How does the world reach limits? This is a question that few dare to examine. My analysis suggests that these limits will come in a very different way than most have expected–through financial stress that ultimately relates to rising unit energy costs, plus the need to use increasing amounts of energy for additional purposes:

• To extract oil and other minerals from locations where extraction is very difficult, such as in shale formations, or very deep under the sea;
• To mitigate water shortages and pollution issues, using processes such as desalination and long distance transport of food; and
• To attempt to reduce future fossil fuel use, by building devices such as solar panels and electric cars that increase fossil fuel energy use now in the hope of reducing energy use later.

We have long known that the world is likely to eventually reach limits. In 1972, the book The Limits to Growth by Donella Meadows and others modeled the likely impact of growing population, limited resources, and rising pollution in a finite world. They considered a number of scenarios under a range of different assumptions. These models strongly suggested the world economy would begin to hit limits in the first half of the 21^st century and would eventually collapse.

The indications of the 1972 analysis were considered nonsense by most. Clearly, the world would work its way around limits of the type suggested. The world would find additional resources in short supply. It would become more efficient at using resources and would tackle the problem of rising pollution. The free market would handle any problems that might arise.

The Limits to Growth analysis modeled the world economy in terms of flows; it did not try to model the financial system. In recent years, I have been looking at the situation and have discovered that as we hit limits in a finite world, the financial system is the most vulnerable part of the system because it ties everything else together. Debt in particular is vulnerable because the time-shifting aspect of debt “works” much better in a rapidly growing economy than in an economy that is barely growing or shrinking.

The problem that now looks like it has the potential to push the world into financial collapse is something no one would have thought of—high oil prices that take a slice out of the economy, without anything to show in return. Consumers find that their own salaries do not rise as oil prices rise. They find that they need to cut back on discretionary spending if they are to have adequate funds to pay for necessities produced using oil. Food is one such necessity; oil is used to run farm equipment, make herbicides and pesticides, and transport finished food products. The result of a cutback in discretionary spending is recession or near recession, and less job availability. Governments find themselves in  financial distress from trying to mitigate the recession-like impacts without adequate tax revenue.

One of our big problems now is a lack of cheap substitutes for oil. Highly touted renewable energy sources such as wind and solar PV are not cheap. They also do not substitute directly for oil, and they increase near-term fossil fuel consumption. Ethanol can act as an “oil extender,” but it is not cheap. Battery powered cars are also not cheap.

The issue of rising oil prices is really a two-sided issue. The least expensive sources of oil tend to be extracted first. Thus, the cost of producing oil tends to rise over time. As a result, oil producers tend to require ever-rising oil prices to cover their costs. It is the interaction of these two forces that leads to the likelihood of financial collapse in the near term:

1. Need for ever-rising oil prices by oil producers.
2. The adverse impact of high-energy prices on consumers.

If a cheap substitute for oil had already come along in adequate quantity, there would be no problem. The issue is that no suitable substitute has been found, and financial problems are here already. In fact, collapse may very well come from oil prices not rising high enough to satisfy the needs of those extracting the oil, because of worldwide recession. Continue reading →