Economies won’t be able to recover after shutdowns

Citizens seem to be clamoring for shutdowns to prevent the spread of COVID-19. There is one major difficulty, however. Once an economy has been shut down, it is extremely difficult for the economy to recover back to the level it had reached previously. In fact, the longer the shutdown lasts, the more critical the problem is likely to be. China can shut down its economy for two weeks over the Chinese New Year, each year, without much damage. But, if the outage is longer and more widespread, damaging effects are likely.

A major reason why economies around the world will have difficulty restarting is because the world economy was in very poor shape before COVID-19 hit; shutting down major parts of the economy for a time leads to even more people with low wages or without any job. It will be very difficult and time-consuming to replace the failed businesses that provided these jobs.

When an outbreak of COVID-19 hit, epidemiologists recommended social distancing approaches that seemed to be helpful back in 1918-1919. The issue, however, is that the world economy has changed. Social distancing rules have a much more adverse impact on today’s economy than on the economy of 100 years ago.

Governments that wanted to push back found themselves up against a wall of citizen expectations. A common belief, even among economists, was that any shutdown would be short, and the recovery would be V-shaped. False information (really propaganda) published by China tended to reinforce the expectation that shutdowns could truly be helpful. But if we look at the real situation, Chinese workers are finding themselves newly laid off as they attempt to return to work. This is leading to protests in the Hubei area.

My analysis indicates that now, in 2020, the world economy cannot withstand long shutdowns. One very serious problem is the fact that the prices of many commodities (including oil, copper and lithium) will fall far too low for producers, leading to disruption in supplies. Broken supply chains can be expected to lead to the loss of many products previously available. Ultimately, the world economy may be headed for collapse.

In this post, I explain some of the reasons for my concerns. Continue reading

Gail in China: In Her Own Words and Pictures

Aired on  Our Finite World and the Doomstead Diner on April 29, 2015

Also available as a downloadable mp3:

As regular readers of  Our Finite World and the Doomstead Diner know, Gail recently took a month long trip to China, where she was invited by Professor Feng to give a compact University course to undergraduate students (with graduate students and faculty sitting in if they liked) at the China University of Petroleum in Beijing.

China University of Petroleum – Beijing (CUPB) is a national key university in China, located in the world famous scenic Changping District, the area close to the Great Wall and Ming Tombs. It is one of the 100 institutions implementing the national “211 Project”.

The university is equipped with the first-class facilities, including a library with a collection of 300,000 books, modernized classrooms, new computer facilities and a comprehensive sports center.

Above all, CUPB has an excellent academic staff body of 545, including 121 full professors and 128 associate professors.

Unfortunately, internet access from China is limited for a couple of reasons.  First off, any number of websites (like Google for example) get the Thumbs Down from the Chinese government.  WordPress is another site not well liked by the Chinese Central Committee.  While you can access some WordPress sites from China, actually getting onto your Admin board to do publication work is close to impossible.  Besides that, access is spotty in terms of bandwidth and speed, so even if a site is theoretically accessible, the infrastructure won’t allow you to access it in any usable form in many locations.  So Gail was a bit concerned before leaving that she wouldn’t be able to fill in the OFW readers on her trip while she was over there. Continue reading

Oil Price Slide – No Good Way Out

The world is in a dangerous place now. A large share of oil sellers need the revenue from oil sales. They have to continue producing, regardless of how low oil prices go unless they are stopped by bankruptcy, revolution, or something else that gives them a very clear signal to stop. Producers of oil from US shale are in this category, as are most oil exporters, including many of the OPEC countries and Russia.

Some large oil companies, such as Shell and ExxonMobil, decided even before the recent drop in prices that they couldn’t make money by developing available producible resources at then-available prices, likely around $100 barrel. See my post, Beginning of the End? Oil Companies Cut Back on Spending. These large companies are in the process of trying to sell off acreage, if they can find someone to buy it. Their actions will eventually lead to a drop in oil production, but not very quickly–maybe in a couple of years.

So there is a definite time lag in slowing production–even with very low prices. In fact, if US shale production keeps rising, and Libya and Iraq keep work at getting oil production on line, we may even see an increase in world oil production, at a time when world oil production needs to decline.

A Decrease in Oil Prices May Not Fix Oil Demand

At the same time, demand doesn’t pick up quickly as prices drop. We are dealing with a world that has a huge amount of debt. China in particular has been on a debt binge that cannot continue at the same pace. A reduction in China’s debt, or even slower growth in its debt, reduces growth in the demand for oil, and thus its price. The same situation holds for other countries that are now saturated with debt, and trying to come closer to balancing their budgets.

Furthermore, the Federal Reserve’s discontinuation of quantitative easing has cut off a major flow of funds to emerging markets. Because of this change, emerging market demand for oil has dropped. This has happened partly because of the lower investment funds available, and partly because the value of emerging market currencies relative to the dollar has fallen. Again, a decrease in oil price is not likely to fix this problem to a significant extent.

Europe and Japan are having difficulty being competitive in today’s world. A drop in oil prices will help a bit, but their problems will mostly remain because to a significant extent they relate to high wages, taxes, and electricity prices compared to other producers. The reduction in oil prices will not fix these issues, unless it leads to lower wages (ouch). The reduction in oil prices is instead likely to lead to a different problem–deflation–that is hard to deal with. Deflation may indirectly lead to debt defaults and a further drop in oil demand and oil prices.

Thus, oil prices are likely to continue their slide for some time, until real damage is done, perhaps to several economies simultaneously.

The United States’ Role in the Oil Over-Production / Under-Demand Clash 

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IEA Investment Report – What is Right; What is Wrong

Recently, the IEA published  a “Special Report” called World Energy Investment Outlook. Lets’s start with things I agree with:

1. World needs $48 trillion in investment to meet its energy needs to 2035. This is certainly true, if we assume, as the IEA assumes, that world economic growth will actually improve a bit, from 3.3% per year in the 1990 to 2011 period to 3.6% per year in the 2011 to 2035 period. It is likely that the growth in investment needs will be even higher than the IEA indicates.

In my view, this is a CYA report. The IEA sees trouble ahead. There is no way that investment of the needed amount (which is likely far more than $48 trillion) can be met. With the publication of this report, the IEA can say, “We told you so. You didn’t invest enough. That is why energy supply ran into huge problems.”

2. Without reform to power markets, the reliability of Europe’s electricity supply is under threat. The current pricing model, in which wind and solar PV get feed in tariffs and electricity prices for other fuels is set using merit order pricing, produces huge market distortions.

In my view, the problem is even worse than the writers of the report understand. The value of wind and solar PV are inherently difficult to determine, because they produce intermittent supply, and this is not comparable to other types of electricity. Furthermore, a big chunk of costs relate to transmission and distribution–42% of electricity investment costs in the New Policies Scenario. Many well-meaning researchers looked at wind and solar PV and thought they were a solution, but they tended to look at the situation too narrowly.

To look at the situation properly, one really needs to look at the total system cost of generating electricity with intermittent renewables (of a given amount) compared to the total system cost of generating electricity without intermittent renewables. Proper pricing needs to include all of the additional costs involved, including the additional cost for storage, the additional cost for long distance transmission, and the additional costs encountered by fossil fuel providers in ramping up and down their generation to match changing output from intermittent renewables.

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Russia and the Ukraine – The Worrisome Connection to World Oil and Gas Problems

What is behind the Russia/Ukraine problem? It seems to me that what we are seeing is Russia’s attempt to fix a two-part problem:

  1. Some oil and gas exporters, including Russia, are not receiving enough oil and gas revenue to meet their needs. They are not able to collect enough taxes to provide the services they have promised to their citizens, plus allow the amount of reinvestment that is needed to maintain production. Russia is starting to experience economic contraction because of the low revenue situation. This situation very closely related similar problems I have written about  previously. In one post I talked about major independent oil companies not producing enough profit to provide the revenue needed for reinvestment, and because of this, cutting back on new investment. In another, I talked about the problem of too low US natural gas sales prices, relative to the cost of extraction.
  2. Some oil and gas importers, including Ukraine, are not using their imported oil and gas in productive enough ways that they are able to afford to pay the market price for oil and gas. Russia gave Ukraine a lower natural gas price because some of Russia’s pipelines cross Ukraine, and Ukraine must maintain the pipeline. But even with this lower natural gas price, Ukraine is behind on its payments to Russia.

If a person thinks about the situation, it looks a lot like a situation where the world is reaching limits on oil and gas production. The marginal producers (including Russia) are being pushed out, at the same time that the marginal consumers (including Ukraine) are being pushed out.

Russia is trying to fix this situation, as best it can. One part of its approach is to make certain that Ukraine will in fact pay at least the European market price for natural gas. To do this, Russia will make Ukraine prepay for its natural gas; otherwise it will cut off its gas supply. Russia is also looking for new customers who can afford to pay higher prices  for natural gas. In particular, Russia is working on a contract to sell LNG to China, quite possibly reducing the amount of natural gas it has available to sell to Europe. Russia is also signing a $10 billion contract with Iran in which it promises to construct new hydroelectric and thermal energy plants in Iran, in return for oil exports from Iran. This contract will increase the amount of oil Russia has to sell, and will increase the oil available on the world market. Russia’s plan will do an end run around US and European sanctions.

Gradually, or perhaps not so gradually, Russia’s exports are being redirected to those who can afford to pay higher prices. European Union purchases of natural gas imports have declined since 2008, presumably because they are having difficulty affording the current price of gas, so they are being relied on less for future sales.

The Russian approach seems to include building a new axis of power, including Russia, China, Iran and perhaps other countries. This new axis of power may threaten the US dollar’s reserve currency status. With the dollar as reserve currency, the US has been able to buy far more goods from other countries than it sells to others. Putting an end to the US dollar as reserve currency would leave more and oil and gas for other countries. If purchases by the US are cut back, it will leave more oil and gas for other countries. The danger is that prices will drop too low because of the drop in US demand, leading to lower production. It this should happen, everyone might lose out.

I am doubtful that Russia’s approach to fixing its problems will work. But if Russia is “between a rock and a hard place,” I can understand its willingness to try something very different. It now has more power than it has had in the past because of its oil and gas exports, and is willing to use that power.

The US/European approach to this problem is to loan Ukraine $17 billion to pay for past natural gas bills. The hope is that with this loan, Ukraine will be able to make changes that will allow it to afford future natural gas bills. There is also the hope that the United States can step in with large natural gas exports to Europe and Ukraine. In addition, the US and Europe are trying to impose sanctions on Russia.

I find it very difficult to believe that the US/European approach will work. The idea that the United States can start exporting huge amounts of natural gas to Europe in the near future borders on the bizarre. There are many hurdles that would need to be overcome for this to happen. Installing LNG export facilities is among the least of these hurdles.

In fact, the West badly needs both the oil and gas that Russia is producing, so it really is in a very precarious position. If Russia cuts off exports, or if Russia is forced to cut off exports because of financial difficulties, both the US and Europe will suffer. It is clear that Europe will suffer because of its dependence on pipeline exports of oil and gas from Russia. But the US will suffer as well, because the US is tied closely to Europe by financial ties, and by import and export arrangements with Europe.

Furthermore, the US/European approach involves a great deal of new debt, in an attempt to fix an inherent inability of the Ukrainian economy to afford high energy prices. Without a huge transformation, Ukraine will be in even more financial difficulty when it comes time to pay back the new debt–it will need make debt payments at the same time that it needs to pay for more expensive future natural gas. More debt doesn’t necessarily fix the situation; it may make it worse.

The US powers that be do not understand what Russia (and the world) is up against, so the policies they propose are likely to make the situation worse, rather than better.

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