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

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

Why are commodity prices, including oil prices, lagging? Ultimately, it comes back to the question, “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 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, 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 getting 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 I am not restricting the nature of these additional costs.

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), less of our resources can go toward producing desired end products. The result is less economic growth, and because of this declining economic growth, less demand for commodities. 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 big increase in costs 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, about 1999.

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

In fact, the inflation-adjusted prices of almost all energy and metal products tended to rise rapidly during the period between 1999 and 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 buyers began defaulting and debt levels began falling in mid-2008, commodity prices of all types dropped.

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

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 would 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, because of 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 other assets they have, 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 government 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 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.

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 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 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 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

our finite world



42 Comments on "Nine Reasons Why Low Oil Prices May “Morph” Into Something Much Worse"

  1. ennui2 on Wed, 22nd Jul 2015 8:33 pm 

    ““Cheap enough” would probably mean approximately $20 barrel for a liquid oil substitute.”

    How convenient. The end result of this piece is to set a ridiculously low price, above which, Gail can continue to claim that peak oil is in some way shape or form causing TEOTWAWKI.

    It’s full of overly complex charts and gyrations just like what used to be on peakoil.com before it was shut down due to irrelevance. It’s just spin.

  2. Makati1 on Wed, 22nd Jul 2015 9:24 pm 

    Another long winded article telling us that BAU is over but pretending that it isn’t. Every bold statement above tells us that it is over. We are in a deep recession now and a deep depression in many countries. Soon it will all be over.

    I wonder if these authors have given thought to what they will do when the SHTF and their career is gone forever? Most careers today are reliant on abundant cheap (<$20) oil. They were born with the Petroleum Age and will die when it dies. There's gonna be hundreds of millions in the Western world that are going to be casualties when that day comes. A smaller percentage in the other countries that are not so 'over developed' will also need to look for a new, subsistence, job. I hope they all have farmer parents to go back to.

  3. ghung on Wed, 22nd Jul 2015 9:31 pm 

    Two of the dumbest comments I’ve seen here in a while. I’ll just leave it at that.

  4. BobInget on Wed, 22nd Jul 2015 9:36 pm 

    Too American Centric for my taste.
    Not a word about OPEC’s decision, KSA really,
    to undermine Russia, Iran and perhaps US shale producers as well.

    Not a word about documented ‘oil wars’
    Syria as proxy for Russian, Iranian proxies vs Saudi Arabia, USA Sudan, Iraq, Saudi Arabia vs Iran, Saudi Arabia vs Yemen, Boko Haram in Nigeria and neighboring states.

    Possible Arctic confrontations, probable China Sea debacle, Turkish cooperation with ISIS fighting Kurds over rich Northern Iraqi oil.
    ISIS vs just about everyone standing in the way
    of IS world oil domination.

    Not one word concerning Climate Changes and effects deviations from normal will have on
    human fight for survival. All of the above becomes trivial in a famine.

    Commodities, in time of extreme emergency take on quite a different color of pricing.

    It will be like an enemy from ‘outer space’ has invaded ‘our’ green earth.
    There will continue to be struggles over the most important commodities, grains grown with oil.

    Now, if we could just solve the mystery of missing two million barrels of oil and ten train loads of gluten.

  5. hosj on Wed, 22nd Jul 2015 11:22 pm 

    Ennui2, if you’d read the article she explains why that “ridiculously low” price is needed.

  6. Boat on Thu, 23rd Jul 2015 12:09 am 

    Chart #5 is seriously cherry picked. Looks like she forgot the last 6 years.

  7. Jimmy on Thu, 23rd Jul 2015 12:44 am 

    @Ennui2

    You find those charts overly complex?! I find them very simple and easy to understand. In fact I find most of Gail’s articles quite good in that they are not overly complex and the simple masses can hopefully understand complex economical systems via her simple explanations. If it’s still to complex for you I wonder if it’s because you’re cognitively impaired or perhaps you’re not very well read or educated.

  8. Northwest Resident on Thu, 23rd Jul 2015 12:45 am 

    We’re scraping the bottom of the world’s energy barrel at a time when global population is bursting at the seams. The strain on high tech just-in-time industrial economies is too much to bear. Not to mention the unsustainable demands on fresh water and food sources.

    Everything is tanking — oil prices, commodities, retail sales, global trade, container shipping, heavy equipment sales, personal computers — you name it. But we haven’t seen anything yet.

    The trend is definitely on a downward slope, and there won’t be any vast new oilfield discoveries to pull us out of the nosedive the economy is in — not this time.

    I often wonder when will it get bad enough that it really starts to impact me. Since I work right in the heart of the financial services industry, and since “they” seem determined to keep at least that illusionary part of the economy pumped up for as long as possible, I like to think that my job will be one of the last ones to go.

    But right now, around the world and here at home, there are a lot of jobs on the line, just a small additional economic downturn away from going poof.

    The turmoil in China’s markets is already putting jobs in danger all around the world. And it is only going to get worse. How much longer will you still have a job?

    China Aftershocks Ripple Through Earnings From Audi To Iron Ore

    http://davidstockmanscontracorner.com/china-aftershocks-ripple-through-earnings-from-audi-to-iron-ore/

  9. Stephen on Thu, 23rd Jul 2015 3:09 am 

    If unemployment gets to say (25%, 50%, even 65%) in a country, and major fortune 500 companies are going bankrupt in groves, I think this will force some major policy changes in the country.

    1) Will suburban streets be re-worked as small towns (using backyards for growing crops and every 4th house be used as a small shop or storage facility)?

    2) Will money be abandoned altogether? If production stops and supply lines fail, with such high unemployment, it is very likely that debts will get jubileed. With so many out of work, foreclosures, bank levies, etc won’t work very well to collect the debts. If the power grid fails, the debt collection industry will be unemployed as well. Plus, prices will face simultaneous hyperinflation (food and basic needs) and hyper-deflation (cars, suburbia, and anything else that won’t work after the grid failure or fuel runs out).

    3) It is very likely that the government, military, etc won’t be fully operational when this happens too. After all, the US military equipment is dependent on petroleum, electricity, and rare earth metals.

    4) I predict that stocks, bonds, gold, etc won’t be valuable when this happens due to the fact that these items cannot be turned into food or water easily.

  10. marmico on Thu, 23rd Jul 2015 5:06 am 

    Tverberg is a retard. She thinks demand curves are upward sloping.

    Her analysis of Figure 9 is pathetic. There is no correlation between U.S. labor force participation rates and energy/metal costs.

  11. theedrich on Thu, 23rd Jul 2015 5:29 am 

    Gail’s articles are one part of the mix.  She is extremely careful to avoid anything political, knowing that, in a time of civilizational downturn, political correctness is the name of the game.  The terminology and boundaries of discussion are pre-determined by the regime and its operatives who allow only anodyne pablum to be fed to the sheeple.  Other observers, however, can incorporate her analyses into the larger picture for themselves.  That picture includes:  the growing antagonism toward the U.S. by reigning elites in other countries;  politically motivated demographic change through regime-encouraged immigration;  ThirdWorld population overload;  drastic birthrate collapse in all White countries;  biospheric degradation (including species extinction and global warming);  and everything else long described on these blogs openly or covertly.  One factor which seems not to be discussed much is the rapid global growth in technology, computer science and other intellectually-based features of modern covert warfare and subversion.  In the U.S. which, under the Church of Obama Worship, seems to be turning into a hophead culture which prefers IQ-reducing narcotics to education and brainwork, prospects for continued global hegemony by the U.S. do not look good.  The deliberate, unrestrained importation of countless millions of low-skilled, often virutally illiterate aliens to swell the ranks of voters for the Demonic Party is not improving the picture.  Add all this to Gail’s piece of the puzzle, and you get a picture of a yawning abyss opening before us.

  12. Davy on Thu, 23rd Jul 2015 7:33 am 

    Moron Marm said “There is no correlation between U.S. labor force participation rates and energy/metal costs.” Marmi fails to understand and acknowledge demand destruction. Poor guy must be nervous with what is happening everywhere. His cognitive dissonance shows with how unbalanced his comments are. His comments “NEVER” acknowledge problems and they are always mean against people that do. That gives away an agenda every time.

  13. ghung on Thu, 23rd Jul 2015 8:52 am 

    Right on, Davy. I generally ignore the Marms and their cherry picking; merely revelations that they either don’t understand, or are too cowardly, to see the macro picture. The baby boomer generation set a very high bar for rates of consumption, and following generations are unable or unwilling to take up the slack as their parents and grandparents fade out of economies.

    Even without other factors such as resource constraints, etc., consumption rates are in the process of taking a big hit => contraction. No amount of stimulus can restore the kind of 20th century growth that expansion monkeys like Marm expect. Demographics, especially in the West, combined with other macro-economic factors will win, and this will be more than a generational storm.

    Question: Who’ll pay off the immense debt left behind from this multi-decade global shopping spree?

    Answer: Nobody.

  14. paulo1 on Thu, 23rd Jul 2015 9:04 am 

    Never one to be nice, Marm rides in on his snark horse.

    A couple of points. Gail is no idiot for those who disagree. She is trained actauary who makes her living on her wits and ability to predict trends.

    Her charts are dumbed down for her readership to the point of little box does not equal big box. If you can’t grok her point then you shouldn’t be commenting.

    She is also not BAU, rather, she is a doomer willing to explore all facets of collapse and her writings reflect that POV. In fact, I have often taken exception to her lack of acknowledgement of mankind’s ability to adapt and do the right thing under certain circumstances.

    And Marm, every time you post I am thankful you are not my neighbour. I expect the feeling is mutual. However, you are simply unpleasant, sir, and take joy in being nasty.

  15. penury on Thu, 23rd Jul 2015 9:53 am 

    Whenever an article is published containing unpleasant but true information you can be certain that the deniers will be the first to reply. You can deny the truth, but you cannot ignore the truth. Gail is unfortunately correct. The delusional among us will have to learn the hard way.

  16. ghung on Thu, 23rd Jul 2015 9:59 am 

    Central Banks Have Shot Their Wad——-Why The Casino Is In For A Rude Awakening, Part I

    “There has been a lot of chatter in recent days about the plunge in commodity prices—–capped off by this week’s slide of the Bloomberg commodity index to levels not seen since 2002. That epochal development is captured in the chart below, but most of the media gumming about the rapidly accelerating “commodity crunch” misses the essential point…..

    [snip]

    ….And therein lies the origins of the deflationary wave now rocking the global commodity markets. Neither the DM consumer borrowing binge nor the China/EM infrastructure and industrial investment spree arose from sustainable real world economics. They were artifacts of what history will show to be a hideous monetary expansion that left DM world stranded at peak household debt and the EM world drowning in excess capacity to produce commodities and industrial goods….

  17. dave thompson on Thu, 23rd Jul 2015 10:17 am 

    Good article sums things up well. We are and have been in the age of resource limits and economic growth. Back in the 70’s the cracks began to show. Trying to hold it all back with bailing wire, straw and political hokum seems to work for now. We the people need to be good to each other or die trying.

  18. Plantagenet on Thu, 23rd Jul 2015 10:45 am 

    So few people understand that oil prices are low because we are in an oil glut. All this talk about resource limits does not describe our current situation. The supply of oil is currently GREATER than demand, resulting in a surplus of about 800,000 bbl of oil each day, and an OIL GLUT.

  19. apneaman on Thu, 23rd Jul 2015 11:02 am 

    Holy shit it’s back. I thought we lost you there planty – thought maybe you got disoriented on one of your canoe trips from all the forest fire haze and ended up as brown bear lunch. Maybe next time eh?

    Human Civilization at Risk of Ending, Scientists, Governors, and Pope Agree

    http://motherboard.vice.com/read/scientists-popes-and-governors-agree-humanity-risks-extinction

  20. shortonoil on Thu, 23rd Jul 2015 11:24 am 

    Gail attempts to explain our present situation in as simple of terms as possible, and she often does an exemplary job of doing it. The primary challenge of her attempts is that she often falls prey to reversing cause and effect. This is a common failure of economic analysis because the theory provides no way of differentiating between the two. The cause is usually established from the opinion of the analyst.

    One common outcome of this methodology is reversing the roles of dollars, and energy. Dollars are held to be a constant, and the cost of energy is adjusted to dollars. Of course this can not be the case as a barrel of 37.5° API crude has contained 5.88 million BTU for at least the last few million years. The dollar has gone through a hundred year decline against the controlling constant energy:

    http://www.thehillsgroup.org/depletion2_008.htm

    A good example of how this skews results can be seen in her graph Average Wages Compared to Oil Price. The graph shows that oil price crossed the wage graph in 1979, and 2012. Graph#12 above shows that the value of a dollar against energy declined by 520 % between those years; at 33,138 BTU/$ and 6,380 BTU/$. The wage earner has been losing significantly against energy when compared to a constant metric; on a dollar bases they have just barely been holding their own.

    Erroneous results of this nature play a part in policy making decisions from the lowest to the highest levels. It can hardly be expected that workable decisions concerning energy policy can be found when energy itself is mostly ignored. What is ironic is that the dollar mythology has been elevated to a level that will eventually ensure its own destruction.

    http://www.thehillsgroup.org/

  21. idontknowmyself on Thu, 23rd Jul 2015 11:50 am 

    We are on our way to crash international trade (or confidence in money) before we actually run out of positive net energy to society. We might have some net positive energy available but won’t be able to extract it because of the lack of trade financial structure.

  22. idontknowmyself on Thu, 23rd Jul 2015 12:04 pm 

    Bridgewater’s Ray Dalio Loses His Cool On China: “There Are No Safe Places Left To Invest”

    When a mutual fund manager is saying this, you know that confidence in money is fading away. These guys have special research team that go through a lot of data and have a better view of what is happening around the world.

    http://www.zerohedge.com/news/2015-07-23/bridgewaters-ray-dalio-loses-his-cool-china-there-are-no-safe-places-left-invest

  23. marmico on Thu, 23rd Jul 2015 12:18 pm 

    The wage earner has been losing significantly against energy when compared to a constant metric; on a dollar bases they have just barely been holding their own

    What a crock of shit. The wage earner can travel 50% further in 2015 on a gallon of gasoline (constant metric) than in 1979.

    DOT Average Fuel Efficiency

  24. BobInget on Thu, 23rd Jul 2015 1:44 pm 

    Yeah, that’s right Marmico. We are learning to use fuels more efficiently. Is there any argument on that?

    Not a single poster wants to go near geopolitical risk driving commodity prices.

    No one will admit, at least publicly, how many actual and potential oil war we are engaged in at present. Today, possible because a red breasted robin landed on a tree near the department of energy, oil prices have been deep diving again. (someone spotted a cat nearby)

    Plant keeps up a glut drumbeat but like my good neighbor NW Resident cherry picks
    parts of the economy in transition. Neither
    offers evidence to back up even a single claim.

    When I rattle off all the nations battling for oil
    i’ll include a few with little or no oil (japan)
    who are forced to militarize to contain more zealous competitors . Ask your mother or someone you respect, why are all these world powers fighting each other directly or indirectly for oil that falls in price daily for being devalued?

    Price oil $100 below cost to end all oil wars.

    It’s possible ‘we’ are being ‘set up’.

  25. marmico on Thu, 23rd Jul 2015 2:06 pm 

    Is there any argument on that?

    The peaker, nutter, doomer, retard tribe is always blinded by efficiency, substitution and conservation, hence argumentation.

  26. Apneaman on Thu, 23rd Jul 2015 2:16 pm 

    Poor little marm, nony, papa smurf, reduced to glorifying some minor efficiency gain and shouting ever louder the dogma of econ 101 while the whole thing is crumbling as we speak. Keep yelling at reality marmApuke, I find your increasing desperation to be very entertaining.

  27. Apneaman on Thu, 23rd Jul 2015 2:24 pm 

    Bob it’s a given that all wars are resource wars. The religion and rhetoric are just pretexts. If the ME was free of imperialism with the wealth spread around a little more there would be no major problem. Look at the socio economic status of the overwhelming majority of the average ME religious warriors and you will find great poverty. If they had decent middle class incomes and families you would not hear a peep out of them. Same as it ever was.

  28. penury on Thu, 23rd Jul 2015 2:28 pm 

    I know that this site is dedicated to energy, esp fossil fuel liquid energy. However, it would be useful for some to take a minor ten minutes to understand the inter relationships of income versus outgo when computing energy usage. The reason energy use is down is simple “the people have no fu^^ing money. And Marm, we are not blinded by e,s,c however I have yet to see any evidence of a lessing use of fossil fuel on the planet.

  29. dave thompson on Thu, 23rd Jul 2015 3:02 pm 

    Net, useable, end user, energy is the problem. A physical, plentiful supply of crude (“glut”), on the market no longer expands the economy, the way it might have in decades past. Notice how planty shows up when I make a comment?

  30. tahoe1780 on Thu, 23rd Jul 2015 3:03 pm 

    @ Marm – “The wage earner can travel 50% further in 2015 on a gallon of gasoline (constant metric) than in 1979.” http://www.1970sflashback.com/1979/economy.asp http://www.cbsnews.com/news/higher-gas-prices-frustrate-fed-up-california-drivers/ 50% further for > 3X as much, and wages haven’t budged http://www.pewresearch.org/fact-tank/2014/10/09/for-most-workers-real-wages-have-barely-budged-for-decades/ How much more energy went into producing that gallon of regular today?

  31. shortonoil on Thu, 23rd Jul 2015 3:50 pm 

    “How much more energy went into producing that gallon of regular today?”

    In 1979 it took 20,200 BTU to extract, process, and distribute a gallon of petroleum. In 2015 it is taking 76,500 BTU.

    Over the next 14 years we will hit a point where it will become theoretically impossible to produce the average barrel. The oil age will have ended.

    If anyone is interested in how those numbers were calculated the first ten pages of the full 67 page report can be downloaded at our site. They are sufficient to explain the theory behind that determination. The particulars can be found in the rest of the report.

    http://www.thehillsgroup.org/

  32. shortonoil on Thu, 23rd Jul 2015 3:53 pm 

    PS Your will find the download in the Order Report section in the left box on the opening page.

  33. BC on Thu, 23rd Jul 2015 4:12 pm 

    Quite a number of the regulars here “get it” that no growth per capita since 2005-08 of unprofitable extraction of marginal costlier, lower-quality crude oil substitutes will no longer permit real growth per capita of uneconomic output.

    No amount of ZIRP, NIRP, and QEternity for TBTE bank reserves and levering up corporate balance sheets to buy back shares to artificially pump up earnings per share and stock prices changes the global macroeconomic situation.

    Growth of global real GDP and “trade” (Anglo-Amercian impierial trade regime, i.e., “globalization”) is over. Growth of operating profits from growth of investment in capacity and revenues is over.

    What Plant persists in referring to as a “glut” is really unsustainable increase in debt to wages and GDP to increase unprofitable extraction of a primary energy resource that is declining in net energy per capita and thus should not have been extracted.

    It’s like borrowing against the equity in your house and selling the furniture and renting out your wife and teenage daughter on the weekends to entertain at the local frat house or titty bar to pay the mortgage on a declining, or negative, net asset.

    Eventually you’re going to have to steal a few of the local farmers’ swine and put lipstick on them to keep the scam going, but pigs don’t fetch as much as attractive wives and teenage girls, and they eat a lot, make a mess, and can be noisy and ornery when they’re not well fed.

    Global trade has been in de facto recession since 2014, and US core durable goods orders and industrial production manufacturing rolled over in Q4 2014 and are exhibiting recession-like YoY and cyclical rates at present.

    But because of the hyper-financialization of the US economy, the recession in the energy and energy-related transport sectors and the rolling over of IP mfg. are being mitigated, or masked, by subprime auto loans driving vehicles sales, which in turn are holding up retail sales and personal consumption expenditures that otherwise would be contracting.

    US Treasury withholding and state and local tax receipts imply that reported employment peaked in the summer of 2014 and are overstated by perhaps as much as 1% or more.

    Therefore, the US economy could be in recession right now, as in winter-spring 2008 and spring-summer 2001, and we, and the stock market, do not know it; and the Fed, TBTE banksters, and DC politicos don’t want us to know, for obvious reasons.

  34. rockman on Thu, 23rd Jul 2015 4:36 pm 

    “… but pigs don’t fetch as much as attractive wives and teenage girls, and they eat a lot, make a mess, and can be noisy and ornery when they’re not well fed.” So pigs really are a lot like wives and teenage girls in some aspects. LOL.

    I think your thoughts go a long way to explaining what happened the last time oil prices crashed in ’08. Simple put even though the average price of oil for 2009 was much less then the average price for 2008 the world still consumed less of the cheaper oil in 2009 then 2008. For what you highlight and other reasons the damage done to the global economy by high energy prices is so severe that even much lower oil prices can’t even maintain BAU during the recovery period let along spur immediate growth.

  35. BC on Thu, 23rd Jul 2015 4:49 pm 

    http://tinyurl.com/nnjk8co

    https://www.youtube.com/watch?v=dLCsMRr7hAg

    http://www.zillow.com/homes/50-Randall-Road–Princeton,-New-Jersey-08540–United-States_rb/

    BTW, Steven Kopits is a brilliant guy (having had a very successful career pimping for big oil and petrobanking and with a million-dollar McMansion in Princeton to show for it) who argued in recent years that we have a “supply-constrainted” market for oil. 🙂

    His conditioning is common among energy and petrobanking types who recently prospered from runaway credit growth from QEternity, oil wars since 9/11, and China’s unsustainable credit and fixed investment boom/bubble, encouraging them to extrapolate the once-in-history growth in perpetuity. Oops!

    He also confuses “efficiency” gains with the necessary equitable distributional and purchasing power aspects of “labor productivity” gains to overall growth of demand and real GDP per capita.

    Efficiency and techno innovation does not result in growth of profits if the population/labor force becomes poorer in the process because of falling labor’s share of output and thus cannot afford to increase real purchasing power per capita.

    IOW, we can no longer afford to extract unprofitable shale and tar AND grow real GDP per capita AND build out the renewable infrastructure to scale AND sustain the fossil fuel infrastructure indefinitely.

    That is, rather than a supply-constrained situation, it is a no-growth- or demand-constrained situation, owing to Peak Oil, population overshoot and bottleneck, Limits to Growth, end of growth, and end of growth of profits, capital formation/accumulation, and capitalism itself.

    Put another way, the bottom 90%+ of households can no longer afford the oil-, auto-, debt-, and suburban housing-based eCONomic model because the costs per capita are now prohibitive, including the cost of maintaining the complex, high-tech, high-entropy infrastructure, gov’t, “health care”, and “education”.

    That means that the typical US working-class, working-poor, and poor households in the bottom 90% of the income distribution can no longer afford the hierarchical system of upward flows of resources, income, wealth, privilege, status, and power to the top 0.001-1%.

    And that includes the cost of gov’t, “education”, and housing in the DC area and Ivy School enclaves in which Mr. Kopits resides. 😀

  36. BC on Thu, 23rd Jul 2015 4:53 pm 

    rock, you said it better in far fewer words than my amateurish attempts at humor could ever do. 😀

  37. peakyeast on Thu, 23rd Jul 2015 7:41 pm 

    Btw. Yes people can theoretically drive longer today on a unit of fuel…

    However – todays technology uses all that fuel producing the efficient car. Besides maintenance, taxes, insurance and so forth today are far more costly – And the fines 😉

  38. shortonoil on Thu, 23rd Jul 2015 9:03 pm 

    “He also confuses “efficiency” gains with the necessary equitable distributional and purchasing power aspects of “labor productivity” gains to overall growth of demand and real GDP per capita.”

    Another aspect of confusion is the differentiation between money, and wealth. When a derivatives position, which has been levered out 100 times, goes bad some investors may lose money. In reality all that was lost was a number of 1s and 0s in a computer memory. The society lost no real wealth; it can merely be replaced by a key board stroke at some Central Bank.

    When an oil project, such as shale goes bad, drilling rigs are stacked to rust, trucks are parked, and miles of pipe are likely to be rendered to the junk yard. The society has lost the wealth of irreplaceable resources, and energy. Arguing for a supply-constrained market, when there is none, results in the destruction of wealth. Real goods and services are invested, and lost in projects that can never repay themselves. Individuals enrich themselves with money at a staggering cost in real wealth to the remaining society. When wealth is lost overall demand, and real GDP per capita must decrease. A supply constrained market will always result in increased wealth. Money will be converted into goods and services that can repay itself. That has not happened.

  39. Makati1 on Thu, 23rd Jul 2015 10:18 pm 

    Gail tells her supporters what they want to hear. You can say that, because she is an actuary, she is worth reading. That does not make it so.

    My oldest grandson is an actuary by college degree (‘A’ student) and he quickly found out that there is not much demand for ‘fortune tellers’ who are honest, so he started a hot dog business outside Home Depot … lol. He does make a decent living, but it is counting change, not predicting the future. I always thought he was a smart boy … even if he is 35 now. His younger brother was smarter. He stayed home and apprenticed as a plumber. Has a higher income than his older brother, and was paid to learn. ^_^

  40. joe on Fri, 24th Jul 2015 2:15 am 

    Tony Blair recently gave a speech regarding the future of the labour party. I believe he let slip something he should not, or which needed to be hinted at. Basically he said that Labour should not take a stand to the left because in the end most voters can be convinced of the benefits of neo-liberalism and therefore at election time they will always vote centerist rather than left/right, even though these points score better in polls. What he let slip was to the effect that Labour should be ready for the days ahead because of the amount of layoffs coming and the policies must be in place to make Labour electable.
    I read into that, they intend to privatise the NHS and BBC, both of which have been pillars of the left since WW2 ended. But a crisis will have to exist before they will do it.
    Also they have to win the referendum to remain in Europe. That will be easy for them. All the have to do is tell the people ‘bad things can happen’ if they leave. Herman Guerring said that people can always be brought to war ‘all you have to do is tell the people that they are in danger and denounce the opposition for lack of patriotism, it works the same in any country’.
    So goes for war, so goes for politics.
    They have to contract money supply before they raise rates, otherwise it would put too much upward pressure on the currency making goods produced too expensive (Europe is already starting to eat Americas lunch with this one). If they raise rates and don’t contract supply, it has no serious effect (the downside of this is with already low rates, there is no weapons to fight another recession). If they just contract money supply they cause recession.
    All of these will have a downward effect on oil prices. The truth is no matter what move they make next, workers and demand will suffer, low oil prices are a symptom, not a cause of the problem.
    I believe that they will raise interest rates soon, cause a recession, then get more blood from workers (what they call productivity). They will then introduce more tech into the workforce and robots will begin to replace white collar workers for the first time as part of ‘productivity’. With a weaker Euro and stronger dollar there will be more parity and when they link their economies with TPP cost savings in Europe will spur an economic union with US/EU economies just in time for the EU to become a federal Republic (good timing eh?).
    Two things which wont be wanted soon (10-20 yrs) white collars and a welfare state.
    Do you think our rulers are stupid? Don’t you think they know the world cannot sustain another 2bln people and survive? Do you think they will do nothing about it? Do you think their solution will be pleasant? Do you think you are part of their future?

  41. BobInget on Fri, 24th Jul 2015 4:24 pm 

    1980’s vs 2015

    Two considerable differences between now and the 80’s oil glut.

    Big difference on the supply side between the 80/90’s period and today is the rapid decline rate of shale vs the conventional oil over supply/production during that period. Conventional oil production was spurred on by high prices in the 70’s, over more than a decade increased capacity was brought on in conventional. Once that production is brought on it is cheaply produced. Totally unlike the shale supply that has been brought on in the U.S leading to the current oversupply situation. Saudi Arabia during the 80’s most times had more than half it’s production off line, in 1980 they were pumping 10 mill barrels , in 1986 they pumped 2.5 mill barrels, today they are pumping full blast at 10.3 mpd. The treadmill of shale and it’s decline rates is totally unlike that era’s conventional production. Today we have 1-2 mill barrels of oversupply, back then it was 10-15 mill barrels per day of supply with no place to go.

    On the demand side it basically stunk in the 80’s. Totally between 1980 and 1993 demand in the world rose 1.5 m Bpd. We have seen those kind of demand increases in a year over the last decade. China will sell 22-23 mill new vehicles into it’s fleet again this year. China can impact day to day sentiment in the markets but that barn door is not about to be shut, they have a growing middle class, lets not forget India. Those markets were nothing in the 80’s.

    So the very basics of the 80’s the supply and demand scenario is extremely hard to contrast with today’s issues. Yes it may rhyme, there was an oil glut, but when you look at the details , nothing like it.

  42. Davy on Sun, 26th Jul 2015 10:31 am 

    Woops NOo, what happened to your dream team?

    http://www.zerohedge.com/news/2015-07-26/energy-companies-face-come-jesus-point-bankruptcies-loom

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