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Why Shale Oil Boosters Are Charlatans In Disguise


Something has bothered me of late: why is the price of crude oil still elevated? Other commodities have taken a battering since 2011. Gold, copper and iron ore – all are way down off their peaks. But oil has seemingly defied gravity. And that’s despite increased supply from shale oil in the U.S., still soft demand particularly in the developed world and declining rates of inflation growth across the globe.

What gives? Well, shale oil proponents will say falling oil prices are just a matter of time. And that the boom in shale oil will reduce U.S. reliance on foreign oil, leading to cheaper local oil, which will free up household budgets and spur consumption as well as the broader economy. Perhaps … though I’d have thought all of that would be already reflected in prices.

On the other side, you have “peak oil” supporters who suggest high oil prices are perfectly natural when oil production has peaked, or at least the good stuff has disappeared. Yet the boom in U.S. shale oil appears to put at least a partial dent in this thesis.

There may be a better explanation, however. It comes from UK sell-side analyst, Tim Morgan, in an important new book called Life After Growth. In it, he suggests that the era of cheap energy is over. That the new unconventional forms of oil are far less efficient than old ones, meaning they require significant amounts of energy to produce. In effect, the energy production versus energy cost of extraction equation is rapidly deteriorating.

Morgan goes a step further though. He says cheap energy has been central to the extraordinary economic growth generated since the Industrial Revolution. And without that cheap energy, future growth will be permanently impaired.

It’s a bold view that’s solidified my own thinking that higher energy prices are here to stay. And the link between cheap energy and economic growth is fascinating and worth exploring further today. Particularly given the implications for the world’s fastest-growing and most energy-intensive region, Asia.

Real vs money economy

First off, a thank you to Bob Moriarty of 321gold for tipping me off to Morgan’s work in this well-written article. Morgan’s book is worth getting but if you want the skinny version, you can find it here.

Morgan begins his book outlining four key challenges facing economies today:

  1. The biggest debt bubble in history
  2. A disastrous experiment with globalisation
  3. The massaging of data to the point where economic trends are obscured
  4. The approach of an energy-returns cliff edge

The first three points aren’t telling us much new so we’re going to focus on the final one.

Here, Morgan makes a key distinction between what he terms the money economy and the real economy. He suggests economists around the world have got it all wrong by focusing on money as the key driver of economies.

Instead, money is the language rather than the substance of the real economy. The real economy is a surplus energy equation, not a monetary one, and economic growth as well as the increase in population since 1750 has resulted from the harnessing of ever-greater quantities of energy.

In fact, society and economies began when agriculture created surplus energy. Before agriculture, in the hunter-gatherer era, there was an energy balance where the energy which people derived from food was largely equivalent to the energy that they expended in finding the food.

Agriculture changed that equation. It allowed for the creation of surplus energy. In essence, three people could be supported by the labor of two people, allowing one person to engage in non-subsistence activities. This person could make better agricultural tools, build bridges for better infrastructure and so on. In economic parlance, this person didn’t have to concentrate on products for immediate consumption but rather the creation of capital goods. The surplus energy equation allowed for that.

The second key development was the invention of the heat engine by Scottish engineer James Watts in 1769, although a more efficient version was produced later in 1799. This invention allowed society to access vast energy resources contained in oil, natural gas, coal and so forth. In other words, the industrial revolution allowed the harnessing of more energy to apply vast leverage to the economy.

World fossil fuel consumption

In sum, the modern economy is the story of how society overcame the limitations of the energy equation. Or as Morgan puts it: “…all goods and services on which money can be spent are the products of energy inputs, either past, present or future.”

The creation of surplus energy during the Industrial Revolution and subsequent explosion in economic and population growth isn’t an accident. They’re tied at the hip.

Energy and the population

Understanding the distinction between the money economy and the real economy can also help us better understand debt. Debt is a claim on future energy. The ability of indebted governments to meet their debt commitments will partially depend on whether the real (energy) economy is large enough to make this possible.

Era of cheap energy is over

Morgan goes on to say that the era of surplus energy, which has driven economic growth since 1750, is over. The key isn’t to be found in the theories of “peak oil” proponents and the potential for absolute declines in oil reserves. Instead, it’s to be found in the relationship between the energy extracted versus the energy consumed in the extraction process, also known as the Energy Return on Energy Invested (EROEI) equation.

The equation maths aren’t difficult to understand. If the EROEI is 10:1, it means that 10 units are extracted for every 1 unit invested in the extraction process.

From 1750-1950, the EROEI of oil discoveries was very high. For instance, discoveries in the 1930s had 100:1 EROEIs. That ratio declined to 30:1 by the 1970s. Today, that ratio is at about 17:1 with few recent discoveries above 10:1.

Morgan’s research suggests that going from EROEIs of 80:1 to 20:1 isn’t disruptive. But once the ratio gets below 15:1, energy becomes a lot more expensive. He suggests the ratio will decline to 11:1 by 2020 and the cost of energy will increase by 50% as a consequence.

Energy returns vs cost to GDP

Non-conventional sources of oil will provide little respite. Shale oil and gas have EROEIs of 5:1 while tar sands and biofuels are even lower at 3:1. In other words, policymakers who pin their hopes on shale oil reducing energy prices are seriously deluded.

EROEI and energy sources

And further technological breakthroughs to better locate and extract oil are unlikely to help either. That’s because technology uses energy rather than creates it. It won’t change the energy equation.

While some unconventional sources offer hope, such as concentrated solar power, they won’t be enough to offset surplus energy turning to a more balanced equation.

Oeuvre to growth tool

If the real economy is energy and the days of surplus energy are coming to an end, then so too is economic growth, according to Morgan. In his own words:

“…the economy, as we have known it for more than two centuries, will cease to be viable at some point within the next ten or so years unless, of course, some way is found to reverse the trend.”

This terribly pessimistic conclusion requires some further explanation. Morgan explains the link between energy and the economy thus. If your EROEI sharply declines, it means more energy is needed for extraction purposes and less energy is available to the economy. Ultimately, this results in the cost of energy rising as a proportion of GDP, leaving less value for other things. Put another way, with the leverage from surplus energy diminished, there’s less energy available for discretionary uses.


Now I don’t have total buy-in to Morgan’s thesis. It certainly solidifies my thinking that the era of cheap energy is indeed over. It provides a unique and compelling way to think about this. And the proof is seemingly all around us. It explains the high oil prices and the surge in agriculture prices (agriculture relies on energy inputs).

You can’t help but being more bullish on energy and agriculture plays in the long-term. Oil drillers for one as they’re more reliant on increased work than the price of oil. Also, the likes of fertiliser companies given agriculture land is tapped out, making an increase in output essential and thereby requiring greater quantities of fertiliser.

Morgan thinks inflation is on the way given a squeezed energy base with still escalating monetary bases. Regular readers will know that I am a deflationist over the next few years. But nothing is certain in this world and Morgan’s arguments on this front have some credibility.

As for whether this spells the end of a glorious 250 year period of economic growth, well, I’m not so sure. The link between energy and economies is compelling. But whether we’re at a tipping point where surplus energy disappears is a guess. I’m convinced that we’re coming up against resource constraints that will inhibit economic growth. To say that we’re imminently coming to the end of economic growth requires further evidence, in humble opinion.

Impact on Asia

Asia has been the largest demand driver for energy over the past decade. The region’s net oil imports total 17 million barrels of oil a day. China is now the largest net oil importer, having recently overtaken the U.S.. Other large net oil importers in Asia include India and Indonesia. Obviously, higher oil prices would be detrimental to these net importing countries.

It may be somewhat offset by agricultural prices staying higher for longer. China and India are agricultural powerhouses. And the impact of agriculture on their economies is still profound (agriculture accounts for 14% of Indian GDP and 10% of China).

On the other hand, higher agricultural prices mean higher food prices. And given lower incomes in Asia, the proportion of household budgets dedicated to purchasing food is much higher than the developed world. Therefore higher food prices has a larger impact on many Asian countries. Witness periodic recent protests on this issue in Indonesia, Thailand and India. So net-net, higher energy prices would still be a large negative for Asia.

Turning to resource constraints potentially inhibiting future economic growth: given Asia has the world’s strongest GDP growth, it would be disproportionately hit if this scenario is right. The past decade may represent a peak in the region’s economic output. Whether there’s sharp drop or gradual fade is impossible to forecast.

These are but a few of the potential implications for Asia.

AC Speed Read

– The real economy is a surplus energy equation, or the harnessing of ever-greater quantities of energy.

– That equation has deteriorated to such an extent that one can now declare the era of cheap energy over.

– If the economy is energy and cheap energy is gone, future economic growth will be inhibited.

– Consequently, higher energy and agricultural prices can be expected in the long-term.

– The impact on Asian growth may be disproportionately large.


16 Comments on "Why Shale Oil Boosters Are Charlatans In Disguise"

  1. Northwest Resident on Mon, 27th Jan 2014 3:08 pm 

    “…future economic growth will be inhibited.”

    Its hard to believe that Forbes came out with an article that actually casts doubt on the future of BAU. Using the word “inhibited” must be their way of saying that things aren’t going to be as good as they have been, but we’ll still manage to get by just fine. Maybe the evidence of peak oil and its consequences have grown so apparent that they have decided that they can no longer just totally deny that reality. Economic growth is already being “inhibited” by the lack of cheap energy and has been for some time — as in, growth has been stopped dead in its tracks — despite the cooked-up numbers being produced showing economic growth. A more honest appraisal would be “…economic growth is over and now we’re sliding backwards down that steep slippery hill that cheap energy allowed us to climb.”

  2. Plantagenet on Mon, 27th Jan 2014 4:44 pm 

    The author of this piece was foolish from the get-to. He doesn’t know that it costs ca. $80/bbl to produce oil by fracking.

    Whining that oil is expensive while not understanding that oil is now expensive to produce doesn’t show a lot of knowledge or deep thinking on this subject.

  3. rockman on Mon, 27th Jan 2014 4:53 pm 

    I’ll join the mob: “Well, shale oil proponents will say falling oil prices are just a matter of time.”. I challenge the author to supply even a single reference from any oil company that made such a statement. Even though the Big Oil PR machine can be crafty with their wording I’ve yet to see one make such a promise.

  4. robertinget on Mon, 27th Jan 2014 5:26 pm 

    Powerful as denial, ‘Wishful Thinking’ is hoping oil prices fall by half. When this doesn’t materialize, wishful thinkers will blame something else like Fukushima, Mideast, African conflicts, devalued currencies or the two thousand pound gorilla, Climate Change.
    (AGW is a forbidden topic at Forbes)

    Forbes gets one thing right, demand for drillers, in particular ultra deep water
    will be greater.

    In fact crude oil is way off its highs
    of about $105 in late August to $95.63
    today. It will be a Goldilox 2014 if crude stays within this range.

  5. J-Gav on Mon, 27th Jan 2014 7:43 pm 

    Oil prices could bounce around over the coming years, depending partly on when the next big economic pinch bites, but the general trend is hardly likely to be ‘down,’ as exporting countries like Venezuela, Saudi, Mexico, Nigeria … with their growing populations, will be using more internally to keep them pacified.

  6. DC on Mon, 27th Jan 2014 7:46 pm 

    Rockman, maybe the oil cartel has not made that promise in those precise terms, but the oil-lobbyists and other pro-oil cheerleaders in the infotainment sphere have certainly *implying* that such things are going to happen. All the language from the pro-oil-all-is-good folks is meant to give the impression that the sorta-oil ‘boom’ means boom for consumers. No, they dont mention that the heavily subsidized tar\shale sands are a boom for oil corporations-and not for anyone else.

    So no, I agree with you no *oil* corporation has likely explicitly promised they age of cheap oil is(around) the corner, they dont have to. That is what API, Yergin and other ‘experts’ in the blogosphere are for. There is no downside for people associated with and receiving funding from oil corporations if the implied results of the over-hyped ‘shale-booms’ don’t materialize for end-users. Ie ‘consumers’.

  7. J-Gav on Mon, 27th Jan 2014 8:26 pm 

    Northwest – Yup – all the books are cooked, all the stats are phony, from unemployment to poverty-levels, to property valuations, to GDP “growth,” etc. Can the inevitable slide you refer to be tempered or is it going to be ‘Olduvai’? That is the question.

  8. rockman on Mon, 27th Jan 2014 8:44 pm 

    Dc – True…hype is hype regardless of the source. Just good to tag the sources correctly. We have our own brand of cornies here that don’t get a penny from the oil patch and some of them post the most optimistic picture of the future of the shales.

  9. nemteck on Mon, 27th Jan 2014 9:19 pm 

    27.01.14. Raymond James investment firm expects prices to fall by as much as 20 per cent some time in the next 12 months, with West Texas Intermediate hitting $70 per barrel and the international benchmark, North Sea Brent, slumping to $90.

    The spin doctors are the investment companies luring in people to invest in drilling operations since more and more wells have to be drilled in the shale patches just to keep production constant.

  10. Dave Thompson on Mon, 27th Jan 2014 10:03 pm 

    Up next; Made up global crisis somewhere besides oil rich nations as a way to “call to arms” against an enemy that we are all supposed to pull together as good freedom loving Americans, whereby we will all be forced to downsize our consumerism worship in order to maintain the status quo.

  11. J-Gav on Mon, 27th Jan 2014 10:54 pm 

    Dave- You’re talking ‘major conflict,’ if I’m not mistaken? It’s enough for ONE crisis to go global, then things could spin out of control, no doubt about social-engineering efficacy in that regard, so you have a point. How far and how fast are things moving that way? Hmmm . We’re always supposed to wait for the verdict of some future historical reading of our times before venturing an opinion on such high-falutin’ matters. Even when it’s obvious that destroying our environment (air, water, biodiversity, you name it …) doesn’t come across as an especially brilliant idea once people see that the Earth is our ‘home’ à tous! Only one we’ve got. As other posters have suggested on this site, the belief that we are rapidly approaching some sort of crossroads in human affairs (avoiding unnecessary apocalyptics) is justified on several counts. Taking action locally and regionally when possible looks like the best bottom-up bet at this juncture. Those expecting some top-down solution are liable to be disappointed.

  12. Stilgar Wilcox on Tue, 28th Jan 2014 1:59 am 

    “In it, he suggests that the era of cheap energy is over. That the new unconventional forms of oil are far less efficient than old ones, meaning they require significant amounts of energy to produce. In effect, the energy production versus energy cost of extraction equation is rapidly deteriorating.”

    Yes, and while EROEI descends, our economy requires growth (ascencion). Two trends headed in opposite directions. That’s why many think the Fed will not be able to taper QE to zero.

  13. action on Tue, 28th Jan 2014 4:17 am 

    You have to be really stupid not to see what’s coming, or too scared to accept the reality, or too ignorant in which that falls the stupid case; but let them keep dancing with retarded looks on their faces… in the end, everyone will get what’s coming when the economic machine grinds to a halt do to decreasing EROEI. All we have is are depth of perception, it can be painful, but man sometimes it feels so good.

  14. rollin on Tue, 28th Jan 2014 3:33 pm 

    Basically the article describes a runaway energy-product feedback loop.

    So the answer is to jump off this high energy – intensive, high product production hamster wheel and move to the sidelines at lower energy/ lower product use.

  15. rockman on Tue, 28th Jan 2014 6:13 pm 

    rollin – Sounds like a plan. OK…you and the majority get after it and I and the Chinese will be right behind you…eventually. Same old problem: every bbl of oil we save (maybe at a tad lower price) leaves one more bbl for the next consumer in line that is desperate to grow his smaller economy.

  16. criticalmass on Tue, 28th Jan 2014 7:38 pm 

    Nemtek is spot-on. Investment traps are fueling drilling that we really need to hold-off on domestically in the US. About 5 years ago I thought we were genius for grabbing other people’s oil under the guise of war, now we squander it against cheap financing! Yikes!
    (Please detect a bit of sarcasm here.)

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