Fossil Fuel Production Is Reaching Limits in a Strange Way

Strangely enough, the limit we seem to be reaching with respect to fossil fuel extraction comes from low prices. At low prices, the extraction of oil, coal, and natural gas becomes unprofitable. Producers go bankrupt, or they voluntarily cut back production in an attempt to force prices higher. As the result of these forces, production tends to fall. This limit comes long before the limit that many people imagine: the amount of fossil fuels in the ground that seems to be available with current extraction techniques.

The last time there was a similar problem was back in 1913, when coal was the predominant fossil fuel used and the United Kingdom was the largest coal producer in the world. The cost of production was rising due to depletion, but coal prices would not rise sufficiently to cover the higher cost of production. As a result, the United Kingdom’s coal production reached its highest level in 1913, the year before World War I started, and began to fall in 1914.

Between 1913 and 1945, the world economy was very troubled. There were two world wars, the Spanish Flu pandemic and the Great Depression. My concern is that we are again headed into another very troubled period that could last for many years.

The way the energy problems of the period between 1913 and 1945 were resolved was through the rapid ramp-up of oil production. Oil was, as that time, inexpensive to produce and could be sold for a very large multiple of the cost of production. If population is to remain at the current level or possibly grow, we need a similar “energy savior.” Unfortunately, none of the alternatives we are looking at now yield a high enough return relative to the required investment.

I recently gave a talk to an engineering group interested in energy research talking about these issues. In this post, I will discuss the slides of this presentation. A PDF of the presentation can be found at this link.

The Low Oil Price Problem

Oil prices seem to bounce around wildly. One major issue is that there is a two-way tug of war between the prices that citizens can afford and the prices that oil companies require. We can look back now and say that the mid-2008 price of over $150 per barrel was too high for consumers. But strangely enough, oil producers began complaining about oil prices being too low to cover their rising cost levels, starting in 2012. Prices, at a 2019 cost level, were at about $120 per barrel at that time. I wrote about this issue in the post, Beginning of the End? Oil Companies Cut Back on Spending. Oil prices now are in the $40 range, so are way, way below both $120 per barrel and $150 per barrel.

Interest rates and the availability of debt also play a role in oil prices. If interest rates are low and debt is readily available, it is easy to buy a new home or new car, and oil prices tend to rise because of the higher demand. When prices are too low for producers, central banks have been able to lower interest rates through a program called “quantitative easing.” This program seems to have helped oil prices to rise again, over a three-year period, after they crashed in 2008.

OPEC producers are known for their low cost of production, but even they report needing high oil prices. The cost of extracting the oil is reported to be very low (perhaps $10 per barrel), but the price charged needs to be high enough to allow governments to collect very high taxes on the oil extracted. If prices are high enough, these countries can continue the food subsidies that their populations depend upon. They can also sponsor development programs to provide jobs for the ever-growing populations of these countries. OPEC producers also need to develop new oil fields because the old ones deplete.

Oil production outside of the United States and Canada entered a bumpy plateau in 2005. The US and Canada added oil production from shale and bitumen in recent years, helping to keep world oil production (including natural gas liquids) rising.

One reason why producers need higher prices is because their cost of extraction tends to rise over time. This happens because the oil that is cheapest to extract and process tends to be extracted first, leaving the oil with higher cost of extraction until later. 

Some OPEC countries, such as Saudi Arabia, can hide the low price problem for a while by borrowing money. But even this approach does not work well for long. The longer low oil prices last, the greater the danger is of governments being overthrown by unhappy citizens. Oil production can then be expected to become erratic because of internal conflicts.

In the US and Canada, oil companies have been funded by bank loans, bond sales and the sale of shares of stock. These sources of funding are drying up, as many oil companies report poor earnings, year after year, and some are seeking bankruptcy protection. 

Chart 6 shows that the number of drilling rigs in operation has dropped dramatically in both the United States and Canada, as oil companies cut back on drilling. There is a lag between the time the number of drilling rigs is cut back and the time production starts to fall of perhaps a year, in the case of shale. These low drilling rig counts suggest that US and Canadian oil production from shale will fall in 2021.

Of course, unused drilling rigs cannot be mothballed indefinitely. At some point, they are sold as scrap and the workers who operated them find other employment. It then becomes difficult to restart oil extraction.

How the Economy Works, and What Goes Wrong as Limits Are Reached

Slide 7 shows one way of visualizing how the world economy, as a self-organizing system, operates. It is somewhat like a child’s building toy. New layers are added as new consumers, new businesses and new laws are added. Old layers tend to disappear, as old consumers die, old products are replaced by new products, and new laws replace old laws. Thus, the structure is to some extent hollow.

Self-organizing objects that grow require energy under the laws of physics. Our human bodies are self-organizing systems that grow. We use food as our source of energy. The economy also requires energy products of many kinds, such as gasoline, jet fuel, coal and electricity to allow it to operate.

It is easy to see that energy consumption allows the economy to produce finished goods and services, such as homes, automobiles, and medical services. It is less obvious, but just as important, that energy consumption provides jobs that pay well. Without energy supplies in addition to food, typical jobs would be digging in the dirt with a stick or gathering food with our hands. These jobs don’t pay well.

Finally, Slide 7 shows an important equivalence between consumers and employees. If consumers are going to be able to afford to buy the output of the economy, they need to have adequate wages.

A typical situation that arises is that population rises more quickly than energy resources, such as land to grow food. For a while, it is possible to work around this shortfall with what is called added complexity: hierarchical organization, specialization, technology, and globalization. Unfortunately, as more complexity is added, the economic system increasingly produces winners and losers. The losers end up with very low wage jobs, or with no jobs at all. The winners get huge wages and often asset ownership, as well. The winners end up with far more revenue than they need to purchase basic goods and services. The losers often do not have enough revenue to feed their families and to buy basic necessities, such as a home and some form of basic transportation.

The strange way the economy works has to do with the physics of the situation. Physicist Francois Roddier explains this as being similar to what happens to water at different temperatures. When the world economy has somewhat inadequate energy supplies, the goods and services produced by the economy tend to bubble to the top members of the world economy, similar to the way steam rises. The bottom members of the economy tend to get “frozen out.” This way, the economy can downsize without losing all members of the economy, simultaneously. This is the way ecosystems of all kinds adapt to changing conditions: The plants and animals that are best adapted to the conditions of the time tend to be the survivors.

These issues are related to the fact that the economy is, in physics terms, a dissipative structure. The economy, like hurricanes and like humans, requires adequate energy if it is not to collapse. Dissipative structures attempt to work around temporary shortfalls in energy supplies. A human being will lose weight if his caloric intake is restricted for a while. A hurricane will lose speed, if the energy it gets from the warm water of the ocean is restricted. A world economy with inadequate energy is likely to shrink back in many ways: unprofitable businesses may fail, layers of government may disappear and population may fall, for example.

In the discussion of Slide 7, I mentioned the fact that if we try to “stretch” energy supply with added complexity, many workers would end up with very low wages. Some of these low wage workers would be in the US and Europe, but many of them would be in China, India and Africa. Even though these workers are producing goods for the world economy, they often cannot afford to buy those same goods themselves. Henry Ford is remembered to have said something to the effect that he needed to pay his workers enough so that they, themselves, could buy the cars they were making. To a significant extent, this is no longer happening when a person takes into account international workers.

The high interest rates that low-wage workers pay mean that loans don’t really help low-wage workers as much as they help high-wage workers. The high interest on credit card debt and personal loans tend to transfer part of the income of low-wage workers to the financial sector, leaving poor people worse off than they would have been without the loans. 

COVID shutdowns are extremely damaging to the world economy. They are like taking support sticks out of the dome on Slide 7. They produce many more unemployed people around the world. People in low wage countries that produce clothing for a living have been particularly hard hit, for example. Migrant workers and miners of various kinds have also been hard hit.

We Seem to Be Reaching a Major Turning Point

Oil production and consumption have both fallen in 2020; oil prices are far too low for producers; wage disparity is a major problem; countries seem to be increasingly having problems getting along. Many analysts are forecasting a prolonged recession.

The last time that we had a similar situation was in 1913, when the largest coal producer in the world was the United Kingdom. The UK’s cost of coal production kept rising because of depletion (deeper mines, thinner seams), but prices would not rise to compensate for the higher cost of production. Miners were paid very inadequate wages; poor workers regularly held strikes for higher wages. World War I started in 1914, the same year coal production of the UK started to fall. The UK’s coal production has fallen nearly every year since then.

The last time that wage disparity started to spike as badly as it has in recent years occurred back in the late 1920s, or perhaps as early as 1913 to 1915.  The chart shown above is for the US; problems were greater in Europe at that time.

With continued low oil prices, production is likely to start falling and may continue to fall for years. It is hard to bring scrapped drilling rigs back into service, for example. The experience in the UK with coal shows that energy prices don’t necessarily rise to compensate for higher costs due to depletion. There need to be buyers for higher-priced goods made with higher-priced coal. If there is too much wage disparity, the many poor people in the system will tend to keep demand, and prices, too low. They may eat poorly, making it easier for pandemics to spread, as with the Spanish Flu in 1918-1919. These people will be unhappy, leading to the rise of leaders promising to change the system to make things better.

My concern is that we may be heading into a long period of unrest, as occurred in the 1913 to 1945 era. Instead of getting high energy prices, we will get disruption of the world economy.  The self-organizing economy is attempting to fix itself, either by getting more energy supply or by eliminating parts of the economy that aren’t contributing enough to the overall system. Conflict between countries, pandemics, bankruptcies and economic contraction are likely to be part of the mix.

Coal Seems to Be Reaching Extraction Limits as Well 

Coal has essentially the same problem as oil: Prices tend to be too low for producers to extract coal profitably. Many coal producers have gone bankrupt. Prices were higher back in 2008, when demand was high for everything, and again in 2011, when quantitative easing had been helpful. 

There have been stories in the press in the past week about China limiting coal imports from Australia, so as to make more jobs for coal miners in China. The big conflict among countries relates to “not enough jobs that pay well” and “not enough profitable companies.” These indirectly are energy issues. If there was more “affordability” of goods made with high-priced coal, there would be no problem.

Coal production worldwide has been on a bumpy plateau since 2012. In fact, China, the largest producer of coal, found its production stagnating, starting about 2012. The problem was a familiar one: The cost of extraction rose because many mines that had been used for quite a number of years were depleted. The selling price would not rise to match the higher cost of extraction because of affordability issues.

The underlying problem is that the economy is a dissipative structure. Commodity prices are set by the laws of physics. Prices don’t rise high enough for producers, if there are not enough customers willing and able to buy the goods made with high-priced coal.

We Have a Major Problem if Both Coal and Oil Production Are in Danger of Falling Because of Low Prices

Oil and coal are the two largest sources of energy in the world. We can’t get along without them. While natural gas production is fairly high, there is not nearly enough natural gas to replace both oil and coal.

Looking down the list, we see that nuclear production hit a maximum back in 2006 and has fallen since then.

Hydroelectric continues to grow, but from a small base. Most of the good sites have already been taken. In many cases, there are conflicts between countries regarding who should get the benefit of water from a given river.

The only grouping that is growing rapidly is Renewables. (This is really Renewables Other than Hydroelectric.) It includes wind and solar plus a few other energy types, including geothermal. This grouping, too, is very small compared to oil and coal.

Natural Gas Has a Low Price Problem as Well

Natural gas, at first glance, looks like it might be a partial solution to the world’s energy problems: It is lower in carbon than coal and oil, and it is fairly abundant. The problem with natural gas is that it is terribly expensive to ship. At one time, people used to talk about there being a lot of “stranded” natural gas. This natural gas seemed to be available, but when shipping costs were included, the price of goods made with it (such as electricity or winter heat for homes) was often unaffordable.

After the run-up in oil prices in the early 2000s, many people became optimistic that, with energy scarcity, natural gas prices would rise sufficiently to make extraction and shipping long distances profitable. Unfortunately, it is becoming increasingly clear that, while prices can temporarily spike due to scarcity and perhaps a debt bubble, keeping the prices up for the long run is extremely difficult. Customers need to be able to afford the goods and services made with these energy products, or the laws of physics bring market prices back down to an affordable level.

The prices in the chart reflect three different natural gas products. The lowest priced one is US Henry Hub, which is priced near the place of extraction, so long distance shipping is not an issue. The other two, German Import and Japan Liquefied Natural Gas (LNG), include different quantities of long distance shipping. Prices in 2020 are even lower than in 2019. For example, some LNG imported by Japan has ben purchased for $4 per million Btu in 2020.

The Economy Needs a Bail-Out Similar to the Growth of Oil After WWII

The oil that was produced shortly after World War II had very important characteristics:

  1. It was very inexpensive to produce, and
  2. It could be sold to customers at a far higher price than its cost of production.

It was as if, today, we had a very useful energy product that could be produced and delivered for $4, but it was so valuable to consumers that they were willing to pay $120 for it. In other words, the consumer was willing to pay 30 times as much as the cost that went into extracting and refining the oil.

With an energy product this valuable, a company producing it would need virtually no debt. It could drill a well or two, and with the profits from the first wells, finance the investment of many more wells. The company could pay very high taxes, allowing governments to build roads, schools, electricity transmission lines and much other infrastructure, without having to raise taxes on citizens.

Besides using the profits for reinvestment and for taxes, oil companies could pay high dividends. This made oil company stocks favorites of pension plans. Thus, in a way, oil company profits could help subsidize pension plans, as well.

Now, because of depletion, we have reached a situation where oil companies, and in fact most companies, are unprofitable. Companies and governments keep adding debt at ever lower interest rates. In fact, the tradition of ever-increasing debt at ever-lower interest rates goes back to 1981. Thus, we have been using debt manipulation to hide energy problems for almost 40 years now.

We need a way to counteract this trend toward ever-lower returns. Some people talk about “Energy Return on Energy Investment” or EROEI. I gave an example in dollars, but a major thing those dollars are buying is energy, so the result is very similar.

I think researchers have set the “bar” far too low, in looking at what is an adequate EROEI. Today’s wind and solar don’t really have an adequate EROEI, when the full cost of delivery is included. If they did, they would not need the subsidy of “going first” on the electric grid. They would also be able to pay high taxes instead of requiring subsidies, year after year. We need much better solutions than the ones we have today.

Some researchers talk about “Net Energy per Capita,” calculated as ((Energy Delivered to the End User) minus (Energy Used in Making and Transporting Energy to the End User)) divided by (Population). It seems to me that Net Energy per Capita needs to stay at least constant, and perhaps rise. If net energy per capita could actually rise, it would allow the economy to increasingly fight depletion and pollution.

Conclusion: We Need a New Very Inexpensive Energy Source Now

We need a new, very inexpensive energy source that buyers will willingly pay a disproportionately high price for right now, not 20 or 50 years from now.

The alternative may be an economy that does poorly for a long time or collapses completely.

The one ray of hope, from a researcher’s perspective, is the fact that people are always looking for solutions. They may be able to provide funds for research at this time, even if funds for full implementation are unlikely.

This entry was posted in Financial Implications by Gail Tverberg. Bookmark the permalink.

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.

2,885 thoughts on “Fossil Fuel Production Is Reaching Limits in a Strange Way

  1. Here are some quotes I found from physicist Geoffrey West’s book _Scale_:
    https://leadershipmarketingandeverything.com/2018/04/01/book-report-scale/
    p31, summarizing the ramifications of scaling laws for cities, and the unfortunate likelihood of a finite time singularity (note that this phenomenon is different from a Malthusian collapse): “In a nutshell, the problem is that the theory also predicts that unbounded growth cannot be sustained without having either infinite resources or inducing major paradigm shifts that ‘reset’ the clock before potential collapse occurs.”

    p31, with another serious catch…we can put off the finite time singularity with innovations, but, “Theory dictates that such discoveries must occur at an increasingly accelerating pace; the time between successive innovations must systematically and inextricably get shorter and shorter.”

    p32, with the kicker: “This is clearly not sustainable, potentially leading to the collapse of the entire urbanized socioeconomic fabric.”

    p414 expands on the inconvenient problem of a finite time singularity, and distinguishes it from a Malthusian collapse: “Because of the presence of a finite time singularity resulting from superlinear scaling, this scenario is categorically different from that of Malthus. If growth were purely exponential as assumed by Malthusians, neo-Malthusians, their followers, and critics, then the production of energy, resources, and food could at least in principle keep up with exponential expansion because all of the relevant characteristics of the economy or city remain finite, even if they continue to increase in size and become very large. This cannot be achieved if you are growing superexponentially and approaching a finite time singularity. In this scenario demand gets progressively larger and larger, eventually becoming infinite within a finite period of time.”

    Here is a link to a lecture by West based on his book. If you don’t have time to listen to the entire one hour lecture (which is very interesting), just listen to the part that begins at 45:50

    https://youtu.be/_JUAx445ReU?list=TLPQMjQxMDIwMjBVov5gneMS7A

    • Thanks! I want to listen to the whole video, but haven’t gotten there yet. We are seeing right now that some cities of large size seem to already be having a problem with scale, with citizens starting to move out.

      I have questions in my mind regarding how this works worldwide. As energy gets constrained, will any cities have lasting power, for example? What insights on collapse does this book give?

      Edit: Listening to the video, one of the things Geoffrey West is saying, is that a new innovation, leading to a major paradigm shift, such as the internet, needs to come along more and more frequently, to avoid the need for soaring energy use, with the way the economy grows. But we really cannot do this. (Of course, this would be an alternative to finding another source of energy, with a very high EROEI.) Something has to happen, or the economy hits a limit.

  2. Dennis,

    Your posting left no further reply prompts, so I am carrying over the thread regarding “single gender” restrooms. I never heard of them before so I looked them up.

    Dennis writes: “My city if I read the paper correctly is now pushing to have single gender restrooms in a new grade school. That is insanity. Which teacher, M/F goes into the restroom? I am uncomfortable when a man brings his daughter into the men’s room, imagine a male teacher going into a mixed restroom with little girls.”

    All inclusive is not at all the same as “single gender”. They are single occupancy, lockable stalls that look very clean and respectable to me. A new resturant in town uses this concept and it seems to work out well. Check out the article and see what you think.

    https://www.cuningham.com/2018/06/25/all-inclusive-restrooms/

    And if you are ever in a Japanese hotel restroom, don’t be surprised if a female attendant starts cleaning the fixture directly besides the one you are using. Just simply say “Ohayou Gozaimasu,”.

    Regards,
    D3G

    • D3G. Japan is a homogenous society with deep societal traditions. These are children and in the US we are having enough trouble with pedophilia.

      What works for a few does not always work for the many. We can agree to disagree, but having been a kid in grade school, I can see two boys having a sword fight. It is pretty funny when you think about it, but it is a guy thing.

      Dennis L.

    • “Rochester Public Schools is seeking an exception to a state code that would allow it to designate the bathrooms in its new elementary school as gender-neutral.

      The document submitted by RPS includes the request from the district, as well as letters from students expressing why they think it’s an important step to take. The date on the request is Oct. 13, but school officials had been discussing the issue prior to submitting the request.

      The elementary school in question, located at 2300 Overland Drive Northwest, is in the early stages of construction. It’s one of the projects funded by the 2019 voter-approved referendum.

      Kevin Holm, an architect with the firm LHB, described the design of the bathrooms during a community meeting about the new middle school that is also under construction. He said the design for the bathroom at the new elementary school would be similar. The doors and walls of the bathroom stalls will be full-height. The stalls will share a common sink area, which will have open doorways to the hallway.”

      https://www.postbulletin.com/news/education/6720948-District-requests-gender-neutral-restrooms

      Some people have way too much time to dream this stuff up, it is tough enough being a kid and growing up, girls mature faster than boys, etc.

      Dennis L.

    • D3G wrote: And if you are ever in a Japanese hotel restroom, don’t be surprised if a female attendant starts cleaning the fixture directly besides the one you are using. Just simply say “Ohayou Gozaimasu,”.

      Is that Japanese for, “I’m a grower, not a shower?”

  3. “[UK Banks have asked specialist debt collectors to help lead the recovery of tens of billions of pounds of government-backed small business loans, as they prepare for an expected wave of defaults and fraud cases…

    “The task is expected to be too onerous to be handled by a single company because of the large number of small businesses forecast to run into trouble, one of the people added.”

    https://www.ft.com/content/52f6ad43-abee-4a5b-929e-921dc4278122

    • “Countries around the world have expanded fiscal expenditure due to the coronavirus pandemic, causing public debt to balloon to unprecedented levels. The debt-to-gross domestic product ratio of advanced economies in 2021 will reach a record high of 125%…

      “The International Monetary Fund issued a report on Oct. 14 stating: “Policymakers need a toolkit of flexible fiscal measures to navigate lockdowns and tentative reopenings, and to facilitate structural transformation to the new post-pandemic economy.”

      “This came in stark contrast to guidance a decade ago during the global financial crisis, when the IMF recommended that countries should raise taxes and implement austerity measures.”

      https://asia.nikkei.com/Spotlight/Datawatch/No-end-in-sight-for-record-high-public-debt-fueled-by-COVID-19

        • @Harry, Exactly! Too many people are starting to imagine that printing money is printing wealth, but real wealth is the goods and services that money buys, and increasing the money supply does not mean that you will increase the supply of goods and services that the average person produces, at least not once any existing slack in the productive capacity has been taken out by the initial increase in demand. Increasing the output per capita requires productivity growth, and productivity growth is hard.

        • I don’t think that’s it. I think they are treating this like an emergency such as a major war. After it is under control, then the austerity needs to begin. Austerity is just reducing your consumption so you can afford to pay back some of your debts. It works very well, but it is not pleasant or fast. Everybody today wants a free lunch: use debt to enhance their living standards, but when it comes time to pay it back, they want “free money” or debt forgiveness.

          The problem from a macro-economic viewpoint is that when credit is easy, everyone piles in and borrows, which stimulates faster than average economic growth. But later, everyone will also find themselves servicing those debts at the same time too, and that will produce below average economic growth. If you want to keep unemployment low under these conditions, then wages need to fall across the board, but, besides there being a lot of resistance to wage reductions, it also makes it even harder to service debt. However, if we would let CPI go negative and then require that all creditors write down the payment owed them proportionately to CPI decreases, then we might get through the austerity phase of the credit cycle with minimal pain (not “no pain”).

          Unfortunately, I don’t hear anyone even discussing this solution. Everyone wants to put off the unpleasant consequences of aggregate debt reduction for as long as possible. It’s like doing everything you can to delay the next forest fire for as long as possible. Eventually, you get a huge conflagration. It’s a good thing we don’t know how to prevent earthquakes. If we could, we would probably let the pressure build up until one day California would just fall into the sea in an unnaturally large megaquake.

          Note that the only reason we are even having this discussion is because reduced growth (which is what austerity produces) is perceived as too painful to bear. Getting to a no growth, steady state economy is like coexisting with the consequences of austerity forever, austerity as the norm of human existence. If people were comfortable with a no-growth economy, austerity would not be perceived as a problem.

          • Yes, “austerity” does not even have to be a problem.

            Compared to the average Joe in the US, I’m probably living quite austere.

            The same with the middle class in India and China.

            My view is that austerity isn’t the same as ending the entitlements.

            Once the excuses are dropped and the legs and cranks start moving, genes will be switched on.

            IC 2.0, will be characterized by high-tech low-tech. It’s about time to end the fossil fueled obscenities.

            It is material consumption switching to immaterial. And it is already happening. Kids value their smartphones and computers more than cars and residential Potemkin facades.

            Following the joneses is such an unbearable bore.

  4. “As campaign season heads into its fraught, final days, police departments across the country are bracing for Election Day, mobilizing officers as they prepare for the possibility of voter intimidation, unrest or violence.

    “…officials say this year’s preparations are unusually extensive because of the sheer levels of anxiety and toxicity across the country.”

    https://www.washingtonpost.com/national/police-brace-for-potential-election-day-unrest-in-a-year-when-everything-is-uncertain/2020/10/24/e30dc34a-1554-11eb-ad6f-36c93e6e94fb_story.html

  5. “Debt from oil and gas bankruptcies reached a record high this year and will likely rise even higher as more companies file for Chapter 11 during the worst oil bust in decades.

    “North American energy companies have brought $89 billion of debt to bankruptcy court this year, up from about $70 billion during the last oil bust in 2014-16…”

    https://www.houstonchronicle.com/business/energy/article/Oil-firms-bring-record-level-of-debt-to-15671216.php

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