A person often reads that low oil prices–for example, $30 per barrel oil prices–will stimulate the economy, and the economy will soon bounce back. What is wrong with this story? A lot of things, as I see it:
1. Oil producers can’t really produce oil for $30 per barrel.
A few countries can get oil out of the ground for $30 per barrel. Figure 1 gives an approximation to technical extraction costs for various countries. Even on this basis, there aren’t many countries extracting oil for under $30 per barrel–only Saudi Arabia, Iran, and Iraq. We wouldn’t have much crude oil if only these countries produced oil.
Figure 1. Global breakeven prices (considering only technical extraction costs) versus production. Source: Alliance Bernstein, October 2014
2. Oil producers really need prices that are higher than the technical extraction costs shown in Figure 1, making the situation even worse.
Oil can only be extracted within a broader system. Companies need to pay taxes. These can be very high. Including these costs has historically brought total costs for many OPEC countries to over $100 per barrel.
Independent oil companies in non-OPEC countries also have costs other than technical extraction costs, including taxes and dividends to stockholders. Also, if companies are to avoid borrowing a huge amount of money, they need to have higher prices than simply the technical extraction costs. If they need to borrow, interest costs need to be considered as well.
3. When oil prices drop very low, producers generally don’t stop producing.
What is ahead for 2016? Most people don’t realize how tightly the following are linked:
- Growth in debt
- Growth in the economy
- Growth in cheap-to-extract energy supplies
- Inflation in the cost of producing commodities
- Growth in asset prices, such as the price of shares of stock and of farmland
- Growth in wages of non-elite workers
- Population growth
It looks to me as though this linkage is about to cause a very substantial disruption to the economy, as oil limits, as well as other energy limits, cause a rapid shift from the benevolent version of the economic supercycle to the portion of the economic supercycle reflecting contraction. Many people have talked about Peak Oil, the Limits to Growth, and the Debt Supercycle without realizing that the underlying problem is really the same–the fact the we are reaching the limits of a finite world.
There are actually a number of different kinds of limits to a finite world, all leading toward the rising cost of commodity production. I will discuss these in more detail later. In the past, the contraction phase of the supercycle seems to have been caused primarily by too high population relative to resources. This time, depleting fossil fuels–particularly oil–plays a major role. Other limits contributing to the end of the current debt supercycle include rising pollution and depletion of resources other than fossil fuels.
The problem of reaching limits in a finite world manifests itself in an unexpected way: slowing wage growth for non-elite workers. Lower wages mean that these workers become less able to afford the output of the system. These problems first lead to commodity oversupply and very low commodity prices. Eventually these problems lead to falling asset prices and widespread debt defaults. These problems are the opposite of what many expect, namely oil shortages and high prices. This strange situation exists because the economy is a networked system. Feedback loops in a networked system don’t necessarily work in the way people expect.
I expect that the particular problem we are likely to reach in 2016 is limits to oil storage. This may happen at different times for crude oil and the various types of refined products. As storage fills, prices can be expected to drop to a very low level–less than $10 per barrel for crude oil, and correspondingly low prices for the various types of oil products, such as gasoline, diesel, and asphalt. We can then expect to face a problem with debt defaults, failing banks, and failing governments (especially of oil exporters). Continue reading
This past week, I gave a presentation to a group interested in a particular type of renewable energy–solar energy that is deployed in space, so it would provide electricity 24 hours per day. Their question was: how low does the production cost of electricity really need to be?
I gave them this two-fold answer:
1. We are hitting something similar to “Peak Oil” right now. The symptoms are the opposite of the ones that most people expected. There is a glut of supply, and prices are far below the cost of production. Many commodities besides oil are affected; these include natural gas, coal, iron ore, many metals, and many types of food. Our concern should be that low prices will bring down production, quite possibly for many commodities simultaneously. Perhaps the problem should be called “Limits to Growth,” rather than “Peak Oil,” because it is a different type of problem than most people expected.
2. The only theoretical solution would be to create a huge supply of renewable energy that would work in today’s devices. It would need to be cheap to produce and be available in the immediate future. Electricity would need to be produced for no more than four cents per kWh, and liquid fuels would need to be produced for less than $20 per barrel of oil equivalent. The low cost would need to be the result of very sparing use of resources, rather than the result of government subsidies.
Of course, we have many other problems associated with a finite world, including rising population, water limits, and climate change. For this reason, even a huge supply of very cheap renewable energy would not be a permanent solution. Continue reading
Economists have put together models of how an economy works, but these models were developed years ago, when the world economy was far from limits. These models may have been reasonably adequate when they were developed, but there is increasing evidence that they don’t work in an economy that is reaching limits. For example, my most recent post, “Why ‘supply and demand’ doesn’t work for oil,” showed that when the world is facing the rising cost of oil extraction, “supply and demand” doesn’t work in the expected way.
In order to figure out what really does happen, we need to consider findings from a variety of different fields, including biology, physics, systems analysis, finance, and the study of past economic collapses. Since I started studying the situation in 2005, I have had the privilege of meeting many people who work in areas related to this problem.
My own background is in mathematics and actuarial science. Actuarial projections, such as those that underlie pensions and long term care policies, are one place where historical assumptions are not likely to be accurate, if an economy is reaching limits. Because of this connection to actuarial work, I have a particular interest in the problem.
How Other Species Grow
We know that other species don’t amass wealth in the way humans do. However, the number of plants or animals of a given type can grow, at least within a range. Techniques that seem to be helpful for increasing the number of a given species include:
- Natural selection. With natural selection, all species have more offspring than needed to reproduce the parent. A species is able to continuously adapt to the changing environment because the best-adapted offspring tend to live.
- Cooperation. Individual cells within an organism cooperate in terms of the functions they perform. Cooperation also occurs among members of the same species, and among different species (symbiosis, parasites, hosts). In some cases, division of labor may occur (for example, bees, other social insects).
- Use of tools. Animals frequently use tools. Sometimes items such as rocks or logs are used directly. At other times, animals craft tools with their forepaws or beaks.
The traditional understanding of supply and demand works in some limited cases–will a manufacturer make red dresses or blue dresses? The manufacturer’s choice doesn’t make much difference to the economic system as a whole, except perhaps in the amount of red and blue dye sold, so it is easy to accommodate.
Figure 1. From Wikipedia: The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.
A gradual switch in consumer preferences from beef to chicken is also fairly easy to accommodate within the system, as more chicken producers are added and the number of beef producers is reduced. The transition is generally helped by the fact that it takes fewer resources to produce a pound of chicken meat than a pound of beef, so that the spendable income of consumers tends to go farther. Thus, while supply and demand are not independent in this example, a rising percentage of chicken consumption tends to be helpful in increasing the “quantity demanded,” because chicken is more affordable than beef. The lack of independence between supply and demand is in the “helpful” direction. It would be different if chicken were a lot more expensive to produce than beef. Then the quantity demanded would tend to decrease as the shift was increasingly made, putting a fairly quick end to the transition to the higher-priced substitute.
A gradual switch to higher-cost energy products, in a sense, works in the opposite direction to a switch from beef to chicken. Instead of taking fewer resources, it takes more resources, because we extracted the cheapest-to-extract energy products first. It takes more and more humans working in these industries to produce a given number of barrels of oil equivalent, or Btus of energy. The workers are becoming less efficient, but not because of any fault of their own. It is really the processes that are being used that are becoming less efficient–deeper wells, locations in the Arctic and other inhospitable climates, use of new procedures like hydraulic fracturing, use of chemicals for extraction that wouldn’t have been used in the past. The workers may be becoming more efficient at drilling one foot of pipe used for extraction; the problem is that so many more feet need to be drilled for extraction to take place. In addition, so many other steps need to take place that the overall process is becoming less efficient. The return on any kind of investment (human labor, US dollars of investment, steel invested, energy invested) is falling. Continue reading