Peak Oil and Reflexivity and Peak Oil
Posted by nate hagens on June 8, 2008 - 10:15am
A good many years ago, I read George Soros' "The Alchemy of Finance", which introduced me to the concept of reflexivity, which in a nutshell is when observers of a phenomenon can't help but impact the phenomenon itself via their 'observing', thus changing the original underlying fundamentals and setting in motion a boom-bust dynamic (i.e. more exaggerated trends in both directions). Since Mr. Soros recently spoke to Congress regarding the oil futures market 'bubble', I thought I'd take a closer look at the concept of reflexivity, both as it relates to oil and commodities in general, as well as its broader implications for efforts in raising awareness of global resource constraints.
"The situations that men define as true, become true for them." Sociologist William Thomas, 1928
Though Soros applied the idea of reflexivity to financial markets (and had huge success), its origins are in social theory. Social (science) phenomena are influenced by a two-way interaction between perception and facts, thereby making it impossible to ascertain a true stand-alone 'fact'. Thus, reflexivity is basically the ecological/systems concept of 'positive feedback' merged into the social sphere where thinking, acting human agents create circular relationships between cause and effect in real-time. Flanagan (1981) and others have argued that reflexivity complicates all three of the traditional roles that are typically played by a classical science: explanation, prediction and control. For example an anthropologist working in an isolated tribal village may impact the native peoples culture and behaviours in unknown ways- e.g. her observations will not be independent of her participation as an observer. This contrasts to the natural sciences, where one set of facts follows another irrespective of what anybody thinks. This is a central example of post hoc ergo propter hoc reasoning that is prevalent in modern Walrasian welfare economics.
In financial markets (which include oil futures), reflexivity occurs when prices themselves influence the fundamentals and that this newly-influenced set of fundamentals then changes expectations, thus influencing prices. This process then continues in a self-reinforcing pattern until it has overshot equilibrium. Because the pattern is self-perpetuating, markets tend towards disequilibrium- where every outcome is uniquely different from the past. (This of course flies in the face of most everything I was taught at the University of Chicago Business School)
Here is what Mr. Soros had to say about reflexivity in a 1994 speech at MIT:
"I am in fundamental disagreement with the prevailing wisdom. The generally accepted theory is that financial markets tend towards equilibrium, and on the whole, discount the future correctly. I operate using a different theory, according to which financial markets cannot possibly discount the future correctly because they do not merely discount the future; they help to shape it. In certain circumstances, financial markets can affect the so-called fundamentals which they are supposed to reflect. When that happens, markets enter into a state of dynamic disequilibrium and behave quite differently from what would be considered normal by the theory of efficient markets. Such boom/bust sequences do not arise very often, but when they do, they can be very disruptive, exactly because they affect the fundamentals of the economy."
"The theory holds, in the most general terms, that the way philosophy and natural science have taught us to look at the world is basically inappropriate when we are considering events which have thinking participants. Both philosophy and natural science have gone to great lengths to separate events from the observations which relate to them. Events are facts and observations are true or false, depending on whether or not they correspond to the facts....The separation between fact and statement was probably a greater advance in the field of thinking than the invention of the wheel in the field of transportation.
But exactly because the approach has been so successful, it has been carried too far. Applied to events which have thinking participants, it provides a distorted picture of reality. The key feature of these events is that the participants’ thinking affects the situation to which it refers. Facts and thoughts cannot be separated in the same way as they are in natural science or, more exactly, by separating them we introduce a distortion which is not present in natural science, because in natural science thoughts and statements are outside the subject matter, whereas in the social sciences they constitute part of the subject matter. If the study of events is confined to the study of facts, an important element, namely, the participants’ thinking, is left out of account. Strange as it may seem, that is exactly what has happened, particularly in economics, which is the most scientific of the social sciences."
Well, economics has been the best path dependent allocation mechanism for a competitive species finding a huge energy subsidy, and as such has developed complicated econometrics and other empirical formulae that appear to be laws. Since energy has always grown, the 'rules' for economics seem like science, but the observations that economists consider to be facts, are based in large part on the specific inputs and history from this cultural system.
More from Soros:
"Classical economics was modeled on Newtonian physics. It sought to establish the equilibrium position and it used differential equations to do so. To make this intellectual feat possible, economic theory assumed perfect knowledge on the part of the participants. Perfect knowledge meant that the participants’ thinking corresponded to the facts and therefore it could be ignored. Unfortunately, reality never quite conformed to the theory. Up to a point, the discrepancies could be dismissed by saying that the equilibrium situation represented the final outcome and the divergence from equilibrium represented temporary noise. But, eventually, the assumption of perfect knowledge became untenable and it was replaced by a methodological device which was invented by my professor at the London School of Economics, Lionel Robbins, who asserted that the task of economics is to study the relationship between supply and demand; therefore it must take supply and demand as given. This methodological device has managed to protect equilibrium theory from the onslaught of reality down to the present day". from George Soros speech to MIT in 1994
The upshot of this is that 'facts', as seen from the financial market participants persective, actually change the behaviour of not only the investors, but also the corporations, policymakers, institutions, etc. In studying supply and demand we impact supply and demand.
With this background on the concept of reflexivity, let's take a look at commodity futures markets. In 2004, the total value of futures contracts outstanding for all 25 index commodities amounted to around $180 billion. At that time, that was 240 times smaller than worldwide equity market cap of $44 trillion. Recent estimates of the global derivative markets notional size are northwards of $600 trillion. This compares to US GDP of about $13 trillion, and around $8 trillion of new inflow into investments each year (savings). The total global equity market and debt (bond) markets are around $50 trillion each.
Source: Michael Masters Testimony to Congress, May 20 2008 (pdf)
Commodities have not had a boom since the late 1970s, and until recently have played a minor role in general portfolio asset allocation. Combined with media coverage (e.g. Jim Rogers) and rapid growth in demand and tightening of supply, commodity markets have had explosive moves the last 5 years. Pension funds, sovereign wealth funds, university endowments and other index speculators have been allocating money away from stocks and bonds into commodities. A common way for these entities to invest is to allocate a % of their capital to commodities in general, without taking a particular sector or timeframe, e.g. they buy exposure to commodities via the front months of each major contract and just before they would have to take delivery of the physical, roll into the next closest futures month. There are several major commodity tracking 'indexes' that differ slightly in their respective commodity weightings. The red, green and blue bars in the above graph track the dollars invested in different indexes compared to the black line which is the SP spot commodity index.
This explosion of funds into commodities, combined with fundamentals, has created some hefty price increases in the major commodity groups:
Source: Michael Masters Testimony to Congress, May 20 2008 (pdf)
The combination of price increases and more funds allocated to commodities has obviously increased the total size of the 'commodity market'. Notice in the below graphic that the amount of index speculators (red area) as a % of the total has risen over time, again a function of their own performance, and general commodity price increases:
Source: Michael Masters Testimony to Congress, May 20 2008 (pdf)
The transfer of 'money' into 'real goods' (or at least paper represntations of them) has been widespread. Commodity-index funds controlled a record 4.51 billion bushels of corn, wheat and soybeans through CBOT futures, equal to half the amount held in U.S. silos as of March 1. According to Mike Masters, in his Congressional Testimony last week, speculators have now stockpiled, via the futures market, the equivalent of 1.1 billion barrels of petroleum, effectively adding eight times as much oil to their own stockpile as the United States added to the Strategic Petroleum Reserve during the last five years. Since there is a positive feedback mechanism with futures index funds, the demand for futures actually increases as prices go up - the opposite of what one would expect from price-sensitive consumer demand.
There are currently position limits for futures contracts for speculators:
Position Accountability Levels and Limits
NYMEX Crude Oil Futures - 1,000 U.S. barrels (42,000 gallons): Any one month/all months: 20,000 net futures, but not to exceed 3,000 contracts in the last three days of trading in the spot month.
NYMEX Henry Hub Natural Gas Futures - 10,000 million British thermal units (mmBtu): Any one month/all months: 12,000 net futures, but not to exceed 1,000 in the last three days of trading in the spot month.
NYNEX Heating Oil Futures - 42,000 U.S. gallons (1,000 barrels): 7,000 contracts for all months combined, but not to exceed 1,000 in the last three days of trading in the spot month.
Exemptions
The Commission and exchanges grant exemptions to their position limits for bona fide hedging, as defined in CFTC Regulation 1.3(z), 17 CFR 1.3(z). A hedge is a derivative transaction or position that represents a substitute for transactions or positions to be taken at a later time in a physical marketing channel. (Source JPMorgan Chase)
Hedgers have no position limits but do have reporting requirements. Currently, an index speculator can call up a bank and request exposure to say, $100 million of oil and enter into a swap - the bank then hedges this via the futures markets - in this way the speculator has bypassed the official position limits, skirting the current intent of the rules. There are rumors that due to pressure from hedge funds, politicians, etc. (either in an effort to reduce energy and food prices or reduce the pain on their short positions..;-), that the definition of 'hedger' is going to soon become more restrictive. In theory this would relieve pressure on commodity prices, as the large positions by index speculators would have to be reduced (e.g. sold). However, it is not clear to me that this rule alone would drop oil prices: 1)there exists a large short interest in oil that counterbalances the index longs -e.g. some large 'shorts' would have to reduce their positions by covering too, 2)at the end of each calendar month, someone is taking delivery and paying these high prices, 3)if speculators were largely responsible for the oil price spike, where would all the stored oil be that they were taking delivery on?
With this brief overview of the commodity markets, let's now revisit the concept of reflexivity.
REFLEXIVITY - TAIL, DOG, WAG?
Back to Mr. Soros:
"So we can observe three very different conditions in history: the “normal,” in which the participants’ views and the actual state of affairs tend to converge; and two far-from- equilibrium conditions, one of apparent changelessness, in which thinking and reality are very far apart and show no tendency to converge, and one of revolutionary change in which the actual situation is so novel and unexpected and changing so rapidly that the participants’ views cannot keep up with it."
Wheat might be a good example of the 2nd of these three conditions. After breaching an all time high of $6 last summer, wheat continued until it peaked over $12 per bushel (hard red wheat hit $25). Droughts in Australia and Eastern Europe exacerbated a low inventory situation and people were caught off guard - thinking and reality now differed. In 2007 Americans consumed 2.22 bushels of wheat per capita. At 1.3 billion bushels, the wheat futures 'stockpile' by index speculators was enough to supply every American with all the bread, pasta and baked goods they could eat for two years (Masters). Yet despite the large bullish position, indeed perhaps because of the large bullish position, wheat futures reversed their asymptotic rise in similar dramatic fashion, with the speculators riding it up and the physical hedgers sending it down. (Sidebar - there is still a massive index speculative position in wheat, despite a nearly 50% selloff, a relevant datapoint to those who believe index speculators are primarily to blame for crude oils rise.)
Dec/08 Wheat futures - daily prices
Here was an example of equilibrium overshoot in two directions, eg. large 'runs' both up and down. Speculators were behind, reached, and got out too far ahead of fundamentals in this case. But what about oil? I would contend that a 1200% increase in price since 1999 and flat production since 2005 with a growing world economy is consistent with either the 2nd or 3rd of Soros' 3 conditions. Whether we have overshot equilibrium or are in a situation of revolutionary change is still an open question. But let's step back first with a thought experiment.
Imagine that there were no Ken Deffeyes, Matt Simmons or Colin Campbell. Imagine that M. King Hubbert spent his retirement playing Parchesi with his wife and not modeling future oil depletion. Imagine that when the UK hit is second (and final) peak in 1999 that no one noticed, and that market participants didn't pay attention to the subsequent 12 fold increase in oil prices. Imagine we didn't know that the energy return on crude oil had declined from over 100:1, to 30:1 to around 10:1. Imagine that Nigerian rebels and Iraqi freedom fighters couldn't cause daily spikes in crude prices by their actions due to the fragility of supply and demand. Imagine that bandits weren't stealing scarce diesel fuel at night in California. And, imagine if places like theoildrum, or ASPO or energybulletin didn't continually posit data and questions that pushed the envelope of conventional energy wisdom. Consider then only geology. That we use horizontal drilling and nitrogen and water injection, that we are drilling more and more wells all around the world using the latest seismic technology, etc. That the EIA continues to model supply forecasts with demand forecasts, because supply has never really been a constraint in the past....Would oil prices be approaching $130? Would T Boone Pickens be interviewed with a mixture of awe and fear on CNBC? Would there be major military presence in what was formerly the fertile crescent? Would Saudi Shura (Parliamant) be voting to keep more oil in the ground for higher future prices? Probably not. Yesterdays 'facts' are influencing today's perceptions which are influencing tomorrows realities.
$100+ oil DOES change consumption habits, but it also changes humans built in beliefs towards their futures, both individually and as nations. Earlier this week the CEO of TOTAL, one of the worlds largest oil companies, stated that new forms of energy would not be able to compensate for the coming oil and gas depletion. He also stated that new oil reserves cost $80 to procure so $80 would become the new price floor for oil going forward. We don't know that this is a fact - but is the opinion of an expert in a position to know more than the average participant. Monsieur de Margerie, via his perceived authority and public pronouncements is therby affecting the fundamentals of the oil industry. Each incremental admission, whether from the IEA, from TOTAL, or from theoildrum.com, shifts the mindsets of participants at the margin, which subsequently changes behaviours.
In 1999 with oil below $10 per barrel, the stock market at all time highs, and resource limit concerns restricted to a handful of cranky environmentalists and Hubbert acolytes, were we at 'equilibrium'? In 2001 with oil at $20? In 2005 with oil at $50? The point is that for a very long time we were not in equilibrium - the pendulum was pulled way to the left and finally let fly in 2000 - the question is, has it now past equilibrium in the other direction? Or have we moved into the third stage, where human collective awareness is accelerating knowledge about and action in the oil sector? More knowledge about finite flow limits changes professionals opinions about the future, which changes investment into refineries, changes long term contracts with exporting nations, changes military strategies, changes hoarding strategies, all of which are reflected in the price moonshot. Soros theory, which I happen to subscribe to, implies we will overshoot in both directions, because gravity and momementum will combine to send the pendulum backwards once market participants have not only caught up, but exceeded the reality of the situation. But Soros (to my knowledge) generally applied this principle to finance, and admitted to Congress he is not an expert in things energy. Reflexivity could of course have larger societal implications beyond investment booms and busts.
Nearly two years ago, in this post about the Amaranth blow up, I suggested that price floors and position limits would eventually become a reality because of the sheer size of dollars vs notional energy values. In A Closer Look at Futures, I commented:
I believe there are 3 different definitions of Peak Oil and they will come in succession.
- The point when we have used half of the oil that will ever be extracted.
- The point when we reach maximum sustained production (given that we use high technology like horizontal drilling and water and nitrogen injection, we are likely borrowing from the second half of what was normally a bell shaped curve so this point will come later).
- The point when the meme of finite energy resources takes hold in society.
For sake of this discussion, lets use the first definition, and assume we are roughly at Peak Oil now. We have used 1 trillion + barrels and have 1 trillion + left. But as discussed previously (exhaustively?), those 1 trillion barrels require a decent amount of energy to locate, harvest, refine, and distribute and this amount of `energy cost' subtracted from the gross is increasing.
Lets assume that the 1 trillion barrels nets out to 650 billion barrels to non-energy society. (Yes I chose this number specifically). Given our current world population, that equates to 100 barrels of net oil remaining for every person on the planet, (and leaves none for our children, grandchildren or subsequent generations). Any Tom, Dick or Rainwater for $4,000 can financially control 1000 barrels of oil in the futures markets, or 10 times his or her all time planetary allotment. Once Peak Oil version #3 is realized, there will be many investors clamoring to financially (or physically) control their 100 barrels, let alone 10,000 or 1,000,000 barrels. Can the futures markets absorb this? Will this make the Hunt Brothers cornering of the silver market seem like childsplay? The world uses 85 million barrels per day - and for a mere $340 million in margin, this entire amount can be controlled via the futures markets. Consider this in contrast to the $7+ Trillion invested or saved annually, and the nearly $100 trillion in stock and bond market assets. Will the market send the right signals? What smart angles will hedge funds take on this?
Isn't this what we would expect in a finite world as people wake up to real resource constraints? What is a dollar, or yen, or euro worth, really? Though Soros' ideas about reflexivity were applied to the financial arena - perhaps we the observers, are impacting the real time experiment of resource constraints in the same vein. Though geologic limits to flow rates are an ostensible signal, the real dilemmas of Peak Oil are all socioeconomic. We are beginning to realize that societies need to be 'intact' with reasonably equal distribution and allocation if the entire system is to continue it's current trajectory. But oil depletion will likely first be a tax on the middle class and poor, accelerating political pressure on things likely to exacerbate the long term situation (e.g. cutting gas taxes, scaling ethanol, giving tax rebates to help economy, etc.) On top of that are myriad human elements that are very difficult to predict. Hoarding behavior is an autocatalytic process which begets other behavioral changes once set in motion. 'Not drilling' or 'not producing' oil and gas at a certain price could also be considered hoarding behaviour. "Virtual hoarding" via futures contracts can also occur to a certain extent. On the one hand accelerated knowledge about geologic limits acts as a needed tax on finite high quality fossil fuels, which spurs investment into alternatives and quickens conservation and consumption behavioral change. On the other hand, once the cat is out of the bag, there is a greater chance of unintended consequences, as the owners of paper money might start to look at it differently. Reflexivity indeed....
SOME PREDICTIONS
Here is my 'participant' part of the equation of Peak Oil. These are not facts, but my opinions:
1)There will be extreme volatility in next 5 years in oil and gas prices. Not only day to day, but year to year. Awareness of possible flow constraints is now upon us, rightly or wrongly. This combined with the tiny size of energy commodity markets compared to investable dollars will engender large position sizes that inevitably will fall victim to the fear/greed/leverage trifecta. Attention to the oil sector guarantees increased volatility. Accelerating oil depletion of older wells and skyrocketing reserve replacement costs guarantees higher highs and higher lows...
2)The Peak Oil community (e.g. those who generally understand that oil production is either peaking now or will peak soon) will begin to bifurcate into two relatively disparate camps - a)the supply-side camp that understands the urgency but will try and address energy and resource shortage via technology, more drilling and alternatives and b)the demand-side camp who will see that no matter what the energy source, a new paradigm of how we live our lives/structure our institutions will be the only full answer to the twin problems of peak fossil fuels and a growing population. Conversations between these two camps will become increasingly disparate and tense. Supply and demand solutions will not be mutually exclusive, but some people recognize that our ends are constrained as well as our means.
3)There will be an eventual slowing and ultimately a cessation of speculation in energy markets by non-producers. This is tantamount to a change in capitalism so I don't say it lightly, but already only 6% of world oil reserves are owned by public companies - the amount of dollars NOW dwarfs the amount of notional physical resources - if printing presses are turned on while resources deplete this disparity will continue to grow. At some point people like you and I won't be allowed to buy oil futures, which is only a short step away from nationalization of the energy industry (which is the case in most countries already).
Conversations and thoughts like these are meant to raise the bar of discourse on energy topics so when real policy discussions take place, either locally or regionally, people will speak a common language. There is a fine line in peak oil outreach - more awareness is needed to accelerate renewable infrastructure and kick-start efficiency and conservation measures - yet too much awareness might cause supply disruptions (hoarding) and make it difficult for oil companies to extend the time horizon that we have access to a large baseline of production, etc. As an editor on this site, I hope we are efforting positive change, but realize many of our readers are likely tuning in to know the latest details in order to improve their own situation, financial or otherwise. One of my concerns is when the pendulum swings back the other direction, and we head towards one of those 'higher lows', that the urgency of both supply and demand response will be lost. Both oil prices and energy stocks will overshoot on the downside and we will lose sight of the long term situation. These are high stakes.
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The other night at a meeting (where the guest speaker was Raj Patel) a local rancher made this same case for oil price rise, and said it was similar to the speculation in land. Such speculative buying has driven the price of land so high that people wanting to buy land for actual economic activity are finding it hard to do so.
I guess a difference is that speculators actually own the land, but the similarity is that they are buying it with the goal of resale at a higher price rather than use.
Do you see land speculation as a basically similar phenomenon?
It's related but different. They aren't making any more land, so I expect 'infinite' dollars will chase 'finite' land in the same way that dollars chase oil. But land isn't liquid at room temperature and in order to maximize the Ricardian rent on land, you need lots of other inputs: people, energy, equipment, etc. There are also unique local economic characteristics in each region that limit true global fungibility for land, beyond pure speculation. We aren't going to start resource wars over land in Mendocino county, but certainly could over oil.
Also as far as land goes a lot of the land bubble was driven by the housing bubble. If the intended use of the land is for a subdivision and your getting 150k-800k and acre for finished lots then the original cost of land is almost no object. This was a huge factor in inflating land values. With the subdivision market effectively gone then agricultural uses garner a much lower price. This effect is so large and it still being felt that other economic aspects of land are probably buried.
Since land is only one of the inputs into agricultural use with oil a predominate other on the cost side you have a strong factor driving down what farmers can pay for land.
Next farmland has a robust rental market similar in some respects to the housing rental market if land prices get to distorted it becomes better to rent than to own. Once this point is reached upward pressure on farmland for farming drops off rapidly. This is what generally collapses speculation in farm land.
I'll stop there but I suspect that land prices will eventually collapse as farmers become limited by the amount they can invest in diesel and fertilizer vs crop prices. Leaving little cash to speculate on buying more farmland and rent vs own calculation favors rent.
I'm a big fan of Soros, his theory of reflexivity and have enjoyed both "the alchemy of finance" and his new one "the new paradigm"...I still believe most Americans are underestimating what is happening with oil....right now demand is around 86.5 million barrels and exceeds supply of around 85 million barrels per day. We're depleting at around 6 million a day which we have to make up to get to 85 million a day.....supply does NOT cover demand.....as far as demand destruction...our slowing US economy/ subprime crisis , recession etc has lessened US demand by around 400k barrels but emerging asia (China, India ) has picked up 500k barrels....I believe we can only expect so much demand destruction anyway the reason: as anyone who has taken econ 101 knows ...Oil is the classic text book example of "price inelasticity of demand" in other words...."Goods that everyone worldwide needs, cannot consume less of, and cannot find substitutes for even if prices rise. For such goods, the price elasticity of demand is considered inelastic" Crude has essentially decoupled from the weak US dollar story. Yes, the dollar will probably remain weak and yes, it is a factor. Oil is not really just a dollar story but is a supply/demand story. Emerging Asia (China and India ) will continue to see phenomenal growth rates...they are essentially emerging from their dark ages and entering the modern world...they have just begun, they have along way to go....oil is going alot higher from here...and yes, pullbacks, even major ones will happen along the way....as an investor these are opportunities to make money...the trend will end up reasserting itself...we need substitutes for oil in a massive way, right now nothing can be done in a big enough way to stop this ...hopefully this will change soon....in the meantime get long and stay long----Patrick Kerr of OilGasFutures.Com
I'm with you on "price inelasticity of demand" of petroleum-based energy in general. There is a little buffer where the world can destruct some demand, but once we get down to cutting out the fluff, what then. We all still need fuel/energy to run the world the way it is. At that point, when we've cut the fluff, price will rebound and then BAU ceases. Instead of cutting fluff, we cut the lesser essentials. Some countries are already to the point where they gone throught those cuts and are starting to cut things that we would all call essential for survival.
agreed
I predict OPIC - the Organisation of Petroleum Importing Countries.
Either the big economies organise between themselves, or they get taken to the cleaners by those still able to export. The unthinking market won't be allowed to control.
Oh, and 'reflexivity' is just the sociologists and economists trying to inherit the mantel of Quantum Mechanics and the Undercertainty Principle. The difference IMHO is QM have had the time and inclination to develop predictive equations that work.
I don't know much about quantum mechanics - has it been/can it be applied to human behaviour?
While some people try and superficially use the language of quantum physics when talking about sociology, psychology, etc, I think it's all bunk. QM specifically applies to physics at very tiny (sub-atomic) scales, and at larger (macro) scales even in pure physics the quantum characteristics disappear. Same for relativistic physics, which only matters at very large scales of time and space. E.g., at the human scale of masses and motion Newtonian physics is accurate and useful.
QM is apparent at atomic and molecular scales. One much larger example is a Bose Einstein condensate in which a single quantum state can extend over thousands of atoms.
Quantum mechanics works at all scales and speeds, and relativity works at all but the smallest scales. It's the *difference* between the older, simpler newtonian physics and modern physics that's only apparent in special situations.
This "reflexivity" concept seems to be an attempt at creating a social-version of Heisenberg's Uncertainty Principle (as garyp notes) - which states that the greater one knows the location of a particle, the less one knows about the particle's momentum. The very act of measuring the particle's position changes the momentum of the particle.
However, since human behavior is only dubiously quantifiable, "reflexivity" is only loosely relevant. So, IMHO, it cannot be applied to human behavior, since I cannot fathom how one would apply Feynman's path integral method (i.e. "sum over histories") to human behavior.
Perhaps, when Hari Seldon is born, and develops psychohistory, we will have the appropriate mathematics to apply quantum mechanics to humans. ;-)
Watch for positronic brain development.
Its not quantum :)
This is classical physics but same result. A chaotic system by definition has infinitely close initial conditions that diverge exponentially over time. This means you don't have to invoke quantum to get a effectively unknowable future result. In addition the system is slam full of noise and incorrect assumptions so a lot of the players are acting on false assumptions. This is of course rapidly coming to a close but as of today the market has not correctly priced crude.
So the net result is that the classical model that I believe models the system i.e a forced logistic equation simply give the result that the system is becoming chaotic and effectively unpredictable.
The island of stability if you will or only stable orbit however you want to put it is that no matter what happens people have to eat and for the foreseeable future they have to have oil.
This rush to stability itself destabilizes the system causing more people to rush to stability.
http://en.wikipedia.org/wiki/Stochastic_resonance
Although the market has a lot of things wrong it has figured out that everything but oil/food/water now has a dubious valuation and this includes the fiat currencies.
The noise from the mainstream media and puppets in control now simply further destabilizes the system. Even though many people hold incorrect assumptions about whats happening the growing consensus is no one believes the puppet masters any more.
In any case a noisy chaotic system with very small islands of stability is sufficient to explain the current situation and effectively as unpredictable as a quantum system of any complexity. Actually less since a quantum system esp model as Feynman path integrals always finds the perfect solution. So a quantum market would pick the perfect answers (plural intended)
In any case I think we will see hoarding become a huge issue over the coming months in a lot of countries esp later in the year as countries scramble to find diesel to get the crops in.
Next year the repeated warning we have gotten about NPK issues will probably become a issue and we could well have crops planting curtailed by lack of diesel and yields lowered by lack of NPK. Global warming will throw in its own curve ball.
This thing can blow up so many different ways now its become impossible to figure it out.
That is, of course, true - but my analogy to Foundation needed to wrap back to the original question on quantum mechanics. :)
I think this is an important and astute observation. The amount of "trust destruction" has greatly increased. Will it reach the point of critical mass?
In theory, would such a quantum market exist in all possible states, and then "collapse" into one of the states at the moment it was observed? ;)
I couldn't agree more.
Aye, I believe hoarding has already started to begin?
http://www.bloomberg.com/apps/news?pid=20601072&sid=aCvsbL.iegY0&refer=e...
I don't know why people are picking on this as an example of hoarding, it completely isn't. Is there something special about storing oil in tankers?
It's sour crude that Iran can't find buyers for, even at a hefty discount. For Gods sake, it even says that in the article you linked to.
Google Robert Prechter and socionomics if you're interested in reflexivity, especially if you want it quantified (fractals and Fibonacci). He's been developing these ideas since the 1970s.
Great article by the way Nate. These ideas need to be discussed, as the flaws of the current paradigm become increasingly obvious. Emotionally driven human herding behaviour is critical to market dynamics. Markets are not rational or efficient and there is no such thing as equilibrium. Equilibrium implies negative feedback, but markets swings at all degrees of trend are based on positive feedback. In financial markets, demand increases as prices rise and everyone chases momentum, and demand falls as prices fall. Trends change suddenly once the greatest sucker has been fleeced, rather than gradually trending back towards a 'set point'.
These are different concepts. Quantum mechanics has been "popularized" to mean a lot of things it isn't. It is a physical indeterminacy and the act of measurement itself "affects" the outcome. (Some might say: there is no "outcome" down there at all, there is just a probability field.)
Soros is talking not just about the act of measurement itself, but the subsequent reports of this measurement throughout the economic system. So if e. g. Hubbert, Deffeyes, Simmons, TOD, etc. etc. all formed a private club to study and discuss "peak oil" among ourselves, our acts of measurement would not affect the market. Once our private club starts to publicize its findings or make market investments, then that upsets the apple cart.
A better analogy to Soros (still imperfect) would be trying to come up with a scientific method of predicting the outcome of computer programs (whether they would crash, loop, or stop). You could, of course, try to write a new computer program to predict the outcome of computer programs . . . but then of course you don't know whether your new computer program will crash, loop, or stop . . . this is an undecidability paradox similar to Goedel's proof -- it can't be done. You just have to run your program in the real world and find out.
Keith
A pretty good parallel, I think. A clue for the concept as Soros uses it, is Karl Popper's assertion that "No scientific predictor can predict its own future results". Soros is Popper's disciple through and through.
The infinite loop solution can be eliminated since we have finite inputs. I.e the program is running on a battery powered laptop. So finite resources actually eliminates one of the solutions thus this problem is more solvably insolvable then the halting problem. Technically this is true for any computation engine that obeys the second law of thermodynamics eventually heat degradation or disorder causes the system to become unable to compute.
I'm not sure if this is known or not.
Next for the same reason only the finite negative outcomes are possible if you don't introduce a new source of power of sufficiently large size so the set of solutions we consider positive can be eliminated again just based on the second law. If you did introduce it this would be the semi-renewable society we talk about renewable enough on time scales that matter to us.
So again this problems solution domain is a smaller infinity than the halting problem.
Next we can invoke the fact that its a complex forced system with positive feedback. Almost all equations that describe such systems have chaotic domains. I have no idea if a proof exists that the all do or not.
Given that these types of equations don't have a closed form one can argue that a week proof of some sort exists that the lack of general closed solutions equals chaos.
This assumption eliminates all of the closed simple solutions that have been presented as predictive models of the future evolution of oil extraction. So we can with some caveats eliminate this entire set.
So it fairly sure bet that everyone that has touted a model for the evolution of oil extraction to date is wrong. Some will eventually be more wrong than others but this is another group of solutions thats we can eliminate with some certainty as being wrong. The ones that require some sort of unified response to peak oil or selfless behavior are probably more wrong than others but in general this is not even relevant.
They are all wrong.
And finally and last but not least our computation engine is certain to be running a incorrectly coded program since noise exists in the system. This means of course even if stable regions exist in the perfectly coded algorithm noise in the system will ensure it explores a wide range of possible solutions and even recodes itself. It a non-linear driven mutating system. Think of it as a battery powered laptop being periodically dropped on the floor and zapped with static electricity. Simulated annealing is what this is called. Thus the chance of remaining close to a stable solution given its forced and noisy is effectively zero.
We happen to know that every 4 billion years or so given a constant influx of energy this computation engine gets smart enough to discover the halting problem.
However outside of this one briefly stable solution all others lead to the program halting early in execution.
Therefore given the odds its a safe bet that the outcome is our own simpler algorithm we call civilization we halt when stressed like all the other attempts before us.
In my opinion the fact that the algorithm or system refuses to recognize that without a lot of work the certain outcome is halting ensures that halting is the outcome. Thus the only solution that works is the one that recognizes or codes around the vast number of halting cases. In fact this is exactly what life figured out after a few billion years.
So in a pretty perverse way the fact we are unable to admit we are up shit creek without a paddle ensures that we are about to go over a waterfall.
I find it a bit sad that we are capable of discovering the halting problem yet is a group unable to except the obvious even though its the very reason we exist in the first place.
Seems like a common problem with much classical physics is that it focusses on closed systems. Prigogine was a leader in pushing thermodynamics beyond the second law. Peter Wegner:
http://www.cs.brown.edu/~pw/
has done something similar with computation. The work of Landauer et al. on the thermodynamics of computing is certainly fascinating and very valuable, but AFAIK it is still about closed systems. It would be great to see that work extended to open systems - how information and energy flow though a computational machine and how such machines behave with such flows.
Reflexivity seems to be another push beyond closed systems, where the environment of the system is developing ideas about the system, and the system itself also has ideas, and the system communicates with its environment, so really it is a two way street with each set of ideas influencing the other.
Perhaps the iterated prisoner's dilemma could be the simplest example of this kind of system:
http://www.prisoners-dilemma.com/
This computational approach is not a lot different from what I'm saying about forced logistic systems.
The natural system if you will would in general obey the logistic except when strongly forced.
The addition of intelligence or computation via markets and demand coupling adds a tremendous amount of force to the system.
As and example consider the long reaching effects of the 1970's Arab oil embargo.
So complex open computational systems can take on surprising values or produce surprising results.
This is in my opinion closely related to the underlying chaotic nature of such systems.
Chaos can be though of as a poormans version of Feynman's path integral. Instead of exploring all of phase space
at once like quantum a chaotic trajectory explores a significant amount over a finite time.
The actual differences are probably small. For the prisoners dilemma consider 100 prisoners with partial
corrupt and potentially incorrect information passing.
Actually knowing you can communicate is in itself a message.
I think if any real progress is made in this area it will be from theorems developed in information theory
that are insensitive to the details of the physics. This is why I think chaotic dynamics is a dead end the approach
yields little useful results.
Yes....Reflexivity in sociology: difficult to describe, as it means different things in different contexts or for different authors.. cause and effect interact (seen from systems theory); or more tritely, one comes back to the (human) observer effect - see the anthropologist in the top post who affects the community she is studying - thus influencing her own vision (though the feedback loop is often forgotten.) The concept was indeed in part borrowed from QM to scientifize - that is a Frenchism - some common sense notions. It also, however, has roots in the idea of a ‘self fulfilling prophecy’ (Robert Merton, but See William Thomas, 1920’s or so) - the idea that how humans define (conceive, view, understand, etc.) situations become the “reality”.
These ideas - reflexivity, effect of measurement, observer effect, Rosenthal effect (something similar: expectations create reality, as when researchers are told the group of rats are ‘intelligent rats’ - lo and behold they perform better than the others, etc.) are all a bit muddled in social / psychological science. Vague ‘principles’, ‘laws,’ caveats, rules of thumb, that attempt to grasp, in some way, the interaction between human perception, concepts, and events in the real world, or ‘facts’ - proper, accepted, descriptions of the world, events, etc.
All such thinking has its roots in a constructivist pov: humans construct a view of reality, and ultimate ‘true’ reality is unknowable, and so possibly irrelevant or uninteresting. Of course, science and conventional wisdom furnishes us with some rock bottom statements or concepts that many or most accept as ‘true’ - cars burn petrol, men desire women, stars exist, plants grow... (Economists, technotopists, seem to accept a whole lot of other precepts as ‘true’...)
Really, the constructivist pov is all that Soros and the OP are referring to, imho at least. Sorting out what is ‘really real/true’ vs. what are human constructs and how these deviate from 'truth' is unresolved (duh!) - in fact everyone has their own version of that divide.
Yes, there was a speaker in "Beyond Belief 2006: Science, Religion, Reason, and Survival", Stuart Hameroff, who believes that quantum theory and mircotubules at least partially explains the process of consciousness. Hameroff is the associate director of the Center for Consciousness Studies at the University of Arizona.
Quantum Consciousness (website)
Beyond Belief 2006 session 4 (google video)
Stuart Hameroff (wiki)
"Reflexivity" also borrows heavily from chaos theory and complexity theory.
Chaos: Making a New Science, by James Gleick (Amazon)
Yep.
Reflexivity in the context given deals with the flow of information through the system, and the feedback implications of that flow. It gets into complexity, the interesting bit being the meta level outcomes (eg what the totality looks like and does).
You could conceive of a QM system that would work similarly. Probably something involving entanglement and interacting systems of particles.
The interesting bits are where the attractors are for different levels of information flow - since they correspond to mode switches within the operation of the larger scale system.
The probability is that and understanding that peak oil is here would represent a sufficiently low level important event to force a switch of attractors (and with it modes of operation). Think of it as supercooled water turning to ice.
excellent insight.
I don't know much about quantum mechanics - has it been/can it be applied to human behaviour?
Has been, yes. Justly? No, except as metaphor in some cases.
Reflexivity occurs everywhere, because you have systems everywhere, whether in biology, in society, in cosmology. Things interact, nothing stands in total isolation. It's a truism.
The thing is to trace the feedback loops and cycles in each different phenomenon. But even after tracing, one does not achieve complete predictability -- systems of cycles very often engender behavior that cannot be deduced from the components participating in the cycles.
What's a meta for? To make an analogy...
When I read the post, the analogy that came to mind was that of a flock of birds, well settled in trees, until a kids appears, flinging a stone into the leaves. The birds fly away, but the direction they follow is the same, each deciding where and how to turn not based upon some knowledge of where the next roost is, but based upon the decision of the bird next to it. The same with some of our markets. In a time of calm, each bird/investor can determine its own way, but when frightened, each bird/investor reacts according to the movements of another frightened bird/investor, and not necessarily in maximization of its own self-interest. The flock flies together, and it takes a strong will and stout heart to move differently.
Oil markets are, and will for a long time be, in a state of crisis, and the birds/investors will be reacting to the movements around them, rather than sitting in a roost in Omaha, figuring out what is the best strategy for the long haul. Maybe that's why we had the spikes in wheat earlier this year, and the wierd jump and fall in WTI today.
You misunderstand the concept a bit. It's perfectly possible to understand a system up to a certain degree by looking at feedbacks and cycles and stuff. But complex interactions and chaos is not the same as reflexivity. Reflexivity becomes a problem when you are an unseparable part of the system you want to predict.
Then you can run into grand scale, real-life versions of the Liar's paradox, where whatever you say the truth is, the act of doing so may change it into something else. From the outside, that may look like chaos. From the inside, it's more subtle than that, and you're stuck on the inside, much as you would like to see it all from above.
This is really closely tied up to what Karl Popper (Soros' great teacher) wrote on historicist ideologies like communism. By declaring rules of evolution that society supposedly follows, and getting people to believe it, they changed the future they were supposedly predicting.
My first thought on hearing the term reflexivity was that it was a variant of the uncertainty principle one of the cornerstones to Quantum Mechanics. As pointed out above simultaneously measuring momentum and position is limited by Plancks constant. This is quite different but the concept is similar in that one recognizes that all actions have consequences and that the magnitude of uncertainity can be quantified. Without going into long discourses, there have been several papers in Science and Nature etc. in the last few years providing evidence that Quantum Mechanics occurs at scales larger then atoms and molecules where it clearly applies. There are in fact numerous books about the possibilities of QM applying to human behaviour. The best that I know is the late Anton Wilson's book "Quantum Psychology". He had degrees in mathematics and psychology. There is also a book by Prof. David Boehme (also deceased) which I consider the best non-fiction book of the 20th century titled "Wholeness and the Implicate Order".
not really the "uncertainty principle" is an artifact of operating at the fundamental limits of physical scale.. you can only "see" with one photon at a time hence your accuracy is limited by the scale of said ruler or photon... for instance
(there is a lot more to it but you get the drift) observation at a fundamental physical levels means "poking" something with energy (simplification) which alters the thing you are trying to see
Soros reflexivity may have some useful ideas in it but economics does not operate at a fundamental level... Economics is a load of stuff that happens.
however the What if scenario you present is intriguing
Boris
London
Heh. The number of replies shows the predilections of a lot of TOD readers.
QM and heisenbergianism as it might be compared to reflexivity in economics is only a metaphor. And no one has yet come up with a decent mechanism for human brains having a quantum aspect to them, nanotubes notwithstanding. They are best understood as chaotic/complex systems with infinite dependence on initial conditions.
However, if it's gonna be raised, let's give QM its due. It isn't just a way of figuring out answers to problems of tiny stuffs... it is perhaps the most spectactularly well-verified physical theory we have. AND it says that the universe is mighty friggin' peculiar. If one actually takes it seriously, they must take a whole lot of other stuff seriously... for instance, among the "what does it actually mean" explanations, the only class which doesn't involve 'magic' or privileged frames of reference or imputing magical powers to human measurements are the Everett many-world interpretations. A good primer on that would be David Deutsch's "Fabric of Reality", particularly if you ignore the last few chapters.
Moreover, quantum indeterminacy can be rather arbitrarily ramped up into the macro world, it's mostly subject to restrictions in information flow in terms of what is "entangled" with what; though that's just a language/math convention for describing a static multiverse from a restricted point of view.
Peak oil may be played out in infinite different ways in multiversal block time; and most of 'us' are probably in a lot of them. Booga booga....
I predict OPIC - the Organisation of Petroleum Importing Countries.
I think it will be more along the lines of regional alliances - the EU, Shanghai Cooperation Council, North American Union, etc. China and India did try this cooperation on oil on a small scale a couple years ago (http://www.cbsnews.com/stories/2006/01/13/ap/business/mainD8F3JRD01.shtml). In the end, I think it will be every country or region for itself.
It only works if the majority join in, but its an obvious route for big government to impose control on the market - so I think it will happen. The critical item is that most exports go by sea, and that pipelines are fragile.
The two disruptive items are Russia (exporter and military power) and China (importer and economic power) - find a way to keep them out of the game and the rest can be bullied into accepting imposed allocations and prices.
Methinks Soros, with his (IMO wrong) comments about an "oil bubble" is just having a (market manipulating) fight with his old friend Rogers. Soros' stock performance this year is probably negative (from his new book). I'm sticking with oil and natural gas stocks. Go "bubble"!
I think Soros said that oil was in the makings of a bubble but not a bubble. I can't disagree because oil is already at inflation-adjusted all-time highs.
In case it was unclear, all the Soros quotes in the above post were from his 1994 interview, NOT from his recent congressional testimony.
At some point people like you and I won't be allowed to buy oil futures, which is only a short step away from nationalization of the energy industry (which is the case in most countries already).
It would have to be enforced globally, however, and I think that is unlikely. Hedgers still need to hedge, and the auction format disappearing is not likely. Speculators provide liquidity and are essential. Individuals could simply move their investments offshore to more investor-friendly exchanges.
Ya - not an easy answer to this one, as it would start a slippery slope, but I think eventually there will be no choice. And hedgers wouldn't need to hedge if they were paid by government or some other entity.
That scenario would not be nationalization of a commodity, but rather globalization of it. I can't think of a historical precedent of globalization of a commodity.
To make it clear although its in other posts. Whats happened is that the market participants have realized that commodities represent a store of value, wealth, money once they are constrained. Thus the market action on the market has been to transform commodities into real money destroying the power of fiat currencies.
Globalization of a commodity is simply another way to say our currencies now have a defacto peg to commodities central bank manipulation only causes pain. The central bankers of course realize this and call it a bubble. In reality its a anti-bubble that prevents them from blowing another fiat currency bubble.
This means of course as more people figure this out that they will pour wealth into commodities since investments outside of commodities and critical industries actually have zero nominal value with sharp drops in market value and this will until this new economy becomes renewable and stabilizes.
The central bankers and governments are just whiners because OPEC took their ball and won't give it back.
"The central bankers and governments are just whiners because OPEC took their ball and won't give it back."
Memmel - Thats just effing brilliant. The concept of your post illustrates an ability to step out side the problem and float around it, assessing the "big picture" in a way than noone (I love this new word, noone, has worked its way through the internets) else has.
I was told early in life that I had an ability to visualize in 3D which helps in seeing the crux of an issue (it also helps in hammering out autoCad files) but you seem to go beyond this into the realm of seer.
Your ability to apply this unique ability to the issues at hand is priceless and I look forward to your post on harmonic, feedback, proximity, coupling, thingy a ma jigy.
Cheers
Thanks.
Seriously even if I'm half wrong the net result of a forced logistic function is chaotic collapse a exponentially forced logistic simply blows up effectively right away. The only solution is a massive turn down in the consumer economy and decoupling from oil.
You don't have to believe me look around you. Oil is still insanely cheap the markets have not priced in peak oil and the wheels are falling off the global economy. And this is just with forcing from primarily export land and static to slightly falling production. We have just put our toe in the realm of exponentially forced logistic functions.
Consider whats going to happen as real declines start to become obvious ?
If people can't see this thing is going to blow up in our faces unless we act then all I can hope for is what I said in a private email I don't want to be collateral damage.
And historically every single empire and civilization has ended in collapse these where not stupid people and in many cases the ruling class was all powerful. So historically some pretty smart wealthy powerful people who where dependent on maintaining the status quo have been taken out time and again by a force that overcame them. Something happened that was beyond their control. Its the height of arrogance to assume that we are that much better/smarter than our ancestors. And I'm pretty sure our ancestors felt the same way I could see the arrogance in the crumbling ruins I've visited.
Globalization of a commodity is simply another way to say our currencies now have a defacto peg to commodities central bank manipulation only causes pain. The central bankers of course realize this and call it a bubble. In reality its a anti-bubble that prevents them from blowing another fiat currency bubble.
This means of course as more people figure this out that they will pour wealth into commodities since investments outside of commodities and critical industries actually have zero nominal value with sharp drops in market value and this will until this new economy becomes renewable and stabilizes.
I probably should have said global "communalism" of a commodity (oil), which I don't see happening. A nationalized ExxonMobil would still have to bid for oil against a nationalized CNOOC. Removing the individual speculator won't reduce oil prices, and will increase volatility. Commodity investing is still considered risky given the high volatility - for example a lot of investors decided to "cut their losses" by selling in the low 120s after buying in the 130s.
I won a bottle of Dom Perignon so YMMV.
to those who say oil is speculative I just snicker and say what are you going to put your money into when stocks aren't doing so well and inflation is raging, bear stearns and subprime mortgages? the fed helped create all of this. are you going to put your money into banks that seem to drop 5% a couple times a week or oil and commodites that seem to break records and/or go up in value every year?
Peak-aware financial analyst Gary Dorsch a few weeks ago coined the phrase "oil vigilantes." That was a brilliant way to tie what is happening with oil now to what happened with bonds in the '70s. The bond vigilantes who punished the pre-Volcker Fed for debasing the currency in the stagflation years have been supplanted by the oil vigilantes. I would just qualify that it's not so much OPEC that has taken the ball away as it is institutional investors pouring money into commodities.
The issue is not really one of starting down a slippery slope but rather one of building a completely new economic edifice. Unless you accept disastrous collapse and eventual regrowth as the normal and inevitable pattern of human history, then the desire of money to make money cannot continue to be the engine which drives infrastructure investment when our net productivity starts to decline. We have to find another organizing principle for our economic activity or chaos and collapse are inevitable.
It is a puzzle how the restriction of who can participate could happen. Futures get closed out and converted to physical possession of oil. Oil gets processed into petrol and diesel fuel and sold to ordinary people. At what point in the chain of ownership does the restriction get removed? Who is responsible for the administration of this activity? The legal system that would support such a system is, to me, mind boggling.
Could you expand a bit on this, if possible? I've had the peak oil versus speculation discussion on other fora, and I still keep coming back to this point. Whatever happens on the futures' markets, someone still ends up with the oil, which I understand is quite expensive to store. And I've also seen it said that stocks are generally going down.
So, is there anyway in which speculation can drive the oil market in the absence of someone willing to pay high spot prices?
Peter.
There are two camps of thought here.
The first, represented by people like Mike Masters, from whose presentation to Congress I grabbed many of the above graphics, believe that index speculators build bigger and bigger positions (due to new capital inflows that must be invested). At the end of each month, the contracts are sold and an equal amount of the next months contract are bought - i.e. the bet is not stopped but continued. This camp believes this 'permanent bid' is a large reason for the oil rise.
The other camp believes that if supply/demand dictated it, the futures prices could go down $20,$30, $50 a barrel, irrespective of what the index funds are doing, because real producers have the ability to sell their production at any price. Remember that at contract expiration, there is someone somewhere in the world paying $130+ for actual oil. If this person is a speculator, (e.g. they can't refine or use the oil themselves), they have to store it somewhere. Worldwide non-user storage is very limited (though increasing). The wheat example above should give a clue that monster futures positions don't by themselves guarantee a bubble - there still exists a very large index long position in wheat, yet it has dropped near 50%.
In shorter version, speculation CAN drive oil prices in the very near term, but at contract expiry (which happens each and every month), someone is paying cash for that oil, and taking physical delivery of it.
Hi Nate
Great post.
The thing I can't get over with the Masters point is when *someone* actually takes delivery of the oil. If the physical delivery represented a large excess, wouldn't we see sharp downward corrections in the spot markets? As high priced contracted oil (i.e., paper oil), becomes actually deliverable oil for which there aren't actually any buyers...
Basically, I am trying to figure out the part of the feedback loop where higher prices are spurring additional production, which will be delivered to *someone* somewhere. If we had speculation pure and simple...inventories should be at historic highs ... they are not ... so, how is this speculation working vis-a-vis actual delivery of product? This has not been adequately explained in my view.... Any help would be nice.
Again, a really excellent post with ramifications that go well beyond purely financial concerns!
Herein lies one of the problems with the current system for oil futures contracts. Those who purchase contracts are not required to take delivery of the product.
Oil is essential to global commerce and to everyday Joes who need it to get from their home to their job, yet we have institutional investors and hedge funds who treat the futures market as their piggy bank and continue to drive the market higher. WTF? Someone needs to step in and put an end to these shenanigans before the entire world economy comes to a screeching halt.
In my view the Hubbert "theory" is not purely a geological theory. Nothing in geology says that you must "develop" an oil field so its output increases exponentially until depletion effects are felt. People can choose to do just a bit of "development", suck the oil out at a constant slow rate for a very long time, and then quit. In practice this is not done, because people are greedy. Hubbert described the real-life behavior of profit-seeking people interacting with geology.
I think it can be best explained (but not fully) by the Maximum Power Principle, which is the subject of my next post. Maximum flow rate has equated to maximum money which has equated to maximum social power, in the short run. It gets back to discount rates - I think Hotelling theory will end up being very wrong.
Nate, I fear your essay is moot. My view is that hoarding will ultimately occur, and probably rather soon. When that happens, the oil market will essentially and rather suddenly cease to exist. Private deals are already being made between exporters and importers. This is likely to accelerate and result in an every nation for itself, mad scramble to secure oil or perish.
Use your own imagination for what happens after this. It it unfolds this way, I don't think I'd want to be King Abdullah as the pressures on that nation will become immense.
Hey, it's a great essay and goes beyond oil.
However, yes, I think the oil market at this point is like an aging Karl Wallenda still walking between tall buildings in his 70's. There is a stable state waiting; it's only a matter of which perturbation ultimately sends it there. We're in something of a consensus trance, having tacitly socially agreed that oil is "worth just a little more than what it costs to obtain". That ain't so, it's the magic that keeps us alive in our multitudes in comfort and high dopamine.
That's the phase shift: the dawning realization that the black goo is where the magic lives and is not subject to replacement by anything. Ever. Humans are pretty delusional - wow - but this is a really really simple concept. Oil would be dirt cheap at $1000 a barrel.
There will be an abrupt phase shift, I think, after which the concept of selling oil cheaply will seem quaintly naive, like a novice hooker who only charges a nickel or Hawaiian royalty giving away their lands to the missionaries for religious salvation. The phase shift and stable state reach for us, and will find us. When Karl Wallenda ultimately spread his wings to concrete skies, were we or he surprised?
Good essay on reflexivity and good thinking, but I think the oil markets will be a short-term study when it comes to money only. Other political considerations will quickly overshadow purely fiscal ones, and I think even the ELM will be overwhelmed by an abruptly changed paradigm sooner than we might think...
Yes, once I came to understand the Maximum Power Principle, I started to think that the only reasonable approach to life is an ascetic one, where you should really continually do without things (or continually try), to not consume, to limit, to look inside for peace, because the temptation is always to want "more" no matter how much one has. The MMP is our interface with our own biology and the physical cosmos at the same time so it's hard to deny it but I think it's a trap if the energy supply is constrained, even temporarily by a drought for example. I don't want to think of god(s) laughing at our oil predicament right now, but that might be what they are doing. They are probably not crying. Why should they? They don't have material needs to meet.
No you turn to art and abstract thought etc.
Look at Japanese culture and to some extent french :)
You focus on quality not quantity. Immense wealth can be generated via high quality. A fine bottle of wine a painting sculpture etc. A fine house etc. In general you do not need any more material to create a work of art or a bunch of plastic bags.
This does not preclude advancement in sciences health etc. In fact we have tremendous room to optimize our crops and biological sciences for quality. And health would be a big factor. We do have "cyberspace" which has barely been explored. Really freeing humanity to peruse interests not labor remains a noble goal and still viable.
We turned our backs on a path that is far from ascetic. Look at the worlds Monasteries in most cases they are works of art.
Consider one case study. The Shaybah Field in Saudi Arabia was discovered in 1968. It was estimated to contain 8 - 25 billion barrels according to numerous theories. The Saudis brought it onstream at 500,000 barrels of oil per day in 1998 as a long life asset.
More recently there were acknowledged problems with loss of production from exiting Saudi Fields.
The Saudis wrote contracts to boost the production of Shaybah by 250,000 barrels a day due in late 2008. This may lessen the lifespan of the field, but will help supply the world with precious fuel for a time.
Saudi Arabia has the option to increase production at some of its fields and discovered new oil fields each year, these were smaller than the giant oil fields of days gone by. Smaller fields did not last as long.
Well lets hope the Saudi's continue to waken up to the nature of the situation. We can forgive them for their outlandish production claims but hopefully they will decide to actually reduce production and reign in their internal subsidies to create a stable economy. They have enough oil and natural gas to produce high value plastics and fertilizers for hundreds of years. Coke production could readily be coupled to reasonably large steel and cement production. Not to mention using their abundant solar resources.
With nuclear they could even run enough desalination plants to have a fair amount of agriculture.
Internally on the religious cultural side they could work towards a Muslim/Arabic culture that was unique but allowed human dignity esp for women. There is no reason that deeply religious cultures must fall prey to the abuse of power thats all to common in theocracies. Having lived in Utah for a bit I think I understand the good and bad side of theocracies better than most Americans. They are not my cup of coffee but as long as people can easily opt out and the respect and foster individual growth and the members are happy more power to them.
The Saudi's don't have to go over the edge with us and unlike us they do have time to rethink what they are doing. Some of the recent moves seem to indicate that they realize this. The save the fields for future generations comments and call on Moslem unity actually tell me they are not blind to whats happening.
I suspect that decisions like the Shaybah expansion are the last time KSA will expand production.
Yes you are absolutely correct. In fact I should have thought of this. Because my job involves what you mentioned, art. No I don't create it (don't I wish) but I teach it and explain it. (A case of those who can do, those who can't.....) And to say that it means a great deal to me would be an understatement.
Nate, just a few comments re your predictions:
1) By "lower lows," do you mean $10 oil, or something else?
2) How about a camp c), "the future is unknown and unknowable" camp?
3) Speculation forms an important feedback loop that keeps prices more closely to market (unarbitraged) values, therefore will increase in the future (as derivatives generally have, etc etc, therefore continuing this trend).
I wrote 'higher lows'. The last rally we had to $80 pulled back to $57 or so. This rally to $135+ will pull back to something higher than that, and so on, into the future.
The future is certainly unknowable. But one can create a probability distribution with all the 'possible' futures one can imagine, based on systems analysis, etc. One of the possible futures will always be 'none of the above'. Determining whether this category represents 99% of the distribution or only 5% of it is part of the reason we effort on this site - to narrow the facts as much as we can thereby reducing future uncertainty. The less uncertainty the better choices we will make.
Nate Hagens -
Very thought provoking article!
I tend to agree that some form of 'reflexivity', as you've described it, is at work in some strange way in the oil market, though it's pretty hard to pin down.
Analogies are always imperfect, so comparing reflexivity with the Heisenberg Uncertainty Principle is not quite a legitimate comparison, but I think it gets the point across in a general way (reminds me that a physics professor of mine used to have a sign over his office door saying, "Heisenberg might have slept here").
What I find maddening about this whole thing is that here at TOD I hear many persuasive arguments that speculators do not and can not have a major impact on oil prices, but then I hear other equally persuasive arguments that weird things are going on and that it's not business as usual and that the game is not being played by the simple rules of Economics 101.
One comment made up-thread struck me and sort of conforms with what I have been thinking of lately. And that is the possibility of an almost total destruction of a functioning true oil market brought about by more and more consuming countries making long-term supply deals with producing countries. Each one of such deals effectively shrinks the open global oil market by the amount and duration of the deal.
Thus, it appears to me that oil may be in the process of being transformed from an openly tradable commodity into something more resembling a utility, in much the same way that in you live in a particular town your water supply will automatically come from a single supplier, no ifs ands or buts. Pehaps something like almost Iranian oil going to China, almost all Saudi oil going to the US, and almost all Russian oil going to Europe, or some combination thereof. If things become structured in such a manner, there will be hardly any oil left to trade, except among the few stragglers at the margins.
This looks like it's going to develop into a deadly game of geopolitical petroleum musical chairs, with the people left standing turning into very sore losers.
Just to slightly flog quantum stuff mentioned higher in the thread, this statement by Nate is actually a pretty good approximation of how one might develop a probabilistic philosophical approach to being one part of a multiverse; except that the probabilities represent actual outcomes which may not communicate between one another. Nice alien thinking; reminiscent of Nassim Taleb. One need not acknowledge a multiverse to benefit from thinking this way, but it might be more interesting philosophically.
On a global scale (versus the 1st world countries) seems like we also should acknowledge the far end of the spectrum: d) those people who will fall entirely off the "oil wagon" and have to learn to get-by mostly without petroleum products because their community has been priced out of the oil market. A sizable proportion of the world's population already fits in this category but of course these folks never log onto TOD, or any other forum, and we can therefore comfortably ignore them. End sarcasm.
Ahh reasonably short term predictions I love them :)
My take on the matter.
Oil is money.
Actually its generalized a bit more in that all commodities are now the new form of money. The world has moved from a fiat currency system to one back by commodities with oil the premier commodity.
Without wheat or oil the value of everything else is zero.
Thinks about this a bit given Nates post we don't have a lot of oil per capita and agricultural production has constraints. This implies a huge deflationary force is now going on in the world currency markets.
With this view point speculative positions in the worlds commodities markets represent the real world bank and so far its woefully under capitalized.
Think about it.
memmel, I agree (as usual). but what do you mean with "the commodities markets are under capitalized"?
Well oil and commodities futures are the new world bank if you will replacing government central banks.
The central banks will attempt to manipulate and debase fiat currencies but long commodities contracts now act as a store of wealth making it impossible for them to devalue commodities.
This is a reversion to a very old type of money the wealth of the country was eventually determined by the yearly harvest the only addition for us is the extraction rate of oil. This is effectively now fixed to declining every year and in terms of commodity worth highly deflationary. You now have two base choices for storing wealth. One way is that one of the large fiat currency vendors recognizes whats happened and jacks up interest rates to make the currency a store of value and continue to do this so its pegged to oil.
In other words currency X is set so 100 units of X = 1 barrel of oil. If it drifts higher interest rates are raised calling in more money until its back in line. This is a effective peg on oil or a oil standard like a gold standard. This currency would be backed by futures contracts on oil and in general by oil suppliers.
Thats a theoretical and maybe I got it slightly wrong real currency pegged on oil.
Since this does not exist you only choice is a huge open interest in oil and commodities using our current fiat currencies. Its the only way to convert worthless fiat money into something valuable.
Futures markets are now the new Fort Knox. And the ME is the worlds gold mine.
So open interest in commodities markets is going to continue to explode unless and until other fiat currencies are forced to peg to oil.
Now since the total base wealth available in a currency backed by oil and commodities is so much smaller than the current amount of fiat money in circulation your going to have to remove trillions of dollars from the worlds economy primarily as defaulted debt and elimination of fractional lending via insanely high interest rates until banks are fully backed by commodities peg.
Whats cool is this is what had to happen to go to a renewable refinement vs growth economy and its being forced down the bankers throats the central banks can do nothing to prevent it.
This is why devaluing the dollar did not work for the Fed's it just kept adding a premium on oil thus a checkmate. Eventually they will be forced to start increasing interest rates as commodity prices continue to explode just stopping is not enough.
OPEC may not be able to produce more oil but they can certainly produce less imagine a Arab Oil embargo on top of our current situation its cold war MAD all over again.
In any case its now effectively impossible to borrow from the future in the form of long term debt since the real currency declining oil will be far more valuable in the future and fiat currencies are messed up.
All we have is this years production and maybe next years to support the world economy. No one is willing to lend further out and the can't until the central banks accept the peg and force their fiat currencies to remain flat vs commodities.
I love it when humanity is forced to do the right thing. This is probably one of the only rays of hope I've seen in a long time since its impossible to manipulate your way out of it.
excellent
however, earth has problems with oil only if demand prevails over supply. if central banks in OECD countries force higher interest rates, the demand rapidly falls with shrinking economy. I believe that the whole financial mess was created with precise plan to deflate it in the right moment.
the elite prepared for peak oil, as it extracted the maximum amounts of money from the middle and lower class in last bubbles. with low classes de facto bankrupt and overwhelmed with bad debt, they don't have anything to get from there so they can as well turn the economy off.
They have no choice. And no oil prices won't fall since if you shrank the economy to fast oil would be cheap and it could grow again and we have different controllers for the various economies so if you did collapse to fast your neighbor would seize the cheap oil and grow.
The scenario your describing is concentration of wealth its a finite way to make money and its been around since the dawn of mankind. But its not wealth creation and in general it eventually leads to revolt when the masses have nothing left to lose. I agree its one of the few games left in town to get rich but its a terminal game.
The important point is that the central banks cannot use financial games to escape this massive deflation sure they can allow concentration of wealth and they probably will support it since concentration looks good from the outside but its a zero sum game. The more wealth gets concentrated the slower the velocity of money and the less transactions occur. The central banks still have plenty of leeway to concentrate wealth to hide the real decline in asset values. For example they can give you a 300k loan on a house only worth 50k and if you have to sell you default. The next guy gets it for 200k then later defaults on the loan etc. The outcome of most house loans going forward will be default. You can see that unless they immediately forgive the default most people could not by a house. This is the game going on right now.
It continues until someone is wealthy enough to buy the house for say 50k cash. From this point forward if the home is sold again good chance its sold to another wealthy investor leading to consolidation.
It may continue to decline in value but its been consolidated and concentrated the fortunes of the wealthy may continue to get nominally smaller but the purchasing power remains constant. In this example from the point the home is bought as a rental for cash going forward the number of home sales drop dramatically and the rental money is the only cash flow. So you can see how velocity of money dropped off a cliff.
And in this example you see how the economy reverts to the annual inputs the only money moving is that earned to survive that year. The wealthy only concentrate wealth at a minimal pace and become unable to expand rapidly.
This is your traditional hard money economy driven by yearly value add from agriculture and manufacturing and whatever oil or other energy resource was extracted that year.
Of course you have a few rosier scenarios where the common worker fares a bit better but they would require some sort of artificial support to prevent concentration of wealth. Communism was one attempt to solve this and it failed.
But in any case we will be forced to confront this simply because the only thing left to distribute at the end of the year is the incremental increase in wealth. It can go in to slowly increasing the nominal wealth at the top or into increasing the standard of living with a decrease in energy usage.
In fact you can see this even at the level of the middle class they now live for the most part paycheck to paycheck with no or a negative savings rate and at best a nominal value attached to a illquid asset the homes that supposedly have equity. If you think about it the real equity is probably 50% of its nominal value.
Lets say I own my home outright and I sell it to someone for 200k and they pay 20% down. Well in two years this home would lose 20% of its value so the buyer has zero equity. Its then sold in foreclosure for 150k.
Lets assume I bought a larger home for 300k owing 100k. My new home drops 20% so its worth 240k if I sell I clear 160k having lost 60k in the transaction rinse and repeat. If you decide not to play this losing game then you still lose 40k as the nominal equity drops but on the other hand your purchasing power is constant with the 300k house your interested in now only 240k. So your 20k ahead of the game by waiting.
Yet your the only buyer who could buy and sell and handle the loss. I.e wealth is concentrated in you but if you spend it your losing money. Buyers that can't pay most of the purchase price lose every penny they put in. But you can see how assets that don't produce income become increasingly worthless. Only when this house is purchased and converted to a cash flow positive rental does it have a worth.
This yearly flow of income becomes the only way to concentrate wealth. This sort of scenario is pretty much the case all over as growth goes to zero. You can only spend the wealth you concentrated that year.
If your income producing asset is still deprecating you may not make anything for a long time.
In this case of homes deprecating at 20% per annum you need a positive cash flow that covers the decline just to break even this is impossible.
So you can't buy until houses get so cheap someone can buy up all the excess stock and stop the decline.
So you can see that although the rich get richer they also get more and more illiquid and have to wait longer and longer to actually make money on any investment. And the ones that invest to early lose everything.
If USA and Europe fall into big recession, so will China. Oil problem (temporarily) solved. Somebody will use that oil in the end, but you need infrastructure to process oil in any meaningful way so it needs some time.
If the price of oil goes higher, we get the recession too. But since the price of oil is now high it seriously impacts agricultural output. So actually I see it as a worse scenario. We need to cut this BAU thing fast, because eating will become a problem in the developed world too. Since we don't have population explosion (especially Europe), having enough food is not a bad thing per se.
To move forward, economy should get rid of most idiotic industry that has no purpose altogether. That's why I think CB are going to raise interest rates. It means different ball game. Of course, bankers will never see the money for bad debts again, but they get in exchange real estate.
So housing may well become cash cow, I agree. Now, a lot of this housing in suburbia is going to become unusable, so maybe the bankers haven't done such a good deal after all.
BTW: if wealthy get the big piece of cake, the velocity of money slows down. But, this means that wealthy people are going to become even wealthier, as disparity between them and lower classes widens. this could lead to problems only if masses wake up and demand their piece of cake. Communism has indeed failed, but this does not mean that it is not going to be attempted at some point. It is not going to be successful, but I always expect the worst to happen =)
finally, memmel, when do you expect WW3 to begin?
The key with a slowing economy is that wealth increasingly moves into store of value and "real wealth" but at a very cheap price. Basically what happens in a shakeout or recession is everyone is forced to realize real gains and losses and settle most open bets. ( These are called debts but in reality bets ).
The losers default on loans and the assests sale for pennies on the dollar. The winners that correctly got out early buy up the assets and historically leverage these after the bottom by taking out new loans and the cycle begins anew. This time around it stops at the fire sale. Given that I expect housing to be discounted 90% of its current value your a fool to buy now with a loan and if your paying cash you better be prepared to lose most of it. This goes four houses boats cars land farmland etc any and every high dollar asset will decline dramatically in value. The reason is simply that very few have cash and leverage is gone.
So the net result is everyone who can buy will be betting on the trickle of monthly cash flow from renting. Overall everyone is really a looser and even the people buying up houses will be taking real losses for years. Probably far longer than they realize. Brazil America with no middle class needs a fraction of the current standing housing stock. I'll give you a estimate I made right now the density per housing unit is 2.6 people per unit. If this increased to 3.6 as people conserve cash for rent then we have 35 million empty housing units.
http://www.nextag.com/home-mortgage/3/byState/California/0.html
This is 3 times the number of housing units in California. But you can see that just a increase about 2.9 would be equivalent to every single house in California being empty. What this means is that we have a massive number of empty bedrooms in the US I think about one empty bedroom for every two people.
The underlying cause is that a lot of baby boomers own 3 and 4 bedroom homes and its only two people.
The fact they refused to downsize resulted in us building out a ton of housing stock for there kids.
Prop 13 in California for example made it smart for older couples with no children to keep the large family home. This misguided policy that will be repealed as California edges towards bankruptcy has distorted the housing market significantly. And of course cheap gasoline played a big role.
WW3 ?
I don't think we will ever have one. Waging war is resource intensive WWII was possible because we where still on a resouce growth path. Japan lost because it could not secure resources and basically the same with germany. Given that oil production is indefensible and in most cases the refineries are not located close to production and VLCC would be sitting ducks I can't see the point in a traditional war.
Same for large scale nuclear war. And this time around Russia has a lot of oil wealth so they don't need to fight for it. Russia/China/India will be tense.
This point to a more protracted series of smaller scale engagements similar to the Iraqi war going forward at least in the near term. In the long term hopefully we simply don't have the resources to wage large wars. Looking even farther into the future by exhausting most of the worlds resources now we may have made it impossible to wage large wars which is a good thing.
The Iran situation could blow up in a second and KSA's stability as they eventually admit to peak and export land results in a end of revenue growth etc makes the situation explosive but we just have to hope that these problems remain confined. North Korea for example will become even more desperate and will become a large issue fairly quickly.
For Iran because of export land and their situation I'm not sure they can last all that much longer. I believe that net exports from Iran go to zero by 2029.
http://www.energybulletin.net/38948.html
But given the large size of the population and the fact they import most of their gasoline they are effectively in trouble now. This is why they want oil prices to go a lot higher.
Internally Iran is suffering 14% inflation etc so economically the country is on thin ice
regardless of the price of oil. I don't think they can continue as just a oil exporting
economy now. They either have to diversify or I think the economy will collapse.
http://en.wikipedia.org/wiki/Economy_of_Iran
They are not all that far off from a Soviet style economic collapse even with high oil prices.
The nominal reason for Nuclear is to free up more oil for exports in my opinion this is one of
the few choices Iran has to get out of the mess they are in.
Its too bad they have decided to tie this to a battle with the world over enrichment but
internally this helps quell dissent.
Certainly US sanctions have had an effect but the Iranians are largely responsible for mismanagement
of their own economy. Cuba under much tougher sanctions managed to resist the US for decades.
I think Iran is trying the North Korean gambit. They want nuclear weapons to try and get aid to
prop up their ailing economy. Probably they hope that if they can get them the US and Saudi Arabia
will pay them not use them. I think its a fools game since North Korea gets away with it because of the
Chinese shield while Russia probably won't protect Iran if push comes to shove.
In any case I don't think most people realize how bad off Iran is its effectively in a major depression right now.
You are also making a bet about inflation.
If you sell your house and put it into cash then your house may loose 90% of it's value, but the cash may loose 99%
You have to guess each time what works, so the right guess in that case might be commodities.
I think its impossible to have massive inflation and asset deflation. You can certainly have scarcity driven price inflation which is what we are seeing. But the inflation your describing would require blowing another debt bubble and asset prices would increase inline with the bubble. By definition almost a massive drop in asset prices means debt levels are heading towards zero. Scarce resources would resist this deflationary force and remain high. At some point since we are talking about debt deflation interest rates would skyrocket since hard money lending would be the only source of debt. Eventually in time they would then decrease as the amount of money and debt in circulation balanced with the new economic level.
As I've said if Commodities are really scarce then this would mean a effective commodities backed currency.
Given the nature of oil the Federal reserve is effectively no longer in control and cannot prevent this so expect them to begin raising rates. I actually predicted this before the EU announced it would probably raise rates next month. BMW says this in the comment I replied too.
So massive asset deflation and a move to commodity backed currencies is pretty much certain if we don't want OPEC to cut off our oil supply. If we continue to devalue our currency I'm fairly certain we will face a embargo.
They have already made it pretty clear that they are not interested in this approach and they have both the cash and the oil.
What I am describing is differential pricing, whether in an inflationary or deflationary environment.
As you argued elsewhere, houses are in oversupply in the US and UK relative to what people are likely to be able to afford in relation to other demands on their wallets.
So whether it is in pounds or peanuts house prices are likely to sink, especially with rising unemployment, and in the US with stranded suburbs with high fuel costs.
Assuming that oil is the limiting factor, many other commodity prices are also likely to be weaker as demand collapses.
Wages and everything else are likely to be weaker still though, as the energy component in commodities will give a floor to prices.
It all boils down to much less purchasing power.
Except: Renewables require borrowing all EROI investment upfront. So do nukes. A high inflation rate is going to kill them.
What you are describing is a financial death spiral. We will be trapped with fossil fuels.
For the most part I agree your pretty much trapped in a downward spiral of every expensive fossil fuels.
In some enlightened areas you will see attempts to convert but the status quo would be downward spiral and wealth concentration on the way down with a mind boggling loss in the value of non productive assets.
Gives new meaning to the produce part of ( Economize Localize Produce ) ELP.
ELP of course is the way out but its not compatible with wealth concentration that will be prevalent now that fiat currencies can no longer be inflated to produce growth. I suspect that Jeffery Brown did not intend to be the Carl Marx of the 21 century but tough :)
The obvious solution is energy and food needs must be met by renewable or long term stable energy sources ( nuclear).
Nuclear and probably later fusion are still viable if needed but outside of providing baseload and concentrated power the real economy has to be sustainable. I'd argue that a robust sustainable economy does not need nuclear since other resource constraints would limit growth at that point not energy.
If you building to last hundreds or thousands of years and are highly energy efficient you simply don't need nuclear on earth at least.
Changing "has moved" with "is at the risk of moving", it is wholly in line with what Benn Steil, Director of International Economics at the CFR, described in his latest piece, the May 20 Testimony on Financial Speculation in Commodity Markets Before the Senate as a logical consequence of the fact that "the Federal Reserve pushed rates too low and held them low for too long, and has since last autumn been exceptionally aggressive in driving them well below the rate of inflation":
The potential move being discussed at the Saudi Shura (restricting oil exports to just cover their import needs) from the news on June 4 is exactly that, with the commodity in question being their oil still in the ground.
BTW, I wonder whether that potential move is the real cause of yesterday's and today's rise in crude prices, rather than the comments from Olmert.
Provocative post -- which is what's needed. I very much agree with point 2 in your conclusion, although I would put it somewhat differently: the debate is whether alternative sources of energy even in toto can come anywhere near making up for what oil has supplied us. If not, then radical retrenchment is unavoidable. I hold the second view. But it really is a matter for research, and I would love to see TOD research and energetically debate this rather than bifurcate.
As for the rest, foolish be the soul who would deny any speculative component to the rush into commodities and energy. Mapping out the decline of the resource is relatively easy. This decline defines and constrains the contour in which societal reaction can take. What will happen within those constraints is far harder to predict, probably impossible, for just the reasons you enumerate. A cat's behavior is (let's say) very unpredictable if you don't feed it. But in the end, you very predictably wind up with a dead cat.
But there have been some who paint the whole thing as speculative which we peakers know it is not. Whether Soros acknowledges the underlying physical reality, I don't know. But the effect he's having is to smother the issue of the physical reality.
No it isn't.
It's obvious to anyone with a calculator that alternative sources can do exactly that: 30,000TWh/yr world energy consumption (quality-adjusted) x $2M/MW for wind / 3000MWh/yr per MW = $20T to replace all the world's energy consumption with wind = 1/3 of world GDP for a single year. If the will and time were there, within 20 years the world could easily generate more renewable power than what is currently obtained from fossil fuels.
There are a lot of questions, but "can renewables generate enough energy" is utterly not one of them.
Some actual questions whose answers are unclear:
The question is not can it be done but will it be done, and that's a much, much more complex question to answer.
Without going into the reasons, which are, as you say, really complex, my vote would be no.
In a story by Jeomre entitled: No Technical Limitation to Wind Power Penetration published on line in the European Tribune, I found a link which led me to a report by the Tyndall Center for Climate Change entitled: Security assessment of future UK electricity scenarios.
In this report they modeled the effects of wind penetration into the U.K. electricity mix up to 35% of total electric energy supplies (I am talking MWh not MW). At this level of penetration they claim that only 9.4% of conventional capacity can be retired. This claim would seem to indicate a problem with completely replacing fossil generating capacity with wind capacity. Here is verbiage from the report commenting on this issue
Due to this disproportion between conventional capacity and energy substitution by the wind source, a considerable number of thermal plants will be running at low output levels over a significant proportion of their operational time in order to accommodate wind energy. Consequently these plants will have to compromise on their efficiency, resulting in increased levels of fuel consumption as well as emissions per unit of electricity produced. This will cause higher electricity production costs.
The average load factors for conventional plants, with 25GW installed wind capacity at 35% average output, will reduce to about 40% (utilization factor for UK plants in the year 2002 was 54%)[DTI04]. Nevertheless the cost recovery of those plants that might be forced to run at lower load factors will be a major challenge for future electricity systems.
What does your calculator tell you about the costs of compensating for the variability of wind power, in an energy system powered entirely my renewables?
Roger
If you want to quote some data and charts from those reports and create a guest post to suss out the issues you raise, I think that would be a great contribution.
Nate,
Let me dig into it and size how much work is required to put something intelligent together. I will get back to you.
It tell me that we need solar and marine power as well, perhaps with a little nuclear thrown in too. Three cheers for diversification!
Not really; it depends on how you do it.
The report you link wasn't about replacing all fossil fueled generation; it was about lowering CO2 emissions. Given that goal, it made sense for them to back up wind with gas and coal.
If you wanted to totally remove gas and coal, you'd back up wind with pumped storage, which they don't touch on at all.
It roughly doubles the price.
You can download hourly wind generation data for the entire year of 2007 from Ontario Hydro, and you can find data on the price of pumped storage ($10/kWh) and generation ($1000/kW). Plugging those in together, you find that a day or two of pumped storage can cover for the intermittency of wind, at least in this real-life dataset.
These two statements do not make sense. A wind/hydro system would be a lot better way of lowering CO2 emissions than a wind/fossil fuel spinning reserve system. If the people projecting the intermediate and long term future (The report in question explicitly uses this term) of renewable energy generation do not consider pumped hydro as potential solution, I would assume that they do not think that sufficient capacity is available to absorb the necessary excess energy. They could be wrong, of course. The key question about pumped hydro is whether or not a sufficient number of sites exist world wide to support per capita energy usage similar that enjoyed today in OECD countries. And in fact if transportation, space and water heating, construction, etc. become electrified electricity demand per capita may rise (assuming we maintain today's standards of living).
The question isn't can wind power save us, the question is whether or not we can solve the problems created by old technology by using new technology, with a growing population in a finite environment, while 6.7 billion of us pollute the planet and extinguish 200 species a day.
The question is will we figure out how:
* to live together in complex equilibrium
* sans the need for perpetual societal growth
* as we did for hundreds of thousands of years before civilization
* while those who wield vast resources, a.k.a. "TPTB", hinder and obfuscate the true scope and nature of the problems
* on less than 1/100th of our current energy budget per person
* before a complex collapse shuts down the global support system which provides food, water, heating, socialization, and shelter to billions of people (i.e., will it happen in time)
* and ushers in the overshoot correction of a die-off
'Cause you know that if we all could address:
* our lack of ability to interact and truly support each other and our communities personally
* living sustainably and locally
* and could deal with the fact that we need not fear our finite existence (we need not fear death) ...
... then the very need for the bulk of our exogenous energy usage would vanish.
But there isn't enough time to accomplish this before a complex collapse. It's like trying to correct the "misdeeds" in your life after you find yourself on your deathbed.
http://news.yahoo.com/s/ap/20080606/ap_on_bi_ge/oil_prices;_ylt=Ahcnn6t3...
Oil up 7 bucks - ouch!!!
Now up $9.47 to $137 and change.
I suggest that we need to factor into our mental machinations the effects of the stress placed on nations around the world, such as Bolivia just nationalized gas pipelines. I think that hoarding and geopolitical rivalries and alliances and coming resource skirmishes, food riots and other ugly things will play a far greater role than market psychology which is on the verge of breaking down into hysteria and panic.
All your costly business school economics and psychology are out the window, folks!
Up $9 now. There is trading halt at $10 for 5 minutes, then another $10 limit above that....
We're in good mythic territory here.
It sounds a bit like Bush and the Reality Based Community
See:
http://en.wikipedia.org/wiki/Reality-based_community
This is a kind of galloping egomania of powerful people.
Forgive me if I ramble off into Carl Jung's classic book 'Man and his Symbols'. He points out that the ego is represented in mythology by various heroic gods. I would drawn your attention to the Twins in the mythology of the Winnebago indians of North Dakota. It seems like an allegory of our dear modern financial services industry. To quote Jung:
The two questions are:
a) how do we tame our gods and convince our financial services industry to exert their power responsibly or maybe go into a state of permanent rest?
b) is it possible to create another more harmonious reality in which everyone lives happily ever after? Or is this just a fairytale hope?
BobE
thought provocative, as always
"yet too much awareness might cause supply disruptions (hoarding)"
excuse me, Nate, are you stating that too much PO awareness is actually a bad thing? if oil gets hoarded, BAU ends quickly and at least world retains large amounts of oil + we start curing the climate change.
of course, wars and dieoff are guaranteed in this scenario, but those are going to happen in the long term anyway
Supposedly, the price of oil depends on the fundamentals.
However, "fundamentals" are difficult to discern,
& buried under layers of fraudulent, forged, data.
We do not know how much oil there really is left.
One reason is human limitation,
but another is human dishonesty.
We have real trouble measuring the world's oil.
We have way more trouble because many people,
who do measure their oil, have good reasons to lie.
In financial markets (which include oil futures),
reflexivity occurs when prices themselves influence the
fundamentals and that this newly-influenced set of
fundamentals then changes expectations,
thus influencing prices.
This process then continues in a self-reinforcing pattern
until it has overshot equilibrium.
Because the pattern is self-perpetuating,
markets tend towards disequilibrium -
where every outcome is uniquely different
from the past.
In natural science thoughts and statements are outside
the subject matter, whereas in the social sciences
they constitute part of the subject matter.
(Of course, this is only relatively true:
measuring small particles with light rays
ends up changing their position & energy.)
Our financial markets are not tending towards equilibrium!
They are headed towards some radical changes of state ...
The fundamentals are buried under bullshit.
We are making decisions based on frauds ...
In dealing with situations promoted by huge lies,
it is only, perhaps, in the longer term, that one
might be able to learn more about what was.
Boom/bust cycles become based on bullshit.
There are fundamental facts buried somewhere.
Those fundamental facts are very important.
But, the lies are controlling more than the truth.
In the short-term, people believe what they want
& the process of discovering more truth stutters.
The general notion of reflexivity
includes any thinking participant.
However, the most crucial of all the conscious players
are those who manipulate others by using the means
of dishonesty, backed up with violence, to create
real conditions based on believing in huge lies.
The core of crucial issues are the ability
of liars to kill alternative truth tellers.
The true fundamentals include death control.
The ability of the central banks to create
new money out of nothing but someone
signing a promise to repay that ...
is the most extreme amplification
of fraud, whereby the incentives
to engage in fraud, & to trick
people to participate in that,
are always overwhelming ...
Prices of commodities have shot up
because people making money out of 0
have been using it to buy more reality.
Transfer of 'money' into 'real goods' (or at least
paper representations of them) has been widespread.
However, this entire system has gone fundamentally insane.
Electronic frauds, backed up with mass destruction weapons,
ARE the fundamentals of the real world's current "economy."
Back to Mr. Soros:
"So we can observe three very different conditions in history:
the “normal,” in which the participants’ views
& the actual state of affairs tend to converge;
and two far-from-equilibrium conditions,
one of apparent changelessness, in which thinking and reality
are very far apart and show no tendency to converge,
and one of revolutionary change in which the actual situation
is so novel and unexpected and changing so rapidly that
the participants’ views cannot keep up with it."
This is the pattern of normal science
punctuated with paradigm shifting ...
The crucial element in human survival
is human beings competing with others.
Human survival, more and more, became
dependent upon being able to tell lies,
& to back those lies up with violence.
Paradoxically, triumphs by huge lies,
the bullies' bullshit world view, made
itself become triumphant by diverging
from reality, more and more and more.
Global civilization is controlled by HUGE LIES.
We are literally living in a Bizarro Mirror World.
There are inherent problems within
short-term triumphs of these lies ...
At the same time as peak everything else,
we are also approaching peak dishonesty.
We are reaching the tipping point where
the huge lies that control civilization
can no longer be as effectively, or as
efficiently, backed up with violence.
Our economy is fundamentally based on organized robbery.
That economy evolved to become symbolic monetary frauds.
We have been living as if there never would be any peak.
We have been living inside bigger and bigger lies
that we told ourselves, and which were backed up
by the ability to discredit and destroy truths.
Economics is not the most scientific social science.
Warfare is the oldest and best developed social science.
Warfare is based on deceit.
This is the deeper paradox of social science's reflexivity.
Economics evolved inside of the context of robbery.
Economic evolved inside the context of warfare.
We have developed a private property system
based on huge lies, backed up with violence.
It is necessarily spinning out of control ...
Soros' The New Paradigm for Financial Markets
http://www.georgesoros.com/crisis08-ftreview-051908
That philosophy derived from his undergraduate studies
at the London School of Economics under Karl Popper.
"relationship between thinking and reality", Soros calls "reflexivity."
In markets, Soros says, participants' thinking plays a dual function:
they try to understand the situation (the "cognitive function"),
and to change it (the "manipulative function").
The two functions can interfere with each other;
when they do so the market displays "reflexivity".
___________________________________
I still prefer the original name to "reflexivity"
that was given by Karl Popper:
... introduced the term "Oedipus effect" to describe
the influence of a theory or expectation or prediction
upon the event which it predicts or describes:
it will be remembered that the causal chain leading to
Oedipus' parricide was started by the oracle's prediction
of this event.
___________________________________
"Reflexivity" is a broader concept,
about the fundamental feedback between
the abilities of the brain to map the world, and
the selection for the survival of that mapping ...
However, I think "Oedipal effects" are more appropriate
BECAUSE of the root role of death controls in debt controls.
Oedipus was about killing,
with the most acute killing being patricide.
The political economy is based on
dishonesty, backed up with violence,
running systematic robberies and fraud ...
Soros was able to operate within those systems,
to speculate in ways that made enormous profits.
That system permitted & rewarded that gambling.
The little I know indicates to me that Soros
is deeper than most, but still very shallow.
Real, radical, revolution is a change in death control.
A most extreme symbol of that is going to be patricide.
Reflexivity is a broader concept, that is valid.
However, the most important application of that
is when the death controls change in real ways
that will then change the debt controls too.
As long as one is still taking for granted
the idea that Sovereigns have the right to
do the death control to all their subjects,
then one is too superficial to perceive it.
Currency speculation rides on a presumption
that Sovereigns enable that kind of robbery.
Soros seems to mostly take that for granted.
(Which it is, in the real world, at present.)
Reflexivity governs all of evolutionary phenomena.
The DNA builds something which survives and reproduces,
and each iteration of that reproduction is selected to
either continue surviving and reproducing, or not ...
The DNA of humans builds brains, inside societies ...
That neural network of those socializing brains becomes
a new information system basis for possible evolutions,
where they might survive & reproduce, or fail to do so.
The political economy is inside that human ecology,
and they evolve together, reflexively ...
However, the most important crux or nexus of that is
the dishonesty and violence between groups of people.
Killing is the most extreme form of robbery.
Killing one's father is the most extreme form of killing.
In any patriarch, militaristic, culture,
patricide was the most extreme of all.
Thus, I think the term Oedipus effect
gets to the real heart of the reflexivity,
as that manifests in our human contexts.
The death of one Sovereign system,
and its replacement by a new one,
is the most important way that
any real revolution happens.
As long as we were still inside
taking for granted the existing
Sovereign power to rob, then we
are inside that real establishment.
As long as we stay within an establishment,
we could take for granted its powers to rob.
We can pretend that money is a symbol of human cooperation.
We can pretend that gamblers may speculate with currencies,
& markets primarily appear to be sophisticated "bartering."
However, inside of the bigger real social contexts,
money is primarily a symbol of human coercion, and
speculation is truly some sophisticated form of robbery.
The Sovereign powers permit that kind of robbery,
that enables speculators to do nothing but gamble,
and, when they turn out to have made the right bets,
they can claim enormous "profit," without having
done anything whatsoever to have produced that ...
(while, if they lose, the public has to pay for it.)
Reflexivity between the death controls and debt controls is
the most important form of the manifestation of reflexivity.
The coercive powers of the Sovereigns
makes the money become real, & that
makes it possible to speculate in the
ways that are sophisticated robberies.
In the post-modernizing world, the greatest reflexivity
(which paradoxically endeavours to not be reflexive on
its own existence) is the way our electronic frauds
are backed up with threats from atomic weapons.
We are inside some extraordinarily bizarre cultures,
where the scientific reality of societies is hidden ...
The markets are not going back to any old equilibrium.
The markets are being pushed towards changes in state.
Our Big Daddy, Big Killing, systems are going insane.
We are going to go through some social patricides ...
It is a general principle of systems theory
that the most labile component controls it.
In human society, the most dishonest and violent
are the most labile components that control that.
The true fundamentals are the uses of oil
that employ its energy for death controls.
Any and all alternatives are systematically
integrated by their real death controls, &
peak oil is going to focus lots of attention
on a period approaching peak dishonesty.
The biggest real problem, that we have
to work through, is the past triumphs
of the huge lies controlling us.
The ability to back up lies
with violence is temporary.
However, it has happened.
The more important anything is,
the more denied and suppressed.
Clearly, there are creative alternatives.
However, none of them matter more than
alternative forms of death controls and
the debt controls that they have made.
Mathematics in exponential growth
make it impossible to continue doing.
By definition, it will be some kind
of death controls that limit growth,
and direct growth to go in new ways.
There will be the most extreme
reflexivity between the forms
of artificial and natural
selection processes ...
We have built a social pyramid society
based on the ability of lies to triumph.
The social pyramid based on oil energy
is also based on triumphs of huge lies.
Peak oil and peak dishonesty coincide.
Greer "Archdruid" blogg considers these ideas as well. I think a book you would find interesting is "The Survival of the Wisest" by Jonas Salk ,1973 Harper & Row. "Systems of Survival" by Jane Jacobs, Vintage 1992 is also of interest. It would seem that your comments should engage a lot of others, but they may be too interested in the oil or the lack of it to see a bigger picture. With respect to answers, the Chinese actually have a population policy but will that hold?
Money does two things well: It allows us to exchange goods efficiently, and to compare the price of goods at one point in time. However it is used for other things that it does less well, particularly in times of economic turbulence. Specifically:
As a corollary, you can't effectively compare prices across time. This universal assumption of money as a store of wealth and as a way of talking about future prices is one of the "thinking" things that gets us into trouble.
[Of course we all do move wealth into the future through money. When you put $1000 in a suitcase under the bed then you reduce the money supply which makes everybody else's dollars worth more. When you take it out of the suitcase to spend it later then you get your wealth back by making everybody elses dollars worth less. This process works fine on short time frames relative to the economic volatility.]
To take the EROEI idea to its logical conclusion, perhaps the trick is to create an imaginary effective-energy "currency" for talking about future costs.
Thats exactly what the commodities markets have become. Constrained commodities are money its just been almost 100 years since they worked as a store of wealth. Go to Minneapolis and see the houses of the wheat barrons or to the pacific coast and the homes of the lumbar barons or the mansions of the cotton/slave economy of the south. It was only in the early twentieth century that commodities lost their place as a store of value or money. Technically the fertility of the land but same difference. Oil has joined the list or more correctly taken the place of whale blubber and tallow albeit and vastly expanded role.
Looking back in history its really the last 70 years of cheap oil and the related green revolution that allowed the magic of fiat currencies and endless growth to happen.
So commodity backed currencies are not imaginary the last seventy years have been imaginary.
Welcome to the real world :)
Nate I spent an hour sitting in my garden, listening to the birds singing, our shrubs are in full bloom (only about 1 month late), thinking, and wondering how you manage to cram so much into 1057 words. Is it your new Mac with its IQ enhancer? Or is it your superior HTMLing skills?
This is a great thought provoking piece and I won't pretend to understand it all. For me its one of these pieces where I understand most of it while I'm reading but then at the end need to ask "wtf was that about?"
It seems that George Soros is quite a clever dude - reinforcing my long held belief that ability and endeavor will ultimately be rewarded.
So what is the true value of oil? Up until 1998 the value was weightless, notional. Following a short period of transition, the market has been trying to set a true value since 2002. I fully subscribe to the notions of over and under shoot seeking equilibrium, but for oil, we are starting from a zero position. Its like trying to strike a value for oxygen or fresh water. Both finite on Earth but intrinsically infinite with respect to our demand at present. Faced with shortage, how much would we pay for oxygen and water. And would we be prepared to kill to secure our share?
In what is destined to become an infamous piece of journalism this week on UK (Scotland) prime time TV Peter Odell said that the true price of oil should be $35 to $40 / bbl. The rest is speculation - according to Odell. So my main point and question. What would demand for oil be today if the price were $40 per barrel. And, assuming the answer is a few million bpd higher than we are now, where would that extra production come from given the large negative stimulus of low price upon the oil companies to produce oil.
My wine is now fully breathed and is to be drunk on a beautiful calm evening in Aberdeen.
Euan
above ground factors =conservation
Boris
London
I'm holding my breath.
Alex Salmond was just interviewed on BBC News channel. He said that "You would have to be very foolish not to realise that there is a very real supply and demand problem." He also dismissed the argument that most of the current oil price is due to speculation. He used the word "froth" rather than a bubble which is exactly the word Soros used last week. Doesn't look like he thinks much of Odell either.
Nate,thanks for this excellent article.I will save it to reread,probably several times.
Re "Tail,Dog,Wag" - A good example,I think,of Soros' second scenario is this AM in Australia.For several days there has been news of QANTAS closing routes and retiring older aircraft because of fuel price rises.There is a report in "The Australian" this morning about Anthony Albanese,federal Minister for Infrastructure,stating that we will have to spend megadollars over the next few years upgrading airline facilities for a huge increase in air traffic.
When I see this sort of disconnect from reality,and it is very common,I know that the inmates are running the asylum and(almost)inevitably the asylum is going to burn down.
The "(almost)" is because I still have hope,but it is diminishing rapidly.
Bravo Hagens; make that a double Bravo.
Soros is a legendary financial expert, but geologically I am of the opinion he will be blindsided by the realities of flow. It is early days and the market responses and flexibility of response on the demand side are yet to be tested. The effects of capital flows have yet to be tested. Thus, to judge this confrontation of the market with geological reality by the price at any given and fleeting moment is folly.
Neither $80 nor $200 would surprise me in the short run, and neither price is particularly indicative of the situation in the longer run. Scarcity being in the driver's seat may make us long for the stability of OPEC and the cartel.
I'm actually happy that we are now at the mercy of OPEC instead of the central bankers.
The central banks have the nukes and opec can turn off the tap so this stalemate is a nice thing.
It will force the central banks to make painful choices either play games and risk collapse or start toughing the economies and winding down the debt bubble.
So I prefer the OPEC overlords at least money is again gold. Black gold but gold.
"... we are now at the mercy of OPEC ..."
I don't think we are at the mercy of OPEC. We consumers of oil and OPEC are both being driven by Scarcity, which is 'in the drivers seat'. OPEC is selling oil and accepting fiat currency as payment, and then 'investing' that currency in financial instruments that are backed only by a foolish faith in the world financial system. They stand to lose the bulk of their sovereign wealth in the coming collapse. They can't escape from this situation because if they withdraw from the system, their populations starve and revolt. When world financial collapse happens, their populations starve and revolt. Not a happy future for them. The details of our future and their future differ, but which is worse? Both are pretty bad. Blaming this on OPEC is, IMO, not useful.
Why will there be a collapse? Because markets, especially derivatives markets, are creations of Law. They cannot function without a legal system. Legal systems require feeding (Courts, Judges, Bailiffs, etc.). When the cost of maintaining a world legal system can no longer be sustained, the system will cease to function.
I disagree OPEC is increasingly moving to realizing that oil is a precious resource. For both their internal populations and for the world. Its a much better guardian than our former masters who believe in infinite growth. OPEC will for the reasons you cite try not to collapse the system but they certainly will force it towards conservation. First in the importing countries and eventually for the internal populations as the flow of wealth in the form of fiat currencies becomes less useful.
So in my opinion your quite wrong OPEC waking up to peak oil and willing to use its power to corral our idiots gives us at least a chance. I hope the announce a conservation policy and systematic cuts in the near future.
One thing they desperately need to do is start starving the wealthy countries of oil and ensure the poorest get adequate fuel supplies. Pakistan and Egypt in particular need some serious help.
So given the super doomer I am a vocal peak oil aware OPEC is a godsend. I hope KSA listens to Venezuela and Iran its time to cut the ties and take control. Certainly the political posturing of Iran and Venezuela needs to be toned down and they need to recognize that if they don't use there power to come up with a reasonable solution for all a bad outcome is certain. But this is something KSA can do buy taking a more moderate stance and introducing a real depletion protocol instead of spouting nonsense.
In any case if we have any chance of getting out of this it will be because of a enlightened but tough OPEC not because of the former rulers of the world doing anything.
Saudi Arabia was the top country during the oil age and they have a rapidly narrowing opportunity to lead the world past whats coming.
You're talking about what they should do, given a only a subset of the constraints under which they operate. What you recommend for them is something that they might have known to do several decades ago. Many of their young princes were educated in well-run British universities, and did rather well in their studies. I take this observation as proof that there is much more to be known about their situation than is currently known on this list.
Just as we are constrained by our past, they also have a past that constrains them. Among other constraints, all nations desire to maintain life and limb of their elite, and to minimize wanton destruction of their general populace. This constraint applies to us both.
" ... if we have any chance of getting out of this ... "
Don't count on OPEC behaving with more godlike wisdom than we have. This is the flip side of them operating under similar constraints.
I guess an example of Globalization of a Commodity could be diamonds. Look how it has worked for the last several decades.
Not sure what you mean by "look how it has worked". Could you elaborate? Do you mean how a consortium historically managed to control the newly-mined supply, and thus maintain an artificially high world price? Cut diamonds were therefore the most portable natural form of wealth - undetectable by metal detectors, and almost mass-free compared to gold. Very easy to smuggle (e.g., so-called "blood diamonds"), but sometimes difficult to market (because naturals commonly could be sourced). Further complexities were 1) that synthetic diamonds became price competetive with naturals for abrasive use (diamond being the hardest natural substance), 2) that "cornering the diamond market" for gems proved difficult, with new areas of production (e.g., in Canada) coming on line as diamond geology became better understood, and perhaps 3) that utterly convincing inexpensive synthetic gem substitutes (e.g., cubic zirconia) became widely available for those who weren't convinced by the "diamond is forever" advertising. Given all these complexities (and I've probably omitted a few), you probably should be more explicit.
Or am I perhaps reading too much into your statement- were you simply referring to the fact that diamonds are so easily portable and valuable that they have always had a global market? Thanks.
I think reflexivity goes deeper than
It's one thing when some sense seems to remain of "the phenomena itself" being something separate from the observation. With reflexivity, we enter a realm where the observing is itself what is being observed.
Does a barrel of oil have an inherent price, apart from whatever we might think about it? Does money have any existence apart from our ideas about it?
I was watching a video about how it's banks that create money, not the government. Then I realized: it isn't the banks, either! It is every one of us!
Where the whole thing takes off is with borrowing and lending, with debt and credit. What is really deep is that these are the foundations of human culture! But just at a monetary level - if I borrow a few bucks, if I write an IOU, that is an item of value that can be exchanged. I have created money!
If money is really such an imaginary fabrication, does it really matter? At some very important level, all that really matters is that the fields get planted and harvested, the wool gets spun, etc. If on the side all the farmers and weavers have these amazing poker games where millions of paper dollars get traded and people win and lose fortunes - if the work gets done and everybody eats, does it matter?
Our amazing human world is constructed by vast networks of cooperative work. When my bicycle breaks, it makes a big difference whether I can find the replacement part I need. Our collective productivity varies vastly as a function of how well we negotiate and coordinate our plans for the future.
Money isn't just a tool for trading, it's also a tool for negotiating plans for the future. And planning does have a reflexive nature. Whether or not my plans are going to pay off well depends on how well they coordinate with everybody else's plans - along with the weather, of course! It's not that there is no reality apart from our imaginations, designs, plans, etc. But our effectiveness at working with that reality varies hugely, depending on our designs etc.
It looks to me like humanity is going to get hit hard over the next twenty, fifty, two hundred years. Of course nobody is going to survive two hundred years! But there will be people around in two hundred years. The possibilities seem quite wide open, what kind of world those people of the future will find themselves in. The most crucial determining factor will be - how well do we manage to coordinate our plans?
Coordinating plans is quite easy, when the future evolves very much like everybody expects it to. Everybody makes their individual plans to fit well into that expected future. That's a very pleasant sort of reflexivity!
But when things turn out quite differently that most folks expect, then everyone is forced to change plans. Now some nasty reflexivity enters. If we fail to coordinate our shifting plans, then day 2 turns out even worse than we planned for on day 1, so again we shift plans. The more we shift, the harder it is to negotiate. The worse we negotiate, the more we are forced to shift. That's a feedback loop with teeth!
How do prices shift, that doesn't interest me in itself. What really hurts is, for example, when stacks of very high tech passenger aircraft get built, and then it turns out they're too expensive to fly, so they just rot on the ground.
I have to tell everyone that I got to meet Soros in Prague in 1992 because my wife was teaching in Lithuania through the Soros Open Society Fund. At the time, we really had no idea what the Open Society Fund was about. We were just glad to be able to go to Lithuania and teach sociology and biology and have it paid for. No matter what you thought of Soros' effort to "westernize" the East Bloc countries, he was an interesting person to meet. I had no idea at the time he was a billionaire...he was just hob-knobbing with all the student-teachers over there to teach in various countries. I've subsequently always thought of him as a more worldly Buffet.
That would be incredibly silly and short-sighted - demand-side and supply-side solutions complement each other perfectly, and it would be madness to ignore half of the available solutions out of pig-headedness.
Of course, that doesn't mean it won't happen.
I do think your classification misses a great number of people, however; in particular, pretty much anyone who hasn't deluded themselves into thinking that the "preferred solution" they've put their faith in - whether that be nuclear buildout or powerdown and dieoff - is somehow "inevitable".
It's certainly possible to power the world with 100% renewables - anyone with a calculator can verify that for themselves - just as it's possible that we'll fail to do so and civilization will collapse. The question is what is probable, and I think there will be a third group that considers that question, how to gather evidence for, how to estimate, and how to influence those probabilities.
It's basically the difference between evidence-based and faith-based reasoning.
"It's basically the difference between evidence-based and faith-based reasoning."
Yes, but it's much harder to do than people think. Let's take renewables for instance...unless you hold a certain amount of "faith" that the technology can be improved and the product can be marketable on a massive scale, you would not be willing to make the effort at all.
I have argued in prior posts that what we suffer is not a crisis of energy but instead is a crisis of will. To be willing to attempt to leave the oil age (before it leaves us) we must believe that the world we are leaving it for will be better not worse, because who would willingly leave the world they are familiar with for a world they know will be much worse? A certain amount of faith in the future is required if we are to attempt to take control of the changes we are approaching and be an active agent in planning and implementing our own future.
RC
I think faith is a bad word. if you read stories of people who created companies they often believe that there companies are a long shot. a better word is risk. what IF I against the odds do succeed? who much will I make? how much will I lose?
** raises hand **
Can I be in the camp with all the hippies? 'Cos it looks like they're havin' more fun.
Disagree. Ethanol is good example. Tar sands another. There are MANY demand and supply side solutions that do not complement eachother at all.
I think you misunderstood my point. Nothing is inevitable, and clearly there are more than two camps. I just mean that the peak oil band of brothers (and sisters) are finally witnessing their common ground (peak oil is real) proven out in mainstream. The paths/policies and strategies they believe will change the future have been disparate from the start, but events and more knowledge of the bigger issues (global inequity, non-energy resource constraints, human drive for relative over absolute, etc.) will make the peak oil aware move more towards a bimodal distribution of viewpoints. (e.g. Community Solutions vs. Rocky Mountain Institute).
If we realize that not only are our means constrained, but our ends as well, then we need to address the 'ends' questions first, before we spend scarce resources trying to replace the same 'means'. Otherwise we find ourselves in the same situation but bigger, 5-10 years further down the road, with more environmental shrapnel.
We are going to need everything. All I was saying is that some very smart people are going to go whole hog trying to amass a cache of silver BBs on new supply, while others will grok the need to just put down the gun.
Reflextivity?? Sorry Nate, didn't even bother to read through all the comments, but just did a word search instead. All Soros has done is rephrase the Entropic Principle in nice easy words that the Boyz on Wall Street can understand.
So Heinberg (not Richard) gets credit for the phenomena and not Soros. Sorry George, but study your physics and you might learn something.
Great post Nate.
I think you have it right by identifying the supply/demand bifurcation in the peak oil community. I think we see that here quite often with those that see alternatives like wind and solar coming to the rescue with others seeing only demand destruction and apocalypse as the only way. I beleive we are certainly entering into a new age in history which will be a long way from the curent collective fantasy.
Nate Hagens,your post is an articulate, powerful and important insight into the economic side of peak-oil. Thank you.
Nate,
How do you think the introduction of full-size freeway speed electric vehicles will affect "participants" thinking?
In a serious crunch I think we can count on serious demand reduction activities... not by reducing per capita demand... but by allowing the number of people demanding anything at all to dwindle... or even to witness active measures (denial of food, medicine, etc.)... in short passive or even active genocide.
For some reason that amuses me. TheOilDrum is a great resource, but I find it improbable to imagine people turning here to improve their own situation. I just can't believe that anyone actually uses this (great, fascinating, enlightening) web site in that way. (Now someone will respond saying they do!)
I respectfully suggest your grasp of human nature needs a little work!
Proving my point? The one about someone disagreeing...
But really, which of my brilliant insights evinces a lack of understanding of human nature? Educate me.
Seriously...
OF COURSE I DO!!
You'd have to be either REALLY dumb or REALLY in denial to not use this web-site to improve your situation.
I'm not saying you're dumb. I'm just responding to you, in essence, saying I"M (and all other TOD'ers are) dumb.
TOD has directly influenced:
where I live (walking distance: waves and diving)
my job (production, non-discretionary)
what I drive (sold beloved truck, bought a Honda Civic)
where I have invested (oil, rig-makers, NPK)
travel (took long flights last 2 years)
long-term planning (where to go when TSHTF)
I must admit I'm surprised. TOD has influenced what I know but little else.
I view Peak Oil more like a tidal wave... should I run toward it? flee it? Oh wtf does it matter?
You believe that, relative to the coming oil shocks your Civic is going to help? That you'll recoup your oil rig investments?
I certainly wasn't saying that "TOD'ers" are dumb. I was saying that the "figure out what to do" approach seems kind of silly to me. But I have no problem if it works for you or others in some way. I'm just surprised that, reading this blog, you reach the conclusion that "doing stuff" makes a difference at the individual level.
The future will arrive, and we'll cope and starve as best we can. Sometimes planning ahead, particularly for highly probable but temporally unpredictable events, wastes more resources and creates more problems than it solves. Sometimes.
The smart investor and the lone ranger - hoarders, hoggers, rippers off, dominators, with calculator or gun - arrrgh, some Europeans would say, those Americans! ;)
Strong, determined, political action, as well as community organization, are what is called for.
Meanwhile the Obama ex vs. Hill now vs McCain jamboree trundles on in a parallel world. The disconnect is beyond schizophrenic.
Using your tidal wave analogy, I see two cases:
1) the tidal wave is small enough to survive if you run away.
2) the tidal wave is too big to survive - running will not help.
Faced with a lack of complete knowledge about the actual size of the wave, it would seem like the most prudent course is to run away. If it's too big to survive, no harm done - everyone is dead. Ah but if not, then your running may provide a dramatic difference in your relative level of comfort.
With what I have learned about peak oil here, I think it is more likely that a economy car will be more valuable in 5 years than a large SUV. So the smart course of action is (more likely than not) to sell the SUV and buy an economy car.
Likewise, since I will continue to own stocks, why not buy an oil driller instead of an airline company?
Being ahead of the curve means your preparations don't cost as much. Buying your water prior to the earthquake is much more economical of time and energy than trying to acquire it immediately afterwards. Sure the next quake in California might be so deadly it kills everyone, but if you aren't killed, then having that water lets you spend your time and energy doing something other than rooting around looted stores competing with everyone else who did not prepare.
The intellectual quality of this thread is what has made TOD my home for several years. It is so wonderful to see something discussed intelligently without flame wars, etc.
Hats off to everyone!
Todd
http://www.marketwatch.com/news/story/soros-says-commodity-bubble-echoes...
notice soros used 1987. he did not use the late 60s or 1929. the 87 crash was temporary and stocks met and exceeded those levels a 2 years or so.
Except Soros' comments directly contradict the comments from the NYMEX exchange itself - to wit, that the large institutional investors had gone short on oil last month not gone long. And in fact, they spent a huge amount of money trying to drive oil down, failed, then had to cover. Further, it looks like the recent run up on Friday was another covering action for institutional investors who went short again.
But as usual with you, john15, when the facts fail to fit your theories, you'll just ignore the facts.
OK. Some time ago I heard Simmonds say words to the effect that energy was the only long term investment he would make. That day I put my major investment into USO. It temporarily went down some but has been a fantastic investment. What will happen as much larger numbers do likewise?
Is that essentially what Nate is getting at in this post?
All this talk of reflexivity and quantum physics is interesting but it appears to my pea brain an effort to fit an inifinitely complex market into a scientific model. If your motivation is to have some pinpoint predictive answer pop out the other side, I am afraid that you will be disappointed.
The approach that has served me well is to look at history and how human behavior repeats itself over and over and over. Is this some new paradigm? Are things are different this time? Have we reached peak oil? I doubt it. Have the laws of supply and demand been repealed? I doubt it. Is the price of oil truly inelastic like insulin to a diabetic? I doubt it.
It is all about money, playing the odds and people talking their book. It is a BUBBLE. Sure, this one is a little bigger in scope. The ramifications of a negative outcome hold the world's people and economies hostage. But, in the end it is a bubble and it will pop. Higher lows? Don't count on it. I wouldn't be a bit surprised too see $10 (in real terms) oil again.
A few observations:
Virtual hoarding - Is it possible? Heck yeah. The fast and hot money is all about making money. The money chasing oil futures is driving the price just like easy mortgage money drove home prices and low float internet stocks went up 10 fold in days. As far as settlement vs. the price of rolling futures contracts, think about which one is driving the price. The market is in futures, not at delivery. How much choice does an entity taking delivery have to back out at the last second? VERY LITTLE. How much choice does fast money have to roll to another contract? NO PROBLEM.
Peak oil - Is the supply limited? Sure. But so were the number of available homes and the available shares of hot internet IPOs. Is demand incresing? Sure. Is Chindia a never ending growth machine? Don't count on it. These are the stories used by fast money to foster fear and greed. Don't believe it! There is always a story as to why it is different this time. It is no different this time. The supply/demand equation can change. It will change. How? When? I can't tell you. Oil at $500 a barrel? Who knows? It is all about playing to your fears and fast money talking their book and selling their story.
Most importantly it is about MONEY and history that repeats itself over and over in so many different mutations.
It only seems to be about money. Its all about energy.
We will have to agree to disagree.
It only seems to be about energy. It's all about money.
Everything is.
Can you print more energy?
No, but you can buy or sell every bit of it.
No, you cannot. Thermodynamics explains why.
Money is an abstract of the transfer of energy and resources. Without energy and resources, money is useless. Without money, energy and resources are still useful.
Energy and resources and systemic interaction (thermodynamics, mass conservation, and chaos/complexity) drive every living thing on the planet. Money only drives an unsustainable human civilizational system, but even that system is still underpinned and bound by energy and resources.
Ok, so I was being a bit facetious. This is becoming a circular argument of chicken and egg. We are arguing semantics.
My orginal point is that this is a huge bubble. Not unlike the internet or housing bubbles of the past few years. Oil was under $10 a barrel in 1999. It moved more than that last friday. Things change. This will change. Don't believe the hype. This all has a lot more to do with money than running out of oil. There were articles declaring an oil glut 10 years ago. Oil could be back to $10 (real dollars) a barrel at some point. Perhaps sooner than later. I am not calling a top. I have lived through enough bubbles to know you can't call the top. Will it be $135, $150, $200, $500? I don't know. What I do know is that it will end and it will be ugly.
That's the funniest thing I've read all week.
Although this came close.
Ah yes, the believers in how it is different this time. Always arrogant, always all knowing after multiple 100% moves.
Here is an interent company, a communications company and a homebuilder:
CMGI
JDSU
KBH
Ponder them. Allow your mouse to move across the historical prices. Perhaps it will give you some insight.
Ben Bernanke, George Soros, Timothy Geithner, Sam Bodman, George Bush, Dick Cheney, Boone Pickens (and I could go on and on) say this is not a speculative bubble (although there is always some "froth") but a fundamental supply/demand problem. Please write to them and tell them they are wrong, arrogant and you know better. Better still bet all your money on oil falling to $10.
There was a supply/demand problem with housing. There was a supply/demand problem with internet IPOs. There was a supply/demand problem with fiber optic cable. Bubbles are supply/demand problems of the worst sort. I could go on and on. In the long run, supply/demand problems get fixed by a thing called reality.
Humans and markets are not always rational and pendulums swing both ways.
For the record, Soros has said oil is a bubble, but I prefer to not put much stock in people talking their book or politically motivated government officials.
No Soros does not say oil is a bubble. He explicitly said "it resembles a bubble" but he also said the speculative element is a "froth" on top of the major element which is lack of supply. In congressional testimony he specifically said that he had been misrepresented by the media on this point.
The difference between this and other bubbles is that if this really is Peak Oil then there will never, ever again (or not for a very long time if we get past this) be sufficient supply of oil. The bubble can't burst.
If there's a miracle and high output, cold fusion engines at $100 a piece are perfected tomorrow then we just might be able to run from oil faster than it runs from us. Other bubbles didn't need a miracle to burst. That's the difference.
Wow, gross ignorance coupled with denial of basic physics coupled with self-immersion in a faulty worldview.
You could not ask for a better example of why the world is screwed. You are it, sir!
I'm sure you mean that in a nice way.
I am guessing you too have drunk the kool-aid and feel oil prices will forever forge higher? Is that your deeply intelligent, non self immersed, independently thought out, rational world view of the oil market, uh, based on physics?
Interesting that you feel my "faulty" world view is some how responsible for single handedly "screwing" it. Seems a bit contradictory and you give me way too much credit. But, I certainly don't mean to question someone of your obvious intelligence.
Again, I really appreciate your insightful post. It really adds to the debate.
I'd imagine that GreyZone feels a little like I do at at times, that attempting to add to the debate, such as explaining things like thermodynamics, biological mass conservation, complexity, carrying capacity, overshoot, or systemic dependence of infrastructure, food, heating, shelter, transportation, and products on petroleum, that explaining any of that would be a lost cause, as you already seem so sure of a fundamentally flawed worldview.
A worldview which is, in fact, contributing to the destruction of the ecosystem, the depletion of resources, and an imminent die-off of Homo sapiens.
But, no, k-bear, you're not single-handedly responsible for screwing the world. At the same time, though, no single raindrop believes it is to blame for the flood, no single snowflake for the blizzard, no single pebble for the avalanche. You might consider growing a pair to own up to the destruction you personally contribute to, so that you might consider doing something about it.
And to be fair, the evaluation of the oil market is not based just on physics, but also includes biology, geology, human sociology, and complexity.
If oil were only a bubble, the surface tension would have already snapped and the bubble popped due to the huge strain high oil prices put on everything else: fuel for ships, trains, planes, 600+ million cars and trucks, pesticides, cosmetics, pharmaceuticals, industrial lubricants, and everything made of plastic.
Oil is not in a bubble. Oil's price is rising because everything we need lies in a continuum of being somehow touched by oil to being utterly dependent on it. Much like blood in the human body.
Maybe we can reach some middle ground here. I don't deny that there is a limited amount of oil, that we are almost totally dependent on it, and that usage has risen over time. I am all for alternatives such as nuclear, coal, wind, solar, fuel cells, etc. This bubble has scared the world toward alternatives and when the bubble does pop we won't abandon progress in these areas. The now realized incentives for alternatives will drive huge innovations and change over time. Call me an optimist.
That said, I think the most significant current driver of oil prices is speculation.
I am not an optimist about the insane financial leverage and speculation that is facilitated by the federal reserve. Losers are bailed out and the winners pocket their gains. Our system is all about privatizing gains and socializing losses. I see this as being a MUCH bigger threat than running out of oil.
People making assumptions about how much real oil is controlled by the various markets have made a huge mistake in there calculations. Most oil grades are sold at a premium or discount vs the the oil contracts nominally traded in the futures markets so billions of barrels of oil are sold at a peg to the various futures markets. If you take this into account the actual speculative interest in the oil markets is a lot smaller than people predict.
Also it makes it impossible to blow much of a bubble in the futures markets since these other grades would be sold at ever widening spreads pulling real WTI purchases out of the market and dropping the prices for real oil delivery. People would simply begin to buy other suitable grades.
Too bad this is posted so late in the thread but I just thought about it.
I am surprised that John Maynard Keynes has not been mentioned. Keynes writing about how markets work and the rationality of traders said basically the same thing as Soros' "unorthodox" view of the markets.
I.e. the market is influence by news about the market, and professional investors cannot ignore that. Therefore expectations of the market (including irrational ones), become part of the market, allowing bubbles and crashes divorced from "fundamentals" to occur.
While Soros may have a point that this thinking has been woefully ignored in some circles, it not a new idea.
And you don't have to invoke any spooky QM analogies, the chaotic behaviour of classical systems is quite sufficient.
COMMENT: SO WHAT SHOULD PEOPLE DO?
A wonderful article, Mr. Hagens. As a relative layman despite having covered the oil markets at a major investment bank for several years, I have long been concerned about the future of both the world and my family as a result of the then-impending, now developing crisis.
Where might you suggest people invest to protect themselves from the unfolding events, both those that are "actual" (i.e. declining production) and reflexive (though of course both are actual, hence your article).
Investing in oil companies' stocks, futures indexes, or hedge funds is of course one means, though obviously fuels the problem (no pun intented). It also is going to be at an ever-higher level of risk given the growing volatility. In fact, if the #3 eventuality you suggest unfolds and people cannot trade energy futures, this suggests the value of futures held will effectively become zero?
What would you suggest for short-term and longer-term strategies/investments for individuals? I can only sense a doomsday.
Finally, I am dismayed by both the low level of understanding and short-term focus of the general public, most of the financial community, and the decision-makers of oil-producing companies and policy-makers alike. I see no way to avoid massive reflexive actions focused solely on the short-term pressures as they arise, thereby furthering the scale of the crisis.
Thank you in advance.
I would suggest turning the abstract of money back into what money represents: energy and resources. Invest in physical things within your personal sphere of management: land, tools, supplies, skills, and community.
Nate,
I saw this quote in the "Military Air Power: The CADRE Digest of Air Power Opinions and Thoughts" manual used by the Air War College.
Have you ever considered the similarities between war theory and economic theory?
Here's the quote:
"All these attempts at theory are only to be considered in their analytical part as progress in the province of truth; but in their synthetical part, in their precepts and rules, they are quite unserviceable.
"They strive after determinate quantities, whilst in War all is undetermined, and the calculation has always to be made with varying quantities.
"They direct the attention only upon material forces, while the whole action is penetrated throughout by intelligent forces and their effects.
"They only pay attention to activity on one side, whilst war is a constant state of reciprocal actions the effects of which are mutual...
"Every theory becomes infinitely more difficult from the moment it touches on the province of moral quantities."
Clausewitz