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.

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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. “Nigerian security forces are struggling to contain increasing cases of looting on government-run warehouses across the country, in the latest incident of unrest following widespread, youth-led protests against police brutality…

    “…it emerged this week relief items were still stored in some of these facilities, as well as the private homes of politicians. The news angered many in the country with the biggest number of people living in extreme poverty globally.”

    aljazeera.com/news/2020/10/25/nigeria-cracks-down-on-rising-mob-looting-on-food-warehouses

  2. As I understand, Japanese are those coping better with degrowth. Their economy has tanked in the last 40 years, so they know about it. They don’t receive immigration (don’t know if they are though on it, but I suppose they don’t try to have it), and population reduces slowly. There are no social conflicts because it’s the individual who cope with the problems (whoever gets out of the system commits suicide). So, they don’t need epidemics to control the situation and don’t allow them

    • Japan has a huge amount of debt and keeps adding to it. It has virtually no energy supplies of its own. I am afraid it will have trouble making it through the coming bottle neck.

      • Japan has the highest debt-to-GDP ratio in the world, has had for a few years. Now over 200% of GDP (https://en.wikipedia.org/wiki/National_debt_of_Japan).

        The rest of the world with an average debt-to-GDP ratio of 125% (I think this is what one of the articles posted yesterday stated) may well think they have plenty of leeway, but I am not too sure that that is how it works. I guess we will find out soon enough.

        • “Tumbling numbers of pregnancies and marriages in Japan during the coronavirus pandemic are likely to intensify a demographic crisis in the rapidly ageing nation.

          “Japan has the most aged society in the world, with more than 35% of its population expected to be 65 and over by 2050, a trend that poses risks for economic growth and straining government finances.”

          https://uk.reuters.com/article/uk-health-coronavirus-japan-ageing-idUKKBN27C0GX

        • Is the debt owed to people in Japan or to people outside Japan. If it is owned internally they are fine the old die with the help of CV19 and the young start fresh.

        • The authors of _This Time Is Different_ examine a large number of historical cases and calculate from those cases that when public debt to GDP exceeds 90%, economic growth is very slow in most cases. The higher the debt, the harder it is for the economy to expand.

          Japan’s credit bubble popped in 1990 and since then its economic growth has been essentially flat, but it cycles stochastically between periods of growth and periods of contraction that completely cancel out the periods of growth.

          In some ways, the country is coping remarkably well and unemployment is generally very low, but it depends on massive and still growing public debt. I think the biggest risks to Japan are debt and the fact that the country is a net food importer. At least they are blessed not to be divided or “diversified” by ethnic, regional, religious, and other identities. It is one of the world’s most homogenous nations, definitely a valuable asset during periods of stress.

    • They can kick the can of debt to 500% GDP, no problem with that, it’s yen nominated (but I guess their economy is doing better right now, without lockdowns). Population is shrinking… which is good. Lots of old people, that won’t protest if they ever have to be “haircutted”, unlike younger people elsewhere that tend to protest and disturb. No indigenous energy, that’s a problem but they have cutting edge tech to trade with. Still the most stable place on Earth (others are in dire social situations with only 120% debt), and I bet they will continue to do fine

  3. Well, now, how to get round those lockdown restrictions? If you can get past the (deliberately) silly man’s introduction on this video, you will see how the (ahem) ‘beautiful’ people do it.

  4. A Slovak blogger of Roma origin, Jozef Kmeto, dies on coronavirus. Here is a video, where he warns about the coronavirus shortly before he was taken by the ambulance, in which he died:

  5. The clash at the Slovak University of Technology (STU) in Bratislava, Slovakia: lowering numbers of students due to the population decline and the ensuing fight over power and orientation, future development of the University. With the assistance of police:

    https://domov.sme.sk/c/22518821/proti-odvolaniu-rektora-stu-sa-postavila-studentska-cast-senatu.html?ref=njct

    Even the technical subjects, which, due to their exact nature, represented stability in comparison to humanities in the past, are subject to serious disturbances connected with the ageing world.

    • “A German retreat
      Since 2007, the Thai king has spent long periods of time in Bavaria in southern Germany. He owns a villa in the lakeside town of Tutzing, but recently also sojourned at the Sonnenbichl Hotel in Garmisch-Partenkirchen. The king’s 15-year-old son even goes to school in Bavaria.

      The king’s presence in the region is often reported on in German tabloids, and photos of the monarch riding his bicycle in the area have surfaced online.

      Thai protesters have criticized both his absence from Thailand and the cost of his stays in Germany.”

      • I don’t know if there were demonstrations against him before, but abandonning his country is the best way to loose the crown. The very good novel The Windup Girl is located in a rather post carbon Thailand, and the Crown plays a major role in it; but now it’s looking outdated

      • This guy strikes me as a total and complete ass. Thailand is a awesome country. It kicks ass. Military kicks ass. Women kick ass. Even its democratic tendencies kick ass. This guy is the fricken king. He could be doing everything he could to serve his wonderful country and be having a incredible life. Instead he steals billions from his poor country and inhabits Germany?????????????????????????????????? What a moron. Morons like this give monarchy a bad name.

  6. While advanced by many theorists, separatism is not succeeding anywhere because the cores of the countries resist it, and because the international community is reluctant to recognize more entities. The UK already was a country, but even the Brits can’t still manage to get out of the EU

  7. I see that the Dow Jones is down a little more than -730 so far today. West Texas Intermediate is $38.54. People are not optimistic about stimulus being passed quickly.

  8. Since end of 2019, DJA down about 3.4%, dividend yield about 2.98%. Yawn.

    Maybe there isn’t anything that makes money, what if the best one can do is lose more slowly than one’s neighbor?

    Stuff is hard to protect, store, etc.

    Stimulus, shimulus, it is moving numbers on a screen, converting capital to cashflow, it works until it doesn’t.

    A guess is the best one can do is trade some paper wealth today for some stuff that may be useful, find a group and share some of that stuff and maybe get a return of a daily meal and a roof along with some goodwill put into the pot which can be withdrawn later. The last clause is to me what makes society work, if one constantly gives or constantly receives it becomes tedious to the giving party.

    A corollary, what does a billionaire talented in derivatives have to offer New Zealand? Probably nothing, he/she is an expense, expenses generally get cut when things get tough.

    Dennis L.

    • They are called apex parasites. They are enabled by a corrupt, debt-based central bank fiat currency system supercharged by the internet and computers which allow millisecond trades, exotic financial instruments that casinos at Las Vegas and Macau could only dream about.

    • Gold is up 20% year on year and silver is up 33%.. Those might be your short term investment opportunities. In the medium term you need to cobble together a community strategy to provide food and water and heat if in the north.

      • Gold leaf, which I use in bookbinding and restoration, has gone up by at least 33% -that’s the cheapest I can find, from my regular bulk supplier. I shopped around, but others were 40-45% up! Possibly also reflects some supply difficulties.

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