Low Oil Prices: An Indication of Major Problems Ahead?

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

Figure 1. Chart showing expected long-term rise in oil prices as the full cost of oil production becomes increasingly expensive due to diminishing returns.

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

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

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

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

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Why we get bad diagnoses for the world’s energy-economy problems

The world economy seems to be seriously ill. The problem is not overly high oil prices, but that does not rule out energy as being a major underlying problem.

Two of the symptoms of the economy’s malaise are slow wage growth and increasing wage disparity. Tariffs are being used as solutions to these issues. Radical leaders are increasingly being elected. The Bank for International Settlements and the International Monetary Fund have raised concerns about the world’s aggregate debt levels. The IMF has even suggested that a second Great Depression might be ahead if major banks should fail in the manner that Lehman Brothers did in 2008.

Figure 1. Ratio of Core Debt Growth (non-financial debt including governmental debt) to GDP, based on data of the Bank of International Settlements.

If the economy were a human being, we would send it to a physician for a diagnosis regarding what is wrong. What really is needed is a physician who has a wide overview, and thus can understand the many symptoms. Hopefully, the physician can also provide a reasonable prognosis of what lies ahead.

Individual specialists studying the world’s economic and energy problems tend to look at these problems from narrow points of view. Some examples include:

  •  Curve fitting and cycle analysis using economic data by country since World War II, as is often performed by economists
  • Analysis of oil supply based on technically recoverable reserves or resources
  • Analysis of fresh water supply problems
  • Analysis of population problems, including rising population relative to arable land, and rising retiree population relative to working population
  • Analysis of ocean problems, including rising acidity and depleting fish stocks
  • Analysis of the expected impact of CO2 production from fossil fuels on climate
  • Analysis of rising debt levels

In fact, we are facing a combined problem, but most analysts/economists are looking at only their own piece of the problem. They assume that the other aspects have little or no influence on their particular result. What we really need is an analysis of the overall economic malady from a broader perspective.

In some ways, the situation is analogous to having no physician with a sufficient overview of where the world economy is headed. Instead, we have a number of specialists (perhaps analogous to a psychiatrist, a urologist, a podiatrist, and a dermatologist), none of whom really understands the underlying problem the patient is facing.

One point of confusion regarding whether today’s oil prices should be of concern is the fact that the maximum affordable oil price seems to decline over time. This happens because workers around the world increasingly cannot afford to buy the goods and services that the world economy produces. Inadequate wage growth within countries, growing globalization and rising interest rates all contribute to this growing affordability problem. To make matters confusing, this growing affordability problem corresponds to “falling demand” in the way economists frame the issues we are facing.

If we believe the technical analysis shown in Figure 2, the maximum affordable West Texas Intermediate oil price has declined from $147 per barrel in July 2008 to $76 per barrel recently. The current price is about $62 per barrel. The chart suggests that downward price resistance might be reached at $55 per barrel, assuming no major event occurs to change the current trend line. Any upward price bounce would appear to leave the price still much lower than oil producers need in order to reinvest sufficiently to allow future oil production to be maintained at current levels.

Figure 2. Down sloping diagonal line at the top of chart gives an estimate of the trend in maximum affordable West Texas Intermediate (WTI) oil prices. The downward trend line starts in July 2008, when oil prices hit a maximum. This high point occurred when the US real estate debt bubble started unwinding. Later maximum points correspond to points when oil prices stopped rising and crude oil reservoirs started refilling. Chart prepared by Amit Noam Tal.

Thus, our concern about adequate future oil supplies should perhaps be focused on keeping oil prices high enough. It takes a growing debt bubble to keep oil demand high; perhaps our concern should be keeping this debt bubble high enough to allow extraction of commodities of all kinds, including oil. Figure 1 seems to show a recent downward trend in Debt to GDP ratios for the Eurozone, the United States and China. This may be part of today’s low price problem for commodities of all types.

Needless to say, climate analyses do not consider the severity of our energy problems, nor do they consider the extent to which there is a connection between energy supply and the ability of the economy to operate as usual. If the real issue is a near-term financial crash that will radically affect future fossil fuel consumption, the climate analysis will certainly miss this event.

The Real Nature of the Limits to Growth Problem

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