Peak Oil has ARRIVED!

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Published on the Doomstead Diner on December 21, 2015

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We are at Peak Oil now; we need very low-cost energy to fix it

This past week, I gave a presentation to a group interested in a particular type of renewable energy–solar energy that is deployed in space, so it would provide electricity 24 hours per day. Their question was: how low does the production cost of electricity really need to be?

I gave them this two-fold answer:

1. We are hitting something similar to “Peak Oil” right now. The symptoms are the opposite of the ones that most people expected. There is a glut of supply, and prices are far below the cost of production. Many commodities besides oil are affected; these include natural gas, coal, iron ore, many metals, and many types of food. Our concern should be that low prices will bring down production, quite possibly for many commodities simultaneously. Perhaps the problem should be called “Limits to Growth,” rather than “Peak Oil,” because it is a different type of problem than most people expected.

2. The only theoretical solution would be to create a huge supply of renewable energy that would work in today’s devices. It would need to be cheap to produce and be available in the immediate future. Electricity would need to be produced for no more than four cents per kWh, and liquid fuels would need to be produced for less than $20 per barrel of oil equivalent. The low cost would need to be the result of very sparing use of resources, rather than the result of government subsidies.

Of course, we have many other problems associated with a finite world, including rising population, water limits, and climate change. For this reason, even a huge supply of very cheap renewable energy would not be a permanent solution.

This is a link to the presentation: Energy Economics Outlook. I will not attempt to explain the slides in detail.

Slide 1




Slide 1




Slide 2




Slide 2




Some people falsely believe that energy supplies are “only needed for industrial purposes.” Energy supplies are, in fact, needed for many things: cooking our food, keeping our homes warm, and creating the clothing we expect to wear. It would be impossible to feed, house, and clothe 7.3 billion people without supplemental energy of some kind.

Slide 3




Slide 3




Slide 4




Slide 4




Slide 4 suggests that the world economy is heading into recession, because recent growth in the use of energy supplies is very low recently. Another sign that we are headed into recession is that fact that CO2 emissions fell in 2015. They usually don’t fall unless a global crisis exists. Emissions fell when the Soviet Union collapsed in 1991, and they fell during the economic crisis in 2008. Perhaps the world economy is hitting headwinds that are not being picked up well in conventional calculations of GDP growth.

Slide 5




Slide 5




Slide 5 shows a chart I put together, using data from several different sources, showing how growth in energy consumption has compared with growth in GDP. Growth in GDP tends to be somewhat higher than growth in energy consumption.

Economic growth (and growth in energy use) was low prior to 1950. There was a big jump in economic growth immediately after World War II, in the 1950-65 period. There was almost as much growth in the 1965- 75 period. Since 1975, economic growth has generally been slowing.

Slide 6




Slide 6




Between the years 1900 and 1998, the use of electricity rose (black line) as the cost of electricity fell (purple, red, and green lines). Electricity consumption could rise because it was becoming more affordable. Rising electricity consumption allowed the economy to make more goods and services. Workers (with the use of electricity) were becoming more efficient, so wages could rise. With higher wages, workers could afford more products that used electricity, such as electric lights for their homes and radios.

If electricity prices had risen instead of fallen, it seems doubtful that this pattern of rising consumption could have taken place.

Slide 7




Slide 7




The comments in Figure 7 represent my own view. It is based on both theoretical considerations and historical relationships. Many who have studied the economy believe that energy is important for economic growth. In my view, the real need is for cheap-to-produce energy, not just any energy. If cheap energy is not really available, then adding more debt can somewhat make up for the high cost of energy production.

Debt is important because it makes goods affordable that would not otherwise be affordable. For example, having a loan for a house or a car makes a huge difference regarding whether such an item is affordable.

Even when energy products are cheap, debt seems to be needed to get oil or coal out of the ground, or to make a new device such as a wind turbine. Part of the problem is the cost of the capital equipment needed to extract the oil or coal, or the cost of the wind turbines themselves. Another part of the problem is paying for factories to make devices that use the energy product. A third problem is making it possible for users to afford the end products, such as houses and cars. It is much easier to borrow the money for a new tractor, and pay the loan off as the tractor is put to use, than it is to save money in advance, using only the funds earned when farming with simple hand-held tools.

Slide 8




Slide 8




I mentioned the need for $20 per barrel oil on Slide 7. This is a very inexpensive price. Slide 8 shows that the only time when oil prices were that low was prior to the mid-1970s. (Note that the amounts in Slide 8 have already been adjusted for inflation, so my $20 per barrel target is an inflation-adjusted amount.) The cost of oil production is now far above $20 per barrel. The sales price now is about $37 per barrel. This is below the price producers need, but still above my target price level.

Slide 9




Slide 9




Slide 9 explains where I got my $20 per barrel price target. Back prior to 1975–in other words, back when oil prices were generally low, $20 per barrel or less–the increase in debt more or less corresponded to the growth in GDP. Once prices rose above $20 per barrel, the amount of debt needed to produce a given amount of GDP growth rose dramatically.

Slide 10




Slide 10




Slide 10 shows interest rates for US debt with 10-year maturity. These interest rates often underlie mortgage rates. As interest rates fall, homeowners can afford increasingly expensive homes. If shorter-term interest rates fall as well, auto loans become cheaper too.

Slide 11




Slide 11




The value to society of a barrel of oil is determined by how many miles it can make a diesel truck go, or how far it can make an airplane fly. This value to society is more or less fixed. The only change is the small increment each year from efficiency changes, making a barrel of oil “go farther.”

In the 2000-14 period, the cost of new oil production was increasing very rapidly–by more than 10% per year, by some estimates. The rising cost of oil production occurred much more quickly than efficiency changes. The result was a falling difference between the value to society and the cost of production. When oil prices are high, oil-importing nations tend to suffer recession. When oil prices are low, oil-exporting nations find it hard to collect enough taxes to support their many programs.

Slide 12




Slide 12




The fact that we need energy for economic growth means that we somehow must obtain this energy, even if doing so costs more. The big run-up in oil prices is a major reason for the historical run-up in debt levels. China’s big build-out of homes, roads, and factories was also financed by debt.

The higher cost of oil affects many things that we don’t think are related, including the cost of building new homes, the cost of building cars, and the cost of building roads. As consumers are forced to buy increasingly expensive homes and cars, and as governments find that the building of roads is increasingly expensive, more debt is used. The terms of loans are often longer as well, to hold down monthly costs.

If we still had cheap oil, this oil by itself could provide a “lift” to the economy. An increasing amount of debt can “sort of” compensate for the absence of cheap oil.

The problem we encounter is that neither cheap energy nor the continued run-up of debt is sustainable. Cheap energy tends to change to expensive energy, because we use the cheapest sources first. The continued debt run-up becomes more and more difficult to handle, unless interest rates fall lower and lower. At some point, interest rates can’t fall enough, and the whole pile of debt tends to collapse, like a Ponzi scheme.

Slide 13




Slide 13




I gave this talk on December 15; the first increase in interest rates took place on December 16. With rising interest rates, we suddenly have “the prop” that was attempting to hold up economic growth taken away.

We need ever expanding debt–that is, debt rising faster than GDP levels–to try to keep the world economy growing, so that the whole pile of debt doesn’t fall over and collapse. If we are to have non-debt growth in the future (because we are reaching limits on debt), it needs to again come from cheap energy alone. We need to get back to something similar to the low-cost energy that fueled the economy before the debt run-up.

Slide 14




Slide 14




Most of us have heard the Peak Oil story, and assume it represents a reasonable view of where we are headed. I think it is close to 180 degrees off course.

Slide 15




Slide 15




M. King Hubbert talked about a very special situation–a situation where another cheap, abundant fuel took over, before fossil fuels began to decline. In this particular situation (and only in this particular situation), it is reasonable to assume that production will follow a symmetric “Hubbert Curve,” with half of the production coming after the peak, and half beforehand. Otherwise, the down slope is likely to be much steeper.

Many peak oilers missed this important point. We certainly are not in a situation today where another very cheap fuel has taken over.

Slide 16




Slide 16




Slide 16 represents what I see as the predominant “Peak Oil” view of the oil limits situation. Some individuals will of course have different opinions.

Slide 17




Slide 17




Peak oilers certainly did get part of the story right–at some point, the cost of oil extraction would rise. What they got wrong was how the whole scenario would play out. It turns out, it plays out pretty much the opposite of what most had supposed–that is, with stagnating wages, loss of buying power, and prices of all commodities falling because of lack of “demand.”

We seem to be hitting energy limits, right now. That is why debt is such a problem, and it is why prices of many commodities, including oil, are far too low compared to the cost of production.

Slide 18




Slide 18




Slide 18 shows the fall of commodity prices up through 2014. The fall in commodity prices has continued in 2015 as well. The story we frequently hear is about low oil prices, but there is also a problem with low natural gas prices. Coal prices are low now too, and, in fact, many coal producers are near bankruptcy. Prices of iron ore, steel, copper, and many other metals are very low, as are prices of many kinds of staple foods traded internationally.

Slide 19




Slide 19




The problem with low commodity prices is that there are many loans that have been taken out to support their production. There is a significant chance of default, if prices remain low. Also, low commodity prices affect asset prices–for example, prices of coalmines, or prices of agricultural land. As the prices of commodities fall, the price of the land used to produce those commodities falls. When this happens, it becomes difficult to repay the loans on the property.

Slide 20




Slide 20




Peak Oilers were right about the cost of production continuing to rise. What they missed was the fact that prices would at some point fall behind the cost of production because of affordability issues. Low prices would then bring the economy down, as it did in the Depression in the 1930s, and in quite a few earlier collapses.

I think of increased demand, provided by debt, as being like a rubber band. Just as a rubber band can stretch for a while, the price of oil can rise for a while, fueled by more and more debt. At some point, debt can’t rise any higher–the rate of return on investments made using debt is too low, and defaults become too frequent. Instead of continuing to rise, commodity prices fall back. Market prices of commodities fall to much lower prices than the costs of production.

In order to get oil prices up higher, the wages of factory workers, restaurant workers, and other non-elite workers need to rise, so that they can afford to buy nice cars and nice homes. Commodities of many types are used both in making homes and cars, and in operating them.

Slide 21




Slide 21




If space solar (or for that matter, any renewable energy) is to be helpful, it needs to be very cheap, so that products made using renewable energy are affordable.

If the replacement energy source is cheap enough, perhaps there will not be a huge run-up in debt to GDP ratios, to finance the new devices used to provide electricity or other energy.

We are encountering problems now, so we need a replacement now, not 20 or 50 years from now.

Slide 22




Slide 22




We cannot expect the cost of electricity production to be more than the current wholesale selling price of electricity. Thus, it needs to be four cents per kWh or less. Ideally, the price of electricity should be falling, as in Slide 6.

Another consideration is that we need to be able to operate our current vehicles using a liquid fuel, made with electricity, because of the time and materials involved in switching over to electric vehicles. This requirement likely reduces the maximum cost of electricity even below four cents per kWh.

Slide 23




Slide 23




It is possible to run into many different kinds of limits, over a period of time. In my view, the first limit we reach is an affordability limit. We can tell we are hitting this limit when high prices reverse to low prices, as they have done since 2011. The fact that prices are continuing to fall is especially worrisome.

Slide 24




Slide 24




There has been a popular myth that it is OK for energy costs to rise. We will just choose the least costly of the high-priced alternatives. This approach doesn’t really work, because wages do not rise at the same time.

Also, we have to compete with other countries. If their energy costs are cheaper, their manufacturing costs are likely to be lower.

Slide 25




Slide 25




If conditions existed that allowed oil prices to rise endlessly (in other words, rising wages of non-elite workers together with debt that could spiral ever higher, as a percentage of GDP), we wouldn’t really have a problem–we could afford increasingly expensive substitutes.  Unfortunately, the story of ever-rising oil prices is simply fiction. It is a pleasant story, but not really true. I explain some of the issues further in “Why ‘supply and demand’ doesn’t work for oil.”








TriangleofDoomgc2reddit-logoOff the keyboard of Geoffrey Chia

Charting by Steve Ludlum

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Published on the Doomstead Diner on November 14, 2015


Triangle of Doom from Steve Ludlum at Economic Undertow

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PEAK OIL REVISITED PART 1a: The Triangle of Doom and the Failure of Price as a Metric


Geoffrey Chia is an Australian physician with a long standing interest in Peak Oil. This essay on oil prices is a necessary prelude to Peak Oil Revisited Part 1b: Is an International Standardised Energy Dollar feasible? followed by Peak Oil Revisited Part 2: Why business as usual guarantees that global industrial collapse will be complete by 2030.


Is Peak Oil dead?


Quote:Reports of my death have been greatly exaggerated” – attributed to Samuel Clemens AKA Mark Twain, upon reading his own obituary in a newspaper


The delusionists who declared that the “theory” of Peak Oil is dead are simply demonstrating their profound ignorance, if not downright duplicity. Peak Oil is not a theory, it is an observation of a physical fact. It is a simple fact that this world has finite supplies of oil. It is a simple fact that every oil well has finite recoverable oil and will go through phases of rising production, peaking of production and terminal decline. Peak Oil refers to (and has always referred to) the maximum rate of production of conventional oil (applied in particular contexts to either a well, a field, a country or the entire world). Global conventional oil output hit a plateau around 2006 and is now on an inexorable downward trend and even the cornucopian EIA admit this.

Fudging current data by adding gas condensates (which cannot be used to derive diesel or kerosene) or other unconventional oils to the total liquid hydrocarbon output does not change the fact that the world is now well past the peak rate of production of conventional oil and we are entering terminal decline soon.

As an alternative tactic, the denialists have tried to change the definition of Peak Oil. They declared that since oil prices are now low, we cannot have gone past Peak Oil, which has therefore been disproved. They ignore the fact that Peak Oil is and was always defined as the peaking of the rate of production of conventional oil i.e. the maximum volume output per unit time (usually over a year) and was not and was never defined by price.


The triangle of doom


As many readers will be aware, Steve Ludlum's triangle of doom refers to the post Peak Oil fluctuation of oil prices, which as time goes by is hypothetically expected to converge to a particular oil price (of say, US$100/- per barrel), above which customers cannot afford the oil, and below which it is uneconomic for vendors to produce the oil (they cannot recuperate their investment costs). In other words, oil which is too expensive leads to destruction of demand (or "demand destruction") and oil which is too cheap leads to destruction of production (or "production destruction"). If $100 per barrel oil is too much for customers to afford but is also too low to meet the cost of production, then in theory, market forces dictate that both oil consumption and production will cease, petroleum will no longer be available and industrial civilisation will collapse. One projection suggested this convergence would occur sometime in 2015 (see graph) however this has obviously not happened for a few reasons:

Firstly, not all oils are the same. Current low oil prices are certainly accelerating "production destruction" of expensive low EROEI oil. However, as long as substantial cheap-to-produce high EROEI oils remain, the latter will continue to supply the market until that high net energy source (Hi-NES) itself eventually transforms into Lo-NES (see explanation below).

Secondly, we have a fair way to go before all discretionary (or non-essential) oil consumption is eliminated from our bloated and wasteful system. Once that occurs, we are in for big trouble.

Furthermore, price is not an accurate predictor of collapse of the oil industry because it is not a reliable marker of whether, where, when and how oil will be produced or consumed, as price can be grossly distorted and manipulated by non-market forces to create perverse incentives.

In the longer term, price as a number is meaningless, unless corrected for inflation/deflation and related to a reference date, or related to a standard basket of goods and services.

The major concern about the current low oil price is that it is strangling upstream funding for oil production in the near future (even for conventional wells) which will eventually cause severe supply constraints in the near term. This will undoubtedly cause another oil price spike and even though restoration of production will take time and effort, it will eventually be done, albeit not to the same previous level. Petroleum will still continue to be produced and consumed in a fluctuating manner, irrespective of the hypothetical triangle of doom, until we run out of easy oil. Going by current trends however, oil will become completely unavailable to the vast majority of humanity within 15 years according to analysis of other parameters (not price) which we will discuss in part 2.


Production issues: Easy and Difficult oil:
The monetary price of a barrel of crude (whether WTI, Brent or Tapis) depends on a large number of factors which may partly be related to genuine physical and chemical issues (eg ease of extraction, ease of refinement) and partly related to genuine supply and demand issues. However price is also prone to all sorts of political and fraudulent distortions and manipulations. Consequently, the adjectives “cheap” and “expensive” are unhelpful and inaccurate, indeed they can lead to great confusion.

Whereas demand destruction in recent times has led to a fall in global oil prices1 , another major contributing factor was the US instructing their proxy Saudi Arabia to maintain maximum oil production2 regardless of reduced global demand, in an aggressive act of predatory pricing which is damaging the economies of Russia and Iran (who face higher production costs than the Saudis). Furthermore unconventional oil producers have been forced to sell at prices below their production costs, accelerating their demise (which was inevitable anyway), to the delight of the Saudis. This “expensive” oil is being sold artificially cheaply, hence the adjectives “expensive” and “cheap” have lost all meaning.

I propose we instead use the terms “easy” and “difficult” oil instead, the difference between them being the ENERGY costs of extracting and processing these types of oil.

Hence easy oil refers to oil from a conventional field of light sweet crude before (and shortly after) production peaks (when EROEI is high). Ultimately this easy oil will become progressively more difficult to extract (because oil extraction from a depleting well requires ever more energy). Even the Peak Oil deniers concede that the days of easy oil are over, however they refuse to acknowledge the underlying reason for this.

Difficult oil refers to low net energy or low EROEI oil, either:

– Unconventional oil of any sort (tar sands, ultra-deep oceanic oil, shale oil, Fischer-Tropf oil, biofuels etc.) or

– Conventional oil from a depleting field well past peak production.

Please note that the terms Easy oil and High EROEI oil are interchangeable, as are the terms Difficult oil and Low EROEI oil. However the adjectives “easy” and “difficult” are simpler and more intuitive to adopt and less of a mouthful.

My term “Hi-NES” is a general term for a high net energy source (or sources). Hi-NES embraces high EROEI conventional oil, high EROEI conventional natural gas and other high EROEI sources. In theory, wind generated electricity in a location where the wind blows strongly and continuously (e.g. the Antarctic coast) may offer an EROEI of more than 10:1 and is therefore potentially a hi-NES. However in practice that is seldom achievable.

The term Conventional oil (i.e. petroleum derived from a conventional oilfield) is not necessarily interchangeable with Easy oil for reasons explained above.

Use of the terms “easy” and “difficult”, rather than “cheap” and “expensive” helps to clarify our thought processes, but remains inadequate to enable deeper understanding of what is happening. Orwell, through the voice of Napoleon the pig, famously said that all animals are equal, but some animals are more equal than others. Accordingly we must appreciate that among difficult oils, some are more difficult than others, which is related to their EROEI. Similarly, among easy oils, some are easier than others, which is also related to their EROEI. Here is an example: Saudi Arabia and Russia as nations are both past Peak Oil, but Russia is further down the curve. Nevertheless both can still be said to possess easy oil, the difference being that the EROEI for Saudi Arabia may be (for example) 20:1 but the EROEI for Russia may be (for example) 18:1. This difference means that Saudi production costs are cheaper than Russia and enables the Saudis to engage in short term predatory pricing which causes trouble for the Russian economy.

The astute reader will naturally ask this question: what is the numerical dividing line between easy/high EROEI oils and difficult/low EROEI oils? We need to invoke the thoughts of Hall, Lambert and Murphy to help us answer this question in Part 2.


Consumption issues: demand destruction:

The confusing terms “cheap” and “expensive” oil will unfortunately continue to be used in common parlance. Most people will continue to focus on price as it can be a useful comparator when considering short term trends.

However even if we were to focus microscopically on just one household budget, price is not the important consideration, it is affordability. Affordability is related to one's income balanced against one's expenditure. Expenditure can be divided into discretionary or non-essential spending (which defines one's disposable income) and non-discretionary or essential spending (food, housing, utilities, transport for work/study, health expenses etc).

Similarly we can adopt the concept of discretionary and non-discretionary petroleum use. Discretionary use refers to frivolous or non-essential consumption of petroleum e.g. jet travel for overseas holidays, running a power boat on weekends etc. Non-discretionary use refers to essential use.

Let us take the example of a tradesman who must drive his pick-up truck (containing his heavy power tools, ladders, trestles, materials etc.) to his clients' locations to perform his work (he cannot use a bicycle or public transport for this purpose). Let us say he is just making ends meet. If two thirds of his petroleum use is discretionary and one third non-discretionary, then when faced with oil escalating in price from, say, $33 per barrel to $100 per barrel, he can initially cope by eliminating 2/3 of his total consumption to keep his petrol bill unchanged. If however the price then exceeds $100 per barrel, he cannot now afford to run his vehicle for work. Continuing work will mean he loses money. After losing money for a few months he is forced to stop work, sell his pick-up (then uses that capital to pay debts incurred when he lost money and for ongoing living expenses) and he drops out of the oil market completely. The latter represents demand destruction. Loss of his job releases the oil he previously consumed into the market. Widespread demand destruction in the general population "frees up" considerable oil supply into the market. Overall oil supply now exceeds demand and leads to a drop in the oil price. However the former tradesman cannot now afford to buy another vehicle to resume his old work. He cannot consume oil again as he did previously and the market price of oil stays low for the time being. Repeat this poor tradesman's story a million fold and you will get an idea of how depletion of the easy (high EROEI) oil will lead to the impoverishment of nations and why low oil prices will not necessarily reinvigorate economic activity3.

Eventually all discretionary oil use will be eliminated from all sectors of all economies, all around the world. All the fat will be cut from the system, leaving only absolutely essential oil use remaining (e.g. petroleum to run ambulances, to produce and distribute food etc.). Demand is now inflexible. As global conventional oil depletes further, oil supply will once again fall behind this fixed, inflexible demand and the oil price will escalate. Hyperinflation will now ensue. This will be the terminal phase of the industrial economy.


Prospects for future resurrection of low EROEI oil production:

The first flurry of low net energy oil production is all but over now. Many ultra deep water projects were shelved after Macondo blew up. The US tight oil producers in particular are now collapsing in droves, their investors, AKA suckers, are losing their shirts. Shell has pulled out of investing in Canadian tar sands. Other potential start-up low EROEI projects are being suppressed by the current low oil price as they need a price of at least $60 (more like $80 to $100) per barrel to get off the ground (price of WTI at the time this article is written is around $44 per barrel)

However in the future, after the eventual elimination of discretionary oil use from the global economy and with subsequent permanent escalation of oil prices, will low EROEI projects be attempted once again? It has been calculated that an EROEI of around 10:1 is required to run basic industrial civilisation and when EROEI drops under 5:1 our net energy availability falls off a cliff4, hence physical laws dictate that very low EROEI projects (especially unconventional oil projects which tend to have an EROEI of 3:1 or less) are for practical purposes useless (not to mention extremely harmful to the environment) and are extremely stupid. For Ponzi purposes however, lo-NES projects are useful scams for fraudsters to promote. We can never underestimate the stupidity of human beings. Hence it seems likely that stupid fucking fracking projects in new locations and other lo-NES projects will arise again, zombie-like in the future, funded by yet another cohort of greedy suckers with goldfish memories.


The failure of price as a metric:

You will note that the idea of the "triangle of doom" alluded to the post Peak oscillating price of oil (as a result of fluctuating supply and demand) which would progressively diminish in amplitude and eventually converge to the point where demand destruction meets production destruction, then the whole oil industry would vanish in a puff of smoke (at least in theory). Price on its own however can be extremely rubbery and is prone to all sorts of manipulation (e.g. inappropriate government subsidies for biofuels from grain) and distortion (e.g. speculation by futures traders). Hence oil prices consistently above $100 per barrel may still be possible in the future, particularly if there is government subsidy (AKA misappropriation of taxpayers money) to favour certain sectors. Expensive oil will not be affordable to all, but it will be affordable to a chosen few, enabling some (albeit diminished) part of the oil production system to continue functioning.

Prices in theory should reflect the simple interaction between supply and demand. Prices in a sane and rational market should be an honest representation of true cost and true value. Proper pricing should stimulate healthy (as opposed to harmful) economic activities. However in reality our markets are insane, irrational and dishonest. In reality prices are frequently distorted by TPTB to create perverse stimuli in the service of vested interests eg the fossil fuel industry or the corn lobby, irrespective of harm caused to ordinary people or the environment. Furthermore price comparisons between different years require corrections for inflationary or deflationary trends. Price as a number is an extremely noisy signal and interpreting circumstances or trends according to price is prone to all sorts of pitfalls.

Forces other than a "sane" market will guarantee future delivery of oil to certain favoured sectors, come hell or high water. The American military is one such sector, and the production and supply of oil to them will be given priority over, say, the allocation of petroleum to produce food for the poor5.This will be one way by which the US military will promote general population die-off, apart from the fact that they will kill poor people directly. When chaos on the streets ensues as a result of the limits to growth, the National Guard will be called in and will start shooting people.

Here is another reason why price, as a number, is essentially meaningless and must be related to some other objective index: any sum of money, say $100, must be related to the goods and services it can buy at that time. We know that $100 could go a lot further a hundred years ago than $100 today because of inflation, which is defined as the expansion of money supply relative to the available pool of goods and services. Accordingly if there is contraction of money supply in the future due to collapse of yet more debt bubbles, deflation will occur and $100 in that future will buy more than the $100 of today (at least until the pool of goods and services also contracts, which will lag behind the money supply contraction). In other words, quoted price must be referenced to a particular year (e.g. 2015) and price must always be corrected for purchasing power (i.e. corrected for inflation or deflation) to have any meaning.

Perhaps a better way to ascribe objective meaning to price is to relate it to a standard basket of goods and services. To simplify things further, the Economist magazine, originally as a joke, decided to relate price to one particular standardised product, the MacDonald's Big Mac burger, which is made to identical specifications in almost all locations around the world (although in India beef is not used). This was in fact found to be a useful means of comparing the true values of different currencies, such that the Economist now publishes its "Big Mac index" twice a year.

The "triangle of doom", being based on price (a variable which can be immensely rubbery), is not an accurate predictor for the global collapse of the oil industry although it does highlight industry difficulties. It was nevertheless an interesting concept because low oil prices can certainly destroy production in many (but not all) instances and high oil prices can certainly destroy demand in many (but not all) instances, however we must also take many other factors into consideration.


Energy as the “gold standard” for money

I previously wrote that money represents the promise of delivery of future useful goods and services. However FUGS can only be created and delivered through the application of energy. I also previously wrote that if Greece had their own hi-NES (such as a Leviathan gas field), they would have no problem leaving the Eurozone to print their own Drachma, which would then be backed up by their hi-NES.

Can we thus say that money is a proxy for energy? Well, yes and no. It is probably too simplistic a paradigm. If money was a true proxy for energy then net oil importing countries with low oil reserves such as the USA should have low currency values, and net oil exporting countries with high oil reserves such as Russia should have high currency values, however in real life the opposite is the case, for many economic and political reasons. Furthermore, it is impossible to accurately value a particular country's currency against its national energy reserves because it may be impossible to accurately estimate the recoverable energy reserves, which may be wrongly declared by that country for various economic and political reasons. For example we know the sudden escalation (on paper) of purported oil reserves in the OPEC countries in the 1980s had nothing to do with discovery of new oil resources but had everything to do with their greed (it was prompted by the then new OPEC oil exporting policy based on stated reserves).

Despite those shortcomings, will it still be worthwhile to use energy as the standard index for money? Should energy be the "gold standard" for money and not gold?

One may argue that this has already been attempted in the form of the US Petrodollar, which from the point of view of the USA has been a massive economic windfall, but from the point of view of the rest of the world has enabled America to become a global parasite, to leech oil and high value products from other countries for free. The Petrodollar scheme has also incentivised the US to keep the Middle East politically unstable, in order to perpetuate this military protection racket. The explanation for this has been previously detailed in this essay:

As a thought experiment however, can we conceive of a global system in which we index money to energy in a more objective fashion? When all its ramifications are explored, such a system seems unlikely to be workable in practice. Even if potentially feasible however, it will almost certainly be sabotaged and violently opposed by the USA as it will threaten their Petrodollar status. (see Part 1b which discusses the ISED, to follow soon).


The Ehrlich-Simon wager:

On a slight tangent, let us briefly mention the famous bet in 1980 between the environmentalist Paul Ehrlich and economist Julian Simon regarding the future prices of five selected minerals. After ten years it was found that all the prices had fallen, hence Simon was declared "winner" and economists around the world trumpeted their triumph over the scientists. Ehrlich's error was to make the bet on the basis of price, which as we mentioned is a rubbery variable prone to all sorts of fluctuations, distortions and manipulations. The point Ehrlich wanted to make was that as time goes by, it becomes progressively more difficult for us to harvest, process and deliver the same amount of product (e.g. metal ingots). This is because we would have previously harvested all the "low hanging fruit", the easy pickings, ab initio. We always transition from initially easily scooping up high concentration ores to eventually scrounging the depths for low grade dregs. If Ehrlich had bet that the ENERGY costs of delivering the same amount of product would be higher after ten years (actually a fifteen or twenty year bet would have been preferable), he would have made a better wager6. This is an example of how even the smartest of scientists can run into trouble when trying to extrapolate the future on the basis of that most unreliable of variables, price.

On the other hand, was Simon's victory a result of greater wisdom or intelligence with regard to how prices work? Actually, no, he was just lucky, as was explained in David Murphy's 2011 post in TOD:

Moral of this story? Making judgements and predictions based on price is prone to all sorts of pitfalls.



Making judgements and predictions about oil availability on the basis of price, is like trying to make sense of a conversation between two people at the far end of a crowded room during a noisy party, with music blaring at full volume. The voices are there, but they are drowned out by too much extra noise. If one has a parabolic microphone and electronic audio filtering mechanisms however, it may be possible to achieve clarity and eliminate the background noise. We may be able to do so with regard to petroleum availability issues by looking at parameters other than the extremely noisy variable of price. This is discussed in Part 2.


Geoffrey Chia, November 2015




1. Another factor contributing to low oil prices is economic deflation. Default of irredeemable debt in many sectors, due to the failure of real economic growth as a result of Peak Oil, has resulted in a contraction of the money supply relative to the pool of goods and services available ie deflation. This results in a fall in commodity prices across the board, oil included.


2. Please note this does not refer to Saudi Arabia increasing their oil output (which they cannot significantly do in a post Peak Oil situation with limited spare capacity), it refers to them refusing to substantially reduce their oil output in an atmosphere of global demand destruction. A sane exporter would reduce oil output in order to preserve high prices for this non-renewable finite resource, to maximise their long term sovereign earning capacity. Indications are that this Saudi insanity was pursued at the behest of the USA Like most of America's foreign policy dirty tricks, this tactic will result in future unintended consequences which will return to bite them. The current predatory low oil pricing is based on the US gamble that loss of foreign revenue by Russia and Iran will lead to their economic collapse and chaos in the short term, which will enhance Washington's ability to covertly implement “regime change” – to appoint US friendly administrations – in those countries. There are numerous examples in history of this US modus operandi, including regime change inflicted by the CIA on Iran itself in 1953. This time it will fail because the world is now wise to their tactics. The other “benefit” of flooding the market with cheaper Saudi oil is this: either Saudi oil will be preferentially purchased over Russian oil by Europe or it will force Russia to sell their oil cheaply to Europe. Either way it will diminish Russia's leverage over Europe, at least in the short term. What the US/Saudi axis is now unintentionally doing is forcing the Russians and Iranians to conserve their petroleum reserves while Saudi Arabia depletes theirs, for a price lower than the Saudi's would otherwise earn if they were not insane. In due course when the Saudi oil becomes more difficult (and hence more expensive) to extract, as it inevitably will, the Russians and Iranians will then, with their huge remaining quantities of (relatively) easy oil, gain the upper hand and be able to dictate the terms of the Great Game in the future. Blowback yet again. Americans see the eclipse of their empire looming and are adopting all sorts of short term desperate measures to forestall the inevitable.


3. Admittedly, this simple story of a struggling tradesman is prone to many "what ifs". Let us ignore the fact that in a deflationary environment, credit usually dries up and obtaining a bank loan may be impossible for a small business such as his. What if he does manage to get a bank loan to purchase another pick-up truck? Even with temporarily low oil prices, resuming work in a new environment of economic contraction with fewer clients, who themselves are under financial stress (and may go bankrupt and default on their payments to this tradesman) is likely to render resumption of his work unviable, apart from the fact he will probably never earn enough to pay back the bank loan for his new pick-up, in which case he will become a permanent debt slave. Much better if the tradie sells all his assets and moves to an off-grid rural community where he can grow his own food and offer his handyman services to his neighbours in an exchange economy.




5. At almost $600 billion per year, the US government spends more on its military than the next eight ranked countries in the world spend on their military combined.

Just diverting 2% of the US military budget per year to feed the poor over 5 years will be sufficient to completely solve world poverty. (Estimated cost to solve global poverty today is $58 billion ) This situation was as true a decade ago as it is today. Why was this not done and why is it not being done and why will it never be done? Because US military expenditure is given priority over saving lives of the poor.


6. The situation is more complicated however. Just like petroleum, minerals go through a phase of rising extraction, a peak of extraction then terminal decline. Even if extraction of a particular ore is entering terminal decline, if that time period coincides with increasing energy availability (as was the case around 1990 with abundant petroleum available pre Peak Oil), then even though ore extraction and processing require more energy, the product may be cheaper due to energy being cheap at the time.


Why Demand is Collapsing for Everything

Off the keyboard of Gail Tverberg

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Published on Our Finite World on May 6, 2015

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Why We Have an Oversupply of Almost Everything (Oil, labor, capital, etc.)

The Wall Street Journal recently ran an article called, Glut of Capital and Labor Challenge Policy Makers: Global oversupply extends beyond commodities, elevating deflation risk. To me, this is a very serious issue, quite likely signaling that we are reaching what has been called Limits to Growth, a situation modeled in 1972 in a book by that name.

What happens is that economic growth eventually runs into limits. Many people have assumed that these limits would be marked by high prices and excessive demand for goods. In my view, the issue is precisely the opposite one: Limits to growth are instead marked by low prices and inadequate demand. Common workers can no longer afford to buy the goods and services that the economy produces, because of inadequate wage growth. The price of all commodities drops, because of lower demand by workers. Furthermore, investors can no longer find investments that provide an adequate return on capital, because prices for finished goods are pulled down by the low demand of workers with inadequate wages.

Evidence Regarding the Connection Between Energy Consumption and GDP Growth

We can see the close connection between world energy consumption and world GDP using historical data.

Figure 1. World GDP in 2010$ compared (from USDA) compared to World Consumption of Energy (from BP Statistical Review of World Energy 2014).





Figure 1. World GDP in 2010$ compared (from USDA) compared to World Consumption of Energy (from BP Statistical Review of World Energy 2014).





This chart gives a clue regarding what is wrong with the economy. The slope of the line implies that adding one percentage point of growth in energy usage tends to add less and less GDP growth over time, as I have shown in Figure 2. This means that if we want to have, for example, a constant 4% growth in world GDP for the period 1969 to 2013, we would need to gradually increase the rate of growth in energy consumption from about 1.8% = (4.0% – 2.2%) growth in energy consumption in 1969 to 2.8% = (4.0% – 1.2%) growth in energy consumption in 2013. This need for more and more growth in energy use to produce the same amount of economic growth is taking place despite all of our efforts toward efficiency, and despite all of our efforts toward becoming more of a “service” economy, using less energy products!

Figure 2. Expected change in GDP growth corresponding to 1% growth in total energy, based on Figure 1 fitted line.





Figure 2. Expected change in GDP growth corresponding to 1% growth in total energy, based on Figure 1 fitted line.





To make matters worse, growth in world energy supply is generally trending downward as well. (This is not just oil supply whose growth is trending downward; this is oil plus everything else, including “renewables”.)

Figure 3. Three year average percent change in world energy consumption, based on BP Statistical Review of World Energy 2014 data.





Figure 3. Three-year average percent change in world energy consumption, based on BP Statistical Review of World Energy 2014 data.





There would be no problem, if economic growth were something that we could simply walk away from with no harmful consequences. Unfortunately, we live in a world where there are only two options–win or lose. We can win in our contest against other species (especially microbes), or we can lose. Winning looks like economic growth; losing looks like financial collapse with huge loss of human population, perhaps to epidemics, because we cannot maintain our current economic system.

The symptoms of losing the game are the symptoms we are seeing today–low commodity prices (temporarily higher, but nowhere nearly high enough to maintain production), not enough good paying jobs for common workers, and lack of investment opportunities, because workers cannot afford the high prices of goods that would be required to provide adequate return on investment.


How We Have Won in Our Contest with Other Species–Early Efforts 

The “secret formula” humans have had for winning in our competition against other species has been the use of supplemental energy, adding to the energy we get from food. There is a physics reason why this approach works: total population by all species is limited by available energy supply. Providing our own external energy supply was (and still is) a great work-around for this limitation. Even in the days of hunter-gatherers, humans used three times as much energy as could be obtained through food alone (Figure 1).

Figure 1





Figure 4





Earliest supplementation of food energy came by burning sticks and other biomass, starting one million years ago. Using this approach, humans were able to gain an advantage over other species in several ways:

  1. We were able to cook some of our food. This made a wider range of plants and animals suitable for food and made the nutrients from these foods more easily available to our bodies.
  2. Because less energy was needed for chewing and digesting, our bodies could put energy into growing a larger brain, thus giving us an advantage over other animals.
  3. The use of cooked food freed up time for such activities as hunting and making clothes, because less time was needed for chewing.
  4. Heat from burning plant material could be used to keep warm in cold areas, thereby extending our range and increasing total human population that could be supported.
  5. Fire could be used to chase off predatory animals and hunt prey animals.

Our bodies are now adapted to the need for supplemental energy. Our teeth our smaller, and our jaws and digestive apparatus have shrunk in size, as our brain has grown. The large population of humans that are alive today could not survive without supplemental energy for many purposes, such as cooking food, heating homes, and fighting illnesses that spread when humans are in as close proximity as they are today.

Our Modern Formula For Winning the Battle Against Other Species

In my view, the formula that has allowed humans to keep winning the battle against other species is the following:

  1. Use increasing amounts of inexpensive supplemental energy to leverage human energy so that finished goods and services produced per worker rises each year.
  2. Pay for this system with debt, because (if supplemental energy costs are cheap enough), it is possible to repay the debt, plus the interest on the debt, with the additional goods and services made possible by the cheap additional energy.
  3. This system gradually becomes more complex to deal with problems that come with rising population and growing use of resources. However, if the output of goods per worker is growing rapidly enough, it should be possible to pay for the costs associated with this increased complexity, in addition to interest costs.
  4. The whole system “works” as long as the total quantity of finished goods and services rises rapidly enough that it can fund all of the following: (a) a rising standard of living for common workers so that they can afford increasing amounts of debt to buy more goods, (b) debt repayment, and interest on the debt of the system, and (c) and an increasing amount of “overhead” in the form of government services, medical care, educational services, and salaries of high paid officials (in business as well as government). This overhead is needed to deal with the increasing complexity that comes with growth.

The formula for a growing economy is now failing. The rate of economic growth is falling, partly because energy supply is slowing (Figure 3), and partly because we need more and more growth of energy supply to produce a given amount of economic growth (Figure 2). With this lowered world economic growth, the amount of goods and services being produced is not rising fast enough to support all of the functions that it needs to cover: interest payments, growing wages of common workers, and growing “overhead” of a more complex society.

Some Reasons the Economic Growth Cycle is Now Failing

Let’s look at a few areas where we are reaching obstacles to this continued growth in final goods and services. An overarching problem is diminishing returns, which is reflected in increasingly higher prices of production.

1. Energy supplies are becoming more expensive to extract.

We extract the easiest to extract energy supplies first, and as these deplete, need to use the more expensive to extract energy supplies. We hear much about “growing efficiency” but, in fact, we are becoming less efficient in the production of energy supplies.

In the US, EIA data shows that we are becoming less efficient at coal production, in terms of coal production per worker hour (Figure 5).

Figure 5. US coal production per worker, on a Btu basis based on EIA data.





Figure 5. US coal production per worker, on a Btu basis based on EIA data.





With oil, growing inefficiency is shown by the steeply rising cost of oil exploration and production since 1999 (Figure 6).

Figure 6. Figure by Steve Kopits of Westwood Douglas showing trends in world oil exploration and production costs per barrel.





Figure 6. Figure by Steve Kopits of Douglas-Westwood showing trends in world oil exploration and production costs per barrel.





Thus, it is for a fairly recent period, namely the period since about 2000, that we have been encountering rising costs both for US coal and for worldwide oil extraction.

The extra workers and extra costs required for producing the same amount of energy  counteract the tendency toward growth in the rest of the economy. This occurs because the rest of the economy must produce finished products with fewer workers and less resources as a result of the extra demands on these resources by the energy sector.

2. Other materials, besides energy products, are experiencing diminishing returns. 

Other resources, such as metals and other minerals and fresh water, are also becoming increasingly expensive to extract. The issue with mineral ores is similar to that with fossil fuels. We start with a fixed amount of ores in good locations and with high mineral percentages. As we move to less desirable ores, both human labor and more energy products are required, making the extraction process less efficient.

With fresh water, the issue is likely to be a need for desalination or long distance transport, to satisfy the needs of a growing population. Workarounds again involve more human labor and more resource use, making the production of fresh water less efficient.

In both of these cases, growing inefficiency leaves the rest of the economy with less human energy and less energy products to produce the finished goods and services that the economy needs.

3. Growing pollution is taking its toll.

Instead of just producing end products, we are increasingly finding ourselves fighting pollution. While this is a benefit to society, it really is only offsetting what would otherwise be a negative. Thus, it acts like overhead, rather than producing economic growth.

From the point of view of workers having to pay for higher cost energy in order to fight pollution (say, substitution of a higher cost energy source, or paying for more pollution controls), the additional cost acts like a tax. Workers need to cut back on other expenditures to afford the pollution control workarounds. The effect is thus recessionary.

4. The amount of “overhead” to the world economy has been growing rapidly in recent years, for a number of reasons: 

  • The amount of overhead is growing because we are reaching natural barriers. For example, population per acre of arable land is growing, so we need more intensity of development to produce food for a rising population.
  • With greater population density and increased bacterial antibiotic resistance, disease transmission becomes a more of a problem.
  • Increasing education is being encouraged, whether or not there are jobs available that will make use of that education. Education that cannot be used in a productive way to produce more goods and services can be considered overhead for the economy. Educational expenses are frequently financed by debt. Repayment of this debt leads to a decrease in demand for other goods, such as new homes and vehicles.
  • We have more elderly to whom we have promised benefits, because with the benefit of better nutrition and medical care, more people are living longer.

5. We are reaching debt limits.

As economic growth has slowed, we have been adding more and more debt, to try to mitigate the problem. This additional debt becomes a problem in many ways: (a) without cheap energy to leverage human labor, there are not many productive investments that can be made; (b) the addition of more debt leads to a need for more interest payments; and (c) at some point debt ratios become overwhelmingly high.

At least part of the slowdown in economic growth that we are seeing today is coming from a slowdown in the growth of debt. Without debt growth, it is hard to keep commodity prices high enough. Investment in new manufacturing plants is also affected by low growth in debt.

Reasons for Confusion in Understanding Our Current Predicament

1. Not understanding that all of the symptoms we are seeing today are manifestations of the same underlying “illness”. 

Most analysts think that the economy has stubbed its toe and has a headache, rather than recognizing that it has a serious underlying illness.

2. Academia is focused way too narrowly, and tied too closely to what has been written before. 

Academics, because of their need to write papers, focus on what previous papers have said. Unfortunately, previous papers have not understood the nature of our problem. Academics have developed models based on our situation when we were away from limits. The issues we are facing cover such diverse subjects as physics, geology, and finance. It is hard for academics to become knowledgeable in many areas at once.

3. Models that seemed to work before are no longer appropriate.

We take models like the familiar supply and demand model of economists and assume that they represent everlasting truths.

Figure 7. (Source Wikipedia). The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.





Figure 7. (Source Wikipedia). The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.





Unfortunately, as we get close to limits, things change. Both wage levels and debt levels have an impact on demand; the quantity goods available is also affected by diminishing returns. The model that worked in the past may be totally inappropriate now.

Even a complex model like the climate change model being used by the IPCC is likely to be affected by financial limits. If near-term financial limits are to be expected, IPCC’s estimate of future carbon from fuels is likely to be too high. At a minimum, the findings of the IPCC need to be framed differently: climate change may be one of a number of problems facing those people who manage to survive a financial crash.

4. Too much wishful thinking.

Everyone would like to present a positive result, especially when grants are being given for academic research will support some favorable finding.

A favorite form of wishful thinking is believing that higher costs of energy products will not be a problem. Higher cost energy products, whether they are renewable or not, are a problem for many reasons:

  • They represent growing inefficiency in the economy. With growing inefficiency, we produce fewer finished goods and services per worker, not more.
  • Countries using more of the higher cost types of energy become less competitive in the world market, and because of this, may develop financial problems. The countries most affected by the Great Recession were countries using a high percentage of oil in their energy mix.
  • The amount workers have available to spend is limited. If a worker has $100 to spend on energy supply, he can buy 100 times as much in energy supplies priced at $1 as he can energy supplies priced at $100. This same principle works even if the cost difference is much lower–say $3.50 gallon vs. $3.00 gallon.

5. Too much faith in, “We pay each other’s wages.”

There is a common belief that growing inefficiency is OK; the wages we pay for unneeded education will work its way through the system as more wages for other workers.

Unfortunately, the real secret to economic growth is not paying each other’s wages; it is growing output of finished products per worker through increased use of cheap energy (and perhaps technology, to make this cheap energy useful).

Increased overhead for the system is not helpful.

6.  An “upside down” peak oil story.

Most people in the peak oil community believe what economists say about supply and demand–namely, that oil prices will rise if there is a supply problem. They have not realized that in a networked economy, wages and prices are tightly linked. The way limits apply is not necessarily the way we expect. Limits may come through a lack of good paying jobs, and because of this lack of jobs, inability to purchase products containing oil.

The connection between energy and jobs is clear. Good jobs require the use of energy, such as electricity and oil; lack of good-paying jobs is likely to be a manifestation of an inadequate supply of cheap energy. Also, high paying jobs are what allow rising buying power, and thus keep demand high. Thus, oil limits may appear as a demand problem, with low oil prices, rather than as a high oil price problem.

In my opinion, what we are seeing now is a manifestation of peak oil. It is just happening in an upside down way relative to what most were expecting.


One way of viewing our problem today is as a crisis of affordability. Young people cannot afford to start families or buy new homes because of a combination of the high cost of higher education (leading to debt), the high cost of fuel-efficient new cars (again leading to debt), the high cost of resale homes, and the relatively low wages paid to young workers. Even older workers often have an affordability problem. Many have found their wages stagnating or falling at the same time that the cost of healthcare, cars, electricity, and (until recently) oil rises. A recent Gallop Survey showed an increasing share of workers categorize themselves as “working class” rather than “middle class.”

It is this affordability crisis that is bringing the system down. Without adequate wages, the amount of debt that can be added to the system lags as well. It becomes impossible to keep prices of commodities up at a high enough level to encourage production of these commodities. Return on investment tends to be low for the same reason. Most researchers have not recognized these problems, because they are narrowly focused and assume that models that worked in the past will continue to work today.





Demand Destruction

logopodcastOff the microphone of RE

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Aired on the Doomstead Diner on February 26, 2015


With this Rant, the Diner breaks through the 88,888 Listen Barrier on Diner Soundcloud!

To paraphrase Doc Brown, “When this Baby hits 88,888 Listens, you are going to see some SERIOUS SHIT! 😀

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Snippet:…Given it is an Epic Fail to try to blame the Saudis for the price crash, the next place the economistas go is to our own Home Grown Frackers, and the idiots on Wall Street and at Da Fed who funded that White Elephant with gobs of cheap credit thrown at Junk Bonds any dimwit with a drilling rig was issuing out. Problem with that idea is that even with drilling rigs being shut in here and production plateauing, the fucking oil price is still dropping and the storage tanks for the stuff are filling up to overflow level. They aren’t producing much more of the stuff, they keep dropping the price, nevertheless the storage tanks keep filling up. This is some kind of big fucking MYSTERY to the economistas and prop desk traders.

The obvious answer here is that if there isn’t too much supply being dropped on here, then the problem has to be on the DEMAND end. As in, J6P simply is not BUYING the Oil in the same quantity at the same rate he was just 1 year ago. Steady Supply, Price Going Down, Inventory Going Up, you are left with only one variable in this bathtub problem, which is that the fucking DRAIN is STOPPED UP!

Now, why oh why would J6P all of a sudden STOP buying gas, even at the new Low Low prices every day of $2/Gallon?  Actually, it’s gone even below $2 in quite a few places. According to Da Goobermint, our Economy is recovering, the UE rate is like 7%, so WTF don’t these assholes start BUYING MORE GAS?

For the rest, LISTEN TO THE RANT!!!

Oil: $20 or $80?

Off the keyboard of Michael Snyder

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Published on The Economic Collapse on February 15, 2015

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Why The Price Of Oil Is More Likely To Fall To 20 Rather Than Rise To 80

This is just the beginning of the oil crisis.  Over the past couple of weeks, the price of U.S. oil has rallied back above 50 dollars a barrel.  In fact, as I write this, it is sitting at $52.93.  But this rally will not last.  In fact, analysts at the big banks are warning that we could soon see U.S. oil hit the $20 mark.  The reason for this is that the production of oil globally is still way above the current level of demand.  Things have gotten so bad that millions of barrels of oil are being stored at sea as companies wait for the price of oil to go back up.  But the price is not going to go back up any time soon.  Even though rigs are being shut down in the United States at the fastest pace since the last financial crisis, oil production continues to go up.  In fact, last week more oil was produced in the U.S. than at any time since the 1970s.  This is really bad news for the economy, because the price of oil is already at a catastrophically low level for the global financial system.  If the price of oil stays at this level for the rest of the year, we are going to see a whole bunch of energy companies fail, billions of dollars of debt issued by energy companies could go bad, and trillions of dollars of derivatives related to the energy industry could implode.  In other words, this is a recipe for a financial meltdown, and the longer the price of oil stays at this level (or lower), the more damage it is going to do.

The way things stand, there is simply just way too much oil sitting out there.  And anyone that has taken Economics 101 knows that when supply far exceeds demand, prices go down

Oil prices have gotten crushed for the last six months. The extent to which that was caused by an excess of supply or by a slowdown in demand has big implications for where prices will head next. People wishing for a big rebound may not want to read farther.

Goldman Sachs released an intriguing analysis on Wednesday that shows what many already suspected: The big culprit in the oil crash has been an abundance of oil flooding the market. A massive supply shock in the second half of last year accounted for most of the decline. In December and January, slowing demand contributed to the continued sell-off.

At this point so much oil has already been stored up that companies are running out of places to put in all.  Just consider the words of Goldman Sachs executive Gary Cohn

“I think the oil market is trying to figure out an equilibrium price. The danger here, as we try and find an equilibrium price, at some point we may end up in a situation where storage capacity gets very, very limited. We may have too much physical oil for the available storage in certain locations. And it may be a locational issue.”

“And you may just see lots of oil in certain locations around the world where oil will have to price to such a cheap discount vis-a-vis the forward price that you make second tier, and third tier and fourth tier storage available.”

[…] “You could see the price fall relatively quickly to make that storage work in the market.”

The market for oil has fundamentally changed, and that means that the price of oil is not going to go back to where it used to be.  In fact, Goldman Sachs economist Sven Jari Stehn says that we are probably heading for permanently lower prices

The big take-away: “[T]he decline in oil has been driven by an oversupplied global oil market,” wrote Goldman economist Sven Jari Stehn. As a result, “the new equilibrium price of oil will likely be much lower than over the past decade.”

So how low could prices ultimately go?

As I mentioned above, some analysts are throwing around $20 as a target number

The recent surge in oil prices is just a “head-fake,” and oil as cheap as $20 a barrel may soon be on the way, Citigroup said in a report on Monday as it lowered its forecast for crude.

Despite global declines in spending that have driven up oil prices in recent weeks, oil production in the U.S. is still rising, wrote Edward Morse, Citigroup’s global head of commodity research. Brazil and Russia are pumping oil at record levels, and Saudi Arabia, Iraq and Iran have been fighting to maintain their market share by cutting prices to Asia. The market is oversupplied, and storage tanks are topping out.

A pullback in production isn’t likely until the third quarter, Morse said. In the meantime, West Texas Intermediate Crude, which currently trades at around $52 a barrel, could fall to the $20 range “for a while,” according to the report.

Keep in mind that the price of oil is already low enough to be a total nightmare for the global financial system if it stays here for the rest of 2015.

If we go down to $20 and stay there, a global financial meltdown is virtually guaranteed.

Meanwhile, the “fracking boom” in the United States that generated so many jobs, so much investment and so much economic activity is now turning into a “fracking bust”

The fracking-for-oil boom started in 2005, collapsed by 60% during the Financial Crisis when money ran out, but got going in earnest after the Fed had begun spreading its newly created money around the land. From the trough in May 2009 to its peak in October 2014, rigs drilling for oil soared from 180 to 1,609: multiplied by a factor of 9 in five years! And oil production soared, to reach 9.2 million barrels a day in January.

It was a great run, but now it is over.

In the months ahead, the trickle of good paying oil industry jobs that are being lost right now is going to turn into a flood.

And this boom was funded with lots and lots of really cheap money from Wall Street.  I like how Wolf Richter described this in a recent article

That’s what real booms look like. They’re fed by limitless low-cost money – exuberant investors that buy the riskiest IPOs, junk bonds, leveraged loans, and CLOs usually indirectly without knowing it via their bond funds, stock funds, leveraged-loan funds, by being part of a public pension system that invests in private equity firms that invest in the boom…. You get the idea.

As all of this bad paper unwinds, a lot of people are going to lose an extraordinary amount of money.

Don’t get caught with your pants down.  You will want your money to be well away from the energy industry long before this thing collapses.

And of course in so many ways what we are facing right now if very reminiscent of 2008.  So many of the same patterns that have played out just prior to previous financial crashes are happening once again.  Right now, oil rigs are shutting down at a pace that is almost unprecedented.  The only time in recent memory that we have seen anything like this was just before the financial crisis in the fall of 2008.  Here is more from Wolf Richter

In the latest reporting week, drillers idled another 84 rigs, the second biggest weekly cut ever, after idling 83 and 94 rigs in the two prior weeks. Only 1056 rigs are still drilling for oil, down 443 for the seven reporting weeks so far this year and down 553 – or 34%! – from the peak in October.

Never before has the rig count plunged this fast this far:

Fracking Bust

What if the fracking bust, on a percentage basis, does what it did during the Financial Crisis when the oil rig count collapsed by 60% from peak to trough? It would take the rig count down to 642!

But even though rigs are shutting down like crazy, U.S. production of oil has continued to rise

Rig counts have long been used to help predict future oil and gas production. In the past week drillers idled 98 rigs, marking the 10th consecutive decline. The total U.S. rig count is down 30 percent since October, an unprecedented retreat. The theory goes that when oil rigs decline, fewer wells are drilled, less new oil is discovered, and oil production slows.

But production isn’t slowing yet. In fact, last week the U.S. pumped more crude than at any time since the 1970s. “The headline U.S. oil rig count offers little insight into the outlook for U.S. oil production growth,” Goldman Sachs analyst Damien Courvalin wrote in a Feb. 10 report.

Look, it should be obvious to anyone with even a basic knowledge of economics that the stage is being set for a massive financial meltdown.

This is just the kind of thing that can plunge us into a deflationary depression.  And when you combine this with the ongoing problems in Europe and in Asia, it is easy to see that a “perfect storm” is brewing on the horizon.

Sadly, a lot of people out there will choose not to believe until the day the crisis arrives.

By then, it will be too late to do anything about it.

Eight Pieces of Our Oil Price Predicament

Off the keyboard of Gail Tverberg

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Published on Our Finite World on October 22, 2014


Discuss this article at the Energy Table inside the Diner

A person might think that oil prices would be fairly stable. Prices would set themselves at a level that would be high enough for the majority of producers, so that in total producers would provide enough–but not too much–oil for the world economy. The prices would be fairly affordable for consumers. And economies around the world would grow robustly with these oil supplies, plus other energy supplies. Unfortunately, it doesn’t seem to work that way recently. Let me explain at least a few of the issues involved.

1. Oil prices are set by our networked economy.

As I have explained previously, we have a networked economy that is made up of businesses, governments, and consumers. It has grown up over time. It includes such things as laws and our international trade system. It continually re-optimizes itself, given the changing rules that we give it. In some ways, it is similar to the interconnected network that a person can build with a child’s toy.

Figure 1. Dome constructed using Leonardo Sticks

Figure 1. Dome constructed using Leonardo Sticks

Thus, these oil prices are not something that individuals consciously set. Instead, oil prices reflect a balance between available supply and the amount purchasers can afford to pay, assuming such a balance actually exists. If such a balance doesn’t exist, the lack of such a balance has the possibility of tearing apart the system.

If the compromise oil price is too high for consumers, it will cause the economy to contract, leading to economic recession, because consumers will not be forced to cut back on discretionary expenditures in order to afford oil products. This will lead to layoffs in discretionary sectors. See my post Ten Reasons Why High Oil Prices are a Problem.

If the compromise price is too low for producers, a disproportionate share of oil producers will stop producing oil. This decline in production will not happen immediately; instead it will happen over a period of years. Without enough oil, many consumers will not be able to commute to work, businesses won’t be able to transport goods, farmers won’t be able to produce food, and governments won’t be able to repair roads. The danger is that some kind of discontinuity will occur–riots, overthrown governments, or even collapse.

2. We think of inadequate supply being the number one problem with oil, and at times it may be. But at other times inadequate demand (really “inadequate affordability”) may be the number one issue. 

Back in the 2005 to 2008 period, as oil prices were increasing rapidly, supply was the major issue. With higher prices came the possibility of higher supply.

As we are seeing now, low prices can be a problem too. Low prices come from lack of affordability. For example, if many young people are without jobs, we can expect that the number of cars bought by young people and the number of miles driven by young people will be down. If countries are entering into recession, the buying of oil is likely to be down, because fewer goods are being manufactured and fewer services are being rendered.

In many ways, low prices caused by un-affordability are more dangerous than high prices. Low prices can lead to collapses of oil exporters. The Soviet Union was an oil exporter that collapsed when oil prices were down. High prices for oil usually come with economic growth (at least initially). We associate many good things with economic growth–plentiful jobs, rising home prices, and solvent banks.

3. Too much oil in too short a time can be disruptive.

US oil supply (broadly defined, including ethanol, LNG, etc.) increased by 1.2 million barrels per day in 2013, and is forecast by the EIA to increase by close to 1.5 million barrels a day in 2014. If the issue at hand were short supply, this big increase would be welcomed. But worldwide, oil consumption is forecast to increase by only 700,000 barrels per day in 2014, according to the IEA.

Dumping more oil onto the world market that it needs is likely to contribute to falling prices. (It is the excess quantity that leads to lower world oil prices; the drop in price doesn’t say anything at all about the cost of production of oil the additional oil.) There is no sign of a recent US slowdown in production either.  Figure 2 shows a chart of crude oil production from the EIA website.

Figure 2. US weekly crude oil production through October 10, as graphed by the US Energy Information Administration.

Figure 2. US weekly crude oil production through October 10, as graphed by the US Energy Information Administration.

4. The balance between supply and demand is being affected by many issues, simultaneously. 

One big issue on the demand (or affordability) side of the balance is the question of whether the growth of the world economy is slowing. Long term, we would expect diminishing returns (and thus higher cost of oil extraction) to push the world economy toward slower economic growth, as it takes more resources to produce a barrel of oil, leaving fewer resources for other purposes. The effect is providing a long-term downward push on the price on demand, and thus on price.

In the short term, though, governments can make oil products more affordable by ramping up debt availability. Conversely, the lack of debt availability can be expected to bring prices down. The big drop in oil prices in 2008 (Figure 3) seems to be at least partly debt-related. See my article, Oil Supply Limits and the Continuing Financial Crisis. Oil prices were brought back up to a more normal level by ramping up debt–increased governmental debt in the US, increased debt of many kinds in China, and Quantitative Easing, starting for the US in November 2008.

Figure 3. Oil price based on EIA data with oval pointing out the drop in oil prices, with a drop in credit outstanding.

Figure 3. Oil price based on EIA data with oval pointing out the drop in oil prices, with a drop in credit outstanding.

In recent months, oil prices have been falling. This drop in oil prices seems to coincide with a number of cutbacks in debt. The recent drop in oil prices took place after the United States began scaling back its monthly buying of securities under Quantitative Easing. Also, China’s debt level seems to be slowing. Furthermore, the growth in the US budget deficit has also slowed. See my recent post, WSJ Gets it Wrong on “Why Peak Oil Predictions Haven’t Come True”.

Another issue affecting the demand side is changes in taxes and in subsidies. A change toward more taxes such as carbon taxes, or even more taxes in general, such as the Japan’s recent increase in sales tax, tends to reduce demand, and thus give a push toward lower world oil prices. (Of course, in the area with the carbon tax, the oil price with the tax is likely to be higher, but the oil price elsewhere around the world will tend to decrease to compensate.)

Many governments of emerging market countries give subsidies to oil products. As these subsidies are lessened (for example in India and in Brazil) the effect is to raise local prices, thus reducing local oil demand. The effect on world oil prices is to lower them slightly, because of the lower demand from the countries with the reduced subsidies.

The items mentioned above all relate to demand. There are several items that affect the supply side of the balance between supply and demand.

With respect to supply, we think first of the “normal” decline in oil supply that takes place as oil fields become exhausted. New fields can be brought on line, but usually at higher cost (because of diminishing returns). The higher cost of extraction gives a long-term upward push on prices, whether or not customers can afford these prices. This conflict between higher extraction costs and affordability is the fundamental conflict we face. It is also the reason that a lot of folks are expecting (erroneously, in my view) a long-term rise in oil prices.

Businesses of course see the decline in oil from existing fields, and add new production where they can. Examples include United States shale operations, Canadian oil sands, and Iraq. This new production tends to be expensive production, when all costs are included. For example, Carbon Tracker estimates that most new oil sands projects require a price of $95 barrel to be sanctioned. Iraq needs to build out its infrastructure and secure peace in its country to greatly ramp up production. These indirect costs lead to a high per-barrel cost of oil for Iraq, even if direct costs are not high.

In the supply-demand balance, there is also the issue of oil supply that is temporarily off line, that operators would like to get back on line. Libya is one obvious example. Its production was as much as 1.8 million barrels a day in 2010. Libya is now producing 800,000 barrels a day, but was producing only 215,000 barrels a day in April. The rapid addition of Libya’s oil to the market adds to pricing disruption. Iran is another country with production it would like to get back on line.

5. Even what seems like low oil prices today (say, $85 for Brent, $80 for WTI) may not be enough to fix the world’s economic growth problems.

High oil prices are terrible for economies of oil importing countries. How much lower do they really need to be to fix the problem? Past history suggests that prices may need to be below the $40 to $50 barrel range for a reasonable level of job growth to again occur in countries that use a lot of oil in their energy mix, such as the United States, Europe, and Japan.

Figure 4. Average wages in 2012$ compared to Brent oil price, also in 2012$. Average wages are total wages based on BEA data adjusted by the CPI-Urban, divided total population. Thus, they reflect changes in the proportion of population employed as well as wage levels.

Figure 4. Average wages in 2012$ compared to Brent oil price, also in 2012$. Average wages are total wages based on BEA data adjusted by the CPI-Urban, divided total population. Thus, they reflect changes in the proportion of population employed as well as wage levels.

Thus, it appears that we can have oil prices that do a lot of damage to oil producers (say $80 to $85 per barrel), without really fixing the world’s low wage and low economic growth problem. This does not bode well for fixing our problem with prices that are too low for oil producers, but still too high for customers.

6. Saudi Arabia, and in fact nearly all oil exporters, need today’s level of exports plus high prices, to maintain their economies.

We tend to think of oil price problems from the point of view of importers of oil. In fact, oil exporters tend to be even more affected by changes in oil markets, because their economies are so oil-centered. Oil exporters need both an adequate quantity of oil exports and adequate prices for their exports. The reason adequate prices are needed is because most of the sales price of oil that is not required for investment in oil production is taken by the government as taxes. These taxes are used for a variety of purposes, including food subsidies and new desalination plants.

A couple of recent examples of countries with collapsing oil exports are Egypt and Syria. (In Figures 5 and 6, exports are the difference between production and consumption.)

Figure 5. Egypt's oil production and consumption, based on BP's 2013 Statistical Review of World Energy data.

Figure 5. Egypt’s oil production and consumption, based on BP’s 2013 Statistical Review of World Energy data.

Figure 6. Syria's oil production and consumption, based on data of the US Energy Information Administration.

Figure 6. Syria’s oil production and consumption, based on data of the US Energy Information Administration.

Saudi Arabia has had flat exports in recent years (green line in Figure 7). Saudi Arabia’s situation is better than, say, Egypt’s situation (Figure 5), but its consumption continues to rise. It needs to keep adding production of natural gas liquids, just to stay even.

Figure 7. Saudi oil production, consumption and exports based on EIA data.

Figure 7. Saudi oil production, consumption and exports based on EIA data.

As indicated previously, Saudi Arabia and other exporting countries depend on tax revenues to balance their budgets. Figure 8 shows one estimate of required oil prices for OPEC countries to balance their budgets in 2104, assuming that the quantity of exported oil is pretty much unchanged from 2013.

Figure 8. Estimate of OPEC break-even oil prices, including tax requirements by parent countries, from APICORP.

Figure 8. Estimate of OPEC break-even oil prices, including tax requirements by parent countries, from APICORP.

Based on Figure 8, Qatar and Kuwait are the only OPEC countries that would find $80 or $85 barrel oil acceptable, assuming the quantity of exports remains unchanged. If the quantity of exports drops, prices would need to be even higher.

Saudi Arabia has set aside funds that it can tap temporarily, so that it can withstand a lower oil price. Thus, it has the ability to withstand low prices for a year or two, if need be. Its recent price-cutting may be an attempt to “shake out” producers who have less-deep pockets when it comes to weathering low prices for a time. Almost any oil producer elsewhere in the world might be in that category.

7. The world really needs all existing oil production, plus more, if the world economy is to grow.

It takes oil to transport goods, and it takes oil to operate agricultural and construction equipment. Admittedly, we can cut back world production oil production with lower price, but this gets us into “a heap of trouble”. We will suddenly find ourselves less able to do the things that make the economy function. Governments will stop fixing roads. Services we take for granted, like long distance flights, will disappear.

A lot of people have a fantasy view of a world economy operating on a much smaller quantity of fossil fuels. Unfortunately, there is no way we can get there by way of a rapid drop in oil prices. In order for such a change to take place, we would have to actually figure out some kind of transition by which we could operate the world economy on a lot less fossil fuel. Meeting this goal is still a very long ways away. Many people have convinced themselves that high oil prices will help make this transition possible, but I don’t see this as happening. High prices for any kind of fuel can be expected to lead to economic contraction. If transition costs are high as well, this will make the situation worse.

The easiest way to reduce consumption of oil is by laying off workers, because making and transporting goods requires oil, and because commuting usually requires oil. As a result, the biggest effect of a cutback on oil production is likely to be huge job layoffs, far worse than in the Great Recession.

8. The cutback in oil supply due to low prices is likely to occur in unexpected ways.

When oil prices drop, most production will continue as usual for a time because wells that have already been put in place tend to produce oil for a time, with little added investment.

When oil production does stop, it won’t necessarily be from high-cost production, because relative to current market prices, a very large share of production is high-cost. What will tend to happen is that production that has already been “started” will continue, but production that is still “in the pipeline” will wither away. This means that the drop in production may be delayed for as much as a year or even two. When it does happen, it may be severe.

It is not clear exactly how oil from shale formations will fare. Producers have leased quite a bit of land, and in some cases have done imaging studies on the land. Thus, these producers have quite a bit of land available on which a share of the costs has been prepaid. Because of this prepaid nature of costs, some shale production may be able to continue, even if prices are too low to justify new investments in shale development. The question then will be whether on a going-forward basis, the operations are profitable enough to continue.

Prices for new oil development have been too low for many oil producers for many months. The cutback in investment for new production has already started taking place, as described in my post, Beginning of the End? Oil Companies Cut Back on Spending. It is quite possible that we are now reaching “peak oil,” but from a different direction than most had expected–from a situation where oil prices are too low for producers, rather than being (vastly) too high for consumers.

The lack of investment that is already occurring is buried deeply within the financial statements of individual companies, so most people are not aware of it. Dividends remain high to confuse the situation. By the time oil supply starts dropping, the situation may be badly out of hand and largely unfixable because of damage to the economy.

One big problem is that our networked economy (Figure 1) is quite inflexible. It doesn’t shrink well. Even a small amount of shrinkage looks like a major recession. If there is significant shrinkage, there is danger of collapse. We haven’t set up a new type of economy that uses less oil. We also don’t have an easy way of going backward to a prior economy, such as one that uses horses for transport. It looks like we are headed for “interesting times”.

The Fifth Horseman

Off the keyboard of Steve from Virginia

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Published on Economic Undertow on September 2, 2014


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John Maynard Keynes famously remarked, “in the long run we are all dead … ”

It is hard to tell whether Keynes had the entire United States in mind. Watching the leering, blithering president stumbling around like a drunk at a Christmas party it is clear that the country’s organizational framework is hopelessly corroded. The only question is how long is it going to last?

If you take some time away from the Internet (as I have been doing for the past few weeks) it is stunningly clear that content for the most part is aggravating noise. Every argument has fifteen sides larded over with conspiracy theories. The web is truly Hobbes’ war of all against all … with kitten videos. The major media outlets offer platefuls of propaganda-advertising disguised as ‘news stories’ while (most of) the rest churn out nonsense. The Internet enables those with modest mental horsepower but with co-optable ideology to disrupt/distract everyone else. Common purpose — reality — is confined to the obscure corners where the bulk of users idiots can’t be bothered to look.

— Moral clarity versus the president’s bumbling duplicity. Events of the past year or so indicate that the West has reached the end of the ‘Age of Expedients’ and entering the far more demanding ‘Age of Consequences’.
Civilization advances by way of the general increase in of the distribution of information. We humans invented language first to coordinate our activities as hunters, then to confuse our (ballooning numbers of) enemies. Prior to Johannes Gutenberg, there was the spoken word and hand copied manuscripts. Due to the labor cost of copyists, the Catholic Church was able to maintain a +1,000 year monopoly over information. The churchmen had access along with elites, the ordinary citizens were left ignorant, with edicts from above and superstitions.

Post- Gutenberg, information cost no more than ink on paper; it could not be hoarded and so the monopoly of the priests and bishops was ended. Because information on a page could be filed and accumulated, the amount of information within the reach of a literate person exploded … along with the numbers of literate persons! As an unintended consequence, the human capacity for memory and the oral tradition became diminished, then largely disappeared. It was unnecessary to recall Beowulf from memory, only remember where to find it on a shelf.

Fast forward and with the Internet has arrived with the thump-and-drag of the one-legged John Silver. The quality of information has relentlessly deteriorated even as it has become ubiquitous. Our smart phones know in advance what we want for dinner or where to park but nothing tells us what is really happening with our country! The information we need to thrive … or even survive … does not fall to hand. With the incoming tides of ‘trivinformation’ comes a decreasing ability to comprehend. We have no need to learn because we can find an app that does it for us. As a consequence … we have become bereft of the ability to make good judgements. We equivocate, rationalize every evil, we compartmentalize … our moral compasses are shut off, we drink the Kool-Aid and beg for more. With time, appreciation for all non-consumable things vanishes because our capacity for empathy is exhausted, what remains is the immediate-term stimulus of acquisition and little else. We have come full circle; from beasts, to partly civilized due to our mastery of spoken language, to print-educated, civilized literates … to machine-dependent incompetents and back to beasts. Consequences emerge to take the form of a post-Warholian dark age of electronic dazzle; the deathly white light where Candy Crush™ stands as equal to Milton. We have become our appetites and nothing more …


Triangle of Doom 090114

The fearsome and relentless Trianglial of Doom, no mincing words here or cacophony; this is the chart that kicks the modern world in the balls and leaves it gasping, by TFC Charts (click for big). With two major wars and a handful of minor ones in petroleum producing regions the present price movement is unexpectedly down. Our precious wars are bankrupting the world’s customers faster than the same wars can adversely affect oil supply. Add one more war or two and the entire world oil extraction enterprise will shut down due to insufficient funds!

Witness the change of age: The Age of Expedients => wars raise oil prices and increase profits; becomes the Age of Consequences => wars bankrupt countries so that they cannot bid for petroleum => the drillers become destitute => leaving everyone without petroleum.

Economists fail to grasp that people (in aggregate) can indeed go broke. In our world of nearly unlimited finance credit, there seems to be no end to money. This leads economists into believing that there is likewise no end to other things. That when liquid fuels run out the world can turn to ‘something else’ and use it as replacement … something like common rocks: if the price is right the rocks will become fuel. In a world of endless money, individuals or firms can be marooned without funds but others will ‘gain theirs’ and by doing so have enough to provide a market. Here is the triumph of hopeful expectations over common sense: funds are nothing more than promises made against (often faulty) expectations. Those whose promises prove empty are bereft of funds, not the other way around. In the Age of Expedients, adding credit => meant more funds available to spend on capital. In the Age of Consequences, adding credit => bankrupts the system with credit costs => there are less funds available to spend on capital. There are less funds because existing claims are exposed as worthless faster than new claims can be created.

Economists have problems with costs because individuals and firms have been so clever in shifting them to unsuspecting ‘others’ across the economic ambit. To the economist, ‘shifted costs’ are little different from ‘no cost at all’. Because he refuses to consider the externalized costs or trivializes them, the economist does not believe there is capital depletion. In the Age of Expedients more capital can be gained by drilling more holes, in the Age of Consequences the costs of holes added to the costs of credit become become breaking => adding more (costly) holes does not add more capital.

Here, ‘capital’ always means non-renewable resources; capital the basis of all of our so-called ‘production’ (which is really extraction and waste).

In the Age of Expedients, costs are shifted forward by multiples of generations so that great-grandchildren are on the hook for yesterdays’ generations’ waste. The economist blithely assumes that the future will be avoided with time machines or other technological whizmos that somehow denature consequences. Else, he is the cynic, realizing that the future is irrelevant because he, like others in the ‘long run’ will be dead: that consequences are someone else’s problem.

In the Age of Expedients, certain direct actions produced certain predictable results. Rattling the sabers in the Middle East was always good for a ten-dollar pop in the price of crude. Building a road would generate more real estate- and retail ‘growth’. Lowered interest rates would generate more borrowing and spending, it would trigger needed inflation … that fighting a real war would stimulate the economy and increase ‘growth’. Growth is the reason behind the state of perpetual war that has occupied the United States since the end of World War Two. In the Age of Expedients, there is no penalty for stupidity, all of it contributes to GDP.

In the Age of Consequences, actions produce … consequences. The future becomes the present bringing demands for repayment of old debts that cannot be retired with new loans. The toxic waste of prior generations becomes a problem we cannot move away from. Wars are likewise too costly to fight, there is no growth to give nations second chances at ‘victory’. Instead, the consequence of defeat is permanent devastation. Waste-infrastructure does not add anything but to the burdens of debt repayment which in turn are stranded as the infrastructure is fundamentally non-remunerative. Perpetual war = national suicide; stupidity now has dire consequences. The non-linear shift from expedients to consequences emerges as a perilous Fifth Horseman: every habit we have learned during the Age of Expedients is now set to work with deadly effect against us; the time to learn new habits simply does not exist.

The War Against Labor

The businessman’s class war against labor began with the flowering of US industry during the 19th century. The Long Depression in the late-19th century as well as the 1930’s Great Depression were class wars. During the latter, the citizens fought the tycoons with the one instrument that the rich had left them: their refusal to spend their money. Instead, they held onto it, giving bits of paper value while denying it to the tycoons. Prior to the Depression, the country’s industrial laborers had vented upon them every sort of abuse, and then the full fury of militarized authority: clubs and bats of strikebreakers and Pinkertons, knives in the dark from goons and machine gun bullets from the Army. All of this failed, yet by their refusing to spend, by keeping clear of finance industry speculations, the public starved the tycoons who could not meet the service expense of their own enormous debts; the tycoons and American-style capitalism became wraiths.

The citizens would have destroyed capitalism save for the rise of the powers in the East and the desire on the part of government to accommodate the industrialists … the government needed the products of industry to engage in World War Two. The reader can come to his- or her own conclusion as to the economic necessity for the war and the roles played by the industrialists in enabling Hitler, Stalin and the Japanese in the first place.

After the war came the crusade against Communism. This crusade was of a piece with the prior labor struggles. In America, ‘Communism’ has always been a code word for labor agitation as well as civil rights for blacks. As during the previous periods of labor strife, the crusade against ‘Communism’ was dark and violent. As Hedges indicates, institutions as well as reputations were destroyed by public witch-hunts, overseas, the US pursued a series of ruinous yet inconclusive wars. When the Soviet Union collapsed — undone by the failure of its agriculture — and China took the path to Las Vegas style ‘reform’, there was no more Communism, no ‘enemy’ that could be superimposed upon the what remained of organized labor. Keeping in mind that by the time of Communism’s decline and fall, these remains had been thoroughly co-opted by mafia criminals, undone by endless ‘investigations’ and rendered impotent from the inside by union corruption. In place of the Communist boogeyman came the ‘terrorist’.


The Man in Black, is he a terrorist murderer … or a Navy Seal? Who can say for sure? The government will not tell you only the examination of US interests gives the game away.

In the twilight of empire the US tries again and again to enrage the citizens against the boogeymen it creates by itself; what better, cheaper way to buy some cheap rage than to cut off a man’s head on television? Already there are Americans fighting again in Iraq, the third (or fourth) attempt to impose our will on that country. Besides attempting to push up the price of crude, the purpose of our wars is to elevate the price of Boeing, Raytheon, General Dynamics, Northrup-Grumman, Oshkosh, etc. shares. Without perpetual war there are few perpetual defense industry profits, no need for half of the country’s discretionary spending to flow toward the military, and from there to our precious hedge fund managers (gangsters).

In the Age of Consequences, success = failure, assets are now liabilities. There is little on the way to mark the change, certainly nothing discernible in the media or the Internet scramble. Instead of rage and fury, the Fifth Horseman ‘non-linearity’ steals in on little cat feet. We are obsessed with the increase in growth, we equate this with success … not realizing that very same success has instantly become a deadly poison. Make quick, now; sell more cars and build more freeways, towers, bridges as this process of selling and building is the means by which the car-and-tower building monster annihilates itself.


Lies, Damn Lies & STOCHASTICS

Off the keyboard of John Ward

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Published on The Slog on August 15, 2014

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Taking stock of market stochastics

So here I sit, in my kitchen, at 8.30 pm CET, noting that the sunsets are getting earlier. But the temperature is that normally associated with May – whereas in May, we had the sort of temperatures one expects in July. In late March/early April it was like August. January this year was similar to September. The pool temperature is a chilly 19 degrees. God, isn’t life a bitch?

It could well be that someone on the commodity markets – in league with the Pentagon – is shuffling the weather deck with a view to making vast virtual profits from the physical death of millions. Or, on the other hand, it could just be that weather glitches do not a climate change make, and that weather is a stochastic sort of thing.

There’s a word you’ve heard from time to time, and then forgotten – or looked up, and then forgotten what it means. ‘Stochastic’ is one of those words that comes into vogue now and then among the commentariat: like gestalt, eclectic, tendentious, inchoate, mnemonic and – one of my favourites – systemic. At University, my Liberal Democratic Theory tutor (a Welshman disabled by eccentric pronunciation of English ) used that last word all the time, and for the first two terms of our Fresher year there was much debate in the Arts Lab coffee lounge as to WTF it was.

WTF it was went much deeper than WTF it meant: we didn’t even know how it was spelt. And if you don’t know how something is spelt, you can’t look up what it means. This is the ultimate jean-creaming aim of all those pretentious folks who use such words: to bamboozle, and thus control. (There is a very good US site devoted to PAWS – Pompous Ass Words)

The first time I heard the word stochastic was in a market research meeting about thirty years ago, except it was in the plural – as in, stochastics. Doing this gives any word added scientific credibility, because the addition of the ‘s’ makes it a field of venerable analysis: as in electronics, media studies, aeronautics and so forth. There’s just one problem with the analysis of stochastic stuff: it defies analysis, because it is completely random.

The dictionary definition of stochastic is not at all stochastic. It states that stochastic phenomena have ‘a random probability distribution or pattern that may be analysed statistically but may not be predicted precisely’.

Isn’t that a belter? Not predicted precisely. This is the scientific equivalent of a politician saying “Not as such”. Let’s get real here, stochastic means ‘unpredictable’. Unpredictable means “You can’t f**king predict it”.

And yet, here are all these onanists engaged in applying statistical probability to the unpredictable. Onanism, by the way, is another of those PAWS, and it means wanking.

Let’s jerk off a little more now and get into the stochastic variable a variable quantity that is random. Financial, commodity and futures markets are full to bursting with people doing what humans always do in the end: try to control that which they cannot control. Thus, in the technical analysis of securities trading, the stochastic oscillator is a momentum indicator that uses support and resistance levels. Dr. George Lane promoted this indicator in the 1950s. It attempts to predict price turning points by comparing the closing price of a security to its price range. The indicator is defined like this:

%K = 100 *(Price-L5)/(H5-L5)
%D  =  100*H3/L3

Well of course it is, for heaven’s sake. Stands to reason, squire. Except, of course, that if a variable quantity is random, it could go up to $1980.35, or down to a dime. Further, if you have the Fed Reserve and the Bank of England pumping not so much unpredictability as directionalised cheating into, say, the Dow Jones Index, then investment in that sector is what we seasoned stochasticians call A Mug’s Game. Had one applied stochastic analysis to the gold market since 2010, for example, by now one would almost certainly have gone blind.

Google the term ‘stochastics’ (2.54m results) and you will find details of stochastic oscillator seminars, conferences about stochastically matching markets, the Infinite Dimensional Stochastic Analysis Perspective René Carmona, stochastic uniform market price formulae, and even a Local Stability Analysis of a Stochastic Evolutionary Financial Market Model with a Risk-free Asset.

FFS guys, get real: stochastic means ‘God knows what’s going to happen’. Applying words like uniform, formula, risk-free and matching is merely another version of the sad bastard gambling his fortune away in Monte Carlo, still convinced that he is but millimetres away from perfecting A System. Or as my tutor at Uni might have said, “The whole point about something stochastic is that it isn’t systemic”.

Two things will, ultimately, render all formulae and process redundant: left-field ideas, and unforeseen events. Homo sapiens has an insatiable desire to control, and to triumph over that of which it doesn’t approve. This is, I suspect, what makes us such a nuisance as a species.

Low Oil Prices Lead to Economic Peak Oil

Off the keyboard of Gail Tverberg

Published on Our Finite World on April 21, 2013

Discuss this article at the Energy Table inside the Diner

We have all heard the story about oil supply supposedly rising and falling for geological reasons. But what if the story is a little different from this–oil production rises and falls for economic reasons? If this is the issue, it doesn’t really matter how much oil is in the ground. What matters is if economic conditions are “right” for continued and rising extraction. I have shown in previous posts that oil prices that are too high are a problem for oil importers while oil prices that are too low are a problem for oil exporters. As a result, oil prices need to be in a Goldilocks zone, or we have serious problems, of one sort or another.

As long as the price of oil keeps rising, there is at least some chance the amount of oil extracted each year will keep rising, because more oil resources will become economic to extract. The real problem arises when oil price falls back from a price level it has held, as it has done recently, and as it did back in July 2008. Then there is a real chance that investment will become non-economic, and because of this, oil production will fall.

Figure 1. World crude oil price and production, based on monthly EIA data.Figure 1. World crude oil price and production, based on monthly EIA data.The corresponding price in late April is approximately $100 barrel, so is even lower yet.

Oil prices play multiple roles:

  1. High oil prices encourage extraction from more difficult locations, because the higher cost covers the additional extraction costs.
  2. High oil prices allow exporters to have adequate money to pacify their populations, even if their oil exports have been declining, as they have been for many exporters.
  3. High oil prices allow funds for investment in new oil fields, as old ones deplete.
  4. High oil prices tend to put oil importing countries into recession, because it raises the costs of goods and services produced, without raising the salaries of the workers. In fact, there is evidence that high oil prices lower wages (both directly and through lower workforce participation).
  5. High oil prices make countries that use large amounts of oil less competitive with countries that use less fuel in general, and less oil in particular.

When oil prices decline, it is evidence that Items 4 and 5 above are outweighing Items 1, 2, and 3.  This tips the scale in the direction of a fall in oil production.

Debt also affects oil prices. As long as investors have faith that businesses can make money, despite high oil prices, they will continue to borrow to expand their businesses. This additional debt helps drive up demand for goods and services of all kinds, including oil, so oil prices rise. Also, if consumers are able to borrow increasing amounts of money, this also drives up demand for goods that use oil, such as cars. But once the debt bubble bursts, it is easy for oil prices fall very far, very fast, as they did in 2008.

If we look at the 2008 situation, oil limits were very much behind the overall problem, even though most people do not recognize this connection. It was the fact that oil limits eventually led to credit limits that caused the system (including oil prices) to crash as it did. High oil prices led to debt defaults and bank write offs, and eventually led to a huge credit contraction in economies of the developed world. This credit contraction affected not just oil demand, but demand for other energy products as well.

The problems of the 2008 period were never really solved: the lack of growth in world oil supply remains, and this lack of growth in world oil supply continues to hold back world economic growth, particularly in developed countries. We recently have not been feeling the effects as much, because with deficit spending, the problems have largely moved from the private sector to the government sector.

The situation remains a tinderbox, however. The financial situation is propped up by ultra-low interest rates, continued government deficit spending, and Quantitative Easing. In a finite world, debt growth cannot continue indefinitely. But if debt growth permanently stops, and switches to contraction, we would end up in an even worse financial mess than in 2008. In fact, such a change would very likely to would lead to a contraction of “Limits to Growth” proportions.

In this post, I will explain some of these issues further.


The Rise and Fall of Oil Prices in 2008

In Figure 1 (near the top of this post), a person can see huge swings in oil prices, with virtually no change in oil production. If the scale on oil production is modified as in Figure 2 below, a person can see that indeed, oil prices and oil production do to some extent vary together.
Figure 2. World crude oil production and Brent oil prices, based on monthly EIA data, with different scale for oil production.Figure 2. World crude oil production and Brent oil prices, based on monthly EIA data, with different scale for oil production.

If we look at world oil production and price between January 1998 and July 2008 on an X-Y graph, we see that as long as oil demand stayed below 71 million barrels a day, oil price stayed low (Figure 3, below). But once demand started to push above that level, oil price started to rise rapidly, with little increase in production. It was as if a brick wall on oil supply had been hit. No matter how much the oil price rose, virtually no more production was available.

Figure 3. X-Y graph of world of monthly world oil production and price data, based on the EIA data shown in Figures 1 and 2. Figure 3. X-Y graph of world of monthly world oil production and price data, based on the EIA data shown in Figures 1 and 2.

If we look at an X-Y graph of the non-OPEC portion of oil supply, we see that the situation was even worse for the non-OPEC portion (Figure 4, below). The amount of oil that could be produced at a given price had actually begun to fall back. While in 2003 and 2004, non-OPEC had been able to produce 42 million barrels a day for only $30 barrel, by 2008, non-OPEC could not reach 42 million barrels a day, no matter how high the price. It looked as though non-OPEC had hit “peak oil” production. Geological limits appeared to have the upper hand.

Figure 4. X-Y graph of world of non-OPEC world oil production and price data, based on EIA data.Figure 4. X-Y graph of world of non-OPEC world oil production and price data, based on EIA data.

Fortunately, during this period OPEC was able to raise its production somewhat, in response to higher prices, as illustrated in Figure 5, below. Between July 2007 and July 2008, it was able to raise oil production by 2.1 million barrels a day, in response to a $56 dollar a barrel increase in price in a one-year time-period. (The small increase in response to a huge price rise suggests that OPEC’s spare capacity was not nearly as great as claimed, however.)

Figure 5. X-Y Graph of OPEC oil production and price, based on EIA data.Figure 5. X-Y Graph of OPEC oil production and price, based on EIA data.

What brought about the collapse in oil prices in July 2008? I believe it was ultimately a financial limit that was reached that eventually worked its way to the credit markets. Once the credit markets were affected, individuals and businesses were not able to borrow as much, and it was this lack of credit that cut back demand for many types of products, including oil.

The way this cutback in credit came about was as follows: Oil prices had been rising for a very long time–since about 2003, affecting the inflation rate in food and fuel prices. The Federal Reserve Open Market Committee tried (unsuccessfully) to get oil prices down by raising target interest rates. I describe this in an article published in the journal Energy called, “Oil Supply Limits and the Continuing Financial Crisis,” available here or here.  The combination of high oil prices and higher interest rates led to falling housing prices starting in 2006 (big oops for the Federal Reserve), and debt defaults, particularly among the most vulnerable (those with sub-price mortgages). As early as 2007, large banks had large debt write-offs, lowering their appetite for more debt of questionable quality. Total US household mortgage debt reached its maximum point on June 30, 2008, and began to fall the following quarter.

Figure 6. US Mortgage Debt Outstanding, based on Federal Reserve Z1 Report. Figure 6. US Mortgage Debt Outstanding, based on Federal Reserve Z1 Report.

By July 2008, the financial problems of consumers in response to high oil prices and falling housing prices had transferred to other credit markets as well. Revolving credit outstanding (mostly credit card debt), hit a maximum in July 2008, and has not recovered (Figure 7 below). (July 2008 is exactly the same month as oil prices began to fall!) Non-revolving credit, such as auto loans, hit a maximum in the same month.

Figure 7. US Revolving Debt Outstanding (mostly credit card debt) based on monthly data of the Federal Reserve.Figure 7. US Revolving Debt Outstanding (mostly credit card debt) based on monthly data of the Federal Reserve.

Credit issues kept getting worse. The Federal takeover of Fannie Mae and Freddie Mac took place in September 2008, as did the bankruptcy of Lehman Brothers. By late 2008, cutbacks in credit had spread to businesses including all sectors of the energy industry. I wrote an article on December 1, 2008, documenting that credit issues led to lower prices not only for oil, but for coal, natural gas, nuclear, and renewables as well.

The reason why a cutback in credit availability is a problem is because it is very difficult to buy a new car or home, or to finance a new business operation, if credit isn’t available. In fact, the amount a business or family can spend depends on the sum of their income during a period, plus the amount of additional debt they take on during that period. If the amount of debt outstanding is going down, then, for example, old credit card debt is being paid down faster than new credit card is being added, and the amount currently spent is lower.

The Federal Government tried to fix the situation by running larger deficits  (Figure 8), starting the very next quarter after oil prices hit a peak and started declining.

Figure 8. US Federal Debt, from Federal Reserve Z-1 Report. (Excludes debt owed to Social Security and other Federal programs.) Figure 8. US Federal Debt, from Federal Reserve Z-1 Report. (Excludes debt owed to Social Security and other Federal programs.)

Oil prices rose again starting in 2009 as demand outside the US, Europe, and Japan continued to grow. By 2011, high oil prices were back. The economies of US, Europe and Japan did not bounce back to the kind of economic growth most expected, because at high oil prices, their products were not competitive in a world marketplace that relied on an energy mix that was slanted more toward coal (which is cheaper), and also offered lower wages.

In 2013, world oil supply is still constrained.

It is easy to get the idea from news reports that everything is rosy, but the story presented to us is painted to look much better than it really is. Production from existing sites is constantly depleting. In order to replace declining production, huge investment must be made in new productive capacity. It is as if oil producers must keep running, just to stay in place.

Part of the problem is that the cost of new capacity keeps escalating. I have called this the Investment Sinkhole Problem. The Financial Times describes the problem as Energy: More Buck, Less Bang.

Cash flow has historically financed much investment. Now we read, Energy Industry Struggling to Generate Free Cash Flow.

Many naive people believe Saudi Arabia’s stories about their “productive capacity” of 12.5 million barrels a day, but their maximum crude and condensate production in recent years has been only been 10,040,000, according to the EIA. Their recent production has been only a little over 9 million barrels a day in recent months, according to OPEC Monthly Oil Market Report.

Iraq is supposed to be the great hope for future oil production, yet it increasingly seems to be stumbling toward civil war.

Russia is now the largest oil producer in the world, with a little over 10.0 million barrels a day of crude and condensate production.   According to a Russian analyst,”Gas condensate production is the real driver behind the [recent] growth. Crude oil output is falling and organic growth currently is impossible.”

What we tend to hear a lot about is US tight oil possibilities (Figure 9).
Figure 9. US crude oil production, based on EIA data. 2012 data estimated based on partial year data. Tight oil split is author's estimate based on state distribution of oil supply increases.Figure 9. US crude oil production, based on EIA data. 2012 data estimated based on partial year data. Tight oil split is author’s estimate based on state distribution of oil supply increases.

Admittedly, tight oil production has ramped up quickly. But it is an expensive technology, that requires a high oil price, and lots upfront investment. There is evidence that such oil is concentrated in “sweet spots” and these get tapped out quickly. In North Dakota, the earliest area for US tight oil extraction, rig count is down from 203 at the beginning of June, 2012, to 176 at April 19, 2013, according to Baker Hughes. Lynn Helms, Director of the North Dakota Department of Mineral Services gave this explanation, “Rapidly escalating costs have consumed capital spending budgets faster than many companies anticipated and uncertainty surrounding future federal policies on hydraulic fracturing is impacting capital investment decisions.” Meanwhile, North Dakota oil production has recently been flat–perhaps because of weather; perhaps because of other issues as well.

The ramp-up in US crude oil production amounted to 812,000 barrels a day in 2012–very small in comparison to world crude oil needs. World oil production, shown in Figures 1 and 2, is barely affected. In a world with 7 billion people, most of whom would like vehicles, the amount of oil supply being added is tiny.

In 2013, the financial problems of the United States, the Euro-zone, and Japan haven’t gone away.

Current high oil prices make the big oil-importing countries less competitive. It is hard to compete with countries with lower average fuel costs, thanks a mix that it much heavier on coal, and lighter on oil.  A graph of oil consumption shows that oil is increasingly going to the Rest of the World, rather than the US, EU, and Japan (Figure 10).

Figure 10. Oil consumption by part of the world, based on EIA data. 2012 world consumption data estimated based on world "all liquids" production amounts.Figure 10. Oil consumption by part of the world, based on EIA data. 2012 world consumption data estimated based on world “all liquids” production amounts.

The countries that see little growth in oil consumption are the same ones struggling with low economic growth. Low economic growth makes debt very difficult to repay. Governments are tempted to add more debt, to try to fix their problems.

Tackling government debt problems in 2013 tends to bring recession back.

The big problem when oil prices rise is that workers’ discretionary income is squeezed, because their wages don’t rise at the same time. This problem can somewhat be offset by deficit spending of governments for programs to help the unemployed, and for stimulus.

Once taxes are raised, or benefits are cut, the old problem of lower discretionary income for workers reappears. Thus, the recession that governments so cleverly found a way around previously, re-emerges.

In 2005, there was a very sharp impact to oil prices when high oil prices indirectly affected the credit system.  This time, a big issue is rising government taxes and lower benefits. These are staggered in their implementation, so the effect feeds in more slowly.  Greece and Spain started their cut-backs early. The US raised Social Security taxes by 2% of wages, as of January 1, 2013. Later it added sequester cuts. All of these effects feed in slowly, and add up.

With respect to debt, in 2013  we are rapidly approaching the time when this time truly is different.

There has been a great deal in the press about a mistake Rienhart and Rogoff recently made in their book, This Time Is Different. I think Rienhart and Rogoff, as well as economists in general, have missed an issue that is much more basic: In a finite world, debt, like anything else, cannot keep growing. The economy (whether economists realize it or not) depends on physical resources, and these are in limited supply. One piece of evidence with respect to the limited supply of oil is the fact that the cost of its extraction keeps rising. This means that fewer resources are available to be used for making other goods and services.

I show in my paper, Oil Supply Limits and the Continuing Financial Crisis, that lower economic growth rates make debt harder to repay. Reinhart and Rogoff seem to confirm this relationship works in practice. In their NBER paper, “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises,” they make the observation, “It is notable that the non-defaulters, by and large, are all hugely successful growth stories.”(They did not seem to understand why, though!)

The 2007-2009 recession partially brought the level of debt down, outside the government sector. Government debt has been ramping up rapidly because tax revenues are down and benefits are up (Figure 8).

Figure 11. US Debt by Sector, based on Federal Reserve Z.1 data.Figure 11. US Debt by Sector, based on Federal Reserve Z.1 data. (Amounts shown exclude government debt that is not publicly held.)

Government debt helps take the place of “missing” debt from other sectors (at least in theory). Now government debt is above acceptable levels. US debt is around 100% of GDP, and growing each quarter.

Without rapid economic growth, only a small portion of the debt that remains can be repaid. If increases in taxes/cutback in benefits leave more without work,  a new round of debt defaults can be expected. Student loans are particularly at risk. Business loans maybe a problem as well, especially in discretionary industries. Government debt is likely to be a problem, especially for states and municipalities. Banks may again have financial problems, especially if they have exposure to debt from other countries, or student loans.

I am not certain what will happen to the huge amount of US government debt, if Quantitative Easing ever stops. The same might be said of the debt of all of the other countries doing quantitative easing. Who will buy the debt? And at what interest rate? If the interest rate rises, there will be a huge problem, because suddenly loans of all types will have higher interest rates. Governments will need higher taxes yet, to pay their debts. It will be hard to sell cars with higher interest rates on debt. Home prices will likely drop, because fewer people can afford to buy homes with higher interest rates.

I showed in Reaching Debt Limits what a big difference increases in household debt can make to per capita income (Figure 12).

Figure 12. Per capita wages (excluding government wages) similar to Figure 5. Also, the sum of per capita wages and the increase in household debt, also on a per-capita basis, and also increased to 2012$ level using the CPI-Urban. Amounts from US BEA Table 2.1 and Federal Reserve Z1 Report.Figure 12. Per capita wages (excluding government wages) similar to Figure 5. Also, the sum of per capita wages and the increase in household debt, also on a per-capita basis, and also increased to 2012$ level using the CPI-Urban. Amounts from US BEA Table 2.1 and Federal Reserve Z1 Report.

If debt starts long-term contraction, we will truly have a mess on our hands. Businesses will have a hard time investing. Individuals will have a hard time buying big-ticket items, like cars, furniture, and houses. Demand for all types of goods and services will fall. I showed in my post Why Malthus Got His Forecast Wrong that increasing debt was what allowed rapid growth in fossil fuel use. If debt stops growing and starts shrinking, we will get to see the reverse of this phenomenon.

What is Ahead?

Lower oil prices indicate that demand is declining. (The cost of extraction is not lower!) Lower oil demand seems to be related to poorer earnings reports for the first quarter of 2013, which in turn is at least partly related to the increase in US Social Security taxes withheld, starting January 1, 2013.  Nothing will necessarily happen quickly, but by next quarter’s earnings reports, some of the “sequester” cuts will be added to the cuts. Businesses with poor earnings are likely to lay off workers, and those workers will file for unemployment benefits. Gradually, we will see increasing evidence of recession.

It is not clear that this time will necessarily lead to the “all time” switch to long-term debt contraction, but it will bring us one step closer, at least in US, and probably in Europe and Japan as well. Oil supply may not drop very much, very quickly. If we are lucky, demand will bounce back and bring prices back up, as in 2009-2010. But with all of the debt problems around the world, it is possible that a contagion will begin, and defaults in one country will spread to other countries. This is what is truly frightening.

Peak Oil Demand Destruction

Off the keyboard of Gail Tverberg

Published on Our Finite World on April 11, 2013

Discuss this article at the Energy Table inside the Diner

We in the United States, the Euro-zone, and Japan are already past peak oil demand. Oil demand has to do with how much oil we can afford. Many of the developed nations are not able to outbid the developing nations when it comes to the world’s limited oil supply. A chart of oil consumption shows that oil consumption peaked for the combination of the United States, EU-27, and Japan in 2005 (Figure 1).

Figure 1. Oil consumption by part of the world, based on EIA data. 2012 world consumption data estimated based on world "all liquids" production amounts.Figure 1. Oil consumption by part of the world, based on EIA data. 2012 world consumption data estimated based on world “all liquids” production amounts.

We can see an even more pronounced version of this pattern if we look at the oil consumption of the five countries known as the PIIGS in Europe: Portugal, Italy, Ireland, Greece, and Spain. All of these countries have had serious declines in oil consumption in recent years, as high oil prices have impeded their economies.

Figure 2. Oil consumption for Portugal, Italy, Ireland, Greece, and Spain, based on EIA data.Figure 2. Oil consumption for Portugal, Italy, Ireland, Greece, and Spain, based on EIA data.

Oil consumption for the PIIGS in total hit its highest level in 2004, before the decline began. Peak oil consumption by country varied a bit: Portugal, 2002; Italy, declining since 1995; Ireland, peak in 2007; Spain, peak in 2007; Greece, peak in 2006.

Peak demand is very much related to jobs. Peak oil demand occurs when a country is not competitive in the world market-place, and because of this, loses industry and jobs. One reason this happens is because the country’s energy cost structure is not competitive in the world market-place. With the run-up in oil prices starting about 2003, oil is by far the most expensive of the traditional energy sources we have available today. Countries that use a large percentage of oil in their energy mix can be expected to have a hard time competing, because of oil’s higher cost.

Figure 3. Oil consumption as percentage of energy consumption for selected countries, based on BP's 2012 Statistical Review of World Energy.Figure 3. Oil consumption as percentage of energy consumption for selected countries, based on BP’s 2012 Statistical Review of World Energy.

Anything else that is done which raises costs for businesses will also have an impact. This would include “carbon taxes,” if competitors do not have them, and if there is no tariff on imported goods to reflect carbon inputs.

High-cost renewables can also have an adverse impact, regardless of whether the cost is borne by businesses, consumers or the government.

  • If the cost is borne by businesses, those businesses must raise their prices to keep the same profit margins, and because of this become less competitive.
  • If the cost is borne by consumers, those consumers will cut back on discretionary expenditures, in order to balance their budgets. This is likely to mean  a cutback in demand for discretionary goods by local consumers.
  • If the government bears the cost, it still must pass the cost back to businesses or consumers, and thus reduce competitiveness because of higher tax costs.

This importance of competitiveness holds, no matter how worthy a given approach is. If costs were “externalized” before, and are now borne by the local system, it makes the local system less competitive. For example, putting in proper pollution controls will make local industry less competitive, if the competition is Chinese industry, acting without such  controls.

One issue in competitiveness is wage levels. Wages in turn are related to standards of living. In a global economy, countries with higher wage levels for workers, and higher benefit levels for workers (such as health insurance and pensions) will be at a competitive disadvantage. Countries that use coal as their prime source of energy will be at an advantage, because workers’ wages will tend to “go farther” in heating their homes and buying electricity.

Countries that are warm in the winter will be at a competitive advantage, because homes don’t have to be built as sturdily, and don’t have to be heated in winter. Workers can commute by bicycle even in the coldest weather.

Energy usage (all types combined, not just oil) is far higher in cold countries than it is in warm wet countries. Countries that extract oil also tend to be high users of energy.

Figure 4. Per capita energy consumption for selected countries for the year 2010, based on EIA data.Figure 4. Per capita energy consumption for selected countries for the year 2010, based on EIA data.

The difference in per capita energy usage among the various countries is truly astounding. For example, Bangladesh’s per capita energy consumption is slightly less than 2% of US energy consumption. This difference in energy consumption means that salaries can be much lower, and thus products made in Bangladesh can be much cheaper, than those made in the United States. This is part of our competitiveness problem, even apart from the energy mix problem mentioned earlier.

In my view, globalization brought on many of our current problems. Perhaps globalization could not be avoided, but we should have foreseen the problems. We could have put tariffs in place to make a more level playing field.  See my post, Twelve Reasons Why Globalization is a Huge Problem.

Inadequate world oil supply isn’t exactly the problem. The issue is far more that the price of oil extraction is rising.  The price of oil extraction is rising for a variety of reasons, an important one being that we extracted the easy to extract oil first, and what is left is more expensive to extract. Another issue is that oil exporters now have large populations that need to be kept fed and clothed, so they don’t revolt. This is a separate issue, that raises costs, even above the direct cost of extraction. There is no reason to believe that these costs will level off or fall, no matter how much oil the US produces using high-priced methods, such as fracking.

When oil prices rise, wages don’t rise at the same time. In fact, in the US there is evidence  that wages stagnate when oil prices are high, partly because fewer are employed, and partly because the wages of those employed flatten.

Figure 5. High oil prices are associated with depressed wages. Oil price through 2011 from BP’s 2012 Statistical Review of World Energy, updated to 2012 using EIA data and CPI-Urban from BLS. Average wages calculated by dividing Private Industry wages from US BEA Table 2.1 by US population, and bringing to 2012 cost level using CPI-Urban.Figure 5. High oil prices are associated with depressed wages. Oil price through 2011 from BP’s 2012 Statistical Review of World Energy, updated to 2012 using EIA data and CPI-Urban from BLS. Average wages calculated by dividing Private Industry wages from US BEA Table 2.1 by US population, and bringing to 2012 cost level using CPI-Urban.

The countries that are most affected by rising oil prices are the countries that use oil to the greatest extent in their mix of energy products. In Figure 3, that would be the PIIGS. The rest of the US, EU-27, and Japan would be next in line.

When oil prices rise, consumers need to balance their budgets. The price of oil products and food rises, so they cut back on discretionary items.  Their smaller purchases of discretionary goods and services means that workers in discretionary sectors get laid off.

Businesses find that the price of oil used in manufacturing and shipping their products has risen. If they raise the sales price of the goods to reflect their higher costs, it means that fewer people can afford their products. This too, leads to cutbacks in sales, and layoffs of workers. Sometimes businesses decide to outsource production to a cheaper country, or use more automation, as a way of mitigating the cost increases that higher oil prices add, but automation or outsourcing also tends to reduce US wages.

The net effect of all of these changes is that there are fewer workers with jobs in the countries with high oil usage. This reduces the demand for oil in the high oil usage countries, both from business owners making goods and from the consumers who might use gasoline to drive their cars. This price mechanism is part of what leads to the oil consumption shift we see in Figure 1.

We are dealing with is close to a zero-sum game, when it comes to oil supply. The amount of oil that is extracted from the ground is almost constant (very slightly increasing for the world in total). If prices stayed at the low level they were in the past (say $20 barrel), there would not be enough to go around. Instead, higher prices redistribute oil to countries that can use it manufacture goods at low overall cost. Workers in factories making these goods are then able to afford to buy goods that use oil, such as a motor scooter.

Citigroup recently released a report titled, “Global Oil Demand Growth, – the End is Nigh.” Its subtitle says,

The substitution of natural gas for oil combined with increasing fuel economy means oil demand is approaching a tipping point.

This is out-and-out baloney, for a number of reasons:

1. There are way too many of “them” compared to the number of “us,” for energy efficiency to make even a dent in our problem.

2. When we look at past oil consumption, changes in vehicle energy efficiency did not make a big difference.

3. Substituting natural gas for oil still leaves cost levels for the US, Europe, and Japan very high, compared to those for the rest of the world, where little energy is used.

4. There are really separate markets in many parts of the globe. Our market is collapsing because of high price. Perhaps increased efficiency and natural gas substitution will help low-cost producers until they reach a different limit of some sort.

Let’s look at these issues separately.

There are way too many of “them” relative to us, for energy efficiency to even make a dent in our problem.

If we look at world population, this is what we see:

Figure 6. World population split between US, EU-27, and Japan, and the Rest of the World.Figure 6. World population split between US, EU-27, and Japan, and the Rest of the World.

Using a ruler, we could probably make fairly reasonable projections of future population for each of these groups.

If we look at per capita oil consumption for the two groups separately, there is a huge disparity:

Figure 7. Per capita oil consumption separately for the group US, EU-27, plus Japan, and for the rest of the world, based on BP's 2102 Statistical Review of World Energy, and population statistics from EIA (since 1980) and Angus Maddison data. (earlier dates).Figure 7. Per capita oil consumption separately for the group US, EU-27, plus Japan, and for the rest of the world, based on BP’s 2102 Statistical Review of World Energy, and population statistics from EIA (since 1980) and Angus Maddison data. (earlier dates).

Per capita oil consumption for the EU, US, and Japan group peaked in 1973–a very long time ago. In recent years, it has been drifting down fairly rapidly, just to keep up with a slight per capita rise in oil consumption of the Rest of the World. Even with recent changes, per capita oil consumption of the EU, US and Japan group is more than 4.5 times that of the rest of the world.

If cars were made more efficient, more people could afford them. The market for cars is unbelievably huge, compared to today’s market, if costs could be brought down. Furthermore, gasoline accounts for less than half of US oil consumption. Even if efficiency were improved to allow cars to use half as much fuel, it would save a little less than one-fourth of current oil consumption. How far would this oil go in satisfying the needs of 6 billion other people–and growing every year?

When we look at past oil consumption, changes in vehicle energy efficiency did not make a big difference.

If we look at per capita oil consumption in the US, split between gasoline and other oil products, we see that the big drop in oil consumption came from the drop in other oil products–that is the commercial and industrial part of US oil consumption.

Figure 8. US per capita consumption of oil products, split between gasoline and other. Total consumption from BP's 2012 Statistical Review of  World Energy. Gasoline consumption from EIA. (Amounts include biofuels.)Figure 8. US per capita consumption of oil products, split between gasoline and other. Total consumption from BP’s 2012 Statistical Review of World Energy. Gasoline consumption from EIA. (Amounts include biofuels.) Difference by subtraction.

The amount of fuel used for gasoline has stayed in the 10 to 12 barrels a year per capita band, since 1970, in spite of huge improvements in vehicle efficiency.

I recently wrote a post called Why is US Oil Consumption Lower? Better Gasoline Mileage? In it, I looked at the decrease in US oil consumption between 2005 and 2012. I concluded that the majority of the decrease in consumption was due to a drop in commercial use. Only 7% was due to an improvement in miles per gallon for gasoline powered vehicles.

Substituting natural gas for oil still leaves the US (as well as Europe and Japan) very high priced, compared to the rest of the world, that doesn’t use much energy.

Living in the US, Europe or Japan, it is  hard to get an idea of the cost structure of the rest of the world. We are so far above the cost structure of the rest of the world that substituting natural gas for oil would do little to fix the situation.

Figure 9. Photo I took of an auto-rickshaw while visiting India in October 2012. A total of 10 of us (including driver) traveled for several miles in a three-seated version of one of these. Those of us on the edges held on tightly to the frame, because there was not room for all of us.  Figure 9. Photo of an auto-rickshaw I took while visiting India in October 2012. A total of 10 of us (including driver) traveled for several miles in a three-seated version of one of these. Those of us on the edges held on tightly to the frame, because there was not room for all of us.

We can also debate how much substitution of natural gas will actually do, and in what timeframe. In the US, natural gas is temporarily very cheap. But it costs more to extract shale gas than the market currently pays, in many areas. Also, a recently University of Texas study showed that Barnett Shale was past peak production, if prices do not rise.

There are really separate markets in many parts of the globe. Our market is collapsing because of high price. Perhaps increased efficiency and natural gas substitution will help low-cost producers, until they reach a different limit of some sort.

When a country is not competitive, it is not just oil consumption that drops, but consumption of other energy products as well.  If we look at the per capita energy consumption of the US, EU-27, and Japan combined, we see that non-oil energy consumption per capita reached its peak in 2004, and is now declining (Figure 10, below).  If consumers are too poor to buy oil products, they are also too poor to buy products made with other types of energy.

Figure 10. Per capita consumption for the sum of the EU-27, US, and Japan, based on BP's 2012 Statistical Review of  World Energy.Figure 10. Per capita consumption for the sum of the EU-27, US, and Japan, based on BP’s 2012 Statistical Review of World Energy.

The Rest of the World followed a very different pattern of energy consumption. Non-oil consumption soared, on a per capita basis. Oil consumption also increased on a per capita basis.

Figure 11. Per capita energy consumption for the Rest of the World, based on BP's 2012 Statistical Review of World Energy.Figure 11. Per capita energy consumption for the Rest of the World, based on BP’s 2012 Statistical Review of World Energy.

More detailed data shows that the big increase in non-oil consumption was a huge rise in coal consumption, after China was admitted to the World Trade Organization in December 2001.

How does peak oil demand work out in the end?

I would argue that lack of competitiveness in world markets is a limit that the US, EU-27 and Japan are hitting right now, but at slightly different rates. EU-27 now seems to be ahead in the race to the bottom, partly because its combined currency. I wrote a post in March 2012 called Why High Oil Prices Are Now Affecting Europe More Than the US, explaining the situation.

It seems to me, though, that a big piece of the problem with lack of competitiveness gets transferred to the governments of the affected countries. This happens because collection of tax revenue lags, because not enough people are working, and those who are working are earning lower wages. At the same time increased payouts are needed to stimulate the economy, and to provide benefits to the many without jobs.

Governments increase their debt to meet the revenue shortfall. They reduce interest rates to record-low levels, to stimulate the economy.  They also use Quantitative Easing, or “printing money” to try to lower long-term interest rates, and to try to make their exports more competitive. Unfortunately, these actions do not solve the basic structural problem of high and rising world oil prices, and the fact that these rising prices make their economies increasingly less competitive in the world marketplace.

One possible way I see of the current situation working out is that the total energy consumption (including all types of energy products, not just oil) of the EU, US and Japan will continue to fall, as high-priced oil continues to erode our competitive position in the world marketplace.

Figure 12. One view of future energy consumption for the EU-27, US, and Japan. Historical is based on BP's 2012 Statistical Review of World Energy. Figure 12. One view of future energy consumption for the EU-27, US, and Japan. Historical is based on BP’s 2012 Statistical Review of World Energy.

The slope of the decline is based on the type of decline experienced by the Former Soviet Union, in the years immediately following its collapse. This pattern might reflect a combination of different patterns for different countries. Greece and Spain, for example might continue to fall quite quickly. The US might lag the EU in the speed at which problems take place. The likely path seems downward, because any action taken to fix the government gap between income and expense can be expected to have a recessionary impact, and thus have an adverse impact on energy consumption.

The Rest of the World is now growing rapidly, but at some point they will start reaching limits. One of these limits will be lack of an export market. Another will be lack of spare parts, because businesses in the US, Europe and Japan are failing for financial reasons. Some of these limits will relate to pollution and lack of fresh water. The effect of these limits will also be to raise costs. For example, a shortage of water can be worked around through desalination, but this raises costs. Lack of spare parts can be worked around by building a new plant to make the spare part. Pollution problems can be mitigated by pollution controls, but these add costs. These higher costs, when passed on to consumers will also lead to a cutback in demand for discretionary goods, and the same kinds of problems experienced in oil exporting nations. Thus, these countries will also have “Peak Demand” problems, because of rising prices, related to limits they are reaching.

I don’t know exactly how soon the Rest of the World will hit limits, but given the interconnectedness of the world system, it would seem to be within the next few years. Figure 13 shows one estimate of how this may occur.

Figure 13. One view of energy consumption for the Rest of the World. Historical data is based on BP's 2012 Statistical Review of World Energy.Figure 13. One view of energy consumption for the Rest of the World. Historical data are based on BP’s 2012 Statistical Review of World Energy.

Here again, individual countries may do better than others. Countries with little connectedness to the world system (for example, countries in central Africa) may have fewer problems than others. Of course, their energy consumption (of the type measured by the EIA or BP) is very low now. They may use cow dung and fallen branches for fuel, but these are not counted in international data.

Figure 14, below, shows the sum of the amounts from Figures 12 and 13. Thus, it gives one estimate of  future world energy consumption based on Peak Demand considerations.

Figure 14. One view of future energy consumption for the world as a whole. History is based on BP's 2012 Statistical Review of World Energy.  Figure 14. One view of future energy consumption for the world as a whole. History is based on BP’s 2012 Statistical Review of World Energy.

If there is a silver lining to all of this, it is that world CO2 emissions are likely to start falling quite rapidly, because of Peak Oil Demand. World CO2 emissions could quite possibly drop below 20% of current levels before 2050. In the scenario I show, energy consumption drops faster than forecasts such as those put out by the Energy Watch Group. Such forecasts do not take into account financial considerations, so are likely overstated.

The downside of Peak Oil Demand is that the world we live in will be very much changed. Population levels will likely drop, indirectly because of serious recession, job loss, and cutbacks in government benefits. The financial system will need to be completely revised, because debt financing will make sense much less often than today. In fact, in a shrinking world economy, money can no longer act as a store of value. There no doubt will be some people who survive and prosper, but their lives will likely be very different from what they are today.

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