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.

One thing that is a little confusing is the relative roles of diminishing returns and efficiency. I see diminishing returns as being more or less the opposite of growing efficiency.

Figure 2.

The fact that inflation-adjusted oil prices are now much higher than they were in the 1940s to 1960s is a sign that for oil, the contest between diminishing returns and efficiency has basically been won by diminishing returns for over 40 years.

Figure 3.

Oil Prices Cannot Rise Endlessly

It makes no sense for oil prices to rise endlessly, for what is inherently growing inefficiency. Endlessly rising prices for oil would be similar to paying a human laborer more and more for building widgets, during a time that that laborer becomes increasingly disabled. If the number of widgets that the worker can produce in one hour decreases by 50%, logically that worker’s wages should fall by 50%, not rise to make up for his/her growing inefficiency.

The problem with paying higher prices for what is equivalent to growing inefficiency can be hidden for a while, if the economy is growing rapidly enough. The way that the growing inefficiency is hidden is by adding Debt and Complexity (Figure 4).

Figure 4.

Growing complexity is very closely related to “Technology will save us.” Growing complexity involves the use of more advanced machinery and ever-more specialized workers. Businesses become larger and more hierarchical. International trade becomes increasingly important. Financial products such as derivatives become common.

Growing debt goes hand in hand with growing complexity. Businesses need growing debt to support capital expenditures for their new technology. Consumers find growing debt helpful in affording major purchases, such as homes and vehicles. Governments make debt-like promises of pensions to citizen. Thanks to these promised pensions, families can have fewer children and devote fewer years to child care at home.

The problem with adding complexity and adding debt is that they, too, reach diminishing returns. The easiest (and cheapest) fixes tend to be added first. For example, irrigating a field in a dry area may be an easy and cheap way to fix a problem with inadequate food supply. There may be other approaches that could be used as well, such as breeding crops that do well with little rainfall, but the payback on this investment may be smaller and later.

A major drawback of adding complexity is that doing so tends to increase wage and wealth disparity. When an employer pays high wages to supervisory workers and highly skilled workers, this leaves fewer funds with which to pay less skilled workers. Furthermore, the huge amount of capital goods required in this more complex economy tends to disproportionately benefit workers who are already highly paid. This happens because the owners of shares of stock in companies tend to overlap with employees who are already highly paid. Low paid employees can’t afford such purchases.

The net result of greater wage and wealth disparity is that it becomes increasingly difficult to keep prices high enough for oil producers. The many workers with low wages find it difficult to afford homes and families of their own. Their low purchasing power tends to hold down prices of commodities of all kinds. The higher wages of the highly trained and supervisory staff don’t make up for the shortfall in commodity demand because these highly paid workers spend their wages differently. They tend to spend proportionately more on services rather than on commodity-intensive goods. For example, they may send their children to elite colleges and pay for tax avoidance services. These services use relatively little in the way of commodities.

Once the Economy Slows Too Much, the Whole System Tends to Implode

A growing economy can hide a multitude of problems. Paying back debt with interest is easy, if a worker finds his wages growing. In fact, it doesn’t matter if the growth that supports his growing wages comes from inflationary growth or “real” growth, since debt repayment is typically not adjusted for inflation.

Figure 5. Repaying loans is easy in a growing economy, but much more difficult in a shrinking economy.

Both real growth and inflationary growth help workers have enough funds left at the end of the period for other goods they need, despite repaying debt with interest.

Once the economy stops growing, the whole system tends to implode. Wage disparity becomes a huge problem. It becomes impossible to repay debt with interest. Young people find that their standards of living are lower than those of their parents. Investments do not appear to be worthwhile without government subsidies. Businesses find that economies of scale no longer work to their advantage. Pension promises become overwhelming, compared to the wages of young people.

The Real Situation with Oil Prices

The real situation with oil prices–and in fact with respect to commodity prices in general–is approximately like that shown in Figure 6.

Figure 6.

What tends to happen is that oil prices tend to fall farther and farther behind what producers require, if they are truly to make adequate reinvestment in new fields and also pay high taxes to their governments. This should not be too surprising because oil prices represent a compromise between what citizens can afford and what producers require.

Figure 7. Illustration indicating that the world has already reached a point where no oil price works for both oil suppliers and oil consumers.

In the years before diminishing returns became too much of a problem (back before 2005, for example), it was possible to find prices that were within an acceptable range for both sellers and buyers. As diminishing returns has become an increasing problem, the price that consumers can afford has tended to fall increasingly far below the price that producers require. This is why oil prices at first fall a little too low for producers, and eventually seem likely to fall far below what producers need to stay in business. The problem is that no price works for both producers and consumers.

Affordability Issues Affect All Commodity Prices, Not Just Oil

We are dealing with a situation in which a growing share of workers (and would be workers) find it difficult to afford a home and family, because of wage disparity issues. Some workers have been displaced from their jobs by robots or by globalization. Some spend many years in advanced schooling and are left with large amounts of debt, making it difficult to afford a home, a family, and other things that many in the older generation were able to take for granted. Many of today’s workers are in low-wage countries; they cannot afford very much of the output of the world economy.

At the same time, diminishing returns affect nearly all commodities, just as they affect oil. Mineral ores are affected by diminishing returns because the highest grade ores tend to be extracted first. Food production is also subject to diminishing returns because population keeps rising, but arable land does not. As a result, each year it is necessary to grow more food per arable acre, leading to a need for more complexity (more irrigation or more fertilizer, or better hybrid seed), often at higher cost.

When the problem of growing wage disparity is matched up with the problem of diminishing returns for the many different types of commodity production, the same problem occurs that occurs with oil. Prices of a wide range of commodities tend to fall below the cost of production–first by a little and, if the debt bubble pops, by a whole lot.

We hear people say, “Of course oil prices will rise. Oil is a necessity.” The thing that they don’t realize is that the problem affects a much bigger “package” of commodities than just oil prices. In fact, finished goods and services of all kinds made with these commodities are also affected, including new homes and vehicles. Thus, the pattern we see of low oil prices, relative to what is required for true profitability, is really an extremely widespread problem.

Interest Rate Policies Affect Affordability

Commodity prices bear surprisingly little relationship to the cost of production. Instead, they seem to depend more on interest rate policies of government agencies. If interest rates rise or fall, this tends to have a big impact on household budgets, because monthly auto payments and home payments depend on interest rates. For example, US interest rates spiked in 1981.

Figure 8. US short and long term interest rates. Graph by FRED.

This spike in interest rates led to a major cutback in energy consumption and in GDP growth.

Figure 9. World GDP Growth versus Energy Consumption Growth, based on data of 2018 BP Statistical Review of World Energy and GDP data in 2010$ amounts, from the World Bank.

Oil prices began to slide, with the higher interest rates.

Figure 10.

Figure 11 indicates that the popping of a debt bubble (mostly relating to US sub-prime housing) sent oil prices down in 2008. Once interest rates were lowered through the US adoption of Quantitative Easing (QE), oil prices rose again. They fell again, when the US discontinued QE.

Figure 11. Figure showing collapsing debt bubble at the time US oil prices peaked, and the use of Quantitative Easing (QE) to stimulate the economy, and thus bring prices back up again.

While these charts show oil prices, there is a tendency for a broad range of commodity prices to move more or less together. This happens because the commodity price issue seems to be driven to a significant extent by the affordability of finished goods and services, including homes, automobiles, and restaurant food.

If the collapse of a major debt bubble occurs again, the world seems likely to experience impacts somewhat similar to those in 2008, depending, of course, on the location(s) and size(s) of the debt bubble(s). A wide variety of commodity prices are likely to fall very low; asset prices may also be affected. This time, however, government organizations seem to have fewer tools for pulling the world economy out of a prolonged slump because interest rates are already very low. Thus, the issues are likely to look more like a widespread economic problem (including far too low commodity prices) than an oil problem.

Lack of Growth in Energy Consumption Per Capita Seems to Lead to Collapse Scenarios

When we look back, the good times from an economic viewpoint occurred when energy consumption per capita (top red parts on Figure 12) were rising rapidly.

Figure 12.

The bad times for the economy were the valleys in Figure 12. Separate labels for these valleys have been added in Figure 13. If energy consumption is not growing relative to the rising world population, collapse in at least a part of the world economy tends to occur.

Figure 13.

The laws of physics tell us that energy consumption is required for movement and for heat. These are the basic processes involved in GDP generation, and in electricity transmission. Thus, it is logical to believe that energy consumption is required for GDP growth. We can see in Figure 9 that growth in energy consumption tends to come before GDP growth, strongly suggesting that it is the cause of GDP growth. This further confirms what the laws of physics tell us.

The fact that partial collapses tend to occur when the growth in energy consumption per capita falls too low is further confirmation of the way the economics system really operates. The Panic of 1857 occurred when the asset price bubble enabled by the California Gold Rush collapsed. Home, farm, and commodity prices fell very low. The problems ultimately were finally resolved in the US Civil War (1861 to 1865).

Similarly, the Depression of the 1930s was preceded by a stock market crash in 1929. During the Great Depression, wage disparity was a major problem. Commodity prices fell very low, as did farm prices. The issues of the Depression were not fully resolved until World War II.

At this point, world growth in energy consumption per capita seems to be falling again. We are also starting to see evidence of some of the same problems associated with earlier collapses: growing wage disparity, growing debt bubbles, and increasingly war-like behavior by world leaders. We should be aware that today’s low oil prices, together with these other symptoms of economic distress, may be pointing to yet another collapse scenario on the horizon.

Oil’s Role in the Economy Is Different From What Many Have Assumed

We have heard for a long time that the world is running out of oil, and we need to find substitutes. The story should have been, “Affordability of all commodities is falling too low, because of diminishing returns and growing wage disparity. We need to find rapidly rising quantities of very, very cheap energy products. We need a cheap substitute for oil. We cannot afford to substitute high-cost energy products for low-cost energy products. High-cost energy products affect the economy too adversely.”

In fact, the whole “Peak Oil” story is not really right. Neither is the “Renewables will save us” story, especially if the renewables require subsidies and are not very scalable. Energy prices can never be expected to rise high enough for renewables to become economic.

The issues we should truly be concerned about are Collapse, as encountered by many economies previously. If Collapse occurs, it seems likely to cut off production of many commodities, including oil and much of the food supply, indirectly because of low prices.

Low oil prices and low prices of other commodities are signs that we truly should be concerned about. Too many people have missed this point. They have been taken in by the false models of economists and by the confusion of Peak Oilers. At this point, we should start considering the very real possibility that our next world problem is likely to be Collapse of at least a portion of the world economy.

Interesting times seem to be ahead.

 

 

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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1,393 Responses to Low Oil Prices: An Indication of Major Problems Ahead?

  1. Chrome Mags says:

    https://oilprice.com/

    Check out WTI & Brent increase in oil price today. Wow!

  2. Baby Doomer says:

    Rex Tillerson on Trump: ‘Undisciplined,’ ‘doesn’t like to read’ and tries to do illegal things

    https://www.sltrib.com/news/nation-world/2018/12/07/rex-tillerson-trump/

    • doomphd says:

      if you live in a rigged setup, what’s wrong with trying to break the rules? Tillerson = Establishment.

      • jupiviv says:

        “Tillerson = Establishment.”

        And Trump is obviously a black swan outsider right? Jesus it’s like a derangement round robin with you edgy nihilists.

        • Duncan Idaho says:

          Trump is what you get with late stage capitalism.
          We are lucky he can read (possibly the case).
          Lets face it- he is a failed real estate scammer (bankrupt 4 times), and tv host.
          No one will touch his business, (loan him money) except the Russians.
          Perfect President?

          • JesseJames says:

            I sure am glad that Hillary and “made man” Obama could read, surely it helped that to create the Libya, Syria and Ukraine disasters.
            These evil people would destroy the world….Trump has not done that. If only he could roll back the wars thendeep state has us mired in.

            • Duncan Idaho says:

              Actually, Trump and Hillary have very similar policy’s , as compared to someone like Sanders. On a macro level, it would be hard to tell.
              In a conversation, you could tell Hillary could read.
              You would know immediately not to do business with Trump, unless you were looking to throw some cash away.

            • Duncan Idaho says:

              Note: I never voted for Trump, Hillary, or Obama

            • Do you live in the US?

          • I believe you are correct. Trump is symptomatic of a late stage collapse similar to what happened in the Soviet Union. He is a reflection of the angst developing between classes, races, and genders as the pie gets smaller and smaller. We’re seeeing the same thing in Italy, France, Mexico, Brazil, India, etc.. we’re seeing radicalization of the leadership reflecting desperation and radicalization of the population. There is no fix for what’s wrong and unlike Japanese monocultural society most of the European and U.S. populations are culturally mixed. There are lots of subgroups to cannibalize which is what desperate societies have done since the beginning of time.

        • doomphd says:

          in a way, he IS a black swan, to the Washington establishment. Trump is no outsider to capitalism. he was the guy that must not win, hence all the pre-election “activity”, some of it criminal, to stop him and then curtail his ability to govern after he won. we still might get into a civil war over this, just in time for collision with a financial collapse, perhaps even triggering it. see some of JHK’s recent posts.

          • doomphd says:

            or perhaps you guys would prefer being subjected to WWIII? recall Hillary was just fine calling Putin a “Hit ler”. the Ukrainian/Syrian/Libyian adventures started under her watch as SOS under Obama. some of those crazies think we can invade or otherwise take down Russia and grab their hydrocarbon resources. not without a fight.

  3. Uncle Bill says:

    Lance Armstrong strikes it Rich
    Sometimes being lucky is just as Good as being Good…

    Texas native invested $100,000 with a venture capital firm in 2009, the bulk of which went to the ride-sharing app that he says was valued at just $3.7 million at the time.

    Today, as the company prepares for its IPO, banks have valued it as high as $120 billion. That could make Armstrong’s shares worth more than $3 billion, but he declined to reveal the exact figure, simply telling CNBC the number is “too good to be true” and “it’s saved our family.”

    Armstrong’s bonanza was a giant stroke of luck after he received a phone call from former Google employee and now billionaire investor Chris Sacca
    “I’m thinking to myself, ‘This guy has a huge personality but he’s also very smart and very well connected.’ So I invested in Chris Sacca. I didn’t even know that he did Uber. I thought he was buying up a bunch of Twitter shares from employees or former employees, and the biggest investment in (the) Lowercase fund one was Uber.”
    WOW…good for him…always admired the Guy…even though he’s a cheater….there are two kinds
    That get caught and those that don’t….everyone cheats
    https://nypost.com/2018/12/07/lance-armstrong-is-poised-to-become-billionaire-despite-doping-downfall/amp/
    See folks one day is all doom and gloom…the next unicorns and rainbows.

  4. Artleads says:

    Brilliant research, but no dealing with the cost of centralized power generation. But can one single model of centralization be subdivided into smaller units of centralization?

      • Davidin100millionbilliontrillionzillionyears says:

        Winona LaDuke is “you know, I’m an economist by training…”

        and she wants a “Green New Deal”?

        I’m sure that she has no clue that FF = prosperity…

        • Artleads says:

          I hear you. The Indian communities of NM are being challenged as never before through Trump leases for drilling on land that affect them. Anglo Greenies where I live are up in righteous fury about the injustice of it all. Winona is the hero. I’m saying you don’t just wait till a day before the leases are sold to hold a rally and end up blocking traffic. You need to have a land plan in writing, and a legal team to back it up. I dare not say that they are dreaming as to the switch to “renewables” that they ALL jut rattle off the lips of their tongues…as though it were just the immorality of oil companies keeping it a bay. But I think everybody has it wrong. Forget renewable (the way it’s fantasized over), but you don’t want poisoned water either. Separate the issues. Poisoned water isn’t the inevitable outcome of FF use. It is more likely the result of “planning” (NOT) and real estate development, and every possible kind of misguided ideology imaginable. But how do you get that notion past the blind allegiance to renewables?

  5. Davidin100millionbilliontrillionzillionyears says:

    Gail, your link to US oil data shows this 20 year graph which shows US exports rising from about 1 million per day around the 2008/2009 “Great Recession” to about 9 million per day now…

    https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WTTEXUS2&f=W

    so is the US in such bad shape that it doesn’t need 8 million more barrels per day like we did pre-2008?

    • Davidin100millionbilliontrillionzillionyears says:

      though US production is up since then, so that would enable increased exports…

      I’m just surprised that the US seems to only need about 10 million per day for “internal” use…

      I though we needed about 20 million per day last decade…

      • Davidin100millionbilliontrillionzillionyears says:

        then, if it’s big news that the US is now a net exporter for the first time in 75 years…

        that may not be good news at all…

        it may mean the US economy has tanked to the point where it doesn’t need as much oil domestically…

        • adonis says:

          you are correct the US economy only needs to import 5 million a day of oil barrels in 2017 but in 2005 it needed to import 13 million a day of oil barrels

    • adonis says:

      it must be all the shale oil that the US cant use that it exports

    • Yoshua says:

      The headline says: U.S weekly crude oil and petroleum product exports.

      The U.S is a refinery super power as it takes in about 25 percent of the global crude oil production and then exports refined petroleum products to the world.

      The oil refining industry is the most energy intensive industry in the U.S. The energy to refine all the crude is coming from the shale gas industry.

  6. Theophilus says:

    I’m confused about collapse

    When I think about collapse. I think of a market where the price is to low for the producer to be profitable and too high for the consumer to afford. When this happens the market stops. No transactions are made since an agreeable price no longer exists. Gail calls this an affordability problem.

    Many markets depend on a cheap and productive energy environment to maintain an affordable price for buyer and seller. We have used up the cheap energy and we seem to be getting diminishing economic returns on the energy we are using. These are closely related problems but they are not the same. Or am I wrong?

    As cheap productive energy is declining some markets will reach a point of collapse. All markets will collapse when they reach a point when the essential energy input falls below a critical level. No market exists where there is no energy. However, the world economy is comprised of many markets. And I’m not just speaking of national markets, but markets for individual products and services. Each market has its own cheap and productive energy requirements. The lemon market might collapse before the lime market. Or am I wrong about this also?

    Now here is where I really get confused. When we talk about collapse we don’t often clarify what exactly we are talking about. Are we talking about one component of the world economy, like the U.S. auto market or French wine market? Or, are we talking about the economic system that all markets depend upon? These are important distinctions.

    When a system collapses it totally fails. Partial collapse is like being partially pregnant. You either are of you aren’t. There is no partial collapse. If a system declines by half, and then stops declining it did not collapse.

    Okay, my final point.

    As energy resources become more expensive and less productive, those markets that are most vulnerable will collapse first. The collapse of individual products or business markets may not initially lead to a larger, broader systemic collapse of the economy. However, the continuing decrease of cheap and productive energy resources will continue to destroy individual markets, destroying those that are most vulnerable first. Eventually, the overall global economy which is dependent on cheap and productive energy will collapse under the weight of all the individual markets that have previously collapsed. Or am I wrong?

    The timing of these events is beyond human calculation because it involves billions of future transactions and the unpredictable order of collapsing markets. However, the end result is inevitable. Our civilization will collapse. Or am I wrong about this also?

    Any help would be greatly appreciated

    • Davidin100millionbilliontrillionzillionyears says:

      good post… full of lots of doom…

      a couple things I see:

      one is that The Collapse is the obvious one where the electricity goes off worldwide and BAU ends totally…

      other uses for the word “collapse” are somewhat misleading…

      next, before looking to the future, look at the present and recent past…

      Venezuela has been “collapsing” since about 2015…

      Bitcoin has been “collapsing” this entire year…

      this year, auto markets throughout the world are falling fast…

      the Australian housing market is “collapsing”…

      etc…

      your “final point” paragraph seems about right…

      every year, there is less surplus energy to maintain economic activity…

      somehow and sometime and someway, there has to be less economic activity in the world…

      I think the near future will be similar to the recent past…

      smaller weaker countries will continue to fall…

      in bigger stronger countries, middle class and lower class will continue to fall…

      we’ll see more riots like in France…

      otherwise, who can say if you will be right or wrong?

      The Collapse could be preceded by a cascading failure of country by country…

      or market by market, as you say…

      suddenly, like in a day or a week…

      or like I still think, drip by drip until about 2025 to 2030…

      who knows?

      thanks for the good doom…

    • The world economy is much more interconnected than in previous collapses. All previous collapses were local. The Great Recession of 2008-2009 was sort of a partial collapse of the world economy.

      Every leader would like to make certain that his own economy is not on the leading edge of collapse. That is why world leaders are acting the way they are today.

      • Sven Røgeberg says:

        When things get serious about who will survive or not, nationalism and great power politics beat liberalism (John J. Mearsheimer)

  7. Davidin100millionbilliontrillionzillionyears says:

    fresh new sale price on Bitcoin tonight…

    about $3400…

    I might buy some for stocking stuffers…

    aren’t they small enough to drop into the stockings hanging on the fireplace mantle?

    anyway…

    I should wait until closer to Xmas…

    should be way under $3000 by then…

  8. Baby Doomer says:

    r/politics is starting to wake up

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