Peak Oil, Oil Prices and their Role in the Great Recession.

Everyone is now familiar with the concept of climate change; however, its effects are likely to be minor in scale in comparison to the havoc that declining oil and associated fossil fuel resources will wreak on our economies and our lives over the next forty years. Fossil fuels underpin almost every aspect of our existence. Approximately 90% of our electrical needs are met using non-renewable resources, while road transport, commercial shipping and air travel are entirely dependent on oil.

 Electricity Generation by Fuel, Ireland

Let’s first consider modern food production. Prior to the invention of mechanised steam and later, the internal combustion engine, a farmer would put in one calorie of labour (on average) for 3 calories “return on investment”; his/her harvest.

Now, we burn 10 calories of fuel to obtain 3 calories of food.  How does this work??  Well, we plant our crops (agricultural machinery uses diesel), then we fertilise them (oil is used to make chemically based fertilisers), then we harvest them (more agricultural machinery and diesel), then we use refrigerated, fossil fuel powered transport to get them, sometimes thousands of miles, to the refrigerated supermarket.

Basically, if we were to wake up tomorrow morning to find out that no more fossil fuels were available, it is highly probable that most non-farmers would starve to death. But just in case anyone was under the impression that fossil fuel shortages can  be entirely solved by changing our wicked ways, giving up the Range Rover, the holidays in Honolulu and conscientiously digging that allotment, think again. This entirely ignores the effects of concomittant economic contraction on the fractional reserve banking system, which is entirely dependent on economic growth.

Energy and the economy

Cheap energy is the shaky foundation underpinning the grand high altar of capitalism; Economic Growth. Studies carried out by a Nobel Prize winning economist, Robert Solow, starting in the 1950s, identified many of the forces behind economic growth; expanding labour forces, favourable demographics, growth in savings and therefore investable capital, technological advances, and so on.  A factor initially unidentified, dubbed the Solow differential, accounted for 50% of economic growth.  Interestingly, the Solow differential has since been identified as resulting from the ever-expanding cheap energy provided to us by fossil fuels since coal was first used to power steam engines.

Protest at Anglo Irish Bank

So, the million dollar, no, correction, the SEVERAL TRILLION dollar question is; what happens to economic growth if fifty percent of its motive force is not only removed, but reversed? Energy, far from cheap and plentiful, is now becoming increasingly scarce and expensive. One can confidently expect, moreover, that net exporters of fossil fuels will make ever increasing profit margins on the fuel that remains, meaning that they need to sell less of it to maintain their incomes.  One can also confidently expect many of the more unscrupulous exporters to use their newfound clout to hold the rest of the world to ransom.  This process is likely to make pre-First World War diplomacy (referred to then as “the Great Game”) look like a Snakes and Ladders tournament for Junior Infants, by comparison.

One notes with interest that control of more and more of the world’s fossil fuel resources has been appropriated by the nation states in whose territories those resources are located. It is likely that attempts have been already been made to seize control of such resources by military means (Alan Greenspan, chairman of the US Federal Reserve under Presidents Clinton and George W. Bush, has admitted that the Iraq war was all about oil, and has expressed surprise that this comment of his caused such a furore).  Ireland, a neutral country, has no means with which to ensure continuity of supply via military means, either real or threatened.

Moreover, military action has been shown to be somewhat ineffective even when used by the well armed; oil production in Iraq does not yet exceed by much, the volumes exported under Saddam Hussein.  Meanwhile, the war in Iraq has cost the UK and US in excess of one trillion dollars by 2007.  They should have spent it on renewables! A further complication of oil supply involves the instability and poor human rights records of many of the larger exporters.  Uneven distribution of petrodollars amongst ruling elites has left many poorer Middle-Eastern consumers very much at the mercy of rising grain prices (a consequence of both global warming and speculation, see Golem XIV’s blog), leaving the regimes at the mercy of restive populations.  The evacuation of foreign oil workers from civil war ridden countries such as Libya has not been conducive to the stable supply of oil to the West.  This disruption looks likely to spread to larger oil producers, possibly leading shortly to the mother of all price hikes.

Victims of US bombing of Iraq 2003 “Shock and awe”

Oil, the property boom and the credit crunch; why oil has been a significant contributor to  the worst financial crisis this century.  What is the evidence that declining oil reserves (and rocketing prices) actually affect the economy??  Concrete evidence dates back to the 1970s, where tripling of oil prices within a matter of months caused shortages, severe recessions, unemployment and rampant stagflation. Many commentators thought that this link might have been broken; from 1999-2007, when oil prices increased from approximately $10 per barrel to above $80, economic growth was not obviously impacted. However, as we now know, banks were awash with liquidity and what consumers, businesses and governments could no longer afford, they borrowed.

The 1990s had been a period of low energy prices, spectacular technological innovation, demographic growth and opening up of many “closed” economies to foreign investment following the fall of the Berlin Wall (the perfect conditions for optimal economic growth). This boom continued into the “noughties”, now fuelled by Eastern savings, delinquent bankers and a population inured to “I cannot die” style optimism by a protracted period of runaway economic expansion.

The result was a collective sense of entitlement and blasé attitudes to ever increasing leverage; in other words, we were drowning in debt without realising it. The temporary economic technical hitch otherwise known as the bursting of the .com bubble merely resulted in loss of trust in stocks and shares; people retreated to a more traditional investment they thought they could understand. Property. In relatively underpopulated countries such as the US, Canada, Ireland and Australia, where public transport was relatively uneconomic in many areas (owing to low population density) and planning laws were lax, given no major shortages of space, building booms ensued, along with spiralling price increases. Low population densities, poor planning and low levels of public transport also meant an increase in car usage in many suburbs and exurbs, one of the many factors that drove oil demand much closer to oil supply (thereby exerting an upward momentum on the price).  Note the rise in oil consumption for Ireland over the Celtic Tiger period (below).  This pattern was mirrored over most of the Anglozone.

Statistics on the Web:  Consumption of oil products; Ireland.

Construction is also a tremendous consumer of energy and raw materials. Commodity prices soared, but banks were awash with money and construction created jobs and put money in the pockets of the relatively unskilled. People borrowed and bought, many with subprime loans. In the US, these were sold with teaser rates that increased to much higher levels after two years, which coincided with an escalation in the oil price that was felt much more keenly in the US than in Europe. Higher oil prices also led, belatedly, to higher interest rates on both sides of the Atlantic. So, your US subprime mortgage holders were suddenly faced with astronomically higher repayments after the expiry of teaser rates, while oil price driven inflation led to base rate increases and rocketing transport, food, and utility bills. The result was to stall, then reverse, house price increases, first in the US, then elsewhere. Then the AAA rated subprime mortgage bonds (which had cleverly managed to disguise the real risk of these investments) failed, resulting eventually in the “domino effect” banking collapse we continue to experience today.

Those economies benefitting from the soaring commodity prices, which increased until July 2008, got a reprieve until early 2009 (confidence and stellar commodity profits take a while to deflate).  A glorious example of people’s inability to join the fossil fuel linked dots was the praise meted out by the financial markets with respect to the lack of bank bailouts in Australia and Canada in late 2008. For them, the boom had just ended; they were raking in profits related to $147/barrel oil prices and related rises in other commodity prices until July 2008. Both countries experienced real estate booms similar in scope to those in the US and UK; the price/income ratio in Australia is now higher than most other places in the world. However, thanks to the commodity price cushion, banks in these countries have been, to date, relatively protected. Given the resumption in fossil fuel price escalation, they will probably remain so.

The real truth of the matter is this; increases in the oil price feed into everything that we buy; commodity prices are a major driver of both inflation and deflation. Oil is used for ALL heavy goods transport (air, road, rail and shipping), and is also a major ingredient in plastics, pharmaceuticals and building materials. The price of oil is linked to that of the other fossil fuels, gas and coal, which are largely used to generate our electricity and heat our homes. Oil price increases therefore feed inflation, which, in the absence of real wage increases, eats away at living standards. With stringent financial regulation and tightly controlled availability of credit, this is felt in the real economy immediately. When the banks are awash with cheap cash and false confidence, the effect is delayed by the easy availability of loans. But as we have seen since 2007, delaying the inevitable only makes things worse.

Egyptian bread protest 2008

The price of fossil fuels was far from the only factor in causing the housing bust that led to the credit crunch. But if massive levels of indebtedness were a loaded machine gun, oil prices increased the pressure on the indebted sufficiently to pull the trigger. We (taxpayers, businesses, financial institutions and governments) are still massively over-leveraged, and oil hovers near $120 per barrel. Furthermore, rising oil prices (the overall trend will move inexorably upward) means that more of decreasing family incomes will have to be spent on food and fuel, less on luxuries, property and servicing what are now unmanageable debts. This means that the process of deleveraging (a.k.a. the banking crash) will proceed apace; those relying on the sale of non-essential items and services, property transactions, construction, travel etc will find themselves either unemployed or with vastly reduced incomes, leading to falling tax revenues and rocketing unemployment levels.

Meanwhile, public purses that are emptied to “treat the symptoms, not the disease”, to bail out and/or recapitalise the banks, will be pressurised to increase public wages and social welfare when no money is available.

A decline in available oil output of 1-6% per annum is likely at some stage after the peak (which may already have passed; production figures in May and December 2005 have yet to be exceeded), prices may be volatile; high during intermittent periods of global growth, then plunging as another wave of inflation induced job losses and asset depreciation leads to further writedowns and recapitalisations, and temporarily lower energy consumption. Energy consumption in OECD countries is indeed down since the peak of the boom in 2006-7. However, for every barrel we fail to consume, economies such  as India and China be willing and able to take up the slack, thus keeping prices high.

Statistics on the Web: Consumption of oil products; People’s Republic of China.

Ensuing low lending levels by the banks will ensure the failure of further small businesses as this progresses. As increasing consumption of cheap energy led to 50+ year of expansionary prosperity, so forced declines in consumption of scarce and expensive energy will lead to 50 years of contraction; declining living standards, inability to maintain healthcare at current levels, lower lifespans, increased levels of hunger and so on. Unfortunately, the “animal spirits” that govern both “irrational exuberance” and the fear and despair associated with recessions will only exacerbate the problems associated with the Great Decline that will occur as energy resources dwindle. In the worst case scenario, where power outages become common in net energy importers such as ourselves, the knowledge economy could collapse; those servers need constant power to operate! We will become better acquainted with the four horsemen of the apocalypse, or, maybe for the modern era, we should make that  eight; Unemployment, Pollution, Resource Depletion, Climatic Instability, Famine, Pestilence, War and Death. Not necessarily in that order!

It is therefore of huge importance that public awareness of this issue is raised. The general public has been bombarded with climate change propaganda; however, as soon as everyone realised that cutting back on energy use voluntarily meant a drop in living standards and risks to economic growth, scepticism towards this issue has risen inexorably, despite the occurrence of phenomena such as hurricanes Katrina, Rita and Wilma or the multiple “once in 100 year” floods in the last 5 years in these islands (RoI + UK). We need to get over the idea that cuts in energy usage are voluntary. If we don’t make them by choice, they will be enforced by the ultimate global dictator; Mother Nature. At current rates of usage, oil reserves will be largely exhausted in 40 years. That means a complete overhaul of every aspect of our society within that time frame. Or, alternatively, near extinction.

The current state of oil reserves

Many have argued that increasing oil prices will result in Herculean efforts to source more oil, gas and coal (which can, at some expense and with vastly polluting effect, be converted to transport fuel using the Fischer-Tropsch process, a chemical reaction used to convert coal to transport fuel). However, two geological studies, one of British coal production over the last 150 years, and another tracking the rise and fall of US oil production, suggest that the effects of “looking harder” on declining production are minimal. Geology rules absolutely, and it is not ruling in our favour .

A graph of UK coal production since 1855 (from David Strahan, the Great Coal Hole). shows a triangle, pretty much, production goes up steeply until about 1915, while decline is similarly pretty inexorable thereafter, reaching less than 1/5 peak by about 1990. No doubt the decline would have been even more steep, were it not for the intervention of foreign supplies and the switch to oil as transport fuel of choice from the 1940s onwards (with British Rail switching from steam to diesel in the 1960’s).

David Strahan’s Blog


(For anyone who STILL thinks we have 250 years of coal…..no, we DON’T).

Similarly, oil supplies are unlikely to react substantially to demand.We burn at least 3 barrels of oil for every one we now discover. The last supergiant oil field was located more than forty years ago. A graph of US oil production also shows that the effects of 1970’s oil shortages have little effect on production rates. Again, the triangle shaped graph goes steeply up on one side, and down on the other. M.King Hubbert’s original prediction that US oil production would peak in 1969-1970 was off by a mere 3 months, despite the fact that prior to 1970, his viewpoint was not respected by either the US Geological Survey or the majority of other commentators (Graph: Jean Laherrere, 2005).

Peak gas and coal may also be closer than we think; meanwhile, the process of sourcing new oil is being repeatedly stymied by legitimate concerns regarding climate change, difficulty of physical access to reserves such as those recently identified in the deep ocean off Brazil, and, believe it or not, water. For example, the Albertan tar sands, the largest reserves of oil (potentially) outside Saudi Arabia have a maximum theoretical output per day of 3-5 million barrels, owing to the fact that refining tar sand currently requires 10-12 barrels of water, in the form of steam, for each barrel of oil produced, and there’s only one North Saskatchewan river.

Globally, we use between 85-87 million barrels of oil per day (Ireland imported 3.411 million tonnes of oil in 2007-IEA). Furthermore, producing the steam for refining requires natural gas, which is under pressure as a result of North American domestic demand. This latter problem can be solved with the planned building of a nuclear reactor or two, but this will take at least a decade.  Recent and ongoing events in Fukushima will ensure a renewed public panic with regard to the safety of nuclear facilities (although concerns about those NOT situated near subduction zones may be seriously logically misplaced).  To add to the difficulties, the current wild fluctuations in oil price (high, $147/barrel, July 2008, low < $40, December 2008) are not helping; what is economic at a sustained price of >$80 may not be so at lower prices; moreover, this applies to more costly alternative energy just as much as it applies to piping oil from thousands of metres under the sea bed. With such uncertainty, investors are collectively not investing in ventures which are, individually, risky.

Methods developed by M. King Hubbert, which successfully predicted the real peak in oil production in the US in 1970, extrapolated to world oil supply, suggest a peak in 2015 (although figures of production reached in 2005 have yet to be exceeded). We can expect supply to be contracting rapidly after 2015 at the latest. That is a mere 4 years away. Graph available from The Oil Depletion Resource Page. Gas is projected to peak in 2025.

http://www.gulland.ca/depletion/depletion.htm

Finally, there is the thorny issue of the accuracy of reserves reported by individual nation states and therefore by the IEA.  Companies, countries and the IEA have many motives that would favour looking on the optimistic side when reporting reserves. The stability of oil company profits (and therefore share price) is determined by looking at the size of reserves, meanwhile in the days of oil surplus back in the 1980s, when OPEC countries were allowed to pump oil in proportion to their stated reserves. Now, if you had an economy to keep afloat and there were legitimate doubts as to the exact size of reserves, the tendency would be to err on the optimistic side. Furthermore, if you were an unstable Middle Eastern state partially dependent on foreign powers for national security (take Saudi Arabia for example), you might be somewhat disinclined to caution if your influence on the world stage (and defence capability) was dependent on enormous stated reserves.

Meanwhile, gas and coal reserves, which look healthy on paper, may also be somewhat shaky for similar reasons. Remember how successful the banks were at hiding risk (until 2007)? Well, world energy reserves may be as overinflated as estimates of risk were underinflated. Regardless, even if the oil producers can keep production stable until 2030 (highly unlikely), the rate of demand increase from the BRIC counties in particular means that supply will still be unable to meet demand. Meanwhile, the abject panic that real shortages would cause on world financial markets is likely to be a reason for unfounded optimism in projecting energy supplies, going forward.

In summary, every Government and private sector decision and expenditure, going forward, MUST be considered through the lens of declining energy reserves, rocketing energy prices and global instability, both financial and political. However, to date, there is little evidence that much planning is being carried out. Rather, governments seem to have a blind faith that the norms of the 20th century (the resumption of economic growth) will be re-established if only they could gather the resources to bail out the banking sector some more. Meanwhile, higher oil prices are regarded as a factor behind inflation, and not as part of the source of the problem. Many economists, especially those currently at the ECB, are refusing to recognize that, rather than being amenable to correction by interest rate increases, energy led inflation will remove money from the pockets of consumers and enterprises, thereby increasing the likelihood of inability to service debt. Raising interest rates when society is chronically indebted will have the same effect. These factors together will, in turn, result in further destabilisation of the banking system, leading to demands for more bailouts. None of this will solve any problems, including those of the banks. The solution is to spend our remaining resources in stabilising and increasing our available non-fossil fuel based energy sources (including nuclear power in areas which are seismically inert), thus allowing some degree of stability and enabling economic activity. Recognition of this by the powers that be, however, is sadly lacking.

Morticia  16.4.2011

 Sources for the above, bibliography, relevant websites:

ASPO: http://peakoil.net

Energy Bulletin: http://www.energybulletin.net/index.php

The Oil Drum: http://www.theoildrum.com/

The Oil Depletion Resource Page: http://www.gulland.ca/depletion/depletion.htm

David Strahan, Homepage: http://www.davidstrahan.com/index.html

International Energy Agency: http://www.iea.org/

WTRG economics: http://www.wtrg.com/daily/clfclose.gif

Middle EastBusiness Intelligence: http://www.meed.com

The Irish Times: http://www.irishtimes.com

Time Magazine: http://www.time.com

New Scientist: http://www.newscientist.com

The Guardian: http://www.guardian.co.uk

The Observer: http://www.observer.com

The Irish Independent: http://www.independent.ie

The Independent: http://www.independent.co.uk

The Financial Times: http://www.ft.com

RTE: http://www.rte.ie

BBC: http://www.bbc.co.uk

1) David Strahan (2007) The last oil shock: survival guide to the imminent extinction of petroleum man.  (John Murray)

2) Jeremy Leggett (2005) Half gone; oil, gas, hot air and the global energy crisis

(Portobello Books)

3) Alan Greenspan (2008) The Age of Turbulence (Penguin Books).

4) Colin Campbell. (2010) Energy supply: from expansion to contraction. http://peakoil.net

5) Jeff Rubin (2009) Why your world is about to get a whole lot smaller. (Random House)

6) George R. Akerloff and Robert J. Schiller (2009) Animal Spirits (Princeton University Press)

7) Jared Diamond (2005) Collapse! (Penguin Books)

8 )  David Craig (2008) Squandered! (Constable)

9) Tom Bower (2009). The squeeze; oil, money and greed in the 21st century (Harper Press)

10) George Monbiot (2008) Bring on the Apocalypse; six arguments for global justice. (Atlantic Books).

11) Geraint Anderson(2008) City Boy: Beer and Loathing in the Square Mile (Headline Books).

12) David Strahan: (2008) The Great Coal Hole. New Scientist 17th Jan 2008.

13) Frank MacDonald and James Nix (2005) Chaos at the Crossroads (Gandon Books).

14) Jean H. Laherrere. (1998) The end of cheap oil. Scientific American March 1998.

One Response

  1. Fab Blog Morticia :)

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Follow

Get every new post delivered to your Inbox.

Join 2,567 other followers

%d bloggers like this: