Interesting times ahead…..

29 11 2018

Very few people join all the dots, and as usual, Gail Tverberg does her best to do so here again…. There are so many signals on the web now pointing to a major reset it’s not funny.

Low Oil Prices: An Indication of Major Problems Ahead?

Many people, including most Peak Oilers, expect that oil prices will rise endlessly. They expect rising oil prices because, over time, companies find it necessary to access more difficult-to-extract oil. Accessing such oil tends to be increasingly expensive because it tends to require the use of greater quantities of resources and more advanced technology. This issue is sometimes referred to as diminishing returns. Figure 1 shows how oil prices might be expected to rise, if the higher costs encountered as a result of diminishing returns can be fully recovered from the ultimate customers of this oil.

In my view, this analysis suggesting ever-rising prices is incomplete. After a point, prices can’t really keep up with rising costs because the wages of many workers lag behind the growing cost of extraction.

The economy is a networked system facing many pressures, including a growing level of debt and the rising use of technology. When these pressures are considered, my analysis indicates that oil prices may fall too low for producers, rather than rise too high for consumers. Oil companies may close down if prices remain too low. Because of this, low oil prices should be of just as much concern as high oil prices.

In recent years, we have heard a great deal about the possibility of Peak Oil, including high oil prices. If the issue we are facing is really prices that are too low for producers, then there seems to be the possibility of a different limits issue, called Collapse. Many early economies seem to have collapsed as they reached resource limits. Collapse seems to be characterized by growing wealth disparity, inadequate wages for non-elite workers, failing governments, debt defaults, resource wars, and epidemics. Eventually, population associated with collapsed economies may fall very low or completely disappear. As Collapse approaches, commodity prices seem to be low, rather than high.

The low oil prices we have been seeing recently fit in disturbingly well with the hypothesis that the world economy is reaching affordability limits for a wide range of commodities, nearly all of which are subject to diminishing returns. This is a different problem than most researchers have been concerned about. In this article, I explain this situation further.

One thing that is a little confusing is the relative roles of diminishing returns and efficiency. I see diminishing returns as being more or less the opposite of growing efficiency.

The fact that inflation-adjusted oil prices are now much higher than they were in the 1940s to 1960s is a sign that for oil, the contest between diminishing returns and efficiency has basically been won by diminishing returns for over 40 years.

Oil Prices Cannot Rise Endlessly

It makes no sense for oil prices to rise endlessly, for what is inherently growing inefficiency. Endlessly rising prices for oil would be similar to paying a human laborer more and more for building widgets, during a time that that laborer becomes increasingly disabled. If the number of widgets that the worker can produce in one hour decreases by 50%, logically that worker’s wages should fall by 50%, not rise to make up for his/her growing inefficiency.

The problem with paying higher prices for what is equivalent to growing inefficiency can be hidden for a while, if the economy is growing rapidly enough. The way that the growing inefficiency is hidden is by adding Debt and Complexity (Figure 4).

Growing complexity is very closely related to “Technology will save us.” Growing complexity involves the use of more advanced machinery and ever-more specialized workers. Businesses become larger and more hierarchical. International trade becomes increasingly important. Financial products such as derivatives become common.

Growing debt goes hand in hand with growing complexity. Businesses need growing debt to support capital expenditures for their new technology. Consumers find growing debt helpful in affording major purchases, such as homes and vehicles. Governments make debt-like promises of pensions to citizen. Thanks to these promised pensions, families can have fewer children and devote fewer years to child care at home.

The problem with adding complexity and adding debt is that they, too, reach diminishing returns. The easiest (and cheapest) fixes tend to be added first. For example, irrigating a field in a dry area may be an easy and cheap way to fix a problem with inadequate food supply. There may be other approaches that could be used as well, such as breeding crops that do well with little rainfall, but the payback on this investment may be smaller and later.

A major drawback of adding complexity is that doing so tends to increase wage and wealth disparity. When an employer pays high wages to supervisory workers and highly skilled workers, this leaves fewer funds with which to pay less skilled workers. Furthermore, the huge amount of capital goods required in this more complex economy tends to disproportionately benefit workers who are already highly paid. This happens because the owners of shares of stock in companies tend to overlap with employees who are already highly paid. Low paid employees can’t afford such purchases.

The net result of greater wage and wealth disparity is that it becomes increasingly difficult to keep prices high enough for oil producers. The many workers with low wages find it difficult to afford homes and families of their own. Their low purchasing power tends to hold down prices of commodities of all kinds. The higher wages of the highly trained and supervisory staff don’t make up for the shortfall in commodity demand because these highly paid workers spend their wages differently. They tend to spend proportionately more on services rather than on commodity-intensive goods. For example, they may send their children to elite colleges and pay for tax avoidance services. These services use relatively little in the way of commodities.

Once the Economy Slows Too Much, the Whole System Tends to Implode

A growing economy can hide a multitude of problems. Paying back debt with interest is easy, if a worker finds his wages growing. In fact, it doesn’t matter if the growth that supports his growing wages comes from inflationary growth or “real” growth, since debt repayment is typically not adjusted for inflation.

Both real growth and inflationary growth help workers have enough funds left at the end of the period for other goods they need, despite repaying debt with interest.

Once the economy stops growing, the whole system tends to implode. Wage disparity becomes a huge problem. It becomes impossible to repay debt with interest. Young people find that their standards of living are lower than those of their parents. Investments do not appear to be worthwhile without government subsidies. Businesses find that economies of scale no longer work to their advantage. Pension promises become overwhelming, compared to the wages of young people.

The Real Situation with Oil Prices

The real situation with oil prices–and in fact with respect to commodity prices in general–is approximately like that shown in Figure 6.

What tends to happen is that oil prices tend to fall farther and farther behind what producers require, if they are truly to make adequate reinvestment in new fields and also pay high taxes to their governments. This should not be too surprising because oil prices represent a compromise between what citizens can afford and what producers require.

In the years before diminishing returns became too much of a problem (back before 2005, for example), it was possible to find prices that were within an acceptable range for both sellers and buyers. As diminishing returns has become an increasing problem, the price that consumers can afford has tended to fall increasingly far below the price that producers require. This is why oil prices at first fall a little too low for producers, and eventually seem likely to fall far below what producers need to stay in business. The problem is that no price works for both producers and consumers.

Affordability Issues Affect All Commodity Prices, Not Just Oil

We are dealing with a situation in which a growing share of workers (and would be workers) find it difficult to afford a home and family, because of wage disparity issues. Some workers have been displaced from their jobs by robots or by globalization. Some spend many years in advanced schooling and are left with large amounts of debt, making it difficult to afford a home, a family, and other things that many in the older generation were able to take for granted. Many of today’s workers are in low-wage countries; they cannot afford very much of the output of the world economy.

At the same time, diminishing returns affect nearly all commodities, just as they affect oil. Mineral ores are affected by diminishing returns because the highest grade ores tend to be extracted first. Food production is also subject to diminishing returns because population keeps rising, but arable land does not. As a result, each year it is necessary to grow more food per arable acre, leading to a need for more complexity (more irrigation or more fertilizer, or better hybrid seed), often at higher cost.

When the problem of growing wage disparity is matched up with the problem of diminishing returns for the many different types of commodity production, the same problem occurs that occurs with oil. Prices of a wide range of commodities tend to fall below the cost of production–first by a little and, if the debt bubble pops, by a whole lot.

We hear people say, “Of course oil prices will rise. Oil is a necessity.” The thing that they don’t realize is that the problem affects a much bigger “package” of commodities than just oil prices. In fact, finished goods and services of all kinds made with these commodities are also affected, including new homes and vehicles. Thus, the pattern we see of low oil prices, relative to what is required for true profitability, is really an extremely widespread problem.

Interest Rate Policies Affect Affordability

Commodity prices bear surprisingly little relationship to the cost of production. Instead, they seem to depend more on interest rate policies of government agencies. If interest rates rise or fall, this tends to have a big impact on household budgets, because monthly auto payments and home payments depend on interest rates. For example, US interest rates spiked in 1981.

This spike in interest rates led to a major cutback in energy consumption and in GDP growth.

Oil prices began to slide, with the higher interest rates.

Figure 11 indicates that the popping of a debt bubble (mostly relating to US sub-prime housing) sent oil prices down in 2008. Once interest rates were lowered through the US adoption of Quantitative Easing (QE), oil prices rose again. They fell again, when the US discontinued QE.

While these charts show oil prices, there is a tendency for a broad range of commodity prices to move more or less together. This happens because the commodity price issue seems to be driven to a significant extent by the affordability of finished goods and services, including homes, automobiles, and restaurant food.

If the collapse of a major debt bubble occurs again, the world seems likely to experience impacts somewhat similar to those in 2008, depending, of course, on the location(s) and size(s) of the debt bubble(s). A wide variety of commodity prices are likely to fall very low; asset prices may also be affected. This time, however, government organizations seem to have fewer tools for pulling the world economy out of a prolonged slump because interest rates are already very low. Thus, the issues are likely to look more like a widespread economic problem (including far too low commodity prices) than an oil problem.

Lack of Growth in Energy Consumption Per Capita Seems to Lead to Collapse Scenarios

When we look back, the good times from an economic viewpoint occurred when energy consumption per capita (top red parts on Figure 12) were rising rapidly.

The bad times for the economy were the valleys in Figure 12. Separate labels for these valleys have been added in Figure 13. If energy consumption is not growing relative to the rising world population, collapse in at least a part of the world economy tends to occur.

The laws of physics tell us that energy consumption is required for movement and for heat. These are the basic processes involved in GDP generation, and in electricity transmission. Thus, it is logical to believe that energy consumption is required for GDP growth. We can see in Figure 9 that growth in energy consumption tends to come before GDP growth, strongly suggesting that it is the cause of GDP growth. This further confirms what the laws of physics tell us.

The fact that partial collapses tend to occur when the growth in energy consumption per capita falls too low is further confirmation of the way the economics system really operates. The Panic of 1857occurred when the asset price bubble enabled by the California Gold Rush collapsed. Home, farm, and commodity prices fell very low. The problems ultimately were finally resolved in the US Civil War (1861 to 1865).

Similarly, the Depression of the 1930s was preceded by a stock market crash in 1929. During the Great Depression, wage disparity was a major problem. Commodity prices fell very low, as did farm prices. The issues of the Depression were not fully resolved until World War II.

At this point, world growth in energy consumption per capita seems to be falling again. We are also starting to see evidence of some of the same problems associated with earlier collapses: growing wage disparity, growing debt bubbles, and increasingly war-like behavior by world leaders. We should be aware that today’s low oil prices, together with these other symptoms of economic distress, may be pointing to yet another collapse scenario on the horizon.

Oil’s Role in the Economy Is Different From What Many Have Assumed

We have heard for a long time that the world is running out of oil, and we need to find substitutes. The story should have been, “Affordability of all commodities is falling too low, because of diminishing returns and growing wage disparity. We need to find rapidly rising quantities of very, very cheap energy products. We need a cheap substitute for oil. We cannot afford to substitute high-cost energy products for low-cost energy products. High-cost energy products affect the economy too adversely.”

In fact, the whole “Peak Oil” story is not really right. Neither is the “Renewables will save us” story, especially if the renewables require subsidies and are not very scalable. Energy prices can never be expected to rise high enough for renewables to become economic.

The issues we should truly be concerned about are Collapse, as encountered by many economies previously. If Collapse occurs, it seems likely to cut off production of many commodities, including oil and much of the food supply, indirectly because of low prices.

Low oil prices and low prices of other commodities are signs that we truly should be concerned about. Too many people have missed this point. They have been taken in by the false models of economists and by the confusion of Peak Oilers. At this point, we should start considering the very real possibility that our next world problem is likely to be Collapse of at least a portion of the world economy.

Interesting times seem to be ahead.





The Price of Oil

10 02 2018

Another excellent article by Dave Pollard over at How to Save the World…..  my only criticism of this article is that he’s not factoring in collapsing ERoEI will have on the production side…..


The clueless gamblers that speculate on stock and commodity prices have been having a field day recently. Desperately chasing profits, like high-rollers who keep increasing their casino bets every time they lose, they have wiped billions out of share and pension values in a lemming-like panic about whether and when the colossally overpriced stock market is going to crash. And they have also pushed the price of oil up to near $70/bbl for the first time in several years. These speculators, who contribute nothing of any value to our economy, are some of the most destructive individuals on the planet, destabilizing markets on which many depend for their lives and livelihoods. (They also wreak havoc on land, real estate, food, and currency prices.) And many of them make millions in commissions and bonuses just rolling the dice for their employers and clients and praying that their lucky bets (mostly on prices rising perpetually) will continue.

A couple of years ago I wrote an article about the price of oil, explaining that the issue we’re going to face in the 21st century isn’t one of energy running out, but of affordableenergy running out. Just as, during great depressions and famines, masses of food is left rotting in the ground because no one can afford to buy it (or even retrieve it and give it away), having oil in the ground that costs $80/bbl to get to market (especially if governments run out of money for subsidies, or, god forbid, decide that oil companies should start to pay the huge external costs of their activities) is not especially useful when you can only afford, in an economy ruined by overexploitation, environmental degradation, excessive debt, inequality and waste, $30/bbl for it.

Before I go further, if you’re one of the many who have been persuaded that “peak oil is over” and that renewables and new technology will soon save us from energy collapse, you might as well not read this article. Instead, I’d suggest you read this, or this, or this, or any of the many other articles written by people who understand the laws of thermodynamics and how the economy actually works.

This time I thought I’d start with a review of oil prices in the past. The chart above plots the course of oil prices (in inflation-adjusted dollars) back to 1946. Green lines show supply curves; red lines demand curves, and the dots at intersections are annual average oil prices for those years. Follow the dots:

  1. 1946-72. Oil prices were remarkably stable at about $25/bbl (in current dollars) during this entire period. The world became dependent on OPEC. Virtually all global growth in real terms since 1946 is attributable to increasing use of oil. Almost none of it is ascribable to new technology (other than energy extraction technology) or “efficiencies” or “innovation” or “economies of scale”. That’s it. If you’re a believer in GDP or that growth is essential to the economy you might want to keep that in mind (and if you are invested in stocks or land or any other industrial resource, you’d better believe, because their “value” is all computed in terms of future growth in exchange value, production and profits). Between 1946 and 1972 the OPEC nations were in bed with the western corporatists (as they still are today, supporting them politically and militarily), fixing the price of oil at that price to ensure the economy could continue to grow, as required, endlessly.
  2. 1973-80. OPEC fights back, realizing that although they can make money at $25/bbl because of the size and ease of tapping their reserves, they have already pumped out more than half of it, and they have only a few decades’ worth left and nothing to support their economy when it runs out. So they constrain production, driving the price up to $60/bbl (1975) and then $110/bbl (1980). At that price they can set money aside for when their oil runs out, and avoid the massive humanitarian crises that the end of oil spells for them. But for the western corporatists, this is disastrous: their economies are in a shambles, with double-digit inflation ruining profits, and line-ups at the pumps.
  3. 1981-85. The western corporatists “convince” OPEC to turn the pumps back on, persuading them that there is a happy medium price for oil (more than the $25-30/bbl that makes exploration for new sources uneconomic, but less than the $75/bbl threshold beyond which the global economy cannot pay for it and hence cannot survive. By 1985, OPEC has increased supply so that, despite the new demand from expanding Asian countries, the price has settled back in the perfect $50-60/bbl range. Remember here that the amount of production and consumption of oil is so close (there’s no place to put much excess once it’s pumped, and there’s no margin for error if there’s a serious shortage) that any changes in production, intentional or not, have a huge impact on price.
  4. 1986-2002. At $60/bbl, there’s an incentive to put more into the market than you can sustainably continue to produce, and also an incentive to find new sources — and remember, a small increase in supply has a big impact on lowering price. From the late 1980s to 2002, the lingering effects of the early-1980s crash kept demand from increasing as it had been, and a number of (heavily subsidized, environmentally catastrophically damaging) new sources of “dirty” and “tight” (harder to extract) oil were found. As a consequence, prices tumbled back to the $30/bbl level. OPEC was not happy, but some of their own short-term-thinking members were opening the taps to try to bolster their struggling economies, and the new sources meant OPEC as a whole had less oligopoly power over supplies and hence prices.
  5. 2003-08. The low prices were unsustainable to many producers, especially those with higher production costs that ceased or curtailed exploring, and that, combined with increasing demand from third-world countries, began pushing prices up again, to $60/bbl in 2005 and $90/bbl in 2008. You remember 2008, the bubble year, right? Over-exuberance had enabled speculators to push the price of everything up to ridiculous levels, and oil was not spared. The crash of 2008 also weakened demand, as many people could not afford to pay for anything, including fuel. But everyone knew the $90/bbl couldn’t last, just as they knew it in 1980.
  6. 2009-17. Banking on continuing high oil prices, speculators jumped into fracking and other high-risk, costly (and heavily-subsidized) smaller-scale oil ventures. For the first time, people who can’t think further ahead than the next quarter’s profit report were saying that there was more than enough oil, and that peak oil was dead. More reasoned experts argued that the danger to our planet from climate change caused by burning oil now exceeded the danger of running out of it (we may well experience both in the years to come). But many of the new ventures depended on sustained high oil prices, and as supply rose, price inevitably dropped. This was exacerbated by a chronic global recession that (despite what you might read in the Wall Street press) has left 90% of the population with massively higher debts and less disposable income than they had back in the 1980s. That recession curtailed demand and added to the price slump that saw oil drop from $90/bbl in 2008 to $60/bbl in 2015 and then back to a near-ruinous (for producers) $40/bbl in 2016-17. Many of the new operators declared bankruptcy, but in the mean-time they (and the ongoing recession for all but the super-rich) had created a short-term oil glut. More people came to believe that oil would be abundant forever, at reasonable prices. Many OPEC countries’ governments, already struggling with unruly political movements, and a permanently unemployed youth workforce, were getting antsy.
  7. 2018. Surprise, surprise, the oil price has risen again, to as high as $70/bbl, though it seems to be hovering mostly around the ‘ideal’ (for producers and consumers) $60/bbl level. The problem is, that’s not quite as ideal as it used to be. The cost of bringing new oil to market has risen from very low-levels (near $15/bbl in the mid-20th-century OPEC countries, to $45/bbl for much “tight” oil extraction). So a very volatile $50-60/bbl price doesn’t provide much margin for producers in an economy that demands significantly increasing profits every year. And it’s expensive for consumers, who start to reduce consumption and turn to alternative sources of energy (where available) when prices move into that $50-60/bbl range.

So what does this mean for the future? The second chart, below, describes what I think we’ll see by the middle of this century. Here we go:

  1. 2018-2025: Just a guess, but there doesn’t seem to be any compelling short-term trend in supply or demand one way or another, so I’m guessing that we’ll have a few years of relative stability, with prices ranging from $40-80/bbl depending on producer actions, politics, climate change proclivities, carbon taxes and regulations, and the strange whims and misconceptions of speculators (damn I’d like to see a huge speculation tax on every do-nothing transaction gamblers put through).
  2. 2025-2050: In the medium term, all bets are off. I can see, as conventional sources of oil get depleted and new ones cost more and more, the cost of getting oil to market rising enough that any price under $70/bbl won’t be worth the risk. And I can see, as the real economy (not the economy-of-the-elite the NYT and WSJ reports on) continues to struggle and inequality widens to become a political and even military issue in many parts of the world, the affordable ceiling price for oil dropping to $40/bbl. So that means there is no “happy medium” that works for both producers and consumers — any price is either too low for producers (keeping/driving them out of the market) or too high for consumers (leading to hoarding, involuntary reductions in use (ie repo’d cars and foreclosed homes) — or both. So I see prices whipsawing between $30/bbl or less (when the economy is in especially bad shape) and $100/bbl or more during speculative frenzies, rationing (in black markets), severe shortages and short-lived “is the long depression over yet?” economic recoveries.
  3. 2050-2100: This is the period in which I’ve forecast economic and/or energy collapse and the onset of chronic serious climate change trends and events. I don’t think the US dollar will survive this, so it’s hard to set a price on anything in that currency. I do see it as a long era of scavenging, re-use, rationing, nationalization (until national governments collapse and leave energy management to struggling local communities), hoarding, black markets, and yes, even conservation at last.

Not a very rosy picture, but those who’ve studied the economy and have been following oil prices for a while tend to support much of this hypothesis. Ultimately, it’s the economy, (not so) stupid. The economy is the tail that wags the energy dog, but ultimately the global industrial economy is founded entirely on the preposterous and untenable requirement that growth must continue forever, and the only thing that has provided sustained growth for the past couple of centuries has been cheap hydrocarbons.

And I understand oil doesn’t keep very well.





A Market Collapse Is On The Horizon

18 02 2016

The bit that worries me the most is this……:
The many problems of 2016 (including rapid moves in currencies, falling commodity prices, and loan defaults) are likely to cause large payouts of derivatives, potentially leading to the bankruptcies of financial institutions, as they did in 2008. To prevent such bankruptcies, most governments plan to move as much of the losses related to derivatives and debt defaults to private parties as possible. It is possible that this approach will lead to depositors losing what appear to be insured bank deposits.
I better spend that money quick smart.  Just had a quote for $17,000 for the blocks to go into the retaining wall.  By the time I’ve bought the double glazing and the roof, most of my big expenses, apart from the footings and slab, will have gone…..
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
By

tverberg

Gail Tverberg

Posted on Sat, 13 February 2016

What is ahead for 2016? Most people don’t realize how tightly the following are linked:

1. Growth in debt
2. Growth in the economy
3. Growth in cheap-to-extract energy supplies
4. Inflation in the cost of producing commodities
5. Growth in asset prices, such as the price of shares of stock and of farmland
6. Growth in wages of non-elite workers
7. Population growth

It looks to me as though this linkage is about to cause a very substantial disruption to the economy, as oil limits, as well as other energy limits, cause a rapid shift from the benevolent version of the economic supercycle to the portion of the economic supercycle reflecting contraction. Many people have talked about Peak Oil, the Limits to Growth, and the Debt Supercycle without realizing that the underlying problem is really the same–the fact the we are reaching the limits of a finite world.

There are actually a number of different kinds of limits to a finite world, all leading toward the rising cost of commodity production. I will discuss these in more detail later. In the past, the contraction phase of the supercycle seems to have been caused primarily by too high a population relative to resources. This time, depleting fossil fuels–particularly oil–plays a major role. Other limits contributing to the end of the current debt supercycle include rising pollution and depletion of resources other than fossil fuels.

The problem of reaching limits in a finite world manifests itself in an unexpected way: slowing wage growth for non-elite workers. Lower wages mean that these workers become less able to afford the output of the system. These problems first lead to commodity oversupply and very low commodity prices. Eventually these problems lead to falling asset prices and widespread debt defaults. These problems are the opposite of what many expect, namely oil shortages and high prices. This strange situation exists because the economy is a networked system. Feedback loops in a networked system don’t necessarily work in the way people expect.

I expect that the particular problem we are likely to reach in 2016 is limits to oil storage. This may happen at different times for crude oil and the various types of refined products. As storage fills, prices can be expected to drop to a very low level–less than $10 per barrel for crude oil, and correspondingly low prices for the various types of oil products, such as gasoline, diesel, and asphalt. We can then expect to face a problem with debt defaults, failing banks, and failing governments (especially of oil exporters).

The idea of a bounce back to new higher oil prices seems exceedingly unlikely, in part because of the huge overhang of supply in storage, which owners will want to sell, keeping supply high for a long time. Furthermore, the underlying cause of the problem is the failure of wages of non-elite workers to rise rapidly enough to keep up with the rising cost of commodity production, particularly oil production. Because of falling inflation-adjusted wages, non-elite workers are becoming increasingly unable to afford the output of the economic system. As non-elite workers cut back on their purchases of goods, the economy tends to contract rather than expand. Efficiencies of scale are lost, and debt becomes increasingly difficult to repay with interest. The whole system tends to collapse.

How the Economic Growth Supercycle Works, in an Ideal Situation

In an ideal situation, growth in debt tends to stimulate the economy. The availability of debt makes the purchase of high-priced goods such as factories, homes, cars, and trucks more affordable. All of these high-priced goods require the use of commodities, including energy products and metals. Thus, growing debt tends to add to the demand for commodities, and helps keep their prices higher than the cost of production, making it profitable to produce these commodities. The availability of profits encourages the extraction of an ever-greater quantity of energy supplies and other commodities.

The growing quantity of energy supplies made possible by this profitability can be used to leverage human labor to an ever-greater extent, so that workers become increasingly productive. For example, energy supplies help build roads, trucks, and machines used in factories, making workers more productive. As a result, wages tend to rise, reflecting the greater productivity of workers in the context of these new investments. Businesses find that demand for their goods and services grows because of the growing wages of workers, and governments find that they can collect increasing tax revenue. The arrangement of repaying debt with interest tends to work well in this situation. GDP grows sufficiently rapidly that the ratio of debt to GDP stays relatively flat.

Over time, the cost of commodity production tends to rise for several reasons:

1. Population tends to grow over time, so the quantity of agricultural land available per person tends to fall. Higher-priced techniques (such as irrigation, better seeds, fertilizer, pesticides, herbicides) are required to increase production per acre. Similarly, rising population gives rise to a need to produce fresh water using increasingly high-priced techniques, such as desalination.

2. Businesses tend to extract the least expensive fuels such as oil, coal, natural gas, and uranium first. They later move on to more expensive to extract fuels, when the less-expensive fuels are depleted. For example, Figure 1 shows the sharp increase in the cost of oil extraction that took place about 1999.

Figure 1. Figure by Steve Kopits of Westwood Douglas showing the trend in per-barrel capital expenditures for oil exploration and production. CAGR is “Compound Annual Growth Rate.”

3. Pollution tends to become an increasing problem because the least polluting commodity sources are used first. When mitigations such as substituting renewables for fossil fuels are used, they tend to be more expensive than the products they are replacing. The leads to the higher cost of final products.

Related: The Hidden Agenda Behind Saudi Arabia’s Market Share Strategy

4. Overuse of resources other than fuels becomes a problem, leading to problems such as the higher cost of producing metals, deforestation, depleted fish stocks, and eroded topsoil. Some workarounds are available, but these tend to add costs as well.

As long as the cost of commodity production is rising only slowly, its increasing cost is benevolent. This increase in cost adds to inflation in the price of goods and helps inflate away prior debt, so that debt is easier to pay. It also leads to asset inflation, making the use of debt seem to be a worthwhile approach to finance future economic growth, including the growth of energy supplies. The whole system seems to work as an economic growth pump, with the rising wages of non-elite workers pushing the growth pump along.

The Big “Oops” Comes when the Price of Commodities Starts Rising Faster than Wages of Non-Elite Workers

Clearly the wages of non-elite workers need to be rising faster than commodity prices in order to push the economic growth pump along. The economic pump effect is lost when the wages of non-elite workers start falling, relative to the price of commodities. This tends to happen when the cost of commodity production begins rising rapidly, as it did for oil after 1999 (Figure 1).

The loss of the economic pump effect occurs because the rising cost of oil (or electricity, or food, or other energy products) forces workers to cut back on discretionary expenditures. This is what happened in the 2003 to 2008 period as oil prices spiked and other energy prices rose sharply. (See my article Oil Supply Limits and the Continuing Financial Crisis.) Non-elite workers found it increasingly difficult to afford expensive products such as homes, cars, and washing machines. Housing prices dropped. Debt growth slowed, leading to a sharp drop in oil prices and other commodity prices.

Figure 2. World oil supply and prices based on EIA data.

It was somewhat possible to “fix” low oil prices through the use of Quantitative Easing (QE) and the growth of debt at very low interest rates, after 2008. In fact, these very low interest rates are what encouraged the very rapid growth in the production of US crude oil, natural gas liquids, and biofuels.

Now, debt is reaching limits. Both the US and China have (in a sense) “taken their foot off the economic debt accelerator.” It doesn’t seem to make sense to encourage more use of debt, because recent very low interest rates have encouraged unwise investments. In China, more factories and homes have been built than the market can absorb. In the US, oil “liquids” production rose faster than it could be absorbed by the world market when prices were over $100 per barrel. This led to the big price drop. If it were possible to produce the additional oil for a very low price, say $20 per barrel, the world economy could probably absorb it. Such a low selling price doesn’t really “work” because of the high cost of production.

Debt is important because it can help an economy grow, as long as the total amount of debt does not become unmanageable. Thus, for a time, growing debt can offset the adverse impact of the rising cost of energy products. We know that oil prices began to rise sharply in the 1970s, and in fact other energy prices rose as well.

Figure 3. Historical World Energy Price in 2014$, from BP Statistical Review of World History 2015.

Looking at debt growth, we find that it rose rapidly, starting about the time oil prices started spiking. Former Director of the Office of Management and Budget, David Stockman, talks about “The Distastrous 40-Year Debt Supercycle,” which he believes is now ending.

Figure 4. Worldwide average inflation-adjusted annual growth rates in debt and GDP, for selected time periods. See post on debt for explanation of methodology.

In recent years, we have been reaching a situation where commodity prices have been rising faster than the wages of non-elite workers. Jobs that are available tend to be low-paid service jobs. Young people find it necessary to stay in school longer. They also find it necessary to delay marriage and postpone buying a car and home. All of these issues contribute to the falling wages of non-elite workers. Some of these individuals are, in fact, getting zero wages, because they are in school longer. Individuals who retire or voluntarily leave the work force further add to the problem of wages no longer rising sufficiently to afford the output of the system.

The US government has recently decided to raise interest rates. This further reduces the buying power of non-elite workers. We have a situation where the “economic growth pump,” created through the use of a rising quantity of cheap energy products plus rising debt, is disappearing. While homes, cars, and vacation travel are available, an increasing share of the population cannot afford them. This tends to lead to a situation where commodity prices fall below the cost of production for a wide range of types of commodities, making the production of commodities unprofitable. In such a situation, a person expects companies to cut back on production. Many defaults may occur.

China has acted as a major growth pump for the world for the last 15 years, since it joined the World Trade Organization in 2001. China’s growth is now slowing, and can be expected to slow further. Its growth was financed by a huge increase in debt. Paying back this debt is likely to be a problem.

Figure 5. Author’s illustration of problem we are now encountering.

Thus, we seem to be coming to the contraction portion of the debt supercycle. This is frightening, because if debt is contracting, asset prices (such as stock prices and the price of land) are likely to fall. Banks are likely to fail, unless they can transfer their problems to others–owners of the bank or even those with bank deposits. Governments will be affected as well, because it will become more expensive to borrow money, and because it becomes more difficult to obtain revenue through taxation. Many governments may fail as well for that reason.

The U. S. Oil Storage Problem

Oil prices began falling in the middle of 2014, so we might expect oil storage problems to start about that time, but this is not exactly the case. Supplies of US crude oil in storage didn’t start rising until about the end of 2014.

Related: Why Today’s Oil Bust Pales In Comparison To The 80’s

Figure 6. US crude oil in storage, excluding Strategic Petroleum Reserve, based on EIA data.

Cushing, Oklahoma, is the largest storage area for crude oil. According to the EIA, maximum working storage for the facility is 73 million barrels. Oil storage at Cushing since oil prices started declining is shown in Figure 7.

Figure 7. Quantity of crude oil stored at Cushing between June 27, 2014, and June 1, 2016, based on EIA data.

Clearly the same kind of run up in oil storage that occurred between December and April one year ago cannot all be stored at Cushing, if maximum working capacity is only 73 million barrels, and the amount currently in storage is 64 million barrels.

Another way of storing oil is as finished products. Here, the run-up in storage began earlier (starting in mid-2014) and stabilized at about 65 million barrels per day above the prior year, by January 2015. Clearly, if companies can do some pre-planning, they would prefer not to refine products for which there is little market. They would rather store unneeded oil as crude, rather than as refined products.

Figure 8. Total Oil Products in Storage, based on EIA data.

EIA indicates that the total capacity for oil products is 1,549 million barrels. Thus, in theory, the amount of oil products stored can be increased by as much as 700 million barrels, assuming that the products needing to be stored and the locations where storage are available match up exactly. In practice, the amount of additional storage available is probably quite a bit less than 700 million barrels because of mismatch problems.

In theory, if companies can be persuaded to refine more products than they can sell, the amount of products that can be stored can rise significantly. Even in this case, the amount of storage is not unlimited. Even if the full 700 million barrels of storage for crude oil products is available, this corresponds to less than one million barrels a day for two years, or two million barrels a day for one year. Thus, products storage could easily be filled as well, if demand remains low.

At this point, we don’t have the mismatch between oil production and consumption fixed. In fact, both Iraq and Iran would like to increase their production, adding to the production/consumption mismatch. China’s economy seems to be stalling, keeping its oil consumption from rising as quickly as in the past, and further adding to the supply/demand mismatch problem. Figure 9 shows an approximation to our mismatch problem. As far as I can tell, the problem is still getting worse, not better.

Figure 9. Total liquids oil production and consumption, based on a combination of BP and EIA data.

There has been a lot of talk about the United States reducing its production, but the impact so far has been small, based on data from EIA’s International Energy Statistics and its December 2015 Monthly Energy Review.

Figure 10. US quarterly oil liquids production data, based on EIA’s International Energy Statistics and Monthly Energy Review.

Based on information through November from EIA’s Monthly Energy Review, total liquids production for the US for the year 2015 will be about 700,000 barrels per day higher than it was for 2014. This increase is likely greater than the increase in production by either Saudi Arabia or Iraq. Perhaps in 2016, oil production of the US will start decreasing, but so far, increases in biofuels and natural gas liquids are partly offsetting recent reductions in crude oil production. Also, even when companies are forced into bankruptcy, oil production does not necessarily stop because of the potential value of the oil to new owners.

Figure 11 shows that very high stocks of oil were a problem, way back in the 1920s. There were other similarities to today’s problems as well, including a deflating debt bubble and low commodity prices. Thus, we should not be too surprised by high oil stocks now, when oil prices are low.

(Click to enlarge)

Figure 11. US ending stock of crude oil, excluding the strategic petroleum reserve. Figure by EIA.

Many people overlook the problems today because the US economy tends to be doing better than that of the rest of the world. The oil storage problem is really a world problem, however, reflecting a combination of low demand growth (caused by low wage growth and lack of debt growth, as the world economy hits limits) continuing supply growth (related to very low interest rates making all kinds of investment appear profitable and new production from Iraq and, in the near future, Iran). Storage on ships is increasingly being filled up and storage in Western Europe is 97% filled. Thus, the US is quite likely to see a growing need for oil storage in the year ahead, partly because there are few other places to put the oil, and partly because the gap between supply and demand has not yet been fixed.

What is Ahead for 2016?

1. Problems with a slowing world economy are likely to become more pronounced, as China’s growth problems continue, and as other commodity-producing countries such as Brazil, South Africa, and Australia experience recession. There may be rapid shifts in currencies, as countries attempt to devalue their currencies, to try to gain an advantage in world markets. Saudi Arabia may decide to devalue its currency, to get more benefit from the oil it sells.

Related: OPEC-Russia Rumors Persist After Comments From Rosneft Chief

2. Oil storage seems likely to become a problem sometime in 2016. In fact, if the run-up in oil supply is heavily front-ended to the December to April period, similar to what happened a year ago, lack of crude oil storage space could become a problem within the next three months. Oil prices could fall to $10 or below. We know that for natural gas and electricity, prices often fall below zero when the ability of the system to absorb more supply disappears. It is not clear the oil prices can fall below zero, but they can certainly fall very low. Even if we can somehow manage to escape the problem of running out of crude oil storage capacity in 2016, we could encounter storage problems of some type in 2017 or 2018.

3. Falling oil prices are likely to cause numerous problems. One is debt defaults, both for oil companies and for companies making products used by the oil industry. Another is layoffs in the oil industry. Another problem is negative inflation rates, making debt harder to repay. Still another issue is falling asset prices, such as stock prices and prices of land used to produce commodities. Part of the reason for the fall in price has to do with the falling price of the commodities produced. Also, sovereign wealth funds will need to sell securities, to have money to keep their economies going. The sale of these securities will put downward pressure on stock and bond prices.

4. Debt defaults are likely to cause major problems in 2016. As noted in the introduction, we seem to be approaching the unwinding of a debt supercycle. We can expect one company after another to fail because of low commodity prices. The problems of these failing companies can be expected to spread to the economy as a whole. Failing companies will lay off workers, reducing the quantity of wages available to buy goods made with commodities. Debt will not be fully repaid, causing problems for banks, insurance companies, and pension funds. Even electricity companies may be affected, if their suppliers go bankrupt and their customers become less able to pay their bills.
5. Governments of some oil exporters may collapse or be overthrown, if prices fall to a low level. The resulting disruption of oil exports may be welcomed, if storage is becoming an increased problem.

6. It is not clear that the complete unwind will take place in 2016, but a major piece of this unwind could take place in 2016, especially if crude oil storage fills up, pushing oil prices to less than $10 per barrel.

7. Whether or not oil storage fills up, oil prices are likely to remain very low, as the result of rising supply, barely rising demand, and no one willing to take steps to try to fix the problem. Everyone seems to think that someone else (Saudi Arabia?) can or should fix the problem. In fact, the problem is too large for Saudi Arabia to fix. The United States could in theory fix the current oil supply problem by taxing its own oil production at a confiscatory tax rate, but this seems exceedingly unlikely. Closing existing oil production before it is forced to close would guarantee future dependency on oil imports. A more likely approach would be to tax imported oil, to keep the amount imported down to a manageable level. This approach would likely cause the ire of oil exporters.

8. The many problems of 2016 (including rapid moves in currencies, falling commodity prices, and loan defaults) are likely to cause large payouts of derivatives, potentially leading to the bankruptcies of financial institutions, as they did in 2008. To prevent such bankruptcies, most governments plan to move as much of the losses related to derivatives and debt defaults to private parties as possible. It is possible that this approach will lead to depositors losing what appear to be insured bank deposits. At first, any such losses will likely be limited to amounts in excess of FDIC insurance limits. As the crisis spreads, losses could spread to other deposits. Deposits of employers may be affected as well, leading to difficulty in paying employees.

9. All in all, 2016 looks likely to be a much worse year than 2008 from a financial perspective. The problems will look similar to those that might have happened in 2008, but didn’t thanks to government intervention. This time, governments appear to be mostly out of approaches to fix the problems.

10. Two years ago, I put together the chart shown as Figure 12. It shows the production of all energy products declining rapidly after 2015. I see no reason why this forecast should be changed. Once the debt supercycle starts its contraction phase, we can expect a major reduction in both the demand and supply of all kinds of energy products.

Figure 12. Estimate of future energy production by author. Historical data based on BP adjusted to IEA groupings.

Conclusion

We are certainly entering a worrying period. We have not really understood how the economy works, so we have tended to assume we could fix one or another part of the problem. The underlying problem seems to be a problem of physics. The economy is a dissipative structure, a type of self-organizing system that forms in thermodynamically open systems. As such, it requires energy to grow. Ultimately, diminishing returns with respect to human labor–what some of us would call falling inflation-adjusted wages of non-elite workers–tends to bring economies down. Thus all economies have finite lifetimes, just as humans, animals, plants, and hurricanes do. We are in the unfortunate position of observing the end of our economy’s lifetime.

Most energy research to date has focused on the Second Law of Thermodynamics. While this is a contributing problem, this is really not the proximate cause of the impending collapse. The Second Law of Thermodynamics operates in thermodynamically closed systems, which is not precisely the issue here.

We know that historically collapses have tended to take many years. This collapse may take place more rapidly because today’s economy is dependent on international supply chains, electricity, and liquid fuels–things that previous economies were not dependent on.





Nine Reasons Why Low Oil Prices May “Morph” Into Something Much Worse

24 07 2015

As oil price collapse to under $50……… by Gail Tverberg, orginally posted here.

Why are commodity prices, including oil prices, lagging? Ultimately, the question comes back to, “Why isn’t the world economy making very many of the end products that use these commodities?” If workers were getting rich enough to buy new homes and cars, demand for these products would be raising the prices of commodities used to build and operate cars, including the price of oil. If governments were rich enough to build an increasing number of roads and more public housing, there would be demand for the commodities used to build roads and public housing.

It looks to me as though we are heading into a deflationary depression, because the prices of commodities are falling below the cost of extraction. We need rapidly rising wages and debt if commodity prices are to rise back to 2011 levels or higher. This isn’t happening. Instead, Janet Yellen is talking about raising interest rates later this year, and  we are seeing commodity prices fall further and further. Let me explain some pieces of what is happening.

1. We have been forcing economic growth upward since 1981 through the use of falling interest rates. Interest rates are now so low that it is hard to force rates down further, in order to encourage further economic growth. 

Falling interest rates are hugely beneficial for the economy. If interest rates stop dropping, or worse yet, begin to rise, we will lose this very beneficial factor affecting the economy. The economy will tend to grow even less quickly, bringing down commodity prices further. The world economy may even start contracting, as it heads into a deflationary depression.

If we look at 10-year US treasury interest rates, there has been a steep fall in rates since 1981.

Figure 1. Chart prepared by St. Louis Fed using data through July 20, 2015.

In fact, almost any kind of interest rates, including interest rates of shorter terms, mortgage interest rates, bank prime loan rates, and Moody’s Seasoned AAA Bonds, show a fairly similar pattern. There is more variability in very short-term interest rates, but the general direction has been down, to the point where interest rates can drop no further.

Declining interest rates stimulate the economy for many reasons:

  • Would-be homeowners find monthly payments are lower, so more people can afford to purchase homes. People already owning homes can afford to “move up” to more expensive homes.
  • Would-be auto owners find monthly payments lower, so more people can afford cars.
  • Employment in the home and auto industries is stimulated, as is employment in home furnishing industries.
  • Employment at colleges and universities grows, as lower interest rates encourage more students to borrow money to attend college.
  • With lower interest rates, businesses can afford to build factories and stores, even when the anticipated rate of return is not very high. The higher demand for autos, homes, home furnishing, and colleges adds to the success of businesses.
  • The low interest rates tend to raise asset prices, including prices of stocks, bonds, homes and farmland, making people feel richer.
  • If housing prices rise sufficiently, homeowners can refinance their mortgages, often at a lower interest rate. With the funds from refinancing, they can remodel, or buy a car, or take a vacation.
  • With low interest rates, the total amount that can be borrowed without interest payments becoming a huge burden rises greatly. This is especially important for governments, since they tend to borrow endlessly, without collateral for their loans.

While this very favorable trend in interest rates has been occurring for years, we don’t know precisely how much impact this stimulus is having on the economy. Instead, the situation is the “new normal.” In some ways, the benefit is like traveling down a hill on a skateboard, and not realizing how much the slope of the hill is affecting the speed of the skateboard. The situation goes on for so long that no one notices the benefit it confers.

If the economy is now moving too slowly, what do we expect to happen when interest rates start rising? Even level interest rates become a problem, if we have become accustomed to the economic boost we get from falling interest rates.

2. The cost of oil extraction tends to rise over time because the cheapest to extract oil is removed first. In fact, this is true for nearly all commodities, including metals. 

If costs always remained the same, we could represent the production of a barrel of oil, or a pound of metal, using the following diagram.

Figure 2

If production is becoming increasingly efficient, then we might represent the situation as follows, where the larger size “box” represents the larger output, using the same inputs.

Figure 3

For oil and for many other commodities, we are experiencing the opposite situation. Instead of becoming increasingly efficient, we are becoming increasingly inefficient (Figure 4). This happens because deeper wells need to be dug, or because we need to use fracking equipment and fracking sand, or because we need to build special refineries to handle the pollution problems of a particular kind of oil. Thus we need more resources to produce the same amount of oil.

Figure 4. Growing inefficiency

Some people might call the situation “diminishing returns,” because the cheap oil has already been extracted, and we need to move on to the more difficult to extract oil. This adds extra steps, and thus extra costs. I have chosen to use the slightly broader term of “increasing inefficiency” because it indicates that the nature of these additional costs is not being restricted.

Very often, new steps need to be added to the process of extraction because wells are deeper, or because refining requires the removal of more pollutants. At times, the higher costs involve changing to a new process that is believed to be more environmentally sound.

Figure 5

The cost of extraction keeps rising, as the cheapest to extract resources become depleted, and as environmental pollution becomes more of a problem.

3. Using more inputs to create the same or smaller output pushes the world economy toward contraction.

Essentially, the problem is that the same quantity of inputs is yielding less and less of the desired final product. For a given quantity of inputs, we are getting more and more intermediate products (such as fracking sand, “scrubbers” for coal-fired power plants, desalination plants for fresh water, and administrators for colleges), but we are not getting as much output in the traditional sense, such as barrels of oil, kilowatts of electricity, gallons of fresh water, or educated young people, ready to join the work force.

We don’t have unlimited inputs. As more and more of our inputs are assigned to creating intermediate products to work around limits we are reaching (including pollution limits), fewer of our resources can go toward producing desired end products. The result is less economic growth. Because of this declining economic growth, there is less demand for commodities. So, prices for commodities tend to drop.

This outcome is to be expected, if increased efficiency is part of what creates economic growth, and what we are experiencing now is the opposite: increased inefficiency.

4. The way workers afford higher commodity costs is primarily through higher wages. At times, higher debt can also be a workaround. If neither of these is available, commodity prices can fall below the cost of production.

If there is a significant increase in the cost of products like houses and cars, this presents a huge challenge to workers. Usually, workers pay for these products using a combination of wages and debt. If costs rise, they either need higher wages, or a debt package that makes the product more affordable–perhaps lower rates, or a longer period for payment.

Commodity costs have been rising very rapidly in the last fifteen years or so. According to a chart prepared by Steven Kopits, some of the major costs of extracting oil began increasing by 10.9% per year, in about 1999.

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

In fact, the inflation-adjusted prices of almost all energy and metal products tended to rise rapidly during the period 1999 to 2008 (Figure 7). This was a time period when the amount of mortgage debt was increasing rapidly as lenders began offering home loans with low initial interest rates to almost anyone, including those with low credit scores and irregular income. When debt levels began falling in mid-2008 (related in part to defaulting home loans), commodity prices of all types dropped.

Figure 6. Inflation adjusted prices adjusted to 1999 price = 100, based on World Bank

Prices then began to rise once Quantitative Easing (QE) was initiated (compare Figures 6 and 7). The use of QE brought down medium-term and long-term interest rates, making it easier for customers to afford homes and cars.

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

More recently, prices have fallen again. Thus, we have had two recent times when prices have fallen below the cost of production for many major commodities. Both of these drops occurred after prices had been high, when debt availability was contracting or failing to rise as much as in the past.

5. Part of the problem that we are experiencing is a slow-down in wage growth.

Figure 8 shows that in the United States, growth in per capita wages tends to disappear when oil prices rise above $40 barrel. (Of course, as noted in Point 1, interest rates have been falling since 1981. If it weren’t for this, the cut off for wage growth might even be lower–perhaps even $20 barrel!)

Figure 8. 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.

There is also a logical reason why we should expect that wages would tend to fall as energy costs rise. How does a manufacturer respond to the much higher cost of one or more of its major inputs? If the manufacturer simply passes the higher cost along, many customers will no longer be able to afford the manufacturer’s or service-provider’s products. If businesses can simply reduce some other costs to offset the rise in the cost in energy products and metals, they might be able to keep most of their customers.

A major area where a manufacturer or service provider can cut costs is in wage expense.  (Note the different types of expenses shown in Figure 5. Wages are a major type of expense for most businesses.)

There are several ways employment costs can be cut:

  1. Shift jobs to lower wage countries overseas.
  2. Use automation to shift some human labor to labor provided by electricity.
  3. Pay workers less. Use “contract workers” or “adjunct faculty” or “interns” who will settle for lower wages.

If a manufacturer decides to shift jobs to China or India, this has the additional advantage of cutting energy costs, since these countries use a lot of coal in their energy mix, and coal is an inexpensive fuel.

Figure 9. United States Percentage of Labor Force Employed, in by St. Louis Federal Reserve.

In fact, we see a drop in the US civilian labor force participation rate (Figure 9) starting at approximately the same time when energy costs and metal costs started to rise. Median inflation-adjusted wages have tended to fall as well in this period. Low wages can be a reason for dropping out of the labor force; it can become too expensive to commute to work and pay day care expenses out of meager wages.

Of course, if wages of workers are not growing and in many cases are actually shrinking, it becomes difficult to sell as many homes, cars, boats, and vacation cruises. These big-ticket items create a significant share of commodity “demand.” If workers are unable to purchase as many of these big-ticket items, demand tends to fall below the (now-inflated) cost of producing these big-ticket items, leading to the lower commodity prices we have seen recently.

6. We are headed in slow motion toward major defaults among commodity producers, including oil producers. 

Quite a few people imagine that if oil prices drop, or if other commodity prices drop, there will be an immediate impact on the output of goods and services.

Figure 10.

Instead, what happens is more of a time-lagged effect (Figure 11).

Figure 11.

Part of the difference lies in the futures markets; companies hold contracts that hold sale prices up for a time, but eventually (often, end of 2015) run out. Part of the difference lies in wells that have already been drilled that keep on producing. Part of the difference lies in the need for businesses to maintain cash flow at all costs, if the price problem is only for a short period. Thus, they will keep parts of the business operating if those parts produce positive cash flow on a going-forward basis, even if they are not profitable considering all costs.

With debt, the big concern is that the oil reserves being used as collateral for loans will drop in value, due to the lower price of oil in the world market. The collateral value of reserves works out to be something like (barrels of oil in reserves x some expected price).

As long as oil is being valued at $100 barrel, the value of the collateral stays close to what was assumed when the loan was taken out. The problem comes when low oil prices gradually work their way through the system and bring down the value of the collateral. This may take a year or more from the initial price drop, because prices are averaged over as much as 12 months, to provide stability to the calculation.

Once the value of the collateral drops below the value of the outstanding loan, the borrowers are in big trouble. They may need to sell some of the other assets they own, to help pay down the loan. Or, they may end up in bankruptcy. The borrowers certainly can’t borrow the additional money they need to keep increasing their production.

When bankruptcy occurs, many follow-on effects can be expected. The banks that made the loans may find themselves in financial difficulty. The oil company may lay off large numbers of workers. The former workers’ lack of wages may affect other businesses in the area, such as car dealerships. The value of homes in the area may drop, causing home mortgages to become “underwater.” All of these effects contribute to still lower demand for commodities of all kinds, including oil.

Because of the time lag problem, the bankruptcy problem is hard to reverse. Oil prices need to stay high for an extended period before lenders will be willing to lend to oil companies again. If it takes, say, five years for oil prices to get up to a level high enough to encourage drilling again, it may take seven years before lenders are willing to lend again.

7. Because many “baby boomers” are retiring now, we are at the beginning of a demographic crunch that has the tendency to push demand down further.

Many workers born in the late 1940s and in the 1950s are retiring now. These workers tend to reduce their own spending, and depend on government programs to pay most of their income. Thus, the retirement of these workers tends to drive up governmental costs at the same time it reduces demand for commodities of all kinds.

Someone needs to pay for the goods and services used by the retirees. Government retirement plans are rarely pre-funded, except with the government’s own debt. Because of this, higher pension payments by governments tend to lead to higher taxes. With higher taxes, workers have less money left to buy homes and cars. Even with pensions, the elderly are never a big market for homes and cars. The overall result is that demand for homes and cars tends to stagnate or decline, holding down the demand for commodities.

8. We are running short of options for fixing our low commodity price problem.

The ideal solution to our low commodity price problem would be to find substitutes that are cheap enough, and could increase in quantity rapidly enough, to power the economy to economic growth. “Cheap enough” would probably mean approximately $20 per barrel for a liquid oil substitute. The price would need to be correspondingly inexpensive for other energy products. Cheap and abundant energy products are needed because oil consumption and energy consumption are highly correlated. If prices are not low, consumers cannot afford them. The economy would react as it does to inefficiency. In other words, it would react as if too much of the output is going into intermediate products, and too little is actually acting to expand the economy.

Figure 12. World GDP in 2010$ compared (from USDA) compared to World Consumption of Energy (from BP Statistical Review of World Energy 2014).

These substitutes would also need to be non-polluting, so that pollution workarounds do not add to costs. These substitutes would need to work in existing vehicles and machinery, so that we do not have to deal with the high cost of transition to new equipment.

Clearly, none of the potential substitutes we are looking at today come anywhere close to meeting cost and scalability requirements. Wind and solar PV can only be built on top of our existing fossil fuel system. All evidence is that they raise total costs, adding to our “Increased Inefficiency” problem, rather than fixing it.

Other solutions to our current problems seem to be debt based. If we look at recent past history, the story seems to be something such as the following:

Besides adopting QE starting in 2008, governments also ramped up their spending (and debt) during the 2008-2011 period. This spending included road building, which increased the demand for commodities directly, and unemployment insurance payments, which indirectly increased the demand for commodities by giving jobless people money, which they used for food and transportation. China also ramped up its use of debt in the 2008-2009 period, building more factories and homes. The combination of QE, China’s debt, and government debt together brought oil prices back up by 2011, although not to as high a level as in 2008 (Figure 7).

More recently, governments have slowed their growth in spending (and debt), realizing that they are reaching maximum prudent debt levels. China has slowed its debt growth, as pollution from coal has become an increasing problem, and as the need for new homes and new factories has become saturated. Its debt ratios are also becoming very high.

QE continues to be used by some countries, but its benefit seems to be waning, as interest rates are already as low as they can go, and as central banks buy up an increasing share of debt that might be used for loan collateral. The credit generated by QE has allowed questionable investments since the required rate of return on investments funded by low interest rate debt is so low. Some of this debt simply recirculates within the financial system, propping up stock prices and land prices. Some of it has gone toward stock buy-backs. Virtually none of it has added to commodity demand.

What we really need is more high wage jobs. Unfortunately, these jobs need to be supported by the availability of large amounts of very inexpensive energy. It is the lack of inexpensive energy, to match the $20 per barrel oil and very cheap coal upon which the economy has been built that is causing our problems. We don’t really have a way to fix this.

9. It is doubtful that the prices of energy products and metals can be raised again without causing recession.

We are not talking about simply raising oil prices. If the economy is to grow again, demand for all commodities needs to rise to the point where it makes sense to extract more of them. We use both energy products and metals in making all kinds of goods and services. If the price of these products rises, the cost of making virtually any kind of goods or services rises.

Raising the cost of energy products and metals leads to the problem represented by Growing Inefficiency (Figure 4). As we saw in Point 5, wages tend to go down, rather than up, when other costs of production rise because manufacturers try to find ways to hold total costs down.

Lower wages and higher prices are a huge problem. This is why we are headed back into recession if prices rise enough to enable rising long-term production of commodities, including oil.





A Roadmap For The Land Access

22 04 2015

Another gem….  this one’s from William Horvath’s blog, and really resonates with me because I am constantly asked how our younger generations can ever duplicate our efforts on their own piece of heaven.  We baby boomers have really cleaned up, and it’s entirely at the expense of our kids….. so what are they to do?  I have reached the conclusion that only we with the wealth (such as it might be…) will have to assist in ensuring our kids do have a future, natural catastrophes aside of course, some things are out of our control, maybe even out of control altogether….  Anyhow, read on and see what William thinks.





Ten Reasons Intermittent Renewables (Wind and Solar PV) are a Problem

26 01 2014

Gail Tverberg

Gail Tverberg

raises many points that have already been posted here…..  I only reproduce her dot points one and nine, because they are the most relevant to DTM, but I recommend you read the entire article on her website if you have the time.  It is, as usual, an excellent well researched piece of journalism

Intermittent renewables–wind and solar photovoltaic panels–have been hailed as an answer to all our energy problems. Certainly, politicians need something to provide hope, especially in countries that are obviously losing their supply of oil, such as the United Kingdom. Unfortunately, the more I look into the situation, the less intermittent renewables have to offer.

1. It is doubtful that intermittent renewables actually reduce carbon dioxide emissions.

It is devilishly difficult to figure out whether on not any particular energy source has a favorable impact on carbon dioxide emissions. The obvious first way of looking at emissions is to look at the fuel burned on a day-to-day basis. Intermittent renewables don’t seem to burn fossil fuel on day-to-day basis, while those using fossil fuels do, so wind and solar PV seem to be the winners.

The catch is that there are many direct and indirect ways that fossil fuels come into play in making the devices that create the renewable energy and in their operation on the grid. The researcher must choose “boundaries” for any analysis. In a sense, we need our whole fossil fuel powered system of schools, roads, airports, hospitals, and electricity transmission lines to make any of type of energy product work, whether oil, natural gas, wind, or solar electric–but it is difficult to make boundaries wide enough to cover everything.

The exercise becomes one of trying to guess how much carbon emissions are saved by looking at tops of icebergs, given that the whole rest of the system is needed to support the new additions. The thing that makes the problem more difficult is the fact that intermittent renewables have more energy-related costs that are not easy to measure than fossil fuel powered energy does. For example, there may be land rental costs, salaries of consultants, and (higher) financing costs because of the front-ended nature of the investment. There are also costs for mitigating intermittency and extra long-distance grid connections.

Many intermittent renewables costs seem to be left out of CO2 analyses under the theory that, say, land rental doesn’t really use energy. But the payment for land rental means that the owner can now go and buy more “stuff,” so it acts to raise fossil fuel energy consumption.

Normally the cost of making an energy-related product gives an indication as to how much fossil fuel energy is involved in the process. A high-priced energy product gives an expectation of high fossil fuel use, since true renewable energy use is free. If the true source of renewable energy were only wind or solar, there would be no cost at all! The fact that wind and solar PV tends to be more expensive than other electricity generation gives an initial expectation that the fossil fuel energy requirements for creating this energy source are high, rather than low, if a wide boundary analysis were to be done.

There are some studies based on narrow boundary studies of various types (Energy Return on Energy Invested, Life Cycle Analysis, and Energy Payback Periods) that suggest that there are some savings (from the top of the icebergs) if intermittent renewables are used. But more broadly based studies show that the overall amount of fossil fuel energy used by intermittent renewables is really so high that we don’t come out ahead by its use. One such study is Weissbach et al.’s study in Energy called  Energy intensities, EROIs (energy returned on invested), and energy payback times of electricity generating power plants. Another is an analysis of Spanish installed solar power by Pedro Prieto and Charles Hall called Spain’s Photovoltaic Revolution: The Energy Return on Energy Invested.

I tend to use an even wider boundary approach: what happens to world CO2 emissions when we ramp up intermittent renewables? As far as I can tell, it tends to raise CO2 emissions. One way this happens is by ramping up China’s economy, through the additional business it generates in the making of wind turbines, solar panels, and the mining of rare earth minerals used in these devices. The benefit China gets from its renewable sales is leveraged several times, as it allows the country to build new homes, roads, and schools, and businesses to service the new manufacturing. In China, the vast majority of manufacturing is with coal.

china-energy-consumption-by-source

Another way intermittent renewables raise world CO2 emissions indirectly is by making the country using intermittent renewables less competitive in the world market-place, because the higher electricity cost raises the price of manufactured goods. This tends to send manufacturing to countries that use lower-priced energy sources for electricity, such as China.

A third way that intermittent renewables can raise world CO2 emissions relates to affordability. Consumers cannot afford high-priced electricity without their standards of living dropping. Governments may be pressured to change their overall electricity mix to include more very low-cost energy sources, such as lignite (a very low grade of coal), in their electricity mix to keep the  overall price in an affordable range. This seems to be at least part of the problem behind Germany’s difficulties with renewables.

If there is any savings at all in CO2 emissions, it would seem to be from inexpensive intermittent renewables–ones that don’t really need subsidies. If renewables need a subsidy or feed in tariff, a red danger light should be flashing. Somewhere the process is  using a lot of fossil fuels in its production.

9. My analysis indicates that the bottleneck we are reaching is not simply oil. Instead, a major problem is inadequate investment capital and too much debt.  Ramping up wind and solar PV tends to make those problems worse, not better.

As I described in my post Why EIA, IEA, and Randers’ 2052 Energy Forecasts are Wrong, we are reaching an investment capital and debt bottleneck, because of the higher extraction costs of oil. Adding intermittent renewables, in which huge costs are paid out in advance, adds to this problem. Because of this, ramping up intermittent renewables tends to make collapse come sooner, rather than later, to the countries trying to ramp up these energy sources.