The World’s Fragile Economic Condition – Part 1

Where is the world economy heading? In my opinion, a large portion of the story that we usually hear about how the world economy operates and the role energy plays is not really correct. In this post (to be continued in Part 2 in the near future), I explain how some of the major elements of the world economy seem to function. I also point out some relationships that tend to make the world’s economic condition more fragile.

Trying to explain the situation a bit further, the economy is a networked system. It doesn’t behave the way nearly everyone expects it to behave. Many people believe that any energy problem will be signaled by high prices. A look at history shows that this is not really the case: fighting and conflict are also likely outcomes. In fact, rising tariffs are a sign of energy problems.

The underlying energy problem represents a conflict between supply and demand, but not in the way most people expect. The world needs rising demand to support the rising cost of energy products, but this rising demand is, in fact, very difficult to produce. The way that this rising demand is normally produced is by adding increasing amounts of debt, at ever-lower interest rates. At some point, the debt bubble created to provide the necessary demand becomes overstretched. Now, we seem to be reaching a situation where the debt bubble may pop, at least in some parts of the world. This is a very concerning situation.

Context. The presentation discussed in this post was given to the Casualty Actuaries of the Southeast. (I am a casualty actuary myself, living in the Southeast.) The attendees tended to be quite young, and they tended not to be very aware of energy issues. I was trying to “bring them up to speed.” This is a link to the presentation: The World’s Fragile Economic Condition.

Slide 1

Slide 2

This post covers only Items 1, 2, and 3 from the Outline in Slide 2. I will save Items 3 through 6 for a post called “The World’s Fragile Economic Condition-Part 2.”

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How energy shortages really affect the economy

Many people expect energy shortages to lead to high prices. This is based on their view of what “running out” of oil might do to the economy.

In this post, I look at historical data surrounding inadequate energy supply. I also consider some of the physics associated with the situation. I see a strange coincidence between when coal production peaked (hit its maximum production before declining) in the United Kingdom and when World War I broke out. There was an equally strange coincidence between when the highest quality coal peaked in Germany and when World War II broke out. A good case can be made that inadequate energy supply is associated with conflict and fighting because leaders recognize how important an adequate energy supply is.

Some of my previous analysis has shown that if we view energy in terms of average energy supply per person, the world as a whole may be again entering into a period of inadequate energy supply. If my view is correct that inadequate energy supply leads to increased conflict, the recent discord that we have been seeing among world leaders may be related to today’s low supply of energy. (My energy analysis considers the combined energy supply available per person from fossil fuels, nuclear, and renewables. It is not simply an oil-based analysis.)

The physics of the low energy situation may be trying to “freeze out” the less efficient portions of the economy. If successful, the outcome might be analogous to the collapse of the central government of the Soviet Union in 1991, after oil prices had been low for several years. Total energy consumption of countries involved in the collapse dropped by close to 40%, on average. The rest of the world benefitted from lower oil prices (resulting from lower total demand). It also benefitted from the oil that remained in the ground and consequently was available for extraction in recent years, when we really needed it.

The idea that oil prices can rise very high seems to be based on the oil price increases of the 1970s and of the early 2000s. While oil prices can temporarily rise very high, it is hard to make a case that they can remain high for an extended period. For one thing, high oil prices tend to cause recessions and lower employment. In such an environment, affordability of energy products is lower, and oil prices tend to fall. For another, it is easy for the Federal Reserve to get oil prices back down by raising interest rates. In fact, the Federal Reserve is raising interest rates right now.

In my opinion, we should be more concerned about low oil prices than high because we live in a world economy with huge debt bubbles. Debt bubbles are part of what enable today’s high employment. Debt bubbles support employers that are close to the edge financially; they also support buyers who would not be able afford automobiles or college educations, if loans were to become more expensive because of higher interest rates. Employment in the affected industries would be cut back, leading to recession.

Because of these issues, pricking the debt bubble is likely to lead to a major recession and, indirectly, lower energy prices, as in late 2008 (Figure 12). These lower prices are not good news because energy providers of all kinds need fairly high energy prices to survive–probably equivalent to oil at $80 per barrel or higher. If energy prices stay persistently low, the world is likely to see much lower oil supply, in part because oil exporters need the tax revenue that they obtain from high-priced oil to fund their programs.  Continue reading

Why oil prices can’t rise very high, for very long

Oil prices are now as high as they have been for three years. At this writing, Brent is $74.14 per barrel and West Texas Intermediate is at $68.76. These prices aren’t really very high, if a person looks at the situation from a longer term point of view than the last three years.

Figure 1. EIA chart of weekly average Brent oil prices, through April 13, 2018.

There is always a question of how high oil prices can go, and for how long.

In fact, we have many resources, of many kinds, whose prices of extraction keep rising higher. For example, obtaining fresh water for the world’s population keeps getting more and more expensive. Some parts of the world need to resort to desalination.

The world economy cannot withstand high prices for any of these resources for very long. Certainly, it cannot withstand high prices for a combination of necessary resources, because people need to cut back on other purchases, in order to afford the necessities whose prices are rising. This article is a guest post by another actuary, who goes by the pseudonym Shunyata. He explains in a different way why high resource prices cannot last, whether they are for oil, or natural gas, water, or even fresh air.

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Why the Standard Model of Future Energy Supply Doesn’t Work

The most prevalent view regarding future oil supply, as well as total energy supply, seems to be fairly closely related to that expressed by Peak Oilers. Future fossil fuel supply is assumed to be determined by the resources in the ground and the technology available for extraction. Prices are assumed to rise as fossil fuels are depleted, allowing more expensive technology for extraction. Substitutes are assumed to become possible, as costs rise.

Those with the most optimistic views about the amount of resources in the ground become especially concerned about climate change. The view seems to be that it is up to humans to decide how much energy resources we will use. We can easily cut back, if we want to.

The problem with this approach is the world economy is much more interconnected than most analysts have ever understood. It is also much more dependent on growing energy supply than most have understood. Surprisingly, we humans aren’t really in charge; the laws of physics ultimately determine what happens.

In my view, Peak Oilers were correct about energy supplies eventually becoming a problem. What they were wrong about is the way the problem can be expected to play out. Major differences between my view and the standard view are summarized on Figure 1.

Figure 1. Prepared by Author.

 

Let me explain some of the issues involved.

[1] Modeling is a lot more difficult than it looks. Continue reading

A Video Game Analogy to Our Energy Predicament

The way the world economy is manipulated by world leaders is a little like a giant video game. The object of the game is to keep the world economy growing, without too many adverse consequences to particular members of the world economy. We represent this need for growth of the world economy as being similar to making a jet airplane fly at ever-higher altitudes.

Figure 1. Author’s view of the situation we are facing. World leaders look at their video screens and adjust their controllers to try to make the world economy fly at ever-higher levels.

World leaders look at their video game screens for indications regarding where the world economy is now. They also want to see whether there are specific parts of the economy that are doing badly.

The game controllers that the world leaders have are somewhat limited in the functions they can perform. Typical adjustments they can make include the following:

  • Add or remove government programs aimed at providing jobs for would-be workers
  • Add or remove government sponsored pension plans and payments to those without jobs
  • Add or remove laws regulating efficiencies of new vehicles
  • Change who or what is taxed, and the overall level of taxation
  • Through the above mechanisms, change government debt levels
  • Change interest rates

There are numerous problems with this approach. For one thing, the video game screen doesn’t give a very complete picture of what is happening. For another, the aspects of the economy that can be controlled are rather limited. Furthermore, the situation is very complex–there seem to be several “sides” of the economy that need to “win” at the same time, for the economy to continue to grow: (a) oil importers and oil exporters, (b) businesses and their would-be customers, (c) governments and their would-be taxpayers, and (d) asset holders and the would-be buyers of these assets, such as families needing new homes.

An even bigger problem is a physics problem that is hidden from the view of those operating the control mechanism. Jet airplanes in the real world cannot rise beyond a certain altitude (varying depending upon the plane), because the atmosphere becomes “too thin.” There is a parallel problem in the economic world. The atmosphere that allows an economy to grow is provided by a combination of (a) an increasing supply of cheap-to-produce energy, and (b) increased technology to put this growing energy supply to use. This atmosphere can become too thin for several reasons, including the higher cost of energy production, rising population, and growing wage disparity.

We know that in the real world, a jet airplane cannot rise ever-higher. Instead, at some point, the airplane hits what has been called its “coffin corner.”

Figure 2. Diagram of Coffin Corner by Aleks Udris of Boldmethod. On the chart, Vs is the velocity; MMO is the Maximum Mach Number.

According to Aleks Udris, “The region is deadly. Get too slow, and you’ll stall the jet at high altitude. Get too fast, and you’ll exceed your critical mach number. The air over your wings will go supersonic, you’ll pitch down, the aircraft will accelerate, and your wings will fall off. Also bad.”

What Happens As Coffin Corner Limits Are Reached in the Economic World?

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