a problem as early as 2013, when oil prices were over $100 per barrel. Oil companies were then complaining about not making a profit on a cash flow basis–in other words, the highest price basis listed above.

My February 2014 post called Beginning of the End? Oil Companies Cut Back on Spending (relating to a presentation by Steve Kopits) talks about oil companies already doing poorly on a cash flow basis. Many needed to borrow money in order to have sufficient funds to pay both dividends and “Exploration & Production” expenses related to potential new fields. Figure 1 is a slide by Kopits showing prices required for selected individual companies to be cash flow neutral:

Figure 1.

 

 

Figure 1.See this link for larger view of image.

The problem back in 2013 was that $100 per barrel was not sufficient for most companies to be profitable on a cash flow basis. At that time, Figure 1 indicates that a price of over $130 per barrel was needed for many US companies to be profitable on that basis. Russian companies needed prices in the $100 to $125 range, while the Chinese companies PetroChina and Sinopec needed prices in the $115 to $130 per barrel range. The Brazilian company Petrobas needed a price over $150 per barrel to be cash flow neutral.

Kopits doesn’t show required prices for OPEC countries to be cash flow neutral, but similar price estimates (required funding including budgeted tax amounts) are available from Arab Petroleum Investments Corporation (Figure 2, below).

Figure 2. Estimate of OPEC break-even oil prices, including tax requirements by parent countries, from Arab Petroleum Investments Corporation.

 

 

Figure 2. Estimate of OPEC break-even oil prices, including tax requirements by parent countries, from Arab Petroleum Investments Corporation.

Based on this exhibit, OPEC costs are generally over $100 per barrel. In other words, OPEC costs are not too different from non-OPEC costs, when all types of expenses, including taxes, are included.

As more oil is extracted, the tendency is for costs to rise. Figure 3, also from the Kopits’ presentation, shows a rapid escalation in some types of costs after 1999. This is what we would expect when we reach the end of readily available “cheap to extract” oil and move to more expensive-to-extract unconventional types of oil.

Figure 3. Figure by Steve Kopits of Westwood Douglas showing trends in world oil exploration and production costs per barrel.

 

 

Figure 3. Figure by Steve Kopits of Douglas Westwood showing trends in world oil exploration and production costs per barrel. CAGR is “Compound Annual Growth Rate”.

What prices do we need on a going-forward basis, to keep the oil extraction system operating on a long-term basis? I would argue that we need a price of at least $130 now in 2015. In the future, this price needs to rise to higher and higher levels, perhaps moving up quite quickly as we move to more-expensive-to-extract resources.

Is it really necessary to include tax revenues in these calculations? I would argue that the inclusion of taxes is especially important for oil exporting nations. Most of these countries depend heavily on oil taxes to provide funds to operate programs providing food and jobs. As the quantity of oil that they can extract depletes, and as the population of these countries rises, the per-barrel amount of revenue required to fund these government programs is likely to increase. If we want to have a reasonable chance of stability within these countries (so that exports can continue), then we need to expect that the tax loads of companies in oil exporting nations will increase in the future.

Also, if there is any plan to subsidize “renewables,” funds to make this possible need to come from somewhere. Indirectly, these funds are available because of surpluses made possible by the fossil fuel industry. Thus taxes from the fossil fuel industry might be considered a way of subsidizing renewables.

Why Production Doesn’t Quickly Reset to Match Prices

Do we really have a problem with oil prices, if oil production hasn’t dropped quickly in response to low prices? I think we do still have a problem.

One reason why oil production doesn’t quickly reset to match prices is related to many different ways of reporting oil extraction costs, mentioned above. A company may not be making money when all costs are included, but it is making money on a cash flow basis if “sunk costs” are ignored.

Another reason why oil production doesn’t quickly reset to match prices is the fact that oil is the lifeblood of companies that produce it. “Cutting back” means laying off trained workers. If these workers are laid off, companies will find it nearly impossible to rehire the same workers later. The workers have families to support; they will need to find work, even if it is in other industries. Companies will need to train new workers from scratch. Thus, companies will do almost anything to keep employees, no matter how low prices drop on a temporary basis.

A similar issue applies to equipment used in oil operations. Drilling equipment that is not used will deteriorate over time and may not be usable in the future. A USA Today article talks about auctions of equipment used in the oil industry. This equipment is likely to be permanently lost to the oil industry, making it hard to ramp back up again.

If a company is a government owned company in an oil-exporting nation, there is an even greater interest in keeping the company operating. Very often, oil is the backbone of the entire country’s economy; most tax revenue comes from oil and gas companies. There is no real option of substantially cutting back operations, because tax funds and jobs are badly needed by the economy. Civil unrest could be a problem without tax revenue. In the short run, some countries, including Saudi Arabia, have reserve funds set aside to cover a rainy day. But these run out, so it is important to maintain market share.

There are additional reasons why oil production stays high in the short term:

  • Some companies have contracts in the futures market that cushion price fluctuations, so they may not directly “feel” the impact of low prices. Because of this, they may not react quickly.
  • Oil companies will very often have debt obligations that they need to meet, and need cash flow to keep meet them. Any cash flow, even if the price covers only a bit more in the direct cost of extraction, is helpful.
  • Large amounts of equity funding have been available, even for companies issuing “junk bonds.” Companies that would otherwise be reaching debt limits have been able to issue large amounts of stock instead. Bloomberg reports that in the first quarter, $8 billion in stock was issued, which is a record.

All of these considerations have allowed production to continue temporarily, but are unlikely to be long-term solutions. In the long run, we know that we are likely to see problems such as defaults on junk rated bonds of oil companies. Futures contracts guaranteeing high prices eventually run out. Also, if prices remain low, government programs of oil exporting countries may need to be cut back, leading to unrest by citizens.

Regardless of what is happening in the short-term, it is clear that eventually production will drop, quite possibly permanently, unless oil prices rise substantially.

Why are Oil Prices so Low?

I see two reasons for low oil prices:

  1. Debt is now not rising fast enough, because debt levels are reaching limits. Increases in debt levels tend to hold up commodity prices because increasing amounts of debt allow consumers to buy additional cars, homes, factories and other goods, thus creating “demand” for oil and other commodities. At some point, debt limits are reached. This can happen because a growth spurt is slowing, as in China, or because governments are reaching limits on the ratio of debt to GDP that they can carry. When debt levels stop rising rapidly, the debt “pump” that has been holding up prices in the past disappears, and commodity prices tend to stay at a lower level.
  2. The wages of ordinary workers are lagging behind. If a young person cannot find a good paying job (or owes too much on college loans), he most likely will live with his parents longer, delaying the purchase of a house and car. If a family discovers that the cost of day care for children plus the cost of commuting is more than the wages of the lower-earning parent, the lower-earning parent may choose not to work. A household with only one employed worker is less likely to buy a house or a second car than a two-worker household. These kinds of responses to low wages tend to hold down “demand” for goods made with commodities. Thus, affordability issues (or low demand related to affordability) tends to hold down the prices of commodities.

The problem of lagging wages of ordinary workers is a very old one. The problem occurs whenever there are issues with diminishing returns. For example, when population reaches a level where there are too many farmers for available land, the average size of plot for each farmer tends to decrease. Each farmer tends to produce less, because of the smaller size of plot available. If each farmer is paid for what he produces, his wages will drop.

We are reaching the same problem today with oil. We continue to produce increasing amounts of oil, but doing so requires increasing numbers of workers and increasing amounts of resources of other types (including fresh water, steel, sand for fracking, and energy products). Workers are on average producing less oil per hour worked. In theory, they should be paid less, because the value of oil is determined by what the oil can do (how far it can move a vehicle), not how much labor was required to produce the oil.

The same problem is occurring in other areas of the economy, including natural gas production, coal production, electricity production, medicine, and higher education. At some point, we find the economy as a whole becoming less efficient, rather than more efficient, because of diminishing returns.

We know from Peter Turchin and Surgey Nefedov’s book, Secular Cycles, that low wages of common workers were frequently a major contributing factor to collapses in pre-fossil fuel days. With lower wages, workers were not able to buy adequate food, allowing epidemics to take hold. Also, governments could not collect adequate taxes from the large number of low-earning workers, leading to governmental financial problems. A person wonders whether today’s economy is reaching a similar situation. Will low wage growth of common workers hold down future GDP growth, or even lead to collapse?

Are the Projections of EIA, IEA, BP, and all the Others Right?

Perhaps these projections would be reasonable, if oil prices could immediately bounce to  $130 per barrel and could continue to inflate in the years ahead.

If, on the other hand, low oil prices are really being caused by lagging wages of ordinary workers and the failure of debt levels to keep rising, then I don’t think we can expect oil prices to reach these lofty levels. Instead, we can expect oil production to fall because of low prices.

The amount of oil available at $60 per barrel seems to be quite low. Perhaps a little low-priced oil would be available from Kuwait and Qatar at that price, but not much else. Some additional oil might be obtained, if governments of non-oil exporters (such as the USA and China) choose to cut back their tax levels on oil companies. Even with the additional oil made possible by lower taxes, total oil supply would still be far less than needed to run today’s world economy.

The world economy would need to contract greatly in order to shrink down to the oil available. Such shrinkage might be accomplished by a cutback in trade and loss of jobs. Debt defaults would likely be another feature of the new smaller economy. Such a scenario would explain how future oil production may deviate significantly from the forecasts of EIA, IEA, and BP.

Fatal Ignorance

Off the keyboard of Steve from Virginia

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Published on Economic Undertow on February 9, 2015

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Figure 1: The Triangle of Flop: (chart by TFC Charts, click on for big). Industrial economies are set to go the way of the Dodo as cost of credit proves to be too great for customers to bear. As oil prices fall the drilling industry calls for more support. The rationale is that drillers borrow already, there can be no harm in adding to the pile of existing debt: if customers cannot pay immediately they certainly will when prices ‘recover’.

(The prices cannot rise unless the customers begin to pay … )

Additional repayment obligations are set to be heaped upon the same customers who can’t bear the drillers’ present costs … this is what the crashing oil prices actually mean. Credit breakdown is taking place in plain sight, under the noses of- and unremarked by ‘real’ economists. That people cannot afford their petroleum doesn’t appear to matter; not nearly as much as how the same people ‘feel’ about the economists themselves.

If the customers could pony up for high-cost fuel they would be doing so; oil prices would be unchanged from last year. In a high-cost environment, lower prices = less petroleum: as with ‘invisible’ credit collapse, the oil extraction peak is occurring right now, but in the shadows! There will never be more oil on petroleum markets than there is right now. It is hard to see how having less petroleum available will make us wealthier or more able to borrow- or service our debts. Instead, lower prices => more oil industry failures + more credit exposure => lower prices in a compounding cycle.

The signs of credit breakdown can be seen everywhere one chooses to look. The US appears to be the cleanest dirty shirt in the laundry basket but the illusions cannot be maintained too much longer, (Gallup):

The Big Lie: 5.6% UnemploymentJim CliftonHere’s something that many Americans — including some of the smartest and most educated among us — don’t know: The official unemployment rate, as reported by the U.S. Department of Labor, is extremely misleading.

Right now, we’re hearing much celebrating from the media, the White House and Wall Street about how unemployment is “down” to 5.6%. The cheerleading for this number is deafening. The media loves a comeback story, the White House wants to score political points and Wall Street would like you to stay in the market.

None of them will tell you this: If you, a family member or anyone is unemployed and has subsequently given up on finding a job — if you are so hopelessly out of work that you’ve stopped looking over the past four weeks — the Department of Labor doesn’t count you as unemployed. That’s right. While you are as unemployed as one can possibly be, and tragically may never find work again, you are not counted in the figure we see relentlessly in the news — currently 5.6%. Right now, as many as 30 million Americans are either out of work or severely underemployed. Trust me, the vast majority of them aren’t throwing parties to toast “falling” unemployment.

There’s another reason why the official rate is misleading. Say you’re an out-of-work engineer or healthcare worker or construction worker or retail manager: If you perform a minimum of one hour of work in a week and are paid at least $20 — maybe someone pays you to mow their lawn — you’re not officially counted as unemployed in the much-reported 5.6%.

Clifton speaking truth to American (business) power leaves him looking nervously over his shoulder, presumably for CIA hitmen:

The industrial regime has oversold ‘productivity’. What meets industry costs are loans, not returns: economists don’t understand thiseconomists don’t understand thiseconomists don’t understand this. Maturing loans are refinanced or repaid with new loans; ‘wages’, ‘earnings’, ‘profits’ are all borrowed. In the eurozone, anything that qualifies as ‘money’ is borrowed from commercial financiers in Frankfurt. Total credit expands exponentially. No matter how to to what extent loans are restructured, all repayments are borrowed, the new amounts added to the debt total. Debts can be repudiated, but industry cannot exist or function without a steady diet of loans. If such a thing were possible, industry would be loan-free already! There would not be a crisis, the ordinary operation of a single, remunerative industry would retire all debts, would make every human being rich.

Four-hundred-plus years of industrialization and factory efficiency has done exactly the opposite, the world is sunk up to its nostrils in a incalculable morass of non-payable debt and strangling pollution. The ‘efficiency’ of debt has declined sharply; that is, each marginal dollar (or euro, yen or whatever) lent into existence returns less in the way of real output. Part of this is the simple exponential function applied to money supply over time: new loans taken on to refinance existing loans increase at a (modest) fixed rate of interest adding to the immensely growing pile. Another component is increased financing for hedging purposes in derivatives’ markets (the costs of which must be borrowed), part of it is confluence of demographics and politics (fewer, older people in industrial nations buy- and borrow less which means governments must borrow more in their place). The basic premise of industrial West is to leverage itself beyond its means … the credulous fools at the base of the economic pyramid cannot afford to pick up the tab any longer.

Diminished funding in the oil patch will result in actual shortages, not immediately but as reservoirs are depleted … a matter of months in ‘unconventional’ plays. All the talk about ‘production’ (or its absence) misses the point: our problems are entirely on the consumption side. We have burned up a trillion barrels of oil and have nothing to show for them … nothing that can replace the oil or match its usefulness. The more the drillers borrow the further underwater they find themselves because their customers have no value that can be ‘spent’ back to the drillers.

Against the background of the ‘non-peak oil discussion’ what turns out to be in short supply is credit, something that is technically infinitely reproducible. Credit (or money) is a claim against purchasing power, not purchasing power itself. The number- or amount of claims can be infinite, underlying purchasing power is tightly bound to the ‘good’ (in aggregate) that is being purchased. When this good runs short, so does purchasing power. Increasing credit claims overall cannot increase purchasing power but shifts it instead from one group (customers) toward others (drillers and their lenders). Drillers and lenders are firms, they can borrow more than customers. The drillers become rich = so what? They beggar their own customers by front-running them: when the customers can no longer borrow or are unwilling, the drillers are stranded. In an trice, drillers’ assets become liabilities: this transformation is occurring right now. It turns out the limit to ‘infinite’ claims is the credit-worthiness of customers.

The stranding process is underway, both in the US and everywhere in the world. Prices cannot rise to reflect perceived shortages (supply vs. demand) because the customers do not bid. Instead prices decline even as the (credit) means to meet the prices declines faster. Eventually, they fall to the level where they can be supported by actual returns, not credit.

Claims against purchasing 020815

Figure 2: Purchasing power in the form of petroleum-capital vs. money-claims against it; chart by Deborah Lawrence- Energy Policy Forum. Purchasing power claims by drillers have consequences, not the least of them is the difficulty on the part of drillers to find and extract oil to replace the oil that has already been consumed.

Desperate drillers who cannot borrow must cut their credit exposure any way they can:

Cash-Starved Oil Producers Trade Treasured Pipelines for MoneyOil and natural gas producers confronting a cash drain are auctioning off the family silver: pipelines and processing plants.Bakken shale billionaire Harold Hamm and Canadian gas giant Encana Corp. are among the latest to peddle some of their most valuable assets and steadiest earners. They don’t have much choice — as the oil price collapse deflates the value of drilling operations, pipes and plants are about the only things attracting big payments for producers vying to stay afloat.

The deals for quick cash are another facet of the energy industry meltdown leading to more than $40 billion in spending cuts and thousands of job losses. The capital infusion comes with a trade-off because producers pay more to process and transport fuel over the lines and in the facilities they used to own.

“At some point they all get desperate enough,” said Michael Formuziewich, a fund manager at Leon Frazier & Associates Inc. in Toronto. Low prices will spur a rise in deals, he said. “The longer it goes on, the more we’ll see.”

Vulnerable drillers can put whatever spin they want onto this process but the end result is little different from liquidation.

Energy return on investment (EROI) does not matter so much as energy return on consumption (EROC). This turns out to be a negative number. Because the energy return on extraction was so great during the beginning of the twentieth century, the absence of returns on the consumption side didn’t matter. Oil became a ‘loss-leader’ for the automobile, real estate and construction industries. Wasting oil was a conversation piece, then a way of life.

This wasting process is coming to a long overdue end. We have no choice but to find some better use for our resources other than to burn them up for nothing. The first step is to stop lying to ourselves, time is running short.

It’s About to Get Ugly

Off the keyboard of Michael Snyder

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Published on The Economic Collapse on February 4, 2015

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It Is About To Get Ugly: Oil Is Crashing And So Is Greece

The price of oil collapsed by more than 8 percent on Wednesday, and a decision by the European Central Bank has Greece at the precipice of a complete and total financial meltdown.  What a difference 24 hours can make.  On Tuesday, things really seemed like they were actually starting to get better.  The price of oil had rallied by more than 20 percent since last Thursday, things in Europe seemed like they were settling down, and there appeared to be a good deal of optimism about how global financial markets would perform this month.  But now fear is back in a big way.  Of course nobody should get too caught up in how the markets behave on any single day.  The key is to take a longer term point of view.  And the fact that the markets have been on such a roller coaster ride over the past few months is a really, really bad sign.  When things are calm, markets tend to steadily go up.  But when the waters start really getting choppy, that is usually a sign that a big move down in on the horizon.  So the huge ups and the huge downs that we have witnessed in recent days are likely an indicator that rough seas are ahead.

A stunning decision that the European Central Bank has just made has set the stage for a major showdown in Europe.  The ECB has decided that it will no longer accept Greek government bonds as collateral from Greek banks.  This gives the European Union a tremendous amount of leverage in negotiations with the new Greek government.  But in the short-term, this could mean some significant pain for the Greek financial system.  The following is how a CNBC article described what just happened…

“The European Central Bank is telling the Greek banking system that it will no longer accept Greek bonds as collateral for any repurchase agreement the Greek banks want to conduct,” said Peter Boockvar, chief market analyst at The Lindsey Group, said in a note.

“This is because the ECB only accepts investment grade paper and up until today gave Greece a waiver to this clause. That waiver has now been taken away and Greek banks now have to go to the Greek Central Bank and tap their Emergency Liquidity Assistance facility for funding,” he said.

And it certainly didn’t take long for global financial markets to respond to this news

The Greek stock market closed hours ago, but the exchange-traded fund that tracks Greek stocks, GREK, crashed during the final minutes of trading in the US markets.

The euro is also getting walloped, falling 1.3% against the US dollar.

The EUR/USD, which had recovered to almost 1.15, fell to nearly 1.13 on news of the action taken by the ECB.

But this is just the beginning.

In coming months, I fully expect the euro to head toward parity with the U.S. dollar.

And if the new Greek government will not submit to the demands of the EU, and Greece ultimately ends up leaving the common currency, it could potentially mean the end of the eurozone in the configuration that we see it today.

Meanwhile, the oil crash has taken a dangerous new turn.

Over the past week, we have seen the price of oil go from $43.58 to $54.24 to less than 48 dollars before rebounding just a bit at the end of the day on Wednesday.

This kind of erratic behavior is the exact opposite of what a healthy market would look like.

What we really need is a slow, steady climb which would take the price of oil back to at least the $80 level.  In the current range in which it has been fluctuating, the price of oil is going to be absolutely catastrophic for the global economy, and the longer it stays in this current range the more damage that it is going to do.

But of course the problems that we are facing are not just limited to the oil price crash and the crisis in Greece.  The truth is that there are birth pangs of the next great financial collapse all over the place.  We just have to be honest with ourselves and realize what all of these signs are telling us.

And it isn’t just in the western world where people are sounding the alarm.  All over the world, highly educated professionals are warning that a great storm is on the horizon.  The other day, I had an economist in Germany write to me with his concerns.  And in China, the head of the Dagong Rating Agency is declaring that we are going to have to face “a new world financial crisis in the next few years”

The world economy may slip into a new global financial crisis in the next few years, China’s Dagong Rating Agency Head Guan Jianzhong said in an interview with TASS news agency on Wednesday.

“I believe we’ll have to face a new world financial crisis in the next few years. It is difficult to give the exact time but all the signs are present, such as the growing volume of debts and the unsteady development of the economies of the US, the EU, China and some other developing countries,” he said, adding the situation is even worse than ahead of 2008.

For a long time, I have been pointing at the year 2015.  But this year is not going to be the end of anything.  Rather, it is just going to be the beginning of the end.

During the past few years, we have experienced a temporary bubble of false stability fueled by reckless money printing and an unprecedented accumulation of debt.  But instead of fixing anything, those measures have just made the eventual crash even worse.

Now a day of reckoning is fast approaching.

Life as we know it is about to change dramatically, and most people are completely and totally unprepared for it.

Peak Oil Pulled a Fast One on Me

Off the keyboard of Allan Stromfeldt Christensen

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Published on From Filmers to Farmers on January 1, 2015

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I’ll admit that I was completely caught off guard by the recent (and ongoing?) crash in oil prices. It’d be a stretch to say I’m embarrassed by my lack of foresight, although perhaps “dumb-ass” would be a bit deserving.

I would say I’m well enough versed with the reality of peak oil: I’ve read perhaps a couple dozen books on the topic, poured through several of the peak oil blogs (upon deciding to end my 5-year Internet hiatus a year ago), have seen several talks given by authors and writers on the topic, and I’ve attended two Age of Limits conferences.

Nevertheless, even though there were bloggers out there discussing the possible ramifications of low oil prices, its possibility still didn’t register with me. I’ll explain what I mean by that shortly, but to do that it’d be best if I first give a recap of what the mainstream media have been saying about collapsing oil prices the past couple of months.

If you’ve been following the recent oil-related news stories then you’ll be familiar with two things: first, that the price of a barrel of oil has been crashing (to nearly 50% of its value half a year ago), and second, that OPEC (Organization of the Petroleum Exporting Countries) has refused to cut back its production, the hope being that a cut in supplies would have resulted in a rise in prices.

The first sign of trouble came after OPEC’s November 27th meeting in Vienna whereupon it was announced that OPEC was going to maintain its production levels. Seeing how no explanation or elaboration was given, it was no surprise when the expected theories on the topic began appearing, and, of course, the conspiracy theories.

Some of the more mundane theories (not to say that there isn’t any truth in them) include (1) that a rising US dollar has resulted in a downward pressure on the price of oil (since oil is priced and predominantly purchased in US dollars); (2) that Libyan production has increased and so contributed to a glut in supply; (3) that demand in Europe has been declining, also leading to a glut in supply; and (4) that increased production in the United States has meant increased consumption of domestic supplies and so a decrease in need for imports, once again resulting in a glut on world oil-supply markets. To name just a few.

Jumping over into the conspiracy theory realm (again, not to say that there isn’t any truth in them), first is the notion that Saudi Arabia has colluded with the United States (something to do with the United States’ Secretary of State having made a trip to Saudi Arabia a few months back), the intent being to bring down oil prices so as to crush the Russian economy (oil and natural gas make up about three-quarters of Russia’s exports and more than half of its budget revenues).

United States oil production levels, in thousands of barrels per day
(image: Peak Oil Barrel)

Another of the popular conspiracy theories is that rather than colluding with the United States, Saudi Arabia is actually attempting to crush the tight oil (otherwise known as shale oil or fracking) boom in the U.S., the idea here being to restore its and OPEC’s dominance in the oil markets. For what’s been going on is that since 2008 the United States has increased its production levels of oil – thanks to fracking – by some 4 million barrels a day, nearly doubling its previous extraction rate.

Secondly, since the peak in conventional oil supplies (that found under the ground and deserts and such) occurred in 2005, the only thing that’s been keeping overall extraction levels increasing (in order to maintain worldwide economic growth) are the newly tapped unconventional oils – tight oil, tar sands, and deepwater offshore oil. And since tapping these forms of oil is similar to the extra effort required when scraping the bottom of a barrel, these unconventional sources require more energy and so cost more money to extract.

The idea then is that since tight oil in the United States is rather expensive to produce, if Saudi Arabia lets the oil price drop, this could very well bankrupt shale oil producers in the U.S. With a drop in production levels, prices would level off if not rise again, and not only would OPEC reap the restored higher prices, but they wouldn’t have lost any market share.

That all being said, deciding to finally end the silence and partially put to rest lingering conspiracy theories, Saudi Arabia’s oil minister was quoted on December 18th as stating that “The share of OPEC, as well as Saudi Arabia, in the global market has not changed for several years… while the production of other non-OPEC [countries] is rising constantly.”

Similarly, the oil minister for the United Arab Emirates stated that “No one likes the price drop, but it is not right that one party should interfere to fix the matter. [The party] responsible for the price fall [by causing the current oil glut] should contribute to fix the imbalance in the market.”

In other words, while OPEC members have maintained their overall production levels of roughly 30 million barrels a day for about a couple of years now, it is the United States’ fracking industry that since 2008 has significantly increased worldwide production levels, earning itself, no less, the rather idiotic moniker of “Saudi America.”

A few days after the aforementioned statements were made, Saudi Arabia’s oil minister again pleaded for non-OPEC members to cut back on production, then adding that those countries “will realize that it is in their interests to cooperate to ensure high prices for everyone.” Furthermore, he also added that OPEC doesn’t intend to cut supply “whatever the price is.” “Whether it goes down to $20, $40, $50, $60, it is irrelevant.”

And finally, in his response to conspiracy theories bandied about regarding Saudi Arabia pulling out the oil weapon on so-and-so countries, Saudi Arabia’s oil minister stated that “Talking about such alleged conspiracies… is absolutely incorrect and indicates a misunderstanding in some minds… Our economy is based on strictly economic strategies, no more, no less.”

So. I suppose that what one could do is wonder whether these statements are simply a smoke-screen for some nefarious, underhanded deals going on. But not only do I not have the faintest clue whether that’s the case or not, and see no good reason for throwing uneducated guesses around, author Ugo Bardi put it even better when he said that “we tend to interpret the present downward cycle as the result of strategic choices or conspiracies, but this is mostly an illusion (the illusion of control).” That being said, what I do see as being important (and useful) is looking at why prices started to get so low in the first place.

Estimated oil price levels needed for OPEC members to balance their government budgets in 2014 (data via The Wall Street Journal)

First off, certain OPEC members – namely Saudi Arabia, the United Arab Emirates, and Qatar – have either built up such substantial financial reserves and/or can extract oil so cheaply that they are able to bear the brunt of low oil prices for some time. Not so much others.

While Iran needs oil in the $100+ range in order to balance its books, Venezuela is in the worst position of all. While the Latin American country is already a very polarized nation, oil accounts for 95% of its export revenue. Low oil prices could therefore easily make a grim situation worse, some people having a propensity to become hostile when their standards of living continually depreciate. Likewise, a default on Venezuela’s debt wouldn’t be out of the blue.

But perhaps more pertinent and interesting to readers of this blog is what of the non-OPEC producing countries? This, I think, would be a much better area to look at, seeing how it would shed much light on how we got into this situation in the first place.

First off, it’s worth noting that for the past three years or so, before oil’s recent crash, the price of crude has been bouncing around the $100 mark. This was a relatively expensive range, particularly in comparison to its long-standing rate of $20-$40 per barrel for more than a decade, before its gradual then meteoric rise to $147 in 2008.

Since oil is entwined with the price of pretty much everything nowadays, its changes in price can have a significant effect on economies (as we currently [mis]understand the term). With higher and higher oil prices sapping a greater percentage from expenditures – be it of “consumers” or businesses – a price point is eventually reached where goods become so expensive that those who can’t afford them anymore simply stop buying them. This is what is called “demand destruction.”

When demand dries up and fewer goods thus end up being bought and sold, a glut in oil supply results, which ends up crashing prices. This is simple supply and demand. Along with other factors, this is what happened after the $147 oil price spike in July of 2008, and resulted in oil tumbling down to $32 by December of that same year.

While the ensuing low oil prices get seen by some as a boon (via the expectation that consumers will have more money to spend), the opposite problem actually kicks in – namely, “offer destruction.” Since many businesses get forced to close down due to crashing oil demand and so in effect fewer sales, and since a number of people get their hours cut or even lose their jobs, there often-times isn’t enough money to pay for oil and other goods, regardless of how low the prices go. This is what happened in 2009, gets referred to as being the Great Recession, and can be fairly described as “the beauty of the market.”

To return to the first paragraph of this post, this is where I got thrown off. To digress:

As mentioned earlier, 2005 is seen by some as the year that conventional supplies of oil peaked. It is because of this (and a few other factors, like speculation) that oil climbed to $147. Although prices subsequently crashed due to demand destruction, they eventually made their way back up, to the point that several unconventional forms of oil (shale oil/fracking, tar sands, and deepwater offshore oil) became somewhat profitable.

The problem with peak oil is that when (if?) growth kicks in again, and since more and more energy is getting used, soon enough the increasing levels of energy-use may very well butt up against maximum extraction levels, resulting in a shortage in supply and causing the whole demand and offer destruction cycle to kick back in again.

Furthermore, and as far as one theory goes, higher highs and higher lows will occur. That is, instead of maxing out at $147 per barrel, oil will reach, say, $200 per barrel, before crashing down to $80 or so instead of $32. And so forth.

And it is because of this notion that peak oil pulled a fast one on me. Expecting the higher high having to happen, what I didn’t clue into was that oil prices at a high enough level for a prolonged period of time would be enough to have a similar effect as a quick rise to $147.

Case in point, one can look at countries that have recently slipped into recession or simply haven’t gotten out since 2009 – Greece, Spain, Italy, Brazil, and so forth. Furthermore, some of the more robust and rich countries are seeing their growth wane – Japan, China, Germany, to name just a few. For what is a slowdown in Europe leads to fewer consumer purchases from China leads to less iron ore and coal bought from Australia.

(image: Resource Crisis)

For a closer look, take a look at Italy. Oil and gas consumption peaked in 2004 and has been on a decline ever since. According to Ugo Bardi over at Resource Crisis, “Italy is in full collapse.” One not only sees that industries are closing down, but also that restaurants are popping up in the attempt to attract the wallets of globe-trotting, placeless tourists, along with all the chic restaurant-hoppers. What is being witnessed, says Bardi, is “unreal.”

Unfortunately, and much like the aforementioned countries, if one is looking for solid explanations about these economic collapses from mainstream news sources, then one is pretty much SOL. As Bardi then explains,

When the crisis is mentioned, different culprits periodically appear in the first pages of the newspapers: the Euro, the European Union, politicians, immigrants, government employees, bureaucracy, lazy workers, terrorism, femicide, Angela Merkel, Vladimir Putin, Silvio Berlusconi, and more. It is a cycle that never stops, it keeps turning, every time pointing at something – new or old – that the government will target to solve the crisis once and for all.

In turn, not only could low-priced oil ($20!?) usher in another Great Recession via a meltdown of the oil market, but the newly enshrined oil ventures are at serious risk of collapse, and whose bubble bursting could be akin to the recent housing bubble. (To be fair, I can’t imagine oil reaching that low if not staying there for very long, for the very simple reason that any number of unfortunate conflicts around the world could cause its price to increase overnight.)

Cost of oil production for various projects and countries
(image: The Oil Drum)

In short, many of the unconventional sources of oil require $100 prices in order to remain financially viable (or at least give that impression). Since many of the fracking plays in the United States are owned by independents who don’t have the financial reserves to weather a prolonged period of prices below costs of production, things could get hairy.

Furthermore, since fracking is capital-intensive, drillers have borrowed ridiculous amounts of money in order to acquire leases, drill wells, as well as purchase and install processing equipment and infrastructure. And since fracked wells have both steep production increase levels and decrease levels, drillers have been forced to continually drill more and more wells to keep up the semblance of growth – and to keep the debt piling up. What’s resulted is a junk bond market possibly akin to what was witnessed a few years back with the housing fracas.

And not to let all the boosters off the hook, for it was once again an all-too-giddy media that kept itself busy cheering on the latest (fraudulent?) money-making scheme, pumping up all the debt with nary a peep about any possible consequences.

And so what’s going on now that prices have crashed? That would be sellers panicking to unload their energy-related junk bonds and other investments in unconventional oil and related industries, and it’s anybody’s guess as to how much of a collapse will occur in these fields – and if it’s significant enough, if they’ll even have a chance to recover.

And as mentioned earlier, a round of offer destruction is expected to kick in after a round of demand destruction. For instance, nearly 40% of the jobs created since 2009 in the United States have been in energy related fields, those being some of the higher paying jobs in the nation, a catastrophe to the U.S. economy if lost.

As John Michael Greer recently put it over at The Archdruid Report, “If I’m right, the spike in domestic US oil production due to fracking was never more than an artifact of fiscal irresponsibility in the first place, and could not have been sustained no matter what.”

What we might be about to find out is how vulnerable the United States’ shale boom is to low prices, and how profitable fracking actually is.

Regardless, what happens next is anybody’s guess, and it would be a fool’s game to try and give any predictions. Nonetheless, it’s worth quoting Terry Lynn Karl from a recent conversation with Andrew Nikiforuk. “We are in a situation where oil supply limits can cause recessions and oil supply gluts can cause stock market failures.”

The reasons to get off oil seem to be piling up.

Boom Goes the Dynamite

Off the keyboard of Michael Snyder

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Published on The Economic Collapse on January 12, 2015

Boom-Goes-The-Dynamite-Public-Domain

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The Crashing Price Of Oil Is Going To Rip The Global Economy To Shreds

If you were waiting for a “black swan event” to come along and devastate the global economy, you don’t have to wait any longer.  As I write this, the price of U.S. oil is sitting at $45.76 a barrel.  It has fallen by more than 60 dollars a barrel since June.  There is only one other time in history when we have seen anything like this happen before.  That was in 2008, just prior to the worst financial crisis since the Great Depression.  But following the financial crisis of 2008, the price of oil rebounded fairly rapidly.  As you will see below, there are very strong reasons to believe that it will not happen this time.  And the longer the price of oil stays this low, the worse our problems are going to get.  At a price of less than $50 a barrel, it is just a matter of time before we see a huge wave of energy company bankruptcies, massive job losses, a junk bond crash followed by a stock market crash, and a crisis in commodity derivatives unlike anything that we have ever seen before.  So let’s hope that a very unlikely miracle happens and the price of oil rebounds substantially in the months ahead.  Because if not, the price of oil is going to absolutely rip the global economy to shreds.

What amazes me is that there are still many economic “experts” in the mainstream media that are proclaiming that the collapse in the price of oil is going to be a good thing for the U.S. economy.

The only precedent that we can compare the current crash to is the oil price collapse of 2008.  You can see both crashes on the chart below…

Price Of Oil Since 2006

If rapidly falling oil prices are good economic news, that collapse should have pushed the U.S. economy into overdrive.

But that didn’t happen, did it?  Instead, we plunged into the deepest recession that we have seen since the Great Depression.

And unless there is a miracle rebound in the price of oil now, we are going to experience something similar this time.

Already, we are seeing oil rigs shut down at a staggering pace.  The following is from Bloomberg

U.S. oil drillers laid down the most rigs in the fourth quarter since 2009. And things are about to get much worse.

The rig count fell by 93 in the three months through Dec. 26, and lost another 17 last week, Baker Hughes Inc. data show. About 200 more will be idled over the next quarter as U.S. oil explorers make good on their promises to curb spending, according to Moody’s Corp.

But that was just the beginning of the carnage.  61 more oil rigs shut down last week alone, and hundreds more are being projected to shut down in the months ahead.

For those that cannot connect the dots, that is going to translate into the loss of large numbers of good paying jobs.  Just check out what is happening in Texas

A few days ago, Helmerich & Payne, announced that it would idle 50 more drilling rigs in February, after having already idled 11 rigs. Each rig accounts for about 100 jobs. This will cut its shale drilling activities by 20%. The other two large drillers, Nabors Industries and Patterson-UTI Energy are on a similar program. All three combined are “likely to cut approximately 15,000 jobs out of the 50,000 people they currently employ,” said Oilpro Managing Director Joseph Triepke.

Unfortunately, this crisis will not just be localized to states such as Texas.  There are tens of thousands of small and mid-size firms that will be affected.  The following is from a recent CNBC report

More than 20,000 small and midsize firms drive the “hydrocarbon revolution” in the U.S. that has helped the oil and gas industry thrive in recent years, and they produce more than 75 percent of the nation’s oil and gas output, according to the Manhattan Institute for Policy Research’s February 2014 Power & Growth Initiative Report. The Manhattan Institute is a conservative think tank in New York City.

A sustained decline in prices could lead to layoffs at these firms, say experts. “The energy industry has been one of the job-growth areas leading us out of the recession,” said Chad Mabry, a Houston-based analyst in the energy and natural resources research department of boutique investment bank MLV & Co. in New York City. “In 2015, that changes in this price environment,” he said. “We’re probably going to see some job losses on a fairy significant scale if this keeps up.”

If the price of oil makes a major comeback, the carnage will ultimately not be that bad.

But if it stays at this level or keeps going down for an extended period of time, it is inevitable that a whole bunch of those firms will go bankrupt and their debt will go bad.

That would mean a junk bond crash unlike anything that Wall Street has ever experienced.

And as I have written about previously, a stock market crash almost always follows a junk bond crash.

These are things that happened during the last financial crisis and that are repeating again right in front of our eyes.

Another thing that happened in 2008 that is happening again is a crash in industrial commodity prices.

At this point, industrial commodity prices have hit a 12 year low.  I am talking about industrial commodities such as copper, iron ore, steel and aluminum.  This is a huge sign that global economic activity is slowing down and that big trouble is on the way.

So what is driving this?  The following excerpt from a recent Zero Hedge article gives us a clue…

Globally there are over $9 trillion worth of borrowed US Dollars in the financial system. When you borrow in US Dollars, you are effectively SHORTING the US Dollar.

Which means that when the US Dollar rallies, your returns implode regardless of where you invested the borrowed money (another currency, stocks, oil, infrastructure projects, derivatives).

Take a look at commodities. Globally, there are over $22 TRILLION worth of derivatives trades involving commodities. ALL of these were at risk of blowing up if the US Dollar rallied.

Unfortunately, starting in mid-2014, it did in a big way.

This move in the US Dollar imploded those derivatives trades. If you want an explanation for why commodities are crashing (aside from the fact the global economy is slowing) this is it.

Once again, much of this could be avoided if the price of oil starts going back up substantially.

Unfortunately, that does not appear likely.  In fact, many of the big banks are projecting that it could go even lower

Goldman Sachs, CitiGroup, Societe General and Commerzbank are among the latest investment banks to reduce crude oil price estimates, and without production cuts, there appears to be more room for lower prices.

“We’re going to keep on going lower,” says industry analyst Brian Milne of energy manager Schneider Electric. “Even with fresher new lows, there’s still more downside.”

OPEC could stabilize global oil prices with a single announcement, but so far OPEC has refused to do this.  Many believe that the OPEC countries actually want the price of oil to fall for competitive reasons…

Representatives of Saudi Arabia, the United Arab Emirates and Kuwait stressed a dozen times in the past six weeks that the group won’t curb output to halt the biggest drop in crude since 2008. Qatar’s estimate for the global oversupply is among the biggest of any producing country. These countries actually want — and are achieving — further price declines as part of an attempt to hasten cutbacks by U.S. shale drillers, according to Barclays Plc and Commerzbank AG.

The oil producing countries in the Middle East seem to be settling in for the long haul.  In fact, one prominent Saudi prince made headlines all over the world this week when he said that “I’m sure we’re never going to see $100 anymore.”

Never is a very strong word.

Could there be such a massive worldwide oil glut going on right now that the price of oil will never get that high again?

Well, without a doubt there is a huge amount of unsold oil floating around out there at the moment.

It has gotten so bad that some big trading companies are actually hiring supertankers to store large quantities of unsold crude oil at sea…

Some of the world’s largest oil traders have this week hired supertankers to store crude at sea, marking a milestone in the build-up of the global glut.

Trading firms including Vitol, Trafiguraand energy major Shell have all booked crude tankers for up to 12 months, freight brokers and shipping sources told Reuters.

They said the flurry of long-term bookings was unusual and suggested traders could use the vessels to store excess crude at sea until prices rebound, repeating a popular 2009 trading gambit when prices last crashed.

The fundamentals for the price of oil are so much worse than they were back in 2008.

We could potentially be looking at sub-$50 oil for an extended period of time.

If that is indeed the case, there will be catastrophic damage to the global economy and to the global financial system.

So hold on to your hats, because it looks like we are going to be in for quite a bumpy ride in 2015.

Black Swan Dive

Off the keyboard of Steve Ludlum

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Published on Economic Undertow on January 7, 2015

Be careful of what you wish for, you might get it.
— Proverb

Triangle of Doom 010115

Figure 1: Triangle of utility function by rational agents; by TFC Charts, (click on for big). In a cash economy the inability to afford crude oil would manifest itself as the steady decline of ‘too high prices’. Our economy is built around structured finance; once credit structures are undermined they collapse.

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There is a ‘perfect storm’ underway; of insolvent customers, over-stressed finance, willful ignorance on the part of the establishment and denial. Both commodity prices and US Treasury yields are indicating another recession. Customers and drillers are asking how low will fuel prices go and how long will they stay there?

Fund manager Jeff Gundlach responds that no one will know until they stop falling. “That answer isn’t meant to be cute,” he says. “When you have a market that showed extraordinary stability for five years — trading consistently at $90 [a barrel] or above — undergo a catastrophic crash like this one, prices usually go down a lot harder and stay down a lot longer than people think is possible.”

Because modern ‘labor’ is waste, the customer must borrow … or some firm or institution must borrow for him. Workers have been able to gain greater amounts in wages in the past when fuel was less costly: wages are credit, high wages represent the historical productivity of credit. Prices cannot rise further because the ability of customers to earn (borrow) is constrained by (relatively) high crude prices, diminishing the productivity of credit.

There are two sets of borrowers: customers and drillers. Both need to borrow to gain fuel. The borrowing requirements of the driller increase over time because he is constrained by geology while the customer is limited only by access to credit and to wasting infrastructure. At the same time, the customer must take on the drillers’ debts by bidding for- and buying fuel. The relationship between the sets of borrowers conforms to simple game theory:
Crude Game Theory 1
Figure 2: Energy relationships in 1998 and prior, drillers and customers each borrowed or didn’t borrow. Not borrowing by both meant no economy and no petroleum produced which obviously did not occur. Both customers and drillers chose to borrow: drillers added to excess petroleum capacity making fuel more affordable. Customer borrowing became added gross domestic product (GDP). This amplified driller borrowing which made even more crude available at still lower prices! During this period, there was no need to allocate between drillers or customers.

From 1998 onward, the productivity of each dollar invested in crude production over time has continually declined. This is the basis for the Undertow argument that Peak Oil occurred in 1998: that the baleful economic effects predicted to occur after Peak Oil started to be felt in 2000. To gain more crude oil drillers were required to add more wells, each well was more costly than the last, each well offered less crude oil than previous wells: the effect of this effort has been felt by oil consumers who have had to compete with the drillers for each dollar of credit.
Crude Game Theory 2
Figure 3: Post-1998, brutal new game theory: mutually assured (demand) destruction!

Borrowing by customers returns less GDP, borrowing by drillers returns less crude. When drillers borrow alongside their customers, they cannot keep pace because demand is easier to create than supply: automobiles are more easily had than new oil fields. Attempting to add to GDP (borrowing by customers) increases demand for crude which exhausts inexpensive fields faster, this in turn adds to the credit requirements of the drillers, returns diminish and borrowing costs pyramid. The outcome is the same as when neither drillers nor customers borrow, there is no economy, all are bankrupted by costs.

The alternative is for the customer to borrow at the expense of the driller or the other way around. Both customer and driller now compete for the same credit dollar: the customers’ need for funds is absolute, they must borrow more than drillers or they cannot buy anything and there is no GDP growth. Drillers need for funds is absolute, they must borrow more than the customers otherwise there is less fuel for the customers.

Unlike finance, petroleum is a bottom up business. At the end of the day every drop of oil/refined product has to be bought by a customer. Because there is so little return on what he does with the product he must borrow to pay for his purchase. He borrows, his boss borrows, his government borrows, his nation borrows other countries’ money (borrow by way of foreign exchange). Our economies are nothing more than interconnected daisy-chains of loans. Over time these chains have grown to amount to hundreds of trillions of dollars. As debt piles up it can only be serviced and retired by taking on more loans.

Even as the US makes less in the way of physical goods like clothing, shoes, washing machines or table radios, its Wall Street firms manufacture the bulk of the world’s credit; this is needed to substitute for absent monetary returns for just about everything else. Driving a car does not pay for the car (times- 1 billion cars), nor does it pay for the fuel, the roads, the massive governments including costly military endeavors, nor does driving pay for the ordinary costs of finance … risk premia and interest carry, which have ballooned exponentially. Other than for the smallest handful of customers — transit, construction, farming, delivery, emergency/first responder — customer use of fossil fuels and other capital is non-remunerative waste, for pleasure-fun, convenience, status, etc. The fashionable wasting processes — including fuel extraction industries — are collateral for more and more loans.

The simplest of models is all that is required to see where this ends up: subtract the costs of petroleum extraction from the small use that provides an actual return. This difference is the price that the economy can actually afford to pay without the use of credit. With extraction costs rising — which cannot be denied by anyone — and with actual returns being very small, the output of the model looks to be a negative number. What that implies is the price of fuel will fall all the way to zero with nothing to be done in the way of ‘administrative adjustments’ to alter this outcome.

Managers appear to be helpless because they have thrown everything at the economy but the kitchen sink: key men have been propped, banks bailed out; interest rates across all maturities are near zero, real rates are negative- or nearly so. Governments around the world are at the borrowing limit, there is little in the way of good collateral remaining for central banks to take on as security for new loans. Conventional marketplace fixes such as debt jubilees/write-offs, re-distribution, bailouts, stimulus, austerity policies, monetary easing, etc. are efforts to reclaim resource capital that no longer exists. Remedies accelerate unraveling process by increasing gross debt (claims against capital) while exposing remaining capital to consumption at higher rates. The capital ‘pie’ cannot be created anew or redivided, only a new and much smaller pie is to be had and carefully tended. Our smaller pie of non-renewable resources is what we have to make use of, to last us and the rest of the world’s creatures until the end of humanity.

Managers certainly understand but refuse to acknowledge that resource extraction over extended periods has consequences. Nations, regions, individuals and firms have experienced temporary shortages of fuel, credit and other resources in the past due to wars, droughts and other disruptions. A grand civilization at the height of its power has not exhausted its prime mover since the Romans stripped their empire of firewood beginning in the first century BCE, precipitating its decline.

Energy Commodity Futures

Commodity Units Price Change % Change Contract
Crude Oil (WTI) USD/bbl. 48.82 +0.89 +1.86% Feb 15
Crude Oil (Brent) USD/bbl. 51.18 +0.08 +0.16% Feb 15
RBOB Gasoline USd/gal. 133.95 -1.48 -1.09% Feb 15
NYMEX Natural Gas USD/MMBtu 2.88 -0.06 -1.97% Feb 15
NYMEX Heating Oil USd/gal. 170.08 -2.54 -1.47% Feb 15

Precious and Industrial Metals

Commodity Units Price Change % Change Contract
COMEX Gold USD/t oz. 1,212.20 -7.20 -0.59% Feb 15
Gold Spot USD/t oz. 1,215.30 -3.28 -0.27% N/A
COMEX Silver USD/t oz. 16.54 -0.10 -0.58% Mar 15
COMEX Copper USd/lb. 276.15 -0.55 -0.20% Mar 15
Platinum Spot USD/t oz. 1,221.25 +1.81 +0.15% N/A

Graphic by Bloomberg:

– Energy deflation is when increased fuel demand relative to supply does not cause prices to rise but undermines the ability of consumers to meet the price even as it falls. This is what is taking place wherever one makes an effort to look. A component of the onrushing crash is the easy money policy in Japan/Abenomics added to the other bits of monetary stimulus in other currency regions. It isn’t the end of the policy that is causing the crash but the policy itself as purchasing power flows from customers toward big business (drillers) and lenders. More easing => more purchasing power diversion => less credit => lower fuel price => more bankruptcies => more credit distress => more easing in a vicious cycle. What drives the process is the foolishness of central bankers who do not understand the consequences of their (obsolete) policies.

– Drillers rely on loans, lease flipping and share offers than upon revenue from sales, this is largely because of higher costs which would otherwise leave them underwater. The fracking boom and other expensive second-generation extraction regimes are as dependent upon structured finance as the real estate plungers were in the US beginning in 2002. The ‘waterfall’ decline in oil prices suggest that financing structures are coming undone. Finance innovations such as CLOs disguise risk and shuffle it around rather than eliminating it. When risks ultimately emerge they overwhelm the structures intended to manage them; hedging strategies rebound against hedgers, those that can race for the exits, the rest suffer severe losses as the prices collapse.

– It is possible that energy companies’ hedging strategies are contributing to the ongoing crash the same way ‘portfolio insurance’ abetted the stock market swan-dive in 1987: that is, sales of contracts in futures markets in order to hedge finance losses, elsewhere.

Because the leverage structures cannot simply reconfigure themselves after they collapse, oil prices cannot ‘bounce back’; a replacement credit regime must take the place of the broken system. Shadow-banking was vaporized by the housing crash in 2008; it was imperfectly replaced by a generalized credit expansion by way of Treasury borrowing along with central bank moral hazard: both of these offer diminished- or negative returns which is why this regime looks to be failing now … with nothing to replace it.

– Every dollar of price decline cuts output. Any oil that would be available at the higher price is removed from the market when prices fall. As the price declines, the only fuel available is that which costs that amount to extract or less:

Canada oil prices 010615

Figure 4: Prices for selected petroleum-fuel plays from Scotiabank (click on for big). Sub-$50/barrel prices looks to shut in as much as 3 million barrels per day, a cutback equal to a third of Saudi Arabia’s output. Price decline is the industry’s fuel cutback mechanism, no other actions by drillers, nations or organizations such as OPEC are needed. This is another component of energy deflation; the only issue is how cuts will affect the customers.

Fuel cutbacks do not occur overnight: contracts between drillers and refiners remain in force and there is inventory in storage. Drillers will borrow as long as they are able to, hoping for a miracle. As the contracts are satisfied and inventories depleted uneconomical supplies will be shut in leaving what remains of lower-cost fuels. Under the circumstances, this remaining supply would likely be hoarded as it would be worth more than other possible uses.

– ‘Dollar Preference’, from the Debtonomics series is the convergence between the value of oil capital and the dollars that are exchanged for it. Fuel by itself is worth more than the real-world enterprises that waste it regardless of what means are used to adjust the price. Enterprises earn nothing on their own and are essentially worthless. They exist solely to borrow, gaining- and making use of credit is their primary product: other goods and services are intended to justify credit issuance in ever-increasing amounts. Part of this stream becomes the property of well-positioned ‘entrepreneurs’: enormous unearned borrowed profits are what drives the system. When debt = wealth, there is an incentive to take on as much debt as possible, keep what you can for yourself and to shift the burdens onto others.

Management is paralyzed by the internal contradictions of the debtonomy. We cannot get rid of (some of) the debt without getting rid of (all of) the wealth. We cannot get rid of the debt because we would need to take on even more ruinous debts immediately afterward to keep vital services operating such as water supply. If we get rid of the debts the prices will fall leaving debt-tending establishments without investment funds. Our debts cannot be rationalized, the absence of debts cannot be tolerated. The debt system is rule-bound. Debts that were increased because of favorable rules face annihilation because of the same rules, changing the rules threatens debt elsewhere. Nowhere are there real returns to service the debts much less retire them. Nothing remains but the arm-waving of central bankers. As the banks create more debt (against their own accounts), their efforts are felt at the gasoline pump which adversely effects debt service.

The debtonomy is Gresham’s Law applied (on purpose?) to goods and services; the bad drives out the good, the worst drives out everything else. The ‘bad’ enterprises which groan under massive obligations possess a competitive advantage over the virtuous ones that earn without taking any debts on. Debts are artificial earnings which are used to price the good companies out of business then engulf their markets. The final step is for the debt-gorged monstrosities to fall bankrupt due to their massive size, these are then bailed out by the even-more bankrupt sovereigns.

Energy guru Chris Cook uses the term ‘Upper Bound’ to describe the fuel price level that constrains economic activity. The price rise can be caused by increases in the available credit or by a decrease in the amount of available fuel relative to the current credit supply.

What happens at the other end of the bound? If the upper is tough to deal with the lower is good, right?

It goes without saying that the crude is vital. The ‘Business of debtonomy is debt’ but the presumption is of fuel waste for a ‘higher purpose’ which is embodied within our progress narrative. Without continuous waste debt becomes an unsupportable dead weight on all enterprises. Here is the confusion over the effects of fuel shortages on economies: ending waste is thrift, it is economical to do so. Ending waste is fatal to our debtonomy which needs the waste to justify its existence: economic thrift is an un-debtonomic catastrophe.

It is different this time: the decline of the fuel price means there is less fuel made available to waste, that the high cost variety is off the market. Low priced fuel means there are no businesses with credit. Lower price fuel is worth more than any enterprise that uses it, the lowest possible price means the industrial scale fuel waste enterprises are ruined, both producers and consumers.

The decrease in the dollar price of crude is ipso facto marketplace repricing more valuable dollars. The lower bound is where dollars become a proxy for crude and are hoarded. At that point all things are discounted to the dollar because the dollar traded for crude is more favorable than a trade of anything else for crude, that includes other currencies as well as dollar-denominated credit.

Just like the upper bound where a dollar is worth less with each increase in fuel price, the lower bound represents a dollar that is worth more because of its price in crude. A low crude price has a dollar that is worth too much to be used for carry trades or interest rate arbitrage which is the primary business activity within the debtonomy.

The lower bound is reached when currencies are discounted to dollars. A reason for this is the universality of the dollar. Because the US has been for so long the world’s consumer of last resort, goods that were sold for dollars in the US are tradeable everywhere in the world for the same dollars. The dollar purchases of the past and dollars in circulation now are the purchasing power of the future.

The dollar is also the world’s reserve currency, dollars being used to settle trade accounts. The trade of goods between countries whose currencies are illiquid may have foreign exchange risks that exceed the profit to be had by way of the trade. The exchange of the currencies for dollars bypasses the risks because the universal dollar is a liquid, stable substitute for third-party currencies. Reserve status of the dollar and its universality provide leverage that other currencies do not possess.

The trade of dollars for crude sets the worth of the dollars rather than do the central bank(s), this trade takes place millions of time a day at gasoline stations all over the world.

Motorists determine the worth of money; this strands the central banks. In their futile attempts to assert some sort of relevance the central bankers and policy makers manipulate interest rates, pillage bank depositors, ignore moral hazard and bail out their friends. They seek to reduce the worth of money relative to other money. In doing so the bank surrenders what small fragments of policy-making ability which remain to it. Bankers can set interest rates to zero but no further, can whitewash the accumulation of risk but cannot set the money price of petroleum except to make it unaffordable which precipitates the catastrophe the bankers are desperate to prevent.

The catastrophe the bankers are desperate to prevent is the destruction of demand, where fuel falls into strong hands and dollars are hoarded because they are proxies for scarce petroleum, energy in-hand.

For this reason, dollar preference effects net energy which is consumption taking place in energy producing countries. This consumption is entirely dependent upon consumer goods that are affordable because of high fuel prices. Russians produce automobiles and other Russians buy them because the national oil companies are able to sell their product for +$100 per barrel. The price subsidizes both Russia’s debts and her energy waste. Ditto for the energy consumption of Saudi Arabia, Iran, US, Kuwait, Iraq and all the rest. When energy prices fall so will energy consumption in producer countries if only because lower priced oil production will be too scarce to waste.

At $10 per barrel, Russia will produce very little fuel, only from the cheapest and easiest to produce fields and will trade it for hard currency only. Domestic sales will take place in black markets for dollars or gold, few Russians will have dollars and those that do will hold onto them for emergencies. Hard currency earned by the export of crude will be used to buy food and medicine, not imported luxury automobiles and television sets.

Diminished net exports are dependent on high prices which are in turn dependent upon constantly expanding credit. When cash is preferred over credit there is nothing to support the high prices or fuel waste. Cash is hoarded and credit is evaporated.

The end-game of dollar preference is crude-driven dollar deflation as took place in the US in 1933. Dollars were held as ‘gold in hand’ and business in the country was the buying and selling of currency to obtain gold which was necessary to settle contracts. The deflationary impulse was ended when the world’s governments ended specie and fixed convertibility, cutting the currency links to gold. The need will be for the US to end the dollar’s convertibility to crude, to go ‘off crude’ as countries went ‘off gold’. The alternative is for dollars to vanish from circulation and cease to be a medium of exchange. Local currencies emerging in the dollar’s place will be of little use in the obtain of fuel imports, the country will be limited to the petroleum that can be sustainably produced on its own soil.

Dollar preference is self-limiting. Dollar preference in 2015 is the demise of the euro, yen, ruble, peso, real … their unraveling illuminates widespread mismanagement. Doubts about currency regimes take root. The differences between the euro, yen, sterling, yuan and dollar currencies are minuscule. Euro debts are no different from the debts of the others, European waste is no different from the waste of others. There is nothing special about the dollar other than a military machine that is debt-dependent and failure-prone. Dollar preference condemns the rest which starts the clock on the ultimate death of the dollar.

Peak Oil…

Off the keyboard of Steve from Virginia

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Published on Economic Undertow on December 24, 2014

Triangle-of-Doom-1101141

Discuss this article at the Energy Table inside the Diner

Part of the current frenzy about energy prices is the insistence on a petroleum ‘glut’. According to conventional wisdom, there is simply so much excess crude on the markets there is nowhere for oil prices to go but down.

The reasons given for the excess crude are many: Saudi intransigence, a Saudi-US geopolitical contest (price war) with Russia/Iran, pesky futures’ market speculators … because/in spite of the president, because/in spite of the governments energy (non)policy … because of clear and concise leadership from Congress. Excess crude is the incredible free enterprise system working its magic! There is a glut of crude because Americans are incredibly clever and hard-working, because they are too fat/not fat enough … because they take too many drugs/not enough drugs, are red (blue); because our brilliant technology has permanently solved the problem of shortages so that our greatest challenge is to manage the onrushing, cornucopian abundance …

Keep in mind, a glut or the appearance of one makes sense at the oil extraction peak, after all, what is a ‘peak’ but the period of the greatest rate of extraction? There cannot be more petroleum available any time than at a peak. All that remains is for consumption to sort itself out; our brilliant-as-technology marketplaces will take care of that by themselves. Glut = cheaper crude! It’s morning in America, again!

That’s can’t be what’s happening … there has to be some mistake. What goes down must go up, right? If prices drop too far the entire extraction industry will go out of business, that the prices have crashed indicates half the industry is already out of business, it just doesn’t know which half it is yet.
Staniford-Oil 122214

Figure 1: various rates of extraction from multiple data sources compiled by Stuart Staniford, this chart is from December, 2013. The top line indicates 92 million barrels of various flammable ‘liquids’ per day including bitumen, natural gas plant liquids and biofuels.

The increase in petroleum volume isn’t necessarily a blessing as the energy content of the newer fuels is no greater than that of smaller volumes seven- or eight years ago. The increased volumes cost more to extract, transport and process so the net-energy yield is less. Regarding conventional crude, the likelihood is that the output peak occurred in 2005.

Every single one of the billions of barrels indicated on this chart have been burned up for nothing. This is the topic that is never discussed, never even acknowledged; our incredible permanently extinguished oil. There are literally zero returns for the precious capital we have burned, nothing to show but junk. This is the collateral for all of our (borrowed) ‘money’ … and the reason why we have financial ‘difficulties’. The dollar and other currencies are backed by fraud, used cars and smog.

Given that the world is at some sort of peak right now, what happens afterward? Because the world has not experienced a peak of existential magnitude before, we tend to make assumptions about what to expect. One assumption is that technology will provide substitutes, higher prices will allow extraction of deeper, harder to extract reserves. In this line of thinking, nothing really changes because extracting crude oil and using it has always been a costly endeavor, it will be a little more costly but manageable.

The plunging price of crude oil does not reflect the cost of extracting it or finding substitutes but rather the paucity of return on its use. This is sensible because returns are what are supposed to pay for extraction- plus a profit. What pays instead are sub-prime loans made against promises of bottomless production rather than actual remunerative use. The highest and best use for crude oil and related goods has been as subjects in a Wall Street finance shell game which is undone by the crash in crude prices … and crash it is, (Bloomberg):

Energy Commodity Futures

Commodity Units Price Change % Change Contract
Crude Oil (WTI) USD/bbl. 55.26 0.00 0.00% Feb 15
Crude Oil (Brent) Hammered again USD/bbl. 60.13 -1.25 -2.04% Feb 15
RBOB Gasoline USd/gal. 153.50 0.00 0.00% Jan 15
NYMEX Natural Gas USD/MMBtu 3.14 0.00 0.00% Jan 15
NYMEX Heating Oil USd/gal. 195.14 0.00 0.00% Jan 15

Precious and Industrial Metals

Commodity Units Price Change % Change Contract
COMEX Gold USD/t oz. 1,179.80 -16.20 -1.35% Feb 15
Gold Spot USD/t oz. 1,177.06 +0.62 +0.05% N/A
COMEX Silver USD/t oz. 15.69 0.00 0.00% Mar 15
COMEX Copper USd/lb. 287.25 0.00 0.00% Mar 15
Platinum Spot USD/t oz. 1,182.88 +0.88 +0.07% N/A

Individual countries are going through the Peak Oil process making it fairly simple to see what sort of outcomes can be expected … these are generally ugly.

Mazama-Egypt 122214

Figure 2: Egyptian crude imports, exports and domestic consumption. Map- graphics by Mazama Science; data by BP. Egypt’s oil output peaked in 1995 at roughly 1 million barrels per day and has followed the classic M. King Hubbert decline curve since then. At its peak, Egypt was a substantial exporter, since then it has become a socioeconomic basket case, increasingly dependent upon both dollar- and fuel subsidies from the US and Persian Gulf states plus the meager returns from the European tourist trade. The country’s fabulously corrupt, autocratic government pretends to manage its zooming human- and auto population, Islamic militancy in the hinterlands, diminished foreign currency reserves and ballooning external debts. Like many other producing countries, Egypt offers, albeit in diminished amounts, subsidized fuel for its millions of worthless cars.

Explosive unrest occurred in the country in 2011 as part of the Arab Spring. Egypt’s management was able to keep the lid on the mid- 90’s as long as there was an increase in marketable fuels, once supplies tightened so did the grip of poverty and a sense of middle-class hopelessness.

Mazama-Nigeria 122214

Figure 3: Crude oil extraction never allowed for a Nigerian ‘golden age’ as much of the returns from sales were stolen by elites. Output increased sharply beginning in the 1970s. It is possible that the peak occurred during that period or later, in 2010. It is hard to say because much of the country’s crude is siphoned off by criminal gangs or spilled from the country’s leaky pipeline infrastructure. Like Egypt, post-peak Nigeria is slowly becoming a hospice patient with grinding poverty, instability and a thievishly inept, autocratic government. Like Egypt, Nigeria is plagued with militants who make life miserable for farmers and villagers in the northern hinterlands.

High crude prices over the past few years allowed the Nigerian establishment to take on the appearance of stability and to paper over some of its economic problems, one such effort has been subsidies for millions of drivers. Lower overall crude prices can do little but cut ordinary citizens’ purchasing power while intensifying the Nigerian elites’ urge to steal as much of the country’s remaining portable wealth as they can and remove it from the country while they still have the chance.

Mazama-Iran 122214

Figure 4: Arguments regarding ‘above-ground issues’ notwithstanding, the peak of Iranian crude production occurred in 1974. The output bumpy plateau from 1990 to 2012 has kept the country ‘open for business’, but the story so far appears to be that of a mature fuel producing region that now extracts less — for whatever reason. At the same time domestic consumption is relentlessly increasing largely due to fuel subsidies for motorists. Like other petro-states, Iran is controlled by an autocratic regime that rules by fear, informants and secret police. Recent high crude prices have allowed Tehran to fund a proxy war against Saudi Arabia for hegemony over the Middle East. Iran also funds ‘resistance’ to Israel at the same time pursuing a costly, pointless nuclear weapons program. The high prices + hard currency inflows by way of Dubai have tended to counteract the effects of international trade- and economic sanctions against the country. Those days are over: lower prices and dollar shortage will amplify the effects of sanctions and certainly act to constrain Iran’s influence, its solvency along with its ability to wage proxy war against ideological- but otherwise almost identical adversaries.

Mazama-Russia 122214

Figure 5: Under the lash of Soviet commissars and the prodding of Five Year Plans, Continental Russia experienced its output peak before the regime collapsed in the late 1980s. Since then, Russian output recovered to some degree but the oil experts within Russia admit now that future output will irretrievably decline.

As in Iran and Egypt, the long, post-peak interval in Russia has been marked by a slide into despotism, sputtering external conflicts, internal repression, harassment and spying, loss of liberties and varying degrees of economic hardship. The role of the ordinary citizens within the current regime is to bear the regime’s ballooning costs: the outcome is a race to remove portable wealth from the country as fast as possible. Russia subsidizes its energy consumers which accelerates depletion, mostly natural gas. Instead of leveling the economic playing field, subsidies divert funds to drillers, toward Russia’s elites, with the customers as conduits.

High crude prices have allowed Russia to keep up pretenses. Hard currency inflows counteracted the effects of the Russian government’s incompetence and corruption. Lower prices and a dollar embargo will have the opposite effect, magnifying Russian leadership failures and burying Russia’s economy: go to sleep in Moscow, wake up in Cairo.

Mazama-UK 122214

Figure 6: the word ‘England’ looks to mean ‘unending crisis’ as the country’s petroleum fuel resource was dumped on the world markets for narrow political advantage in the mid-1980s and ’90s with the peak output occurring in 1999. Since then, England has been experiencing what can only be called a ‘Long Descent’ into the energy abyss. Along with the other post-peak examples, England suffers from incompetent and increasingly autocratic government and an economy undermined with fuel subsidies on one hand, unpayable debts on the other. The UK’s economic assets are opaque derivatives and pricey houses for tax exiles in central London. Its liabilities are millions of guzzling automobiles and a hodgepodge of poorly considered, blindingly expensive energy megaprojects that have zero chance to solve the country’s problem … if they are ever finished! England and fuel-starved Japan look to be the world’s first credit providers to default or experience runs out of their respective currencies.

Low prices will hammer what remains of the UK’s petroleum industry which is almost entirely offshore. This version of the Seneca Curve will leave Britons more dependent upon imports … and an increasingly shaky pound. Worst-case scenario would have UK looking to buy hard to find dollars at any price in order to gain fuel; conservation taking the form of a bitter and cruel comeuppance.

Mazama-Australia 122214

Figure 7: This is what denial looks like: Australia’s peak occurred in 2000, since then fuel output has relentlessly declined alongside Australians’ galloping internal consumption. Australia government has coped by becoming increasingly inept. As the coal- and iron miner to China, Australia has been able to avoid some of the worst outcomes that afflict other post-peak economies. If nothing else, lower China consumption and the more costly US dollar will end the lucrative carry trade that has subsidized Australian credit expansion and wasteful consumption.

Mazama-Argentina 122214

Figure 8: Argentina’s oil output peak took place in 2002, the same time auto-driven consumption began to increase; like other oil nations, Argentina subsidizes consumption. The outcome as been creeping bankruptcy … default, hyperinflation/currency collapse, goods-shortages and riots, instability, increasing poverty; all helped along by the usual inept, thievish government(s). Lower prices and the broken Argentine economy look to strand drillers leaving the country to import fuel … if citizens can find the dollars to do so.

Mazama-Venezuela 122214

Figure 9: Venezuela’s peak was in 1970 … it has been a roller-coaster ride since. Output- and price fluctuations have since played havoc on Venezuela’s clownishly inept governments and flailing economy. If oil bounty is a curse, the depletion of bounty is descent into Inferno: as in Argentina, there is government corruption, inflation/hyperinflation, instability, social unrest. Even though the country is bankrupt, the government subsidizes fuel for its non-remunerative fleet of worthless automobiles. Venezuelans can use their last tankfuls of gas to drive to the poorhouse …

Mazama-Mexico 122214

Figure 10: Poor Mexico; so far from God, so close to the United States. Mexico’s petroleum story has largely been that of the super-giant Cantarell oilfield; its peak was in 2005. Since then, Mexican output has declined despite much hand-waving on the part of the Mexican establishment. Up until recently, petroleum extraction was nationalized, Mexico also subsidized motor fuel consumption. Along with the baleful effects of NAFTA and the burgeoning drug trade to the US, Mexico suffers the usual economic- and political rot found elsewhere in other oil states: sclerotic government, wrenching poverty, corruption, pollution with drug mafias standing in for the ‘Brand X’ militants found elsewhere.

Mazama-US 122214

Figure 11: The USA peak in 1970 looked to be overtaken by new output from Bakken and other shale plays leading to throaty proclamations of ‘energy independence’. Even with shale additions, US finds itself importing six million barrels per day; ongoing reductions are due to creeping impoverishment and less consumption. As with other countries the US massively subsidizes petroleum consumption:

Oil Subsidies 122214

Figure 12: Industrial nations’ fuel subsidies by way of BBC/IMF: The cost of subsidies ultimately proves to be unbearable even for petro-states with large reserves such as the US. Subsidies are a primary driver of declining net exports. Subsidies directed toward consumers flow immediately from them to the drillers: they are loans, laundered by way of governments from the same customers who receive them. As with monetary easing: more subsidies => more bankrupt customers and ultimately, bankrupt drillers.

Most oil states post-peak share the same characteristics: inept, pilfering, absolutist regimes, faltering economies overburdened with debt, over-reliance upon subsidies; there is war, militancy and social unrest. Some of these countries face more of some problems and less of others. Of the oil ‘producers’ that are post-peak only a handful, such as Norway and Denmark, have been able to maintain a tentative of political-economic equilibrium.

Mazama-Denmark 122314

Figure 13: Denmark’s extraction peak occurred in 2005, Norway’s in 2002. It would appear the best way to cope with oil peaking is to reduce consumption, for countries to become more like Denmark and less like Argentina or Egypt. Consumption in Denmark has declined by more than half since 1973; for it to decline by half again over the next ten years does not look to be a big problem.

With world-wide financial repression and the propping up of key-men everywhere, any energy crisis initially will not take familiar forms: gas lines, rationing and highway speed restrictions. Instead, the crisis will emerge as a credit crunch which is underway right now. Credit is being systematically revealed as worthless, leaving the fuel industry to provide for those elements of the fuel-use economy that can pay for themselves. This amounts to a very small fraction of current ‘use’ which is mostly for entertainment and pleasure.

It is hard to see how prices can rise in real terms from here.

Purchasing power rests more with the tycoons. Given enough deflationary medicine and tycoons will be just as broke as the rest of us. Purchasing power is the equivalent relationship between a good that is exchanged and what is gained for it: one is always worth the other; otherwise the exchange does not occur. Capital is non-renewable resources, it is the ultimate good, the basis of all ‘production’; as capital is depleted or diminished for whatever reason, so is purchasing power.

Customers must buy the fuel products that allow the drillers to retire their own loans. Customers can only buy when they borrow themselves … or after their employers borrow in turn from their own customers. The cost of ongoing oil peak = fewer customers borrowing overall, they have been fired, lost their businesses, have had their wages cut or they have other more important costs to meet, like food, housing or medical care.

Every post-peak country is in the same boat. China is slowing … because Americans and Europeans are buying less Chinese-made goods with borrowed money => less purchases from Australia and other resource providers. Large swaths of the world are embroiled in conflict which is a dead- loss to all sides. There are fewer places for any bid going to come from. How are prices going to rise?

“Central banks will print money,” is the usual nonsense refrain. Central banks cannot increase purchasing power, they can only dilute it. Finance can lend but the cost of moral hazard — a kind of indirect subsidy — has risen to where even largest governments cannot bear it. More loans won’t work anyway: money flows to drillers starving customers of funds leaving nobody to retire the drillers’ loans.

At the same time, oil states need to sell as much as they can to gain what cash-flow is possible. All petroleum is high cost now b/c of the need to work over old, depleting fields. Drillers are frantic to make up their losses on volume …

There is nobody with a handle on this situation, it is running away on its own.

Oil Shock

Off the keyboard of Steve from Virginia

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Published on Economic Undertow on December 10, 2014
Triangle of Doom 120414Figure 1: Triangle of Pants by TFC Charts, (click for big). What is taking place right now is an oil shock very similar to that which occurred in 2008-09. What triggered the current reaction was $105/barrel a few months ago as opposed to the much higher 2008 price. The lower price confounds expectations, convention leads us to believe that any fuel price shock would result from prices higher than $147 per barrel.

Discuss this article at the Economics Table inside the Diner

Since 2008, the world has become poorer; what remains of purchasing power has been diverted away from ordinary customers toward elites. Monetary- and fiscal policies around the world have amplified this flow making it difficult for customers to buy industrial goods including oil. By catering to crony ‘friends’ the central banks and governments have been working against their own stated interests, precipitating the very crisis they have been working so hard (?) to avoid.

The hope: more easing => lower money cost for drillers => price bubble ‘hedge’ against high- and increasing crude price => more financial market support for drillers. Finance makes money lending to all concerned.

The reality: more easing => more tycoon ‘success’ => more customer insolvency => lower crude prices => deflation => finance-lender bankruptcy => driller distress leading to more easing. Finance fails as customers are unable to retire firms’ debts and they (firms) default.

Because there are no organic returns from fuel use, customers must borrow.

There is a constant need for individuals to take on more debt; even as globalization has expanded the number of debtors it has not expanded their means. The world’s credit market is inundated with obligations that outweigh the ability of humans to retire them by way of labor. Reduced means = price declines. The elites cannot- or will not support a mass-market enterprise like oil consumption: they will lend some of their own (borrowed) funds to participating firms but refuse to squander a meaningful proportion of their wealth to simply buy and waste fuel. As the non-elites imitate their betters => price declines.

The economic arguments against inequality have narrow merit: the success of elites of grabbing more for themselves offers diminished returns. Non-elites’ obligation include servicing and retiring the elites’ debts, they do so by borrowing- and buying overpriced goods. From a wider viewpoint, elite success at pauperizing the bulk of the human race is a crude form of resource conservation. Greed undermines our consumption economy; this is a blessing in disguise! Pillage-to-breakdown gives our planetary life support system what small chance remains for it to do its job through the balance of the millennium … until we can learn to husband our capital wisely.

Retirement of loans requires productive activities that gain returns that can be applied against principal; productive activity is where ‘means’ are supposed to come from. The gargantuan amounts of debts today indicates there are really no productive activities at all, only borrowing platforms and (false) narratives. Debts are not retired with the output of industry but rather with new rounds of lending. Debts multiply exponentially as old debts drag from coffins like vampires-plus-interest. At the same time, new credit is always needed to fund the latest fashionable failing enterprises. Our dead-money debts are worthless claims against a rapidly diminishing capital account. Not just citizens but the world entire economy is insolvent: the oil price tells us that we can no longer borrow against the promise of future productivity … because there is no such thing.

Technology makes every sort of outlandish promise but is never able to simply pay its own way. Technology-related costs expand faster than returns, at the same time tech pushes aside forms that might serve to retire some of these costs: the voracious power demands of Internet data centers must be met with coal, Internet companies such as Amazon that perpetually lose money replace profitable ‘brick and mortar’ stores that provided the revenues which enabled the online firms’ rise in the first place.

The price for crude oil does not measure the worth of extraction but rather the worth of consumption … over the past six months there has been the downward repricing (depricing) of consumption by 35%. At the same time, reducing the price of inputs does not increase the solvency of the world’s bankrupts. A society cannot borrow- or consume its way to wealth. Only the careful husbandry of capital produces wealth. Industrialization is the strip mining of our capital and hunt for more. What propels the wasting process is the false promise that the mining process ‘creates’ capital rather than annihilating it.

Crude futures take another hit, (Bloomberg):

Energy Commodity Futures

Commodity Units Price Change % Change Contract
Crude Oil (WTI) USD/bbl. 62.93 -2.91 -4.42% Jan 15
Crude Oil (Brent) USD/bbl. 66.10 -2.97 -4.30% Jan 15
RBOB Gasoline USd/gal. 170.40 -6.94 -3.91% Jan 15
NYMEX Natural Gas USD/MMBtu 3.62 -0.18 -4.81% Jan 15
NYMEX Heating Oil USd/gal. 205.09 -5.69 -2.70% Jan 15

Precious and Industrial Metals

Commodity Units Price Change % Change Contract
COMEX Gold USD/t oz. 1,204.30 +13.90 +1.17% Feb 15
Gold Spot USD/t oz. 1,202.67 +10.32 +0.87% N/A
COMEX Silver USD/t oz. 16.39 +0.13 +0.78% Mar 15
COMEX Copper USd/lb. 288.50 -1.75 -0.60% Mar 15
Platinum Spot USD/t oz. 1,233.25 +10.25 +0.84% N/A

Says Arthur Cutten:

Oil took a 4 percent hit, and concern is growing that this is a sign of slackness in aggregate demand, and not a over production move by the US and some of its allies to punish Russia, or the Saudis to give the shale oil crowd a stiff gut check on their long term viability.

The same folks who are needed to push up the price of crude are on food stamps, have lost 35% of their wealth in Japan, have ‘slowed’ in China; are mired in depression in southern Europe … and in northern, eastern and western Europe as well. Because a car cannot be paid for by driving the car, the world is ruined by way of its 1 billion cars.

Driving the car does not pay for the fuel, or the roads or any of the rest of the associated junk including the massive, intrusive governments that everyone loves to hate. What pays is hundreds of trillion$ of debt … that can never be retired.

The costs of housing, education, Obamacare, wars, infrastructure maintenance and entertainment (drugs) are borne by citizens who must borrow additional amounts to bid the price of petroleum products. The customers have reached their credit limits, as a consequence they are insolvent: customers must borrow to retire their own debts. Credit breakdowns caused by driller defaults will smash the customers even harder … the bid will shrink leading to more defaults in a vicious cycle: this is ‘Energy Deflation’, similar to Irving Fisher’s debt deflation model.

Energy Deflation is Underway Right Now.

The price will decline to the level where use (waste) of petroleum is deemed to offer a return. Because there are no returns, there is nowhere for oil prices to go but to decline. At the same time, no matter how low the nominal prices fall, they will always be a bit out of reach for the marginal customer. Ultimately, only the elites will be able to afford fuel, time will tell how much of a fuel supply- and use system elites can support.

By refusing to institute voluntary stringent conservation we are set to experience ‘Conservation by Other Means™’ less fuel use by way of war, national ruin, credit and currency crises.

Saudi Arabia has nothing to do with this as they are fully committed to high-priced crude to pay welfare to their millions of unemployable citizens. This is also true for the rest of OPEC. There is also no real excess supply of crude as the flow of fuel supplies is 6- or 7 million barrels per day below pre-2005 trends. This ongoing shortage does not cause price to increase, it reduces customer purchasing power, instead. This is what the economists miss: oil prices will test the 2009 low, there will be the tendency toward even lower prices.

Tighten your chin straps: the next phase of the Great Financial Crisis has begun.

Problems of Deflating Oil Prices

Off the keyboard of Gail Tverberg

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Published on Our Finite World on December 7, 2014

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Ten Reasons Why a Severe Drop in Oil Prices is a Problem

Not long ago, I wrote Ten Reasons Why High Oil Prices are a Problem. If high oil prices can be a problem, how can low oil prices also be a problem? In particular, how can the steep drop in oil prices we have recently been experiencing also be a problem?

Let me explain some of the issues:

Issue 1. If the price of oil is too low, it will simply be left in the ground.

The world badly needs oil for many purposes: to power its cars, to plant it fields, to operate its oil-powered irrigation pumps, and to act as a raw material for making many kinds of products, including medicines and fabrics.

If the price of oil is too low, it will be left in the ground. With low oil prices, production may drop off rapidly. High price encourages more production and more substitutes; low price leads to a whole series of secondary effects (debt defaults resulting from deflation, job loss, collapse of oil exporters, loss of letters of credit needed for exports, bank failures) that indirectly lead to a much quicker decline in oil production.

The view is sometimes expressed that once 50% of oil is extracted, the amount of oil we can extract will gradually begin to decline, for geological reasons. This view is only true if high prices prevail, as we hit limits. If our problem is low oil prices because of debt problems or other issues, then the decline is likely to be far more rapid. With low oil prices, even what we consider to be proved oil reserves today may be left in the ground.

Issue 2. The drop in oil prices is already having an impact on shale extraction and offshore drilling.

While many claims have been made that US shale drilling can be profitable at low prices, actions speak louder than words. (The problem may be a cash flow problem rather than profitability, but either problem cuts off drilling.) Reuters indicates that new oil and gas well permits tumbled by 40% in November.

Offshore drilling is also being affected. Transocean, the owner of the biggest fleet of deep water drilling rigs, recently took a $2.76 billion charge, among a “drilling rig glut.”

3. Shale operations have a huge impact on US employment. 

Zero Hedge posted the following chart of employment growth, in states with and without current drilling from shale formations:

Jobs in States with and without Shale Formations, from Zero Hedge.

Clearly, the shale states are doing much better, job-wise. According to the article, since December 2007, shale states have added 1.36 million jobs, while non-shale states have lost 424,000 jobs. The growth in jobs includes all types of employment, including jobs only indirectly related to oil and gas production, such as jobs involved with the construction of a new supermarket to serve the growing population.

It might be noted that even the “Non-Shale” states have benefited to some extent from shale drilling. Some support jobs related to shale extraction, such as extraction of sand used in fracking, college courses to educate new engineers, and manufacturing of parts for drilling equipment, are in states other than those with shale formations. Also, all states benefit from the lower oil imports required.

Issue 4. Low oil prices tend to cause debt defaults that have wide ranging consequences. If defaults become widespread, they could affect bank deposits and international trade.

With low oil prices, it becomes much more difficult for shale drillers to pay back the loans they have taken out. Cash flow is much lower, and interest rates on new loans are likely much higher. The huge amount of debt that shale drillers have taken on suddenly becomes at-risk. Energy debt currently accounts for 16% of the US junk bond market, so the amount at risk is substantial.

Dropping oil prices affect international debt as well. The value of Venezuelan bonds recently fell to 51 cents on the dollar, because of the high default risk with low oil prices.  Russia’s Rosneft is also reported to be having difficulty with its loans.

There are many ways banks might be adversely affected by defaults, including

  • Directly by defaults on loans held be a bank
  • Indirectly, by defaults on securities the bank owns that relate to loans elsewhere
  • By derivative defaults made more likely by sharp changes in interest rates or in currency levels
  • By liquidity problems, relating to the need to quickly sell or buy securities related to ETFs

After the many bank bailouts in 2008, there has been discussion of changing the system so that there is no longer a need to bail out “too big to fail” banks. One proposal that has been discussed is to force bank depositors and pension funds to cover part of the losses, using Cyprus-style bail-ins. According to some reports, such an approach has been approved by the G20 at a meeting the weekend of November 16, 2014. If this is true, our bank accounts and pension plans could already be at risk.1

Another bank-related issue if debt defaults become widespread, is the possibility that junk bonds and Letters of Credit2 will become outrageously expensive for companies that have poor credit ratings. Supply chains often include some businesses with poor credit ratings. Thus, even businesses with good credit ratings may find their supply chains broken by companies that can no longer afford high-priced credit. This was one of the issues in the 2008 credit crisis.

Issue 5. Low oil prices can lead to collapses of oil exporters, and loss of virtually all of the oil they export.

The collapse of the Former Soviet Union in 1991 seems to be related to a drop in oil prices.

Figure 2. Oil production and price of the Former Soviet Union, based on BP Statistical Review of World Energy 2013.

Oil prices dropped dramatically in the 1980s after the issues that gave rise to the earlier spike were mitigated. The Soviet Union was dependent on oil for its export revenue. With low oil prices, its ability to invest in new production was impaired, and its export revenue dried up. The Soviet Union collapsed for a number of reasons, some of them financial, in late 1991, after several years of low oil prices had had a chance to affect its economy.

Many oil-exporting countries are at risk of collapse if oil prices stay very low very long. Venezuela is a clear risk, with its big debt problem. Nigeria’s economy is reported to be “tanking.” Russia even has a possibility of collapse, although probably not in the near future.

Even apart from collapse, there is the possibility of increased unrest in the Middle East, as oil-exporting nations find it necessary to cut back on their food and oil subsidies. There is also more possibility of warfare among groups, including new groups such as ISIL. When everyone is prosperous, there is little reason to fight, but when oil-related funds dry up, fighting among neighbors increases, as does unrest among those with lower subsidies.

Issue 6. The benefits to consumers of a drop in oil prices are likely to be much smaller than the adverse impact on consumers of an oil price rise. 

When oil prices rose, businesses were quick to add fuel surcharges. They are less quick to offer fuel rebates when oil prices go down. They will try to keep the benefit of the oil price drop for themselves for as long as possible.

Airlines seem to be more interested in adding flights than reducing ticket prices in response to lower oil prices, perhaps because additional planes are already available. Their intent is to increase profits, through an increase in ticket sales, not to give consumers the benefit of lower prices.

In some cases, governments will take advantage of the lower oil prices to increase their revenue. China recently raised its oil products consumption tax, so that the government gets part of the benefit of lower prices. Malaysia is using the low oil prices as a time to reduce oil subsidies.

Most businesses recognize that the oil price drop is at most a temporary situation, since the cost of extraction continues to rise (because we are getting oil from more difficult-to-extract locations). Because the price drop this is only temporary, few business people are saying to themselves, “Wow, oil is cheap again! I am going to invest a huge amount of money in a new road building company [or other business that depends on cheap oil].” Instead, they are cautious, making changes that require little capital investment and that can easily be reversed. While there may be some jobs added, those added will tend to be ones that can easily be dropped if oil prices rise again.

Issue 7. Hoped for crude and LNG sales abroad are likely to disappear, with low oil prices.

There has been a great deal of publicity about the desire of US oil and gas producers to sell both crude oil and LNG abroad, so as to be able to take advantage of higher oil and gas prices outside the US. With a big drop in oil prices, these hopes are likely to be dashed. Already, we are seeing the story, Asia stops buying US crude oil. According to this story, “There’s so much oversupply that Middle East crudes are now trading at discounts and it is not economical to bring over crudes from the US anymore.”

LNG prices tend to drop if oil prices drop. (Some LNG prices are linked to oil prices, but even those that are not directly linked are likely to be affected by the lower demand for energy products.) At these lower prices, the financial incentive to export LNG becomes much less. Even fluctuating LNG prices become a problem for those considering investment in infrastructure such as ships to transport LNG.

Issue 8. Hoped-for increases in renewables will become more difficult, if oil prices are low.

Many people believe that renewables can eventually take over the role of fossil fuels. (I am not of view that this is possible.) For those with this view, low oil prices are a problem, because they discourage the hoped-for transition to renewables.

Despite all of the statements made about renewables, they don’t really substitute for oil. Biofuels come closest, but they are simply oil-extenders. We add ethanol made from corn to gasoline to extend its quantity. But it still takes oil to operate the farm equipment to grow the corn, and oil to transport the corn to the ethanol plant. If oil isn’t around, the biofuel production system comes to a screeching halt.

Issue 9. A major drop in oil prices tends to lead to deflation, and because of this, difficulty in repaying debts.

If oil prices rise, so do food prices, and the price of making most goods. Thus rising oil prices contribute to inflation. The reverse of this is true as well. Falling oil prices tend to lead to a lower price for growing food and a lower price for making most goods. The net result can be deflation. Not all countries are affected equally; some experience this result to a greater extent than others.

Those countries experiencing deflation are likely to eventually have problems with debt defaults, because it will become more difficult for workers to repay loans, if wages are drifting downward. These same countries are likely to experience an outflow of investment funds because investors realize that funds invested these countries will not earn an adequate return. This outflow of funds will tend to push their currencies down, relative to other currencies. This is at least part of what has been happening in recent months.

The value of the dollar has been rising rapidly, relative to many other currencies. Debt repayment is likely to especially be a problem for those countries where substantial debt is denominated in US dollars, but whose local currency has recently fallen in value relative to the US dollar.

Figure 3. US Dollar Index from Intercontinental Exchange

The big increase in the US dollar index came since June 2014 (Figure 3), which coincides with the drop in oil prices. Those countries with low currency prices, including Japan, Europe, Brazil, Argentina, and South Africa, find it expensive to import goods of all kinds, including those made with oil products. This is part of what reduces demand for oil products.

China’s yuan is relatively closely tied to the dollar. The collapse of other currencies relative to the US dollar makes Chinese exports more expensive, and is part of the reason why the Chinese economy has been doing less well recently. There are no doubt other reasons why China’s growth is lower recently, and thus its growth in debt. China is now trying to lower the level of its currency.

Issue 10. The drop in oil prices seems to reflect a basic underlying problem: the world is reaching the limits of its debt expansion.

There is a natural limit to the amount of debt that a government, or business, or individual can borrow. At some point, interest payments become so high, that it becomes difficult to cover other needed expenses. The obvious way around this problem is to lower interest rates to practically zero, through Quantitative Easing (QE) and other techniques.

(Increasing debt is a big part of pumps up “demand” for oil, and because of this, oil prices. If this is confusing, think of buying a car. It is much easier to buy a car with a loan than without one. So adding debt allows goods to be more affordable. Reducing debt levels has the opposite effect.)

QE doesn’t work as a long-term technique, because it tends to create bubbles in asset prices, such as stock market prices and prices of farmland. It also tends to encourage investment in enterprises that have questionable chance of success. Arguably, investment in shale oil and gas operations are in this category.

As it turns out, it looks very much as if the presence or absence of QE may have an impact on oil prices as well (Figure 4), providing the “uplift” needed to keep oil prices high enough to cover production costs.

Figure 4. World "liquids production" (that is oil and oil substitutes) based on EIA data, plus OPEC estimates and judgment of author for August to October 2014. Oil price is monthly average Brent oil spot price, based on EIA data.

The sharp drop in price in 2008 was credit-related, and was only solved when the US initiated its program of QE started in late November 2008. Oil prices began to rise in December 2008. The US has had three periods of QE, with the last of these, QE3, finally tapering down and ending in October 2014. Since QE seems to have been part of the solution that stopped the drop in oil prices in 2008, we should not be surprised if discontinuing QE is contributing to the drop in oil prices now.

Part of the problem seems to be differential effect that happens when other countries are continuing to use QE, but the US not. The US dollar tends to rise, relative to other currencies. This situation contributes to the situation shown in Figure 3.

QE allows more borrowing from the future than would be possible if market interest rates really had to be paid. This allows financiers to temporarily disguise a growing problem of un-affordability of oil and other commodities.

The problem we have is that, because we live in a finite world, we reach a point where it becomes more expensive to produce commodities of many kinds: oil (deeper wells, fracking), coal (farther from markets, so more transport costs), metals (poorer ore quality), fresh water (desalination needed), and food (more irrigation needed). Wages don’t rise correspondingly, because more and more labor is needed to provide less and less actual benefit, in terms of the commodities produced and goods made from those commodities. Thus, workers find themselves becoming poorer and poorer, in terms of what they can afford to purchase.

QE allows financiers to disguise growing mismatch between what it costs to produce commodities, and what customers can really afford. Thus, QE allows commodity prices to rise to levels that are unaffordable by customers, unless customers’ lack of income is disguised by a continued growth in debt.

Once commodity prices (including oil prices) fall to levels that are affordable based on the incomes of customers, they fall to levels that cut out a large share of production of these commodities. As commodity production drops to levels that can be produced at affordable prices, so does the world’s ability to make goods and services. Unfortunately, the goods whose production is likely to be cut back if commodity production is cut back are those of every kind, including houses, cars, food, and electrical transmission equipment.

 Conclusion

There are really two different problems that a person can be concerned about:

  1. Peak oil: the possibility that oil prices will rise, and because of this production will fall in a rounded curve. Substitutes that are possible because of high prices will perhaps take over.
  2. Debt related collapse: oil limits will play out in a very different way than most have imagined, through lower oil prices as limits to growth in debt are reached, and thus a collapse in oil “demand” (really affordability). The collapse in production, when it comes, will be sharper and will affect the entire economy, not just oil.

In my view, a rapid drop in oil prices is likely a symptom that we are approaching a debt-related collapse–in other words, the second of these two problems. Underlying this debt-related collapse is the fact that we seem to be reaching the limits of a finite world. There is a growing mismatch between what workers in oil importing countries can afford, and the rising real costs of extraction, including associated governmental costs. This has been covered up to date by rising debt, but at some point, it will not be possible to keep increasing the debt sufficiently.

The timing of collapse may not be immediate. Low oil prices take a while to work their way through the system. It is also possible that the world’s financiers will put off a major collapse for a while longer, through more QE, or more programs related to QE. For example, actually getting money into the hands of customers would seem to be temporarily helpful.

At some point the debt situation will eventually reach a breaking point. One way this could happen is through an increase in interest rates. If this happens, world economic growth is likely to slow greatly. Oil and commodity prices will fall further. Debt defaults will skyrocket. Not only will oil production drop, but production of many other commodities will drop, including natural gas and coal. In such a scenario, the downslope of all energy use is likely to be quite steep, perhaps similar to what is shown in the following chart.

Figure 5. Estimate of future energy production by author. Historical data based on BP adjusted to IEA groupings.

Related Articles:

Low Oil Prices: Sign of a Debt Bubble Collapse, Leading to the End of Oil Supply?

WSJ Gets it Wrong on “Why Peak Oil Predictions Haven’t Come True”

Eight Pieces of Our Oil Price Predicament

Notes:

[1] There is of course insurance by the FDIC and the PBGC, but the actual funding for these two insurance programs is tiny in relationship to the kind of risk that would occur if there were widespread debt defaults and derivative defaults affecting many banks and many pension plans at once. While depositors and pension holders might try to collect this insurance, there wouldn’t be enough money to actually cover these demands. This problem would be similar to the issue that arose in Iceland in 2008. Insurance would seem to be available, but in practice, would not pay out much.

Also, I learned after writing this post that bail-ins were mandated for US banks by the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010. In the language of the summary, bank depositors are “unsecured creditors,” and are thus among those to whom the burden of loss is transferred. The FDIC is not allowed to borrow extra funds, beyond bank funds, to cover this loss.

[2] LOCs are required when goods are shipped internationally, before payment has actually been made. They offer a guarantee that a buyer will be able to “make good” on his promise to pay for goods when they arrive.

The Oil Derivatives Bomb

Off the keyboard of Michael Snyder

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Published on The Economic Collapse on December 3, 2014

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Plummeting Oil Prices Could Destroy The Banks That Are Holding Trillions In Commodity Derivatives

Panic Button - Public DomainCould rapidly falling oil prices trigger a nightmare scenario for the commodity derivatives market?  The big Wall Street banks did not expect plunging home prices to cause a mortgage-backed securities implosion back in 2008, and their models did not anticipate a decline in the price of oil by more than 40 dollars in less than six months this time either.  If the price of oil stays at this level or goes down even more, someone out there is going to have to absorb some absolutely massive losses.  In some cases, the losses will be absorbed by oil producers, but many of the big players in the industry have already locked in high prices for their oil next year through derivatives contracts.  The companies enter into these derivatives contracts for a couple of reasons.  Number one, many lenders do not want to give them any money unless they can show that they have locked in a price for their oil that is higher than the cost of production.  Secondly, derivatives contracts protect the profits of oil producers from dramatic swings in the marketplace.  These dramatic swings rarely happen, but when they do they can be absolutely crippling.  So the oil companies that have locked in high prices for their oil in 2015 and 2016 are feeling pretty good right about now.  But who is on the other end of those contracts?  In many cases, it is the big Wall Street banks, and if the price of oil does not rebound substantially they could be facing absolutely colossal losses.

It has been estimated that the six largest “too big to fail” banks control $3.9 trillion in commodity derivatives contracts.  And a very large chunk of that amount is made up of oil derivatives.

By the middle of next year, we could be facing a situation where many of these oil producers have locked in a price of 90 or 100 dollars a barrel on their oil but the price has fallen to about 50 dollars a barrel.

In such a case, the losses for those on the wrong end of the derivatives contracts would be astronomical.

At this point, some of the biggest players in the shale oil industry have already locked in high prices for most of their oil for the coming year.  The following is an excerpt from a recent article by Ambrose Evans-Pritchard

US producers have locked in higher prices through derivatives contracts. Noble Energy and Devon Energy have both hedged over three-quarters of their output for 2015.

Pioneer Natural Resources said it has options through 2016 covering two- thirds of its likely production.

So they are protected to a very large degree.  It is those that are on the losing end of those contracts that are going to get burned.

Of course not all shale oil producers protected themselves.  Those that didn’t are in danger of going under.

For example, Continental Resources cashed out approximately 4 billion dollars in hedges about a month ago in a gamble that oil prices would go back up.  Instead, they just kept falling, so now this company is likely headed for some rough financial times…

Continental Resources (CLR.N), the pioneering U.S. driller that bet big on North Dakota’s Bakken shale patch when its rivals were looking abroad, is once again flying in the face of convention: cashing out some $4 billion worth of hedges in a huge gamble that oil prices will rebound.

Late on Tuesday, the company run by Harold Hamm, the Oklahoma wildcatter who once sued OPEC, said it had opted to take profits on more than 31 million barrels worth of U.S. and Brent crude oil hedges for 2015 and 2016, plus as much as 8 million barrels’ worth of outstanding positions over the rest of 2014, netting a $433 million extra profit for the fourth quarter. Based on its third quarter production of about 128,000 barrels per day (bpd) of crude, its hedges for next year would have covered nearly two-thirds of its oil production.

Oops.

When things are nice and stable, the derivatives marketplace works quite well most of the time.

But when there is a “black swan event” such as a dramatic swing in the price of oil, it can create really big winners and really big losers.

And no matter how complicated these derivatives become, and no matter how many times you transfer risk, you can never make these bets truly safe.  The following is from a recent article by Charles Hugh Smith

Financialization is always based on the presumption that risk can be cancelled out by hedging bets made with counterparties. This sounds appealing, but as I have noted many times, risk cannot be disappeared, it can only be masked or transferred to others.

Relying on counterparties to pay out cannot make risk vanish; it only masks the risk of default by transferring the risk to counterparties, who then transfer it to still other counterparties, and so on.
This illusory vanishing act hasn’t made risk disappear: rather, it has set up a line of dominoes waiting for one domino to topple. This one domino will proceed to take down the entire line of financial dominoes.
The 35% drop in the price of oil is the first domino. All the supposedly safe, low-risk loans and bets placed on oil, made with the supreme confidence that oil would continue to trade in a band around $100/barrel, are now revealed as high-risk.

In recent years, Wall Street has been transformed into the largest casino in the history of the world.

Most of the time the big banks are very careful to make sure that they come out on top, but this time their house of cards may come toppling down on top of them.

If you think that this is good news, you should keep in mind that if they collapse it virtually guarantees a full-blown economic meltdown.  The following is an extended excerpt from one of my previous articles

—–

For those looking forward to the day when these mammoth banks will collapse, you need to keep in mind that when they do go down the entire system is going to utterly fall apart.

At this point our economic system is so completely dependent on these banks that there is no way that it can function without them.

It is like a patient with an extremely advanced case of cancer.

Doctors can try to kill the cancer, but it is almost inevitable that the patient will die in the process.

The same thing could be said about our relationship with the “too big to fail” banks.  If they fail, so do the rest of us.

We were told that something would be done about the “too big to fail” problem after the last crisis, but it never happened.

In fact, as I have written about previously, the “too big to fail” banks have collectively gotten 37 percent larger since the last recession.

At this point, the five largest banks in the country account for 42 percent of all loans in the United States, and the six largest banks control 67 percent of all banking assets.

If those banks were to disappear tomorrow, we would not have much of an economy left.

—-

Our entire economy is based on the flow of credit.  And all of that debt comes from the banks.  That is why it has been so dangerous for us to become so deeply dependent on them.  Without their loans, the entire country could soon resemble White Flint Mall near Washington D.C….

It was once a hubbub of activity, where shoppers would snap up seasonal steals and teens would hang out to ‘look cool’.

But now White Flint Mall in Bethesda, Maryland – which opened its doors in March 1977 – looks like a modern-day mausoleum with just two tenants remaining.

Photographs taken inside the 874,000-square-foot complex show spotless faux marble floors, empty escalators and stationary elevators.

Only a couple of cars can be seen in the parking lot, where well-tended shrubbery appears to be the only thing alive.

I keep on saying it, and I will keep on saying it until it happens.  We are heading for a derivatives crisis unlike anything that we have ever seen.  It is going to make the financial meltdown of 2008 look like a walk in the park.

Our politicians promised that they would do something about the “too big to fail” banks and the out of control gambling on Wall Street, but they didn’t.

Now a day of reckoning is rapidly approaching, and it is going to horrify the entire planet.

COMETH DEFLATION!

logopodcastOff the microphone of RE

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Aired on the Doomstead Diner on December 3, 2014

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Oil Prices do a Baumgartner

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Von Essen Club Sandwich: The World’s Most Expensive Deli Sandwich, dropping in here in the Triple Digits at £100 ($156 USD at the latest exchange rate). Where’s the Deflation?

Snippet:

…It has been patently obvious for quite some time that the Saudis cannot increase their production further, they are flatlined. Neither can they cut back, because they have a lot of folks ready to riot if they gotta cut jobz or cut subsidies. By no means did the Saudis plan for or instigate a price fall down from $90, they like high prices as much as any Oil exporter does. This does however give them an opportunity to put competitors outta biz. Issue there is who can outlast who and for how long?

One of the better theories floating around is that the price drop was instigated by the end of QE from Da Fed, and the theoretical end of EZ financing for White Elephants. As a trigger mechanism that is probably true, but the underlying problems have been building steadily since the last crash in 2008, when in order to “save” the banking system, enormous bailouts were issued to the TBTF Banks, along with assorted other companies deemed TBTF, like the auto companies, insurance companies, etc.

The means by which they were bailed out was of course, DEBT. What a bailout amounts to is taking the bad debt of a large corporation, buying it all up at par and dropping it on the balance sheet of Da Fed, with the US Taxpayer then theoretically on the hook for this. The bailed out company now has a load of fresh cash, and Da Fed has a load of dogshit on its books…

For the rest, LISTEN TO THE RANT!!!

Upcoming on the Diner, the SEQUEL to our Oil Crash Analysis, with the Usual Suspects involved.  Stay tuned to the Diner for the Air Date.  If you missed Part 1, here it is again:

Constipation has hit the SKITTLE SHITTING UNICORNS

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OIL FUTURES?  HERE THEY COME TO SELL ‘EM AGAIN!  CALL ALAN!!!

Are You Confused Yet?

Off the keyboard of Steve from Virginia

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Published on Economic Undertow on November 29, 2014

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You too can be a winner! (A loser!)

The recent and ongoing drop in oil prices is good for you! (There is a sense of edgy uncertainty that this may not be true.) With lower prices at the pump everyone can rush over to the nearest car dealer and purchase a new, gas-guzzling SUV or giant pickup truck … or fly the family to Disney World in Orlando! This is good for the economy, right? (No, it’s insane!)

We’re all consumers, right? (No, we all work for finance, we are paid whatever we can borrow.)

For the past six months there has been uncertainty (lies) regarding the causes- and effects of reduced prices and the petroleum industry. (Managers are loathe to admit it,) the trend is deflationary with prices being a consequence of above-ground factors that reduce the ability of petroleum consumers to pay … the number-one above ground factor being the high price of petroleum.

Analysts discuss the rousing success (challenges) of the petroleum supply industries; none of them discuss the (abject) failure of consumption as a business endeavor. Because consumption does not earn anything, all returns must be borrowed. The result is an economy dependent upon finance issuing exponentially expanding debt to fund new consumption as well as to retire- and service maturing legacy loans … in the amounts of hundreds of trillions of dollars.

Oil prices are declining because consumers are insolvent! They cannot borrow any more nor can their governments borrow more in their place. Without loans there is insufficient support for higher prices. This is true for all kinds of goods not just petroleum … as well as for credit itself!

The multiyear reflationary efforts on the part of the world’s central bankers (theft of the citizens’ savings) has been undone in a matter of a few days. The price of fuel is embedded in almost every good if only the shipping component. As the fuel price declines, so must asset prices. While the fuel itself cannot be the collateral for finance industry loans, the companies themselves and their properties certainly are. The last few weeks of plunging oil prices have crushed banks’ collateral holdings by 30% and more. Some form of retrenchment (margin call) is indicated … nothing good for the fuel extraction industry.

All the talk of ‘energy boom’ and ‘revolution’ have served only to make us complacent and ignore risks: underway is an oil shock but we do not recognize it. Unlike 1974 when there were gas lines, odd-even days and the hated ‘double-nickel’, the shock in 2014 takes the form of a credit crisis.
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Figure 1: (chart by Euan Mearns with additions). When is a glut not a glut? Consider stock vs. flow: since 2005 conventional crude and condensate extraction has remained more or less flat. Increased output (flow) has come from expensive unconventional sources such as tar sands and ‘shale’ by way of fracking. Our recent, historically high prices are the result of diminished flow rates relative to consumption rate particularly within Asia. Customers there have been willing to pay more (globalization has given them access to Western credit markets).

At the same time, there is inventory buildup (stock) in North American terminals and elsewhere. Oil in the ground isn’t where it’s needed and the distribution infrastructure is insufficient to move it to potential customers. From the standpoint of flow, there is a shortage, from the standpoint of stock, there is a glut … the result of which is another cyclical bust that has tormented oil business in the past, (Byron King, Daily Reckoning):

American Association of Petroleum Geologists (AAPG) has about 30,000 members now, about half the number that it had back in the early 1980s. This is another way of saying that things were booming in the oil biz back then. But many people who worked in the geology business were laid off during the mid- to late-1980s and throughout the 1990s, due to what we look back and call the “oil bust.” From its high price of about $50 per barrel back in 1980 (using the dollars of that era, and it would be over $100 per barrel today in our inflated U.S. dollars), oil crashed in price to near $5 per barrel by the mid-1980s, a 90% fall in price.

The difference between eras: the increased flows in the past were due to new production from Alaska and the North Sea. There were also left-over conservation efforts in the West; China was communist and backward, the developing world was not a significant oil consumer. There was a large inventory build along with increased relative flows. Fast-forward to the present, there are sub-mediocre flows against ballooning worldwide demand and the black-swannish consequences of excess leverage needed to obtain any flows at all.

How high is too high? A lot lower than you think.

Citizens expect oil shocks to be accompanied by very high prices but this can be misleading. The rationing mechanism works identically at high- or low prices. During 2008, prices skyrocketed to a record $147/barrel, consumption fell because customers refused to pay the high price. A few months later price of oil had fallen to $34; another inventory-driven bust.

When customers are broke, even low prices will ration consumption … prices will decline to lower levels. The assumption is that at some (low) price consumption offers an organic return, once the oil price declines sufficiently oil consumption will begin to pay for itself and the economy will return to growth. This assumption is foundationally incorrect: consumption is purely waste, it offers zero return. What matters is credit availability and cost. With world credit leveraged to the solvency of fly-by-night energy companies the availability of credit becomes more and more … iffy.

Economists assume consumption will increase to the upper bound created by available supply … yet this is clearly not so. The upper bound is available credit rather than available fuel. Economists assume there is unlimited credit because interest rates are low, which implies pent-up demand. In reality, low interest rates are the product of central bank bond-buying and rate manipulation. At the finance level there are billions available to firms in the international credit markets, at the same time, customers are unable- or they sensibly refuse to borrow. Within the credit marketplace, customers compete vs. energy companies for funds. At the same time, the amounts the companies must borrow in order to extract fuel, must be borrowed by the customers in their turn to retire the drillers’ loans … plus interest. Drillers can only succeed by ‘out-borrowing’ their customers: the consequence of success is catastrophic! The customers are broke: when companies are unable to lay off their exposure onto their customers, the companies collapse.

Customers can only out-borrow the companies for a little while, they exhaust their own credit along with the resource which increases the funding burden of the companies. Invariably, the customers bankrupt themselves by cannibalizing their capital; this is the fundamental nature of the extract-to-consume regime … that economists don’t seem to grasp.

Energy Commodity Futures

Commodity Units Price Change % Change Contract
Crude Oil (WTI) USD/bbl. 69.31 -4.38 -5.94% Jan 15
Crude Oil (Brent) USD/bbl. 73.17 +0.59 +0.81% Jan 15
RBOB Gasoline USd/gal. 192.12 -11.39 -5.60% Dec 14
NYMEX Natural Gas USD/MMBtu 4.24 -0.11 -2.62% Jan 15
NYMEX Heating Oil USd/gal. 229.32 -10.33 -4.31% Dec 14

Precious and Industrial Metals

Commodity Units Price Change % Change Contract
COMEX Gold USD/t oz. 1,185.70 -11.80 -0.99% Feb 15
Gold Spot USD/t oz. 1,187.71 -4.96 -0.42% N/A
COMEX Silver USD/t oz. 16.14 -0.47 -2.84% Mar 15
COMEX Copper USd/lb. 289.30 -6.35 -2.15% Mar 15
Platinum Spot USD/t oz. 1,214.38 -3.62 -0.30% N/A

Analysts suggest with a straight face that conventional oil producers such as Saudi Arabia (and Iran) are now engaging in a ‘price war’ vs. the marginal barrel producers in North America. This is part of the narrative that denies the possibility of an energy shortage, (Telegraph):

World on brink of oil price war as OPEC set to keep pumpingAndrew CritchlowSaudi oil minister suggests Opec oil cartel would keep its production ceiling at 30m barrels per daySome Opec members want producers outside the cartel to shoulder some of the responsibility for balancing the oil market by essentially cutting their output.Crude traded in the US fell to as low as $74 per barrel $69 as traders bet that Opec will allow the price to fall further amid growing signs of a global price war amid producers.“There remains little prospect of any production cut being agreed at [Thursday’s] Opec meeting,” said brokers at Commerzbank. “Opec will merely agree to comply better with the current production target of 30m bpd.

Price war sounds sexy but it is misleading. Nobody in the energy business wants lower prices as diminished output losses cannot be made up with volume. As it is, every energy company is bringing every possible barrel to market …

ada307
Figure 2: Saudi oil ‘production’ since 1973, (Oil Price.com, source data by EIA). The Saudis have not increased their output so they have not affected the price. It would be more accurate to accuse shale- and tar sands companies for starting a price war against themselves. Oil analysts can look to the shale gas industry, (Deborah Rogers):

Shale and Wall Street: Was the Decline in Natural Gas Prices Orchestrated? – The price of natural gas has been driven down largely due to severe overproduction in meeting financial analysts’ targets of production growth for share appreciation coupled and exacerbated by imprudent leverage and thus a concomitant need to produce to meet debt service.– Due to extreme levels of debt, stated proved undeveloped reserves (PUDs) may not have been in compliance with SEC rules at some shale companies because of the threat of collateral default for those operators.– Industry is demonstrating reticence to engage in further shale investment, abandoning pipeline projects, IPOs and joint venture projects in spite of public rhetoric proclaiming shales to be a panacea for U.S. energy policy.– Exportation is being pursued for the differential between the domestic and international prices in an effort to shore up ailing balance sheets invested in shale assets.

As with the gas industry, overproduction is relative: unconventional natural gas plays are landlocked, the wells deplete before pipeline distribution networks to new consumers can be installed. Increased gas (stock) fed into legacy distribution systems = crashing natural gas prices. North America’s shale- and syncrude companies’ reserves are landlocked and dependent upon costly railroad distribution to terminals and refineries rather than pipelines.

Inaccessible supply and higher transport costs = discounted well-head price = reduced cash flow. This has left drillers dependent upon Wall Street junk bond financing and increased debt which in turn requires companies to misstate reserves.

As with natural gas, the Ponzi-incentives are for companies to flip acreage in the US and elsewhere. Finance offers more returns than actual physical output. Meanwhile, the debt- straitened companies look to Washington for permission to export (a bailout).

The price war argument is nonsense. Saudi Aramco has been selling 9 million barrels per day @ $108/barrel earning (borrowing) almost a billion dollars per day. At today’s price the same barrels earn roughly $650 million @ $78/barrel. The reduction in revenue implies the Saudis have put onto the market an additional 3 million barrels per day … if they could actually increase output by that much. Otherwise, the Saudis stand to lose hundreds of millions of dollars per day.

Conversely, producers would need to cut production by 3 million barrels in order to push the price back to $105/barrel. This would make sense only if there is an actual excess of supply. Instead, an output cut of that magnitude would cause a shift from an implied shortage (diminished flow relative to consumption) to an actual, physical shortage. So far, the implied shortage has affected customers’ ability to borrow. Further diminishing supply would the crash credit system altogether, this would certainly impact drillers including Saudi Arabia, which is just as dependent upon credit as any driller in the Bakken.

Less credit => less consumption => more of a ‘glut’ => lower prices => less output => less (high-yield) credit for drillers in a vicious cycle.

The claims of energy independence have served to obscure the price signal. Fuel constraints are evidenced by +$100 per barrel prices. Our grim- and nasty ‘auto-habitat’ has been built assuming sub-$20 per barrel into infinity and beyond, any price above that is too high. At the same time: sub- $20 per barrel petroleum = bankruptcy of the entire petroleum industry … along with finance which makes use of petroleum ‘assets’ as collateral.

What is underway is ‘Conservation by Other Means™’. Customers are rendered insolvent faster than lower prices can bail them out … which renders the current state of affairs resistant to management efforts. Central banks cannot reduce the physical costs of drilling even as they manipulate interest rate cost. Subsidies attempt to shift costs from drillers to their already insolvent customers. ‘Marginal Man’ — who sets the falling price for the rest — can be anyone in the world, not necessarily an American; he can be an (ex)motorist in Japan, or a busted tycoon in China.

Any bailout is a temporary reprieve. Accelerating the rate of consumption is stupidly counterproductive; customers are simply ruined, faster. Tepid attempts at mandated conservation will fail from the start: mandated efforts will compound those driven by events. Managers are chasing their tails: the pet theory that at some very-low price, consumption will offer a return. There is no such price! Consumption offers nothing at all but waste.

Conservation mandates only work at levels of consumption far lower than current rates; Euan Mearns’ missing 7 million barrels per day. The alternative solution is to find those missing barrels … too bad, they have already been burned up for fun. The barrels themselves are a moving target as depletion never quits! After 7 million come 8 million … 10 million then 20. We humans needed to make significant program changes starting in the early 1970s but we surrendered to liars and gamblers. Just because we refuse to recognize our oil shock for what it is does not mean it isn’t real.

I wonder how many people will scratch their heads as they’re filling up their tanks this week and wonder how much of a mixed blessing that cheap gas is. They should. They should ask themselves how and why and how much the plummeting gas price is a reflection of the real state of the global economy, and what that says about their futures.— Raúl Ilargi Meijer

Future = less.

Oil Price Crash!!!

logopodcastOff the microphone of RE

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Aired on the Doomstead Diner on November 29, 2014

So Much for Levitation…

wileycoyote1

How LOW can we GO here?

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Bad Times for Frackers…not a good time to stop sniffing glue…

Halliburton gets HAMMERED

http://markets.money.cnn.com/services/api/chart/snapshot_chart_api.asp?symb=HAL

EOG Resources Heads South of the Border

Discuss this RANT at the Podcast Table inside the Diner

Snippet:

…It’s Turkey Day, and I just finished consuming my Steak & Gumbo dinner, which substituted for the traditional Turkey this year. You can read more about that in my last article, A Homeless Thanksiving.

While the individual problems of each person immersed in collapsing industrial civilization are really the most important ones as time progresses here,the grand problems of the Economy and how it downspins remains important to try and understand.

Going back to my years on Peak Oil, pundits there predicted prices of $200 and more for oil as the supply diminished. This was not a scenario I ever bought into, it makes no sense. To be able to SELL Oil at $200/Barrel, you need somebody who can afford to BUY it at $200/barrel. With credit being constrained and fewer people all the time able to BUY at this price, in my view and the view of a VERY few other people in the Peak Oil community including Nicole Foss from The Automatic Earth and my good friend Steve Ludlum from Economic Undertow, really the price of Oil had nowhere to go but DOWN as time progressed…

For the rest, LISTEN TO THE RANT!!!

 

The Instability Express

From the keyboard of James Howard Kunstler
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pyramid-scheme
Originally Published on Clusterfuck Nation November 17, 2014

The mentally-challenged kibitzers “out there” — in the hills and hollows of the commentary universe, cable news, the blogosphere, and the pathetic vestige of newspaperdom — are all jumping up and down in a rapture over cheap gasoline prices. Overlay on this picture the fairy tale of coming US energy independence, stir in the approach of winter in the North Dakota shale oil fields, put an early November polar vortex cherry on top, and you have quite a recipe for smashed expectations.

Plummeting oil prices are a symptom of terrible mounting instabilities in the world. After years of stagnation, complacency, and official pretense, the linked matrix of systems we depend on for running our techno-industrial society is shaking itself to pieces. American officials either don’t understand what they’re seeing, or don’t want you to know what they see. The tensions between energy, money, and economy have entered a new phase of destructive unwind.

The global economy has caught the equivalent of financial Ebola: deflation, which is the recognition that debts can’t be repaid, obligations can’t be met, and contracts won’t be honored. Credit evaporates and actual business declines steeply as a result of all those things. Who wants to send a cargo ship of aluminum ore to Guangzhou if nobody shows up at the dock with a certified check to pay for it? Financial Ebola means that the connective tissues of trade start to dissolve, and pretty soon blood starts dribbling out of national economies.

One way this expresses itself is the violent rise and fall of comparative currency values. The Japanese yen and the euro go down, the dollar goes up. It happens in a few months, which is quickly in the world of money. Foolish US cheerleaders suppose that the rising dollar is like the rising score of an NFL football team on any given Sunday. “We’re numbah one!” It’s just not like that. The global economy is not some stupid football contest.

When currencies change value quickly, as has happened since the past summer, big banks get into big trouble. Their revenue streams are pegged to so-called “carry trades” in which big blobs of money are borrowed in one currency and used to place bets in other currencies. When currency values change radically, carry trades blow up. So do so-called “derivatives” such as bets on interest rate differentials. When the sums of money involved are grotesquely large, the parties involved discover that they never had any ability to pay off their losing bet. It was all pretense. In fact, the chance that the bet might go bad never figured into their calculations. The net result of all that foolish irresponsibility is that banks find themselves in a position of being unable to trust each other on virtually any transaction.

When that happens, the flow of credit, a.k.a. “liquidity,” dries up and you have a bona fide financial crisis. Nobody can pay anybody else. Nobody trusts anybody. Fortunes are lost. Elephants stomp around in distress, then keel over and die, and a lot of “little people” get crushed in the dusty ground.

The happy dance about low gasoline pump prices featured on Fox News, combined with the awful instability in currency markets, will cut a swathe of destruction through the shale oil “miracle.” That industry has been relying on high yield “junk” financing to perform its relentless drilling-and-fracking operations — imperative due to the extremely rapid depletion rate of shale oil wells. Across the board, shale oil production has not been a profitable venture since it was ramped up around 2006. Below $80 a barrel, chasing profit only becomes more difficult for those who couldn’t make a profit at $100. A lot of those junk bond “investments” are about to become worthless, and the “investment community” will lose its appetite for any more of it. That will leave the US government as the investor of last resort. Expect that to be the object of the next round of Quantitative Easing. The ultimate destination of these shenanigans will be the sovereign debt crisis of 2015.

 

***

James Howard Kunstler is the author of many books including (non-fiction) The Geography of Nowhere, The City in Mind: Notes on the Urban Condition, Home from Nowhere, The Long Emergency, and Too Much Magic: Wishful Thinking, Technology and the Fate of the Nation. His novels include World Made By Hand, The Witch of Hebron, Maggie Darling — A Modern Romance, The Halloween Ball, an Embarrassment of Riches, and many others. He has published three novellas with Water Street Press: Manhattan Gothic, A Christmas Orphan, and The Flight of Mehetabel.

Last Line of Defense

Off the keyboard of Steve from Virginia

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Published on Economic Undertow on November 4, 2014

Triangle-of-Doom-1101141Figure 1: Continuous WTI futures (TFC Charts, click on for big). Price convergence results in a breakdown as customers are unwilling- or unable to bid prices higher. Absent the high prices there is insufficient cash flow to enable drillers to continue operations. Today’s marginal barrels are extracted from high cost deepwater offshore plays, from tight-oil shale formations and from ‘tar’ sands: without customer credit, drillers are more dependent upon junk bond leverage than ever.

Discuss this article at the Economics Table inside the Diner

Of course, once on the borrowing treadmill, it is impossible to step off. Borrowers must run faster to stay in place, ever-increasing amounts are needed to keep pace with operating- and service costs as well as to rollover maturing legacy debt. Consumer access to credit must be considered a ‘hard limit’ to petroleum extraction along with geology. Even as drillers are able to borrow they find there are fewer ‘end users’ with available credit … onto whom the drillers can lay off their ballooning exposure.

Conventional analysis insists that fuel constraints result in higher prices due to simply supply and demand. The assumption is that consumers will always find more funds. Instead, fuel constraints reduce customer purchasing power: customers stumble first, the drillers fail afterwards. As customers’ borrowing capacity shrinks the petroleum industry has little choice but to adjust prices to meet the market which forces drillers to reduce output. At some point they fail outright. Fuel supply cuts => diminished consumer borrowing capacity => more fuel supply cuts in a vicious, self-reinforcing cycle.

Saudi Arabia Signals It Will Let Oil Slide Further, FACTS SaysAnthony DiPaola, Robert Tuttle

Saudi Arabia, the world’s biggest oil exporter, is telling the market it won’t cut output to lift crude back to $100 a barrel and that prices must fall further before it does so, according to consultant FACTS Global Energy.

Swelling supplies from non-OPEC producers drove Brent crude into a bear market on Oct. 8 amid waning demand from China, the world’s second-largest importer. The Organization of Petroleum Exporting Countries meets Nov. 27 to consider changing its production target in the face of the highest U.S. crude output in almost 30 years.

“Production of shale oil in the U.S. will not be hit as hard as the Saudis think” by the price decline, FGE Chairman Fereidun Fesharaki said at a conference today in Doha, Qatar. Producers in the U.S. “can withstand a lot of pressure” by reining in their operating costs before they curb investment in new wells and production, he said.

Crude could drop to between $60 and $80 a barrel and stay within that range there for about six months until global production aligns with demand, Fesharaki said at the Condensate & Naphtha Forum. Oil in that range is the “right price” to balance the market, Fesharaki said.

Nobody knows what the ‘right price’ is, Saudia cannot push the oil price by reducing output: fuel constraints reduce customer purchasing power: the customers stumble first, the drillers fail afterwards. The oil industry is waking in a new world, where fuel waste is discretionary rather than inelastic; where shortages constrain- or eliminate customer purchasing power altogether rather than diverting an increased share toward the petroleum industry.

Petroleum prices have been high relative to historical norms for decades, with the breakout appearing in dollars in 1974, after the Yom Kippur War and the OPEC oil embargo:

Figure 2: nominal- and adjusted historical crude oil prices by way of BP Statistical Review, (Charts Bin – click on for big). The world’s consumption enterprise has been designed and built assuming sub-$20/barrel petroleum into perpetuity … with energy-guzzling consumer products intermediating every human activity. While the (borrowed) profits from this venture have been collected already, the costs continue to mount. One of the largest is aggregating credit expense. The question now is whether enough (resource) capital can be mustered to re-order our living arrangements or whether the status quo will simply fall apart under its own weight?

After 1974, the establishment chose to hedge against capital-resource shortages rather than meet the problem directly. Strategies included increased financialization and globalization; the shipping of Western industrial jobs offshore to cheap-labor countries, using finance credit to inflate asset prices worldwide as well as by instituting the European currency union: all of these are energy price hedges, all of them have failed completely.

Shipping Western industrial jobs overseas saved manufacturers money but not fuel, which was shipped overseas along with the jobs. Workers in newly industrialized countries used their purchasing power to buy cars and other gas-guzzling gadgets at the same time the Western workers’ purchasing power was chopped. Fuel consumption overseas (supported with direct fuel subsidies) pushed prices higher, this ultimately eroded purchasing power everywhere. Instead of conservation as an outcome of policy there is ‘conservation by other means™’.

Bubbles offer the ‘wealth effect’ that occurs when credit streams into assets … prices rise faster than the price of fuel. At some point credit becomes expensive, there are no more buyers to be had and prices collapse all at once. Those left behind are stripped of their ‘wealth’. Asset price bubbles are Ponzi schemes, the beneficiaries are the bubble promoters and well-positioned shills/insiders who are able to exit asset markets before other speculators.

Globalization allows the free flow of labor and funds, the fuel markets are globalized along with the rest. While more resources-capital is made available to industry so are more risks. Anyone, anywhere is likely be the marginal fuel consumer; that is, the user that sets the price for the everyone else ‘on the margin’. With billions of customers, it is far more likely ‘Marginal Man’ is an inhabitant of a newly impoverished country such as Russia, Brazil, China or Japan; the odds against price support for oil drillers lengthen as more countries become vulnerable due to adverse changes in exchange rates or flight of investment funds out of these countries.

The Europeans created the euro as a hard-currency alternative to the US dollar and UK sterling; to give the little countries of Europe the same purchasing power as the larger nations (and to create a captive market for larger nations’ manufacturers). Ironically, the same administrative structures put in place to support the euro have turned out to make practical fiscal union impossible. Mercantile powerhouse Germany is pitted against the rest: the outcome is failure as the vulnerable countries Greece, Spain and Italy — also Ukraine and Russia — drag everyone down.

Desperation is almost palpable as the Bank of Japan announces an expansion of its bond-buying program in an attempt to keep market forces (reality) from overwhelming the economy in that country and elsewhere. Bank of Japan boss Kuroda is a fireman for the US Federal Reserve Chairperson Janet Yellen. The central bankers are now the last line of defense for a waste-based enterprise that has exhausted both its resource- and intellectual capital. Our economic problem is not a shortage of cheap credit but a shortage of cheap petroleum. At the same time, getting our hands on the petroleum would not solve anything: our conceptual problem is dependence upon a system that only functions when capital is annihilated. Cheap credit lets us pretend a little while that ‘business as usual’ has a future; the bankers’ success undermines that future.

Petroleum is a resource, it is capital; credit and money are simply purchasing power claims against capital. In Japan and elsewhere, purchasing power is wrenched away from citizens toward the stock and bond gamblers as well as toward overseas energy producers: as the gamblers ‘win’ the citizens lose and energy producers falter. As the Bank of Japan lends, the yen is depreciated on world currency markets; as it falls the fuel price in yen increases, it becomes less affordable. Japanese customers are less able to meet higher prices for fuel => marginal demand is reduced => this causes fuel prices everywhere to tumble. The bankers are working against themselves; the more easing, the less Japanese support there is for fuel prices; the more Kuroda, the greater likelihood that the critical marginal petroleum consumer is a bankrupted Japanese.

What goes up must come down.

Monetary easing reduces borrowing costs but only for those who actually borrow. After years of easing, the only remaining borrowers are finance market gamblers. Cheap (finance) credit is used to push share- and bond prices higher in one-way markets:

L < Rs

With apologies to Thomas Piketty: leverage costs less than what the market offers to speculators. Returns Rs are determined by (artificially constrained) supply relative to demand; leverage costs L are manipulated to near-zero by the central banks: all other costs are considered to be externalities.

Credit is not the product of the central banks but of finance. The aim of central bank intervention is to manipulate the interest rate, to force real borrowing costs (interest-less rate of inflation) as low as possible. Low interest cost renders reduces risks associated with carry trades and stock speculation; low cost + high returns = one-way markets. Theoretically, with sufficient credit, these markets can run forever. In reality, as speculators borrow, the total aggregate debt load increases exponentially while force-fed markets are subject to same diminishing returns as every other speculative endeavor. Over time there is less return for each borrowed dollar, at some point even the most outrageous finance borrowing cannot not move the markets. When borrowing capacity is required to service debts => Minsky Moment.

Manias, panics and crashes are expressions of the ‘Paradox of Thrift’, which states that one-way markets — all buyers or all sellers (or all savers) — cannot exist without severe consequences. A market where all participants are buyers means a market that is ultimately deprived of them. Everyone who is willing to buy has done so: no one remains able to ‘buy from the buyers’. A market where all are thrifty is one where money is ‘saved’ out of circulation so that day-to-day business becomes impossible. A market crash occurs when free-spenders are forced by conditions … to be thrifty all at once!

The need for a new way of economic thinking is more urgent than ever.

Quoted at length from Steve Waldman, (Interfluidity):

“Quantitative Easing” — economics jargon for central banks issuing a fixed quantity of base money to buy some stuff — has been much in the news this week. On Wednesday, US Federal Reserve completed a gradual “taper” of its program to exchange new base money for US government and agency debt. Two days later, the Bank of Japan unexpectedly expanded its QE program, to the dramatic approval of equity markets. I have long been of two minds regarding QE. On the one hand, I think most of the developed world has fallen into a “hard money” trap, in which we are prioritizing protection of existing nominal assets over measures that would boost real economic activity … “

Real economic activity so far has been little other than strip-mining capital and burning it for fun. Asset protection is a bit misleading since worth of assets = their (useless) purchasing power claims against capital: as capital is exhausted so is purchasing power. At the end of the day there are mountains of diluted or redundant claims with nothing to purchase with them. This is the fatal flaw within all redistributionist regimes which either multiply the numbers of claims or shuffle them around.

“My preferred policy instrument is “helicopter drops”, defined as cash transfers from the fisc (government) or central bank to the general public, see e.g. David Beckworth, or me, or many many others. But, as a near-term political matter, helicopter drops have not been on the table.

There are no helicopter drops because the general public has little or nothing to offer as collateral. Central banks are unable to offer unsecured loans. Should they do so they become indistinguishable from insolvent private sector lenders and are insolvent themselves => there is no effective lender of last resort => no guarantor for bank deposits (unsecured loans to banks from the general public). The effective collateral for unsecured loans to depositors would be their own deposits: the outcome => bank runs.

Support for easier money has meant support for QE, as that has been the only choice. So, with an uncomfortable shrug, I guess I’m supportive of QE. I don’t think the Fed ought to have quit now, when wage growth is anemic and inflation subdued and NGDP has not recovered the trend it was violently shaken from six years ago. But my support for QE is very much like the support I typically give US politicians. I pull the lever for the really-pretty-awful to stave off something-much-worse, and hate both myself and the political system for doing so.

‘Something-much-worse’ would be the consequences of capital exhaustion, ‘Something-much-better’ is folly: to somehow gain access to what remains of our capital so that it too might also be annihilated … in a futile attempt to pursue ‘prosperity’ for a vanishingly small period of time.

20141028_oilgdp

Figure 3: Declining economic activity precedes fuel price decline, (chart by ZeroHedge): unsurprisingly, expensive crude oil adversely affects economic activity.

“Much better potential economies may be characterized by higher interest rates and lower prices of housing and financial assets. But transitions from the current equilibrium to a better one would be politically difficult. Falling asset prices are not often welcomed by policymakers, and absent additional means of demand stimulus, would likely provoke a real-economy recession that would harm the poor and precariously employed. Austrian-ish claims that we must let a recession “run its course” will be countered, and should be countered, on grounds that a speculative theory of economic rebalancing cannot justify certain misery of indefinite duration for the most vulnerable among us. We will go right back to QE, secular stagnation, and all of that, to the relief of both homeowners, financial asset-holders, and the most precariously employed, while the real economy continues to under-perform.”

Waldman sees outcomes but not clearly enough. Consumption economies cannot be ‘fixed’ or adjusted but replaced with something less destructive … the Austrian economic rebalancing hypothesis is indeed faulty yet misery of indefinite duration for the most vulnerable among us is both certain and underway. It is a consequence not an alternative. We multiply ourselves and our appetites without restraint and devour our increasingly scarce capital without any thought other than to do so before someone else beats us to it. A better economy would reward those who husband our capital, to tend what remains rather than seeking to gain the pawnbroker’s pittance …

The drillers are canaries in the coal mine, even as they are able to borrow they find there are fewer ‘end users’ with available credit … onto whom they can lay off their ballooning exposure. In place of the non-existent customers is the central bank, a conduit by which credit costs are shifted from the bankrupt customers to the same customers’ children. This is the last line of defense … what remains between our fantasies of endless creature comforts and the pit.

Knarf plays the Doomer Blues

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  • From Filmers to Farmers

Shaking the August Stick By Cognitive Dissonance     Sometime towards the end of the third or fourth [...]

Empire in Decline - Propaganda and the American Myth By Cognitive Dissonance     “Oh, what a tangled [...]

Meanderings By Cognitive Dissonance     Tis the Season Silly season is upon us. And I, for one, welc [...]

The Brainwashing of a Nation by Daniel Greenfield via Sultan Knish blog Image by ElisaRiva from Pixa [...]

A Window Into Our World By Cognitive Dissonance   Every year during the early spring awakening I qui [...]

Event Update For 2019-09-16http://jumpingjackflashhypothesis.blogspot.com/2012/02/jumping-jack-flash-hypothesis-its-gas.html Th [...]

Event Update For 2019-09-15http://jumpingjackflashhypothesis.blogspot.com/2012/02/jumping-jack-flash-hypothesis-its-gas.htmlThe [...]

Event Update For 2019-09-14http://jumpingjackflashhypothesis.blogspot.com/2012/02/jumping-jack-flash-hypothesis-its-gas.htmlThe [...]

Event Update For 2019-09-13http://jumpingjackflashhypothesis.blogspot.com/2012/02/jumping-jack-flash-hypothesis-its-gas.htmlThe [...]

Event Update For 2019-09-12http://jumpingjackflashhypothesis.blogspot.com/2012/02/jumping-jack-flash-hypothesis-its-gas.htmlThe [...]

With fusion energy perpetually 20 years away we now also perpetually have [fill in the blank] years [...]

My mea culpa for having inadvertently neglected FF2F for so long, and an update on the upcoming post [...]

NYC plans to undertake the swindle of the civilisation by suing the companies that have enabled it t [...]

MbS, the personification of the age-old pre-revolutionary scenario in which an expiring regime attem [...]

Daily Doom Photo

man-watching-tv

Sustainability

  • Peak Surfer
  • SUN
  • Transition Voice

The Trickster's Tale"Everyone has some wisdom, but no one has all of it." Come gather 'round my children [...]

Nothing Again - Naomi Klein Renews Her Climate Prescription"By now we should all be well aware by now of the havoc being caused by climate change." I [...]

Leaves of Seagrass"Seawater is the circulatory system of Gaia"In 1855, Walt Whitman penned the free verse, “ [...]

Treeplanting Olympics"Withdrawing 700 gigatons of carbon from the atmosphere could be accomplished by as early as mi [...]

The Dark Cloud"Skynet needs to send a terminator back to 1984 and take out Mark Zuckerberg’s mom before he ca [...]

The folks at Windward have been doing great work at living sustainably for many years now.  Part of [...]

 The Daily SUN☼ Building a Better Tomorrow by Sustaining Universal Needs April 3, 2017 Powering Down [...]

Off the keyboard of Bob Montgomery Follow us on Twitter @doomstead666 Friend us on Facebook Publishe [...]

Visit SUN on Facebook Here [...]

What extinction crisis? Believe it or not, there are still climate science deniers out there. And th [...]

My new book, Abolish Oil Now, will talk about why the climate movement has failed and what we can do [...]

A new climate protest movement out of the UK has taken Europe by storm and made governments sit down [...]

The success of Apollo 11 flipped the American public from skeptics to fans. The climate movement nee [...]

Today's movement to abolish fossil fuels can learn from two different paths that the British an [...]

Top Commentariats

  • Our Finite World
  • Economic Undertow

This does look worrisome! More fund seem to be needed, regularly. [...]

I tried to look up a little more about Ghana. Based on what the EIA has to say, the true availabilit [...]

A situation when inflation-adjusted interest rates are zero or below is just bizarre. Investment rea [...]

In the US, we know that wages rise less rapidly than GDP. In fact, we would expect that to be the ca [...]

It seems like the countries that were doing best before the last recession most likely had the highe [...]

Hi Steve. I recently found what I believe is a little gem, and I'm quite confident you'd a [...]

The Federal Reserve is thinking about capping yields? I don't know how long TPTB can keep this [...]

As some one who has spent years trying to figure out what the limits to growth are. let me say that [...]

Peak oil definitely happened for gods sake. Just because it isn't mad max right now is no indic [...]

@Volvo - KMO says he made some life choices he regrets. Not sure what they were. And I don't th [...]

RE Economics

Going Cashless

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Simplifying the Final Countdown

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Bond Market Collapse and the Banning of Cash

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Do Central Bankers Recognize there is NO GROWTH?

Discuss this article @ the ECONOMICS TABLE inside the...

Singularity of the Dollar

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Kurrency Kollapse: To Print or Not To Print?

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SWISSIE CAPITULATION!

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Of Heat Sinks & Debt Sinks: A Thermodynamic View of Money

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Merry Doomy Christmas

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Peak Customers: The Final Liquidation Sale

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Collapse Fiction

Useful Links

Technical Journals

The Antarctic Centennial Oscillation (ACO) is a paleoclimate temperature cycle that originates in th [...]

The building environment parameterization scheme (BEP) is a built-in “urban physics” sch [...]