Ten Reasons Why a Severe Drop in Oil Prices is a Problem

Not long ago, I wrote Ten Reasons Why High Oil Prices are a Problem. If high oil prices can be a problem, how can low oil prices also be a problem? In particular, how can the steep drop in oil prices we have recently been experiencing also be a problem?

Let me explain some of the issues:

Issue 1. If the price of oil is too low, it will simply be left in the ground.

The world badly needs oil for many purposes: to power its cars, to plant it fields, to operate its oil-powered irrigation pumps, and to act as a raw material for making many kinds of products, including medicines and fabrics.

If the price of oil is too low, it will be left in the ground. With low oil prices, production may drop off rapidly. High price encourages more production and more substitutes; low price leads to a whole series of secondary effects (debt defaults resulting from deflation, job loss, collapse of oil exporters, loss of letters of credit needed for exports, bank failures) that indirectly lead to a much quicker decline in oil production.

The view is sometimes expressed that once 50% of oil is extracted, the amount of oil we can extract will gradually begin to decline, for geological reasons. This view is only true if high prices prevail, as we hit limits. If our problem is low oil prices because of debt problems or other issues, then the decline is likely to be far more rapid. With low oil prices, even what we consider to be proved oil reserves today may be left in the ground.

Issue 2. The drop in oil prices is already having an impact on shale extraction and offshore drilling.

While many claims have been made that US shale drilling can be profitable at low prices, actions speak louder than words. (The problem may be a cash flow problem rather than profitability, but either problem cuts off drilling.) Reuters indicates that new oil and gas well permits tumbled by 40% in November.

Offshore drilling is also being affected. Transocean, the owner of the biggest fleet of deep water drilling rigs, recently took a $2.76 billion charge, among a “drilling rig glut.”

3. Shale operations have a huge impact on US employment. 

Zero Hedge posted the following chart of employment growth, in states with and without current drilling from shale formations:

Jobs in States with and without Shale Formations, from Zero Hedge.

Figure 1. Jobs in States with and without Shale Formations, from Zero Hedge.

Clearly, the shale states are doing much better, job-wise. According to the article, since December 2007, shale states have added 1.36 million jobs, while non-shale states have lost 424,000 jobs. The growth in jobs includes all types of employment, including jobs only indirectly related to oil and gas production, such as jobs involved with the construction of a new supermarket to serve the growing population.

It might be noted that even the “Non-Shale” states have benefited to some extent from shale drilling. Some support jobs related to shale extraction, such as extraction of sand used in fracking, college courses to educate new engineers, and manufacturing of parts for drilling equipment, are in states other than those with shale formations. Also, all states benefit from the lower oil imports required.

Issue 4. Low oil prices tend to cause debt defaults that have wide ranging consequences. If defaults become widespread, they could affect bank deposits and international trade.

With low oil prices, it becomes much more difficult for shale drillers to pay back the loans they have taken out. Cash flow is much lower, and interest rates on new loans are likely much higher. The huge amount of debt that shale drillers have taken on suddenly becomes at-risk. Energy debt currently accounts for 16% of the US junk bond market, so the amount at risk is substantial.

Dropping oil prices affect international debt as well. The value of Venezuelan bonds recently fell to 51 cents on the dollar, because of the high default risk with low oil prices.  Russia’s Rosneft is also reported to be having difficulty with its loans.

There are many ways banks might be adversely affected by defaults, including

  • Directly by defaults on loans held by a bank
  • Indirectly, by defaults on securities the bank owns that relate to loans elsewhere
  • By derivative defaults made more likely by sharp changes in interest rates or in currency levels
  • By liquidity problems, relating to the need to quickly sell or buy securities related to ETFs

After the many bank bailouts in 2008, there has been discussion of changing the system so that there is no longer a need to bail out “too big to fail” banks. One proposal that has been discussed is to force bank depositors and pension funds to cover part of the losses, using Cyprus-style bail-ins. According to some reports, such an approach has been approved by the G20 at a meeting the weekend of November 16, 2014. If this is true, our bank accounts and pension plans could already be at risk.1

Another bank-related issue if debt defaults become widespread, is the possibility that junk bonds and Letters of Credit2 will become outrageously expensive for companies that have poor credit ratings. Supply chains often include some businesses with poor credit ratings. Thus, even businesses with good credit ratings may find their supply chains broken by companies that can no longer afford high-priced credit. This was one of the issues in the 2008 credit crisis.

Issue 5. Low oil prices can lead to collapses of oil exporters, and loss of virtually all of the oil they export.

The collapse of the Former Soviet Union in 1991 seems to be related to a drop in oil prices.

Figure 2. Oil production and price of the Former Soviet Union, based on BP Statistical Review of World Energy 2013.

Figure 2. Oil production and price of the Former Soviet Union, based on BP Statistical Review of World Energy 2013.

Oil prices dropped dramatically in the 1980s after the issues that gave rise to the earlier spike were mitigated. The Soviet Union was dependent on oil for its export revenue. With low oil prices, its ability to invest in new production was impaired, and its export revenue dried up. The Soviet Union collapsed for a number of reasons, some of them financial, in late 1991, after several years of low oil prices had had a chance to affect its economy.

Many oil-exporting countries are at risk of collapse if oil prices stay very low very long. Venezuela is a clear risk, with its big debt problem. Nigeria’s economy is reported to be “tanking.” Russia even has a possibility of collapse, although probably not in the near future.

Even apart from collapse, there is the possibility of increased unrest in the Middle East, as oil-exporting nations find it necessary to cut back on their food and oil subsidies. There is also more possibility of warfare among groups, including new groups such as ISIL. When everyone is prosperous, there is little reason to fight, but when oil-related funds dry up, fighting among neighbors increases, as does unrest among those with lower subsidies.

Issue 6. The benefits to consumers of a drop in oil prices are likely to be much smaller than the adverse impact on consumers of an oil price rise. 

When oil prices rose, businesses were quick to add fuel surcharges. They are less quick to offer fuel rebates when oil prices go down. They will try to keep the benefit of the oil price drop for themselves for as long as possible.

Airlines seem to be more interested in adding flights than reducing ticket prices in response to lower oil prices, perhaps because additional planes are already available. Their intent is to increase profits, through an increase in ticket sales, not to give consumers the benefit of lower prices.

In some cases, governments will take advantage of the lower oil prices to increase their revenue. China recently raised its oil products consumption tax, so that the government gets part of the benefit of lower prices. Malaysia is using the low oil prices as a time to reduce oil subsidies.

Most businesses recognize that the oil price drop is at most a temporary situation, since the cost of extraction continues to rise (because we are getting oil from more difficult-to-extract locations). Because this price drop is only temporary, few business people are saying to themselves, “Wow, oil is cheap again! I am going to invest a huge amount of money in a new road building company [or other business that depends on cheap oil].” Instead, they are cautious, making changes that require little capital investment and that can easily be reversed. While there may be some jobs added, those added will tend to be ones that can easily be dropped if oil prices rise again.

Issue 7. Hoped for crude and LNG sales abroad are likely to disappear, with low oil prices.

There has been a great deal of publicity about the desire of US oil and gas producers to sell both crude oil and LNG abroad, so as to be able to take advantage of higher oil and gas prices outside the US. With a big drop in oil prices, these hopes are likely to be dashed. Already, we are seeing the story, Asia stops buying US crude oil. According to this story, “There’s so much oversupply that Middle East crudes are now trading at discounts and it is not economical to bring over crudes from the US anymore.” 

LNG prices tend to drop if oil prices drop. (Some LNG prices are linked to oil prices, but even those that are not directly linked are likely to be affected by the lower demand for energy products.) At these lower prices, the financial incentive to export LNG becomes much less. Even fluctuating LNG prices become a problem for those considering investment in infrastructure such as ships to transport LNG.

Issue 8. Hoped-for increases in renewables will become more difficult, if oil prices are low.

Many people believe that renewables can eventually take over the role of fossil fuels. (I am not of the view that this is possible.) For those with this view, low oil prices are a problem, because they discourage the hoped-for transition to renewables.

Despite all of the statements made about renewables, they don’t really substitute for oil. Biofuels come closest, but they are simply oil-extenders. We add ethanol made from corn to gasoline to extend its quantity. But it still takes oil to operate the farm equipment to grow the corn, and oil to transport the corn to the ethanol plant. If oil isn’t around, the biofuel production system comes to a screeching halt.

Issue 9. A major drop in oil prices tends to lead to deflation, and because of this, difficulty in repaying debts.

If oil prices rise, so do food prices, and the price of making most goods. Thus rising oil prices contribute to inflation. The reverse of this is true as well. Falling oil prices tend to lead to a lower price for growing food and a lower price for making most goods. The net result can be deflation. Not all countries are affected equally; some experience this result to a greater extent than others.

Those countries experiencing deflation are likely to eventually have problems with debt defaults, because it will become more difficult for workers to repay loans, if wages are drifting downward. These same countries are likely to experience an outflow of investment funds because investors realize that funds invested these countries will not earn an adequate return. This outflow of funds will tend to push their currencies down, relative to other currencies. This is at least part of what has been happening in recent months.

The value of the dollar has been rising rapidly, relative to many other currencies. Debt repayment is likely to especially be a problem for those countries where substantial debt is denominated in US dollars, but whose local currency has recently fallen in value relative to the US dollar.

Figure 3. US Dollar Index from Intercontinental Exchange

Figure 3. US Dollar Index from Intercontinental Exchange

The big increase in the US dollar index came since June 2014 (Figure 3), which coincides with the drop in oil prices. Those countries with low currency prices, including Japan, Europe, Brazil, Argentina, and South Africa, find it expensive to import goods of all kinds, including those made with oil products. This is part of what reduces demand for oil products.

China’s yuan is relatively closely tied to the dollar. The collapse of other currencies relative to the US dollar makes Chinese exports more expensive, and is part of the reason why the Chinese economy has been doing less well recently. There are no doubt other reasons why China’s growth is lower recently, and thus its growth in debt. China is now trying to lower the level of its currency.

Issue 10. The drop in oil prices seems to reflect a basic underlying problem: the world is reaching the limits of its debt expansion.

There is a natural limit to the amount of debt that a government, or business, or individual can borrow. At some point, interest payments become so high, that it becomes difficult to cover other needed expenses. The obvious way around this problem is to lower interest rates to practically zero, through Quantitative Easing (QE) and other techniques.

(Increasing debt is a big part of what pumps up “demand” for oil, and because of this, oil prices. If this is confusing, think of buying a car. It is much easier to buy a car with a loan than without one. So adding debt allows goods to be more affordable. Reducing debt levels has the opposite effect.)

QE doesn’t work as a long-term technique, because it tends to create bubbles in asset prices, such as stock market prices and prices of farmland. It also tends to encourage investment in enterprises that have questionable chance of success. Arguably, investment in shale oil and gas operations are in this category.

As it turns out, it looks very much as if the presence or absence of QE may have an impact on oil prices as well (Figure 4), providing the “uplift” needed to keep oil prices high enough to cover production costs.

Figure 4. World

Figure 4. World “liquids production” (that is oil and oil substitutes) based on EIA data, plus OPEC estimates and judgment of author for August to October 2014. Oil price is monthly average Brent oil spot price, based on EIA data.

The sharp drop in price in 2008 was credit-related, and was only solved when the US initiated its program of QE started in late November 2008. Oil prices began to rise in December 2008. The US has had three periods of QE, with the last of these, QE3, finally tapering down and ending in October 2014. Since QE seems to have been part of the solution that stopped the drop in oil prices in 2008, we should not be surprised if discontinuing QE is contributing to the drop in oil prices now.

Part of the problem seems to be the differential effect that happens when other countries are continuing to use QE, but the US not. The US dollar tends to rise, relative to other currencies. This situation contributes to the situation shown in Figure 3.

QE allows more borrowing from the future than would be possible if market interest rates really had to be paid. This allows financiers to temporarily disguise a growing problem of un-affordability of oil and other commodities.

The problem we have is that, because we live in a finite world, we reach a point where it becomes more expensive to produce commodities of many kinds: oil (deeper wells, fracking), coal (farther from markets, so more transport costs), metals (poorer ore quality), fresh water (desalination needed), and food (more irrigation needed). Wages don’t rise correspondingly, because more and more labor is needed to provide less and less actual benefit, in terms of the commodities produced and goods made from those commodities. Thus, workers find themselves becoming poorer and poorer, in terms of what they can afford to purchase.

QE allows financiers to disguise a growing mismatch between what it costs to produce commodities, and what customers can really afford. Thus, QE allows commodity prices to rise to levels that are unaffordable by customers, unless customers’ lack of income is disguised by a continued growth in debt.

Once commodity prices (including oil prices) fall to levels that are affordable based on the incomes of customers, they fall to levels that cut out a large share of production of these commodities. As commodity production drops to levels that can be produced at affordable prices, so does the world’s ability to make goods and services. Unfortunately, the goods whose production is likely to be cut back if commodity production is cut back are those of every kind, including houses, cars, food, and electrical transmission equipment.

 Conclusion

There are really two different problems that a person can be concerned about:

  1. Peak oil: the possibility that oil prices will rise, and because of this production will fall in a rounded curve. Substitutes that are possible because of high prices will perhaps take over.
  2. Debt related collapse: oil limits will play out in a very different way than most have imagined, through lower oil prices as limits to growth in debt are reached, and thus a collapse in oil “demand” (really affordability). The collapse in production, when it comes, will be sharper and will affect the entire economy, not just oil.

In my view, a rapid drop in oil prices is likely a symptom that we are approaching a debt-related collapse–in other words, the second of these two problems. Underlying this debt-related collapse is the fact that we seem to be reaching the limits of a finite world. There is a growing mismatch between what workers in oil importing countries can afford, and the rising real costs of extraction, including associated governmental costs. This has been covered up to date by rising debt, but at some point, it will not be possible to keep increasing the debt sufficiently.

The timing of collapse may not be immediate. Low oil prices take a while to work their way through the system. It is also possible that the world’s financiers will put off a major collapse for a while longer, through more QE, or more programs related to QE. For example, actually getting money into the hands of customers would seem to be temporarily helpful.

At some point the debt situation will eventually reach a breaking point. One way this could happen is through an increase in interest rates. If this happens, world economic growth is likely to slow greatly. Oil and commodity prices will fall further. Debt defaults will skyrocket. Not only will oil production drop, but production of many other commodities will drop, including natural gas and coal. In such a scenario, the downslope of all energy use is likely to be quite steep, perhaps similar to what is shown in the following chart.

Figure 5. Estimate of future energy production by author. Historical data based on BP adjusted to IEA groupings.

Figure 5. Estimate of future energy production by author. Historical data based on BP adjusted to IEA groupings.

Related Articles:

Low Oil Prices: Sign of a Debt Bubble Collapse, Leading to the End of Oil Supply?

WSJ Gets it Wrong on “Why Peak Oil Predictions Haven’t Come True”

Eight Pieces of Our Oil Price Predicament

Notes:

[1] There is of course insurance by the FDIC and the PBGC, but the actual funding for these two insurance programs is tiny in relationship to the kind of risk that would occur if there were widespread debt defaults and derivative defaults affecting many banks and many pension plans at once. While depositors and pension holders might try to collect this insurance, there wouldn’t be enough money to actually cover these demands. This problem would be similar to the issue that arose in Iceland in 2008. Insurance would seem to be available, but in practice, would not pay out much.

Also, I learned after writing this post that bail-ins were mandated for US banks by the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010. In the language of the summary, bank depositors are “unsecured creditors,” and are thus among those to whom the burden of loss is transferred. The FDIC is not allowed to borrow extra funds, beyond bank funds, to cover this loss.

[2] LOCs are required when goods are shipped internationally, before payment has actually been made. They offer a guarantee that a buyer will be able to “make good” on his promise to pay for goods when they arrive.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to financial problems for oil producers and for oil exporting countries. We are really dealing with a physics problem that affects many parts of the economy at once, including wages and the financial system. I try to look at the overall problem.
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1,055 Responses to Ten Reasons Why a Severe Drop in Oil Prices is a Problem

  1. We discussed the Oil Price drop in detail today on the Diner, unfortunately Gail could not make this one. Ugo Bardi from Resource Limits, Ron Patterson from Peak Oil Barrel and Steve Ludlum from Economic Undertow made the show though.

    Also you folks might be interested in The Dimming Bulb, a look at how the electrical grid is contracting.

    http://www.doomsteaddiner.net/blog/2014/12/07/the-dimming-bulb/

    RE

    • For those of you interested in the psychological and sociological manifestations of Collapse, I just got up an Interview we did on the Collapse Cafe with Mark Garavan from FEASTA.
      Psychology & Sociology of Collapse: Interview with Mark Garavan
      RE

    • Regarding the planet ever going dark, I would point out that the planet has never been dark for the last million years, which represents much of the evolutionary time of humans. In early days, humans burned biomass or perhaps fat from animals. In more recent years, we have used lights powered by electricity. I suppose in Alaska, this burning of animal fats may have taken place in igloos, so it wasn’t very apparent from space.

      Humans can’t be expected to do very well, for very long, without some external source of energy, even if it is only burned blubber from animals.

      • James says:

        I hate to say it but, or the burned blubber from each other. We Americans, in particular, have a whole lot of thermal energy units bound up in our waistlines.

        • Jan Steinman says:

          “We Americans, in particular, have a whole lot of thermal energy units bound up in our waistlines.”

          What a waste! Solyent Green is people!

          • garand555 says:

            I maintain that such gallows humor is healthy and will continue to laugh at it. I’m laughing at both James’s and Jan’s posts.

      • Don Stewart says:

        Dear Gail and Reverse Engineer
        First, thanks for doing the FEASTA interview. It is relevant and timely.

        Second, I suggest that people might want to do three things. First, rent a copy of Ingmar Bergman’s 1963 movie Winter Light about a minister who loses his faith. He concludes that there either is no God or else that God exists but is a malignant spider, creating senseless suffering in the world. The minister delivers a doomer speech to one of his church members, who then kills himself.

        Second, buy the slim little book 7 Ways to Think Differently by Looby Macnamara. All about positive responses to challenges, and how we look at the question largely defines whether we will be able to find a solution.

        Third, contemplate Vanessa Woods’ book Bonobo Handshake. How do our closest relatives navigate the sociological and psychological waters without benefit of fossil fuels or complex societies? They have the same hormonal systems we have.

        As a very simple example of thinking differently. Suppose the default sex act is non-procreative, such as oral sex. The bonobos seem to like it. Is there any limit on how much oral sex a couple can engage in? What sort of hormones are released? How does that relate to life satisfaction, stress relief, and what we learned from the FEASTA interview? How does it impact population growth? Are global corporations involved in oral sex? How much oil needs to be pumped to enable oral sex? Do we need Congress to tell us it is OK (well,,.I will admit they are probably working on it).

        Don Stewart

        • FrY10cK says:

          Great info as always Don. If I can only buy one item should it be a Looby Macnamara book or a Kelly McGonagal audio CD/MP3?

          • Don Stewart says:

            Dear FrY10cK
            I imagine you can pick up a copy of Looby’s book, used, for a couple of bucks. I don’t know about Kelly’s DVD as used. If you compare them, you will find that both meld together current neuroscience and what we might call the Buddhist tradition of introspection and the Yoga mind/body connection…although other wisdom traditions have come to similar conclusions. Either will serve you well. Try to find a soul-mate. You buy one, they buy the other, and you pool resources.

            Don Stewart

        • Have you been taking hormone therapy Don!

      • “Regarding the planet ever going dark, I would point out that the planet has never been dark for the last million years, which represents much of the evolutionary time of humans.”-Gail

        To be visible from space at this resolution, you need a LOT more lumens than you get from burning whale blubber Gail. In fact, small forest fires aren’t even visible, you need to burn on a scale of Bakken to got those bright bulbs visible from Space.

        http://www.doomsteaddiner.net/blog/2014/12/07/the-dimming-bulb/

        As long as the biosphere remains operational, there will always be what to burn, the trick is not to burn it faster than it grows. That is living sustainably, and we did it for 10s of 1000s of years, cooking food mainly. FYI, you don’t heat Igloos burning anything except the food you eat, they get plenty warm with 3 guys and a dozen dogs sleeping in them, I can tell you that from personal experience.

        We only started burning it faster than it grows with the development of metallurgy and ceramics, and then exacerbated the problem by denuding the landscape for Agriculture. You get rid of Ag, Metallurgy and Ceramics, and there is no shortage of what to burn for cooking purposes. It takes remarkably little energy to cook food, you can do it easily in a simple Solar Oven. You can burn dried sedge grass or dried dung in a rocket stove. Not to mention the mountains of Plastic in Landfills around the world.

        Homo Sapiens has no problem adapting to most of the Earth environment with very little in the way of external energy input besides the food you eat. Obviously not at the current population level, but that will take care of itself in no time.

        RE

      • InAlaska says:

        Gail,
        The Inupiat People of the northern coast would burn seal oil in stone lamps inside their igloos all winter. It provided light and kept the temperature inside somewhere just above freezing. Seal oil was traded all over the Arctic, stored in water proof bladders of marine mammals.

    • Peak Customers: The Final Liquidation Sale
      now UP on the Diner Blog!
      My definitive conclusion to the Hyperinflation vs. Deflation Argument.
       
      RE

      • Of course, when we get to the end, there will be virtually nothing to buy, if international trade disappears. On the way down, I agree it seems likely to be deflation all the way.

        Governments will collapse, leading to much smaller governed areas. Once governments collapse, we will have new currencies with which to buy whatever can be made locally, which is not much.

  2. Lucas says:

    1. With regard to bail-in (i.e. mandatory debt-for-equity swaps) of banks, unsecured creditors include holders of long-term unsecured bonds, and not just depositors. The first to be bailed in will be the holders of bonds. Mandatory debt-for-equity swaps are not a bad thing, and large bank salaries plus all bonuses should be paid in long-term unsecured bonds, and not in cash.
    2. Debt expansion is still possible: billions of humans are living outside the banking system. They are living on land to which they have no title, but since no government -unless such government were led by a Hitler or a Stalin- would dare evict them, the squatters might as well be given legal title to the land they are occupying. But eventually, when every human has mortgage debt plus credit card debt, further debt expansion becomes less sustainable, and debt collapse harder to avoid.
    3. There is no evidence that certain Opec countries, including allies of the US (KSA, UAE, Kuwait, Qatar), are keeping oil prices low so as to hurt Russia. The low prices are a consequence of 10 years of high oil prices, during which various oil and gas projects, notably US tight oil, were developed, and Opec’s consequent decision to defend market share, not price. The question is whether the recent supply-side boost is sustainable. Low prices may be a temporary phenomenon, for as Gail notes, renewables are far from being a substitute for fossil fuel.

    • garand555 says:

      Except that the Saudis increased production, and during the last OPEC meeting they basically said “We’re not cutting. Isn’t the US a huge producer? Why can’t they cut production?”

      • Yes, it seems that there are a couple of things going on.
        Oil production may be as much as 1 million barrels greater than demand right now. Most of this appears to be from OPEC members producing in excess of their quota. The Saudis seem to be trying to achieve two goals:
        1. Get America to set production limits, effectively joining the cartel
        2. Whip other OPEC members into compliance with their agreed upon production levels

        Whether they will succeed, and set a new price around $150 / barrel, or whether the whole system comes apart at the seems, we get to find out as it happens.

        • garand555 says:

          Either outcome is bad for our economy. $150/bbl and many Americans won’t be able to both afford food and buy gas to go to work. It will cost more to ship cheap Chinese crap to stores so that already cash strapped people won’t be able to buy as much. Subsidies will mean more government debt, which will ultimately mean more QE or some other form of monetizing the debt. Oil companies going out of business means that there is less oil to ship food, clothing and cheap Chinese crap to consumers. Both of those options are what you would do if you were trying to sustain an unsustainable status quo.

          • “Either outcome is bad for our economy. $150/bbl and many Americans won’t be able to both afford food and buy gas to go to work.”

            The money will have to come from somewhere else – likely housing. Mortgage defaults and downsizing.

            “It will cost more to ship cheap Chinese crap to stores so that already cash strapped people won’t be able to buy as much.”

            It doesn’t matter how much STUFF people buy, it matters the total PRICE of the things they buy. If people buy half as much stuff at twice the price, tax revenues and GDP remain the same.

    • Regarding 1, I expect the writer of the Dodd-Frank Act and other bail-in legislation didn’t think about how bad a predicament we could get ourselves into. If it is just a small predicament, affecting at most a handful of banks, and perhaps a share funds that can be covered by long-term unsecured bonds plus bank salaries and other sources of revenue, then perhaps this approach works. But if it is a systemwide problem, related to a crash in commodity prices and eventually production, then the approach just spreads the problem to banks, and eventually to every business everywhere. Admittedly, governments theoretically still stay in business, but I am not sure that that is necessarily sufficient to keep the economy going. I expect governments will be overthrown quickly, once citizens figure out how they have been treated.

      Regarding 2, you really need a cheap source of energy supply to fuel economic growth. China was able to arrange economic growth for a while, by ramping up its coal production at the same time it ramped up debt (by doing something similar to what you suggest–selling workers their own condos, with a mortgage, after living for years in “free” un-fancy housing that comes with employment. Once the cheap source of energy depletes, or pollution effects become too great, or some other limits is hit (such as working age population starts to fall because of one-child family), then the model falls apart. Part of Africa have been mentioned as substitutes for China, but they are lacking for suitable cheap energy sources.

      Regarding 3. I don’t see how we can have high prices for other than a very brief period. Wages need to rise, and ability to repay debt with interest must happen. With diminishing returns, this isn’t happening.

    • James says:

      They are living on land to which they have no title, but since no government -unless such government were led by a Hitler or a Stalin- would dare evict them, the squatters might as well be given legal title to the land they are occupying.

      How very western of you. In the end, what are titles anyway? Government decrees that so and so “owns” a piece of earth. Authentic Native Americans and other native peoples everywhere would scoff at the idea.

      • Edward Park says:

        Indians killed each other for hundreds of years over ‘title’. It is not an arbitrary idea. Population control? Maybe.

        • James says:

          Indians fought and killed among themselves for territory, not title. And they never practiced genocide or lasting subjugation and reprogramming of those they conquered. It’s a uniquely western proposition to hold title, aka “dominion,” over natural resources, which of course will all go out the window with the collapse of our current system. Population control? Yeah, it’s gonna be arriving pretty darn soon, I expect. But not in a form any of us are gonna like.

          • “Indians fought and killed among themselves for territory, not title. And they never practiced genocide or lasting subjugation and reprogramming of those they conquered. ”

            If you’re talking about American Indians, the Aztec and Anasazi certainly did those things. Out here on the west coast, the Haida tried to genocide and/or enslave the other tribes. Humans are not so different from one another, no matter what continent they live on.

          • Edward Park says:

            James, think you missed my point. You did raise a point that I haven’t thought about in this collapse meme. That being ‘what are property rights anyway’. As you likely know, next door neighbors can come to blows over a property line, and these grudges can grow to murder. It doesn’t take much. In a sharp decline, enforcement of property rights is likely to get ultra messy, with state courts swamped with claims and counter claims at the same time revenue for court operations is dramatically cut back.

            I’d hate to see an environment where possession is the rule of the day, and it could happen. My current neighborhood is terrible for folks getting called out or reported for minor property issues. Taking this starting point, and adding an extent of lawlessness due to lax enforcement, and things could tumble out of control within neighborhoods. Another unhappy reality.

          • edpell says:

            The native American held slaves.

            • Don Stewart says:

              Dear edpell and others
              I think it is generally unproductive to try to characterize some particular group of people as ‘evil’ or ‘virtuous’. For example, Andrew Jackson got along very well with certain tribes of Native Americans when he was allied with them fighting other Native Americans, but when gold was discovered in the American South, it was clear that ‘God intended the white race to have that gold’. And so the Native Americans were forcibly moved to Oklahoma. Where several of the tribes held black African slaves.

              I think that the only way we make progress in understanding is to examine the details. Exactly how did the tribes in upstate New York avoid warfare? What circumstances led the Cherokee to develop a written language? How did the Maya collapse as an empire, but thrive as small communities afterwards? How did the Japanese go about eliminating guns during the Edo period? What factors led them to rediscover guns and ‘engage in wholesale slaughter in Manchuria’ after the Restoration? How can we explain why the torturers at Guantanamo are heroes to so many Americans? Why isn’t Dick Cheyney in jail?

              Don Stewart

  3. Eileen Griffin says:

    Hi Wheaton:

    Here is the lady I love! She is so smart and connects very complicated issues in a holistic framework that few, if any, economists, scientists, government leaders and industry folks do or even can do. She “sees” holistically so that her information is deeper than all the other reporting I hear on these issues.

    I would love it if you would read this posting and let me know what you think.

    Thanks! Bean

  4. Daniel Hood says:

    “While many claims have been made that US shale drilling can be profitable at low prices, actions speak louder than words.”

    If ever truer words were spoken.

    This is the “sub-prime energy crisis” warned about, it’s upon us. It’s obvious that like the sub-prime banking crisis in 2008, the Fed will almost certainly subsidize/backstop the entire US fracking industry, it’s just too strategic to US interests to see the bubble burst. I can’t see how they’ll allow this stratetic sector succumb to free market forces.

    I promise you, central govt, the Fed & those struggling unprofitable small operators will find a way to suspend free market capitalism. Remember when the banks suspended “mark to market valuations” switching to a few men in smoke filled room instead?

    No way will they let this industry dive. They’ll “claim” US drillers are still profitable and find Enron style ways to keep the industry alive, the same way they did with the banks.

    100% guaranteed. It’s either that or America would face the mother of deflationary depressions dragging down the entire Western hemisphere.

    In other news, China is now the worlds largest economy, so long America you were so 20th century, now it’s China’s turn.

  5. Rodster says:

    “Issue 10. The drop in oil prices seems to reflect a basic underlying problem: the world is reaching the limits of its debt expansion.”

    This really all sums it up, in a nice little bow and IS at the heart of the matter. The entire system is designed to expand exponentially (see Chris Martenson) and without exponential growth the system contracts. Which is NOT allowed to happen or you arrive at debt defaults.

    The consumption and pricing of fossil fuels is also based on the same debt based system so the consumption and price needs to rise exponentially with other debt levels. There are two problems with this system.

    1) Wages need to keep up with ever expanding debt levels

    2) Consumers need to consume at exponential rates to keep up with all and future debt levels.

    3) Wages are in contraction because of globalization.

    4) Consumers are tapped out and CAN’T afford more debt because they don’t have the money.

    It’s like watching a hamster in a wheel constantly running as fast as it can only to watch the operate constantly increasing the speed until the hamster dies from exhaustion. That is where this ENTIRE debt based system is heading and we are well on our way. 😉

    • VPK says:

      From the book by Dan Wakefield “Kurt Vonnegut: Letters”
      “These were the last words of advice Vonnegut wrote to be delivered to an audience:
      “And how should we behave during the Apocalypse? We should be unusually kind to one another, certainly. But we should also stop being so serious. Jokes help a lot. And get a dog, if you don’t already have one….I’m out of here.”
      Thank you Gail for your overview of the real deal.
      All is bright and sunny here in Philadelphia!

      Hope you like the joke…now to adopt a puppy

    • Right! At one point, I thought about putting this first, but decided the point was too difficult for most readers.

      I might add a few fine points to your list. Wages are partly in contraction because of globalization (and thus competition with coal, which is much cheaper to produce, and other differences, such as willingness to ignore pollution issues). Wages are also in contraction because the value oil adds, over and above the energy cost of extraction, is falling–something that is related to its lack of competitiveness with coal.

  6. John Drake says:

    Dear Gail,

    Your analysis is always of great interest. The general conclusion that you have reached in your present paper are correct. However, they fail to take into account the recent “development” with Russia.

    Why are you ignoring the fact that an all out “economic war” is on-going between the US led Occidental World and Russia since the beginning of 2014?

    Why are you ignoring that one of the main economic weapons currently being used against Russia is the downward “oil price” pressure essentially generated by the same alliance between the US and Saudi Arabia that took down the USSR – after almost 10 years of efforts – in 1991 ?

    The key questions that one should be asking is “how long” can the US and Saudi Arabia continue to maintain oil prices so low and how far can they take that price down ?

    Another interesting question is “how can the US continue to maintain its tight oil production in the present economic war context” ?

    Finally, it should be clear to any keen observer that the present economic conflict with Russia has for objective to effect a “regime change” in that country and to find a way to transfer effective control over its strategic resources (including oil & gas reserves) to the US led Occidental World.

    Of course, if the US led Occidental World was to lose the current economic war, in particular by exhausting its key domestic oil reserve or by imploding its financial system before Vlad is removed by a spontaneous “coup d’état”, then the consequences for the living standard of Occidental World citizens might become quite dramatic…

    • James says:

      The US fancies Vlad and Russia as the proverbial “next greatest fools.” So far Vlad at least has been able to refute that proposition, although the Russian people themselves might ultimately reject him as well. But I wouldn’t count on that. There’s certainly no signs that they’re so inclined so far, and Americans are gravely mistaken if they think Russians are as easily bought off as they are.

    • I am afraid I am not into speculating on the outcome of the conflict with Russia. A world economy grows a lot better than one splintered into smaller parts. Thus, the fight tends to push us toward collapse quicker, unless somehow someone can magically take over Russia–something I don’t see happening very soon. If nothing else, they still have nuclear weapons.

      • James says:

        Agree. If anything, Russia is positioned to come out of the current situation even stronger in my mind. If I were biased politically, I’d be much more worried about the long term prospects of the US.

      • John Drake says:

        Yet, in 1991 very few people considered the possibility that the USSR would “peacefully” disintegrate as it then did…

        Which means that there were very good reasons why that happened and not the contrary… and, if it can be done once, why not twice… Key people were then “bought” and given access to the full spectrum of “pleasures” available when you have a nice and discrete account in an Occidental World bank. Those people decided that this was better than nuclear war… and most of those people are still alive today…

        The “prize” of such a “deal” is of course huge i.e. access by Occidental World corporations to the vast Russian strategic mineral base, and in particular to its oil & gas reserves.

        Of course failure to effect a “regime change” in Russia as a result of an economic attrition war may result in an exhaustion of Occidental World’s critical oil reserves or, even before that, may result in the implosion of its financial system…

        In any case Gail, my point is that the current economic war between the US led Occidental World and Russia (and its Iranian and Venezuelan allies – China has not yet fully committed itself to support Russia) cannot be ignored when you analyze the current oil price fluctuations.

        These oil price fluctuations are currently not the simple end result of the market’s “invisible hand” but also the consequence of deliberate war guided strategic decisions.

  7. Don Stewart says:

    Dear Gail and All
    The ever interesting shortonoil posted this at a discussion on how OPEC is showing the US tight oil guys who is the boss…Don Stewart
    PS For the record, I am a passivist along with Jan Steinman, and so do not advocate horse-whipping anyone.

    ‘OPEC is not doing one dam thing that it wasn’t doing 3 years ago. LTO isn’t even competition for OPEC because at least half of it doesn’t produce transportation fuels, half of it is a feed stock material. These writers pushing the Bogey Man theme should be horse whipped. LTO is failing because it never was worth very much, and still isn’t. It is an net energy dead man walking.’

    • Jan Steinman says:

      “I am a passivist along with Jan Steinman”

      Was that a typo?

      I am not a “passivist,” although I might be called a “pacifist,” but more likely, a “pacifist-activist.” 🙂

      I think the best defense is being a small target. And that’s getting easier and easier to do!

      • Don Stewart says:

        Jan
        Sorry. What I meant is what you say, with a little bit of tongue in cheek about the hyperbole I am responding to.

        Don Stewart
        I do think, however, that the current production numbers from OPEC, as displayed on Ron Patterson’s site, should give everyone pause. I don’t see any huge increase in OPEC production.

        I think Gail should formulate a ‘peak propaganda’ theory. Alain deBotton has a new book out on ‘what the news is really telling you’. And very little of what they are telling you is relevant facts.

    • Creedon says:

      Thanks Don for quoting Shortonoil. I think in the same quote he called LTO camel piss.

      • Creedon says:

        Full quote from Shortonoil; “Now the world’s economy is dying from the camel Pea they are pedaling off as oil. Half of it is nothing more than a precursor to a piece of plastic pipe. The value of oil is falling because it isn’t able to power it’s own extraction, to say nothing of the world economy.” Gail has told us in the past, growth in GDP requires cheap energy. The world’s cheap energy is gone.

        • Daniel Hood says:

          I think someone else on here made some brilliant points, essentially it’s all zero-sum from this point forth.

          Producers need high prices for energy but that triggers numerous interconnected crisis for consumers, demand destruction etc and consumers need low prices (where we’re at now) but that triggers numerous interconnected crisis for producers where the focus is on now.

          The US and the Western hemisphere is both a producer and consumer fully laden with toxic debt.

          So we’ll see this undulating spike in energy prices as the global economy gets obliterated and numerous families are wiped out.

          Those with huge obligations will be hit the hardest.

          • Daniel Hood says:

            This is it, this is the big one we’ve all been waiting for. 2015 the real collapse is starting and we’ll never recover.

            The final graph that Gail has showing the decline off the plateau starting 2015 is looking more and more accurate.

            The questions now is what will collapse look like? How fast will it be? What are the consequences? Where, when and how will it manifest? We’ll probably see some surprising non-linear stuff until the problem of overpopulation on a finite planet is solved, until we find some kind of equilibrium.

            • Jan Steinman says:

              “2015 the real collapse is starting and we’ll never recover.”

              I guess it depends on how you define “collapse.” 2008 was a collapse, of sorts, and billions of people didn’t die. There wasn’t rioting in the streets. (Well, not much.) Governments didn’t fall. (Well, not many.)

              So I expect the next “collapse” to be similar, but more severe. More rioting. More governments falling. But the strong ones (and the ones that still have inexpensive oil) will stick around for a while longer. (I’m not certain that includes the US and Canada, though!)

              Richard Heinberg’s prognosis makes the most sense to me. That’s a stair-step decline. Strong governments will remain in power, weak ones will dissolve and re-assemble, probably as smaller, regional entities. Proper nutrition will decline, as will longevity. Baby boomers may lose a decade or less. It’s their kids I’d worry about!

              Humanity will go out with a whimper, not a bang.

            • garand555 says:

              @Jan

              How do you want to define collapse? Since US oil production peaked? We came off of a quasi-gold standard then, and almost hit hyperinflation until Volker raised interest rates to insane levels. That is also when private debt levels really started to rise. Lagging that by a few years was more and more people entering the workforce to keep up with the Joneses. There were some good times during that period, but the employment:population ratio started to decline around ~2000, Or how about post Lehman? The employment:population ratio dropped and hasn’t come back up.

              Where do you define the start of collapse? Is it the local peaking of a key resource? The beginning of the removal of legal financial limits? The need to borrow more and work more just to keep up? When that starts to break down? Or the “OMG! I never saw it coming” downturn that was driven by expensive resources and ponzinomics? You can make an argument for any of those. Me personally, I’ll stick to the point when the employment:population ratio started to decline as a marker. By that, we’ve been in a state of slow collapse for almost 15 years. We’ve had good years during that, but we were in a state of collapse nonetheless.

              I expect the slow, grinding to collapse to continue and to be punctuated with horrific events. I expect that one will eventually mark the end of our current system. I’m not optimistic that the next big economic/geopolitical event won’t be the big one. We are so fragile now that we can only deal with one or two major issues at a time, and we may be faced with multiple issues at once during the next crisis.

            • Jan Steinman says:

              “How do you want to define collapse? … I’ll stick to the point when the employment:population ratio started to decline as a marker… we’ve been in a state of slow collapse for almost 15 years.”

              Collapse: (of a structure) suddenly fall down or give way.

              I try to be precise about words, so according to the dictionary, a fifteen-year process is not really a “collapse.”

              Of course, the dictionary does not specify what “suddenly” means, and a future geologist will probably note a “collapse” that took several hundred years to complete, while a quantum physicist talks of a “collapse of the wave function” that happens as instantaneously as we can measure.

              On human time scales, most would agree that the stock market collapse was the beginning of the Great Depression, yet there was a long, slow decline before and after that.

              I think of “collapse” as an event, rather than a process. When you talk about a 15-year “collapse,” that sounds like a process, rather than an event. Processes can be explained through logical cause-and-effect analysis. A collapse is more of a “straw that broke the camel’s back” sort of non-predictable (even in hindsight), stochastic event.

              But I’m probably just waxing pedantic. Call it what you will, with the caution that if you make up your own definitions, it is harder to communicate with others.

            • The United States had peak employment as a percentage of the population about 2000.

              US employment as percentage of the population

              The peak in employment corresponded pretty close to the low in world inflation-adjusted oil price. Now, more folks are finding that the pay is so low, it doesn’t make sense to work, when a person considers the costs involved: commuting, child care, elder care, clothing

            • InAlaska says:

              Jan,
              “Humanity will go out with a whimper, not a bang.” Ok Jan and Daniel Hood, stop it already, you’re freaking me out! I’m going to Costco to buy another bag of rice now…bye.

            • Jan Steinman says:

              “I’m going to Costco to buy another bag of rice now…bye.”

              Yea, rice grows pretty good there in Alaska, no? Does Costco fly that stuff in, or what? 🙂

              Sorry for the “holier than thou” attitude. I’ve got no reason to act that way. I’m having trouble keeping goats alive this winter, seemingly due to a combination of resistant intestinal parasites and a poor quality hay harvest. I depend on share-cropping with my neighbour to get the hay up, and he took his sweet time this year. I’ll bet it’s only 6% protein, when it should be 11%. I have a “Lazarus” kid in the laundry room (easily cleaned floor) that I’ve found flat three times, and nursed back with cheese curds and black oil sunflower seeds. I’ve got an adult down in the shed that I’m feeding peanut butter and BOSS four times a day. I’ve got at least five or six others that are on the skinny side of healthy that I’m keeping an eye on, feeding three lean kids BOSS and beet pulp in addition to that no-good hay.

              So one can boast about “pasture-fed milk,” until someone screws up. And this was with diesel-powered haying machinery! (I guess if you were scything and shooking, you’d make damn sure you cut at the right time, just before flowering of seed heads. But when you’ve got diesel-powered supply chains, just go down to the feed store and stock up on BOSS, beet pulp, and grain.)

            • garand555 says:

              @Jan

              And I view the collapse of civilizations as a process, not an event. I think that process will be marked by events, but you have to remember that the English language, and all natural languages are inherently imprecise. If you look at the dictionary, you’ll notice various definitions for the world collapse, and you’ll also notice various vague definitions for worlds like “sudden.” For the most part, they don’t deal specifically with civilizations, so it is out of necessity that people start using their own definitions that don’t quite line up with normal use of the words. On top of that, not all definitions use “sudden” as a qualifier.

              However you want to play it with semantics, it was around 2000 that the data started becoming available that we should be decreasing the complexity of our civilization, yet we’ve increased it. A lot of that complexity, which is driven by keeping up with the Joneses cannot be sustained, and thus is going to go away. If you equate our complex civilization to a physical structure, you can think of what’s going on as being akin to somebody taking an ax and hacking away one piece of the foundation at a time, while others are going to the hacked parts of the foundation and trying to repair the damage done with sub-par materials. Eventually, something is going to give away.

            • Jan Steinman says:

              “it was around 2000 that the data started becoming available that we should be decreasing the complexity of our civilization, yet we’ve increased it.”

              Oh. I thought it was about 1970. 🙂

            • Around 2000 (slightly before, actually) was when we hit the lowest price of oil, and the highest percentage of the population employed. It has gone downhill from there.

            • garand555 says:

              “Oh. I thought it was about 1970. :-)”

              I’m not going to argue that that is wrong. US oil production peaked and we started transitioning to a financial economy rather than a productive one a year later. Picking the most important points out is indeed a fuzzy idea. I picked the decline in employment:population ratio as a point because it marks the point where the standard of living inevitability started to decline in developed countries. Oil had only peaked in the US, but not worldwide, and we figured out how to get as much as we needed. I’m living it, I’m watching it, and I bet that, should enough documentation survive, future historians who have the benefit of hindsight will be arguing over this. When did the decline really start? I see two things: The decline of the US because that is where I reside and the decline of the global economy, because we have, for worse, become globalized.

            • Jan Steinman says:

              “future historians who have the benefit of hindsight will be arguing over this”

              The real question is, will those “future historians” be hominoid? Or perhaps some canid will develop opposable thumbs?

              “History” sits pretty far up Maslow’s Hierarchy. I wonder if there’ll be much time and energy for things other than food and shelter, and perhaps a bit of song or poetry.

        • Rodster says:

          I’ve never heard of the website “shortonoil”.

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  10. Stilgar Wilcox says:

    “Once commodity prices (including oil prices) fall to levels that are affordable based on the incomes of customers, they fall to levels that cut out a large share of production of these commodities.”

    Great article, Gail! The above is exactly what I’ve been trying to tell people who think these low oil prices are great – that low oil prices risks future supply. We are in effect being cut off from our beloved supply of oil by way of declining net energy. It’s not something that can be averted when relying on a finite resource in which crude oil extraction has not risen much since 05. Other oils have gone up to help continue growth but they are oil extenders only as Gail points out at a high price.

    Next stop, Palukaville with “Debt related collapse: oil limits will play out in a very different way than most have imagined, through lower oil prices as limits to growth in debt are reached, and thus a collapse in oil “demand” (really affordability). The collapse in production, when it comes, will be sharper and will affect the entire economy, not just oil.”

    We are quickly approaching collapse. I don’t know the exact timing, but each of these events that take place, like the recent oil price drop are indicative of peak oil. It’s happening, it’s just not collapsed yet.

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