The Connection Between Financial Markets and Energy - Open Thread

Today, the financial markets are struggling with Lehman Brothers' Chapter 11 bankruptcy, AIG's problems, and the sale of Merrill Lynch to Bank of America. There is also the problem of the unwind of the credit-default swaps tied to hundreds of billions of dollars of Fannie and Freddie debt. This thread is intended for folks who want to discuss what is now happening.

Some may be asking how all of this is tied to oil and energy. There are quite a number of relationships:

(1) Some of the organizations with problems were no doubt speculating in oil futures. Once the prices started to drop, the balance sheets of the organizations were affected, and they suddenly needed more capital.

(2) As the companies who speculated in the oil market (all of them, not just the particular ones having problems today) try to unwind their positions because of margin calls, they drive down the price of oil in the futures market. That is likely why we are seeing declining oil prices, at a time when fundamentals would say they should be rising.

(3) As the price of oil and food rises, people have less money to pay debt of all kinds. This has contributed to the rising mortgages defaults, and is helping to drive down home prices. This is very closely tied to problems of banks and other financial institutions.

(4) Structured securities based on sliced and diced mortgages and other debt depend on assumptions regarding "independence of defaults". Once a shortage of oil and higher food and energy prices start causing mortgage defaults, the defaults are no longer independent (as they would be if they were caused by an illness of a particular homeowner, for example). Instead, there is a systematic bias in the pricing the risk, and the structuring doesn't work as planned.

(5) Energy companies need well-functioning credit markets to expand their exploration and production, and to pursue alternative energy approaches. For example, expanding the use of wind energy, or electric-powered vehicles, is likely to need a huge amount of debt financing.

I have warned in the past about the possibility of a debt implosion. There is a significant possibility that what we are seeing now is beginning of such an implosion. There are a number of institutions that have problems. Systemic risk (caused in part by counter-party failures) can cause these problems to spread to other institutions.

Here are some links to some earlier articles that may be of interest:

Peak Oil and the Financial Markets: A Forecast for 2008 by Gail the Actuary (Gail Tverberg)

The Failure of Networked Systems by aeldric.

The Expected Economic Impact of an Energy Downturn by Gail the Actuary (Gail Tverberg)

Peak Oil and the Financial Markets: A Forecast for 2008--July 31 Update by Gail the Actuary (Gail Tverberg)

This is the front illustration from that post:

Figure 1. An example of a system with systemic risk (Photo from

In that article, I say:

15. There is a chance that some type of discontinuity will make financial conditions suddenly take a turn for the worse.

With the events of last weekend and this weekend, there is a significant chance we are hitting such a point. In that article, I say:

As we go forward, I expect that there will be more and more individuals, businesses and governments that will be unable to repay their debt, because of indirect impacts of higher oil prices flowing through the economy. Eventually, the US government will have to make a decision as to what to do about all these defaults. The most obvious options would seem to be:

(1) Prop up as many as possible
(2) Let the chips fall where they may

We are now getting to see what happens when the US government lets the chips fall where they may.

Another article that is of interest is an article by Jerome a Paris (Jerome Guillet):

Lehman: more socialising the losses of the rich

While Jerome guessed wrong on which way the Lehman situation would turn out, his analysis is helpful for understanding some of the problems that could be ahead. Also, the discussion thread from yesterday has many links to recent articles on what is happening in financial markets.

Finally, Energy, Hurricanes, and Hedge Funds explains why short term financial movements have the ability to overpower the energy supply/demand fundamentals - especially their impact on energy prices.

Here are some connections I posted today to LATOC when explaining how a lot of the Big Banks getting decimated in the last few months were the ones most involved in laundering drug money, particularly drug money coming out of the world's new heroin capital of Afghanistan. We're talking (literally) trillions of dollars here that's been getting laundered into everything from suburban construction projects to oil futures, offshore rigs, and alternative energy infrastructure. These volumes of money can't be hidden in mattresses, they have have to be moved into the "legitimate" economy.

Booms in drug money laundering tend to coincide with construction booms, in case anybody here wasn't aware of that. Examples include Dubai which is both the money laundering capital of the world and the construction capital. In the 1980s, that distinction belonged to Miami. In the documentary "Cocaine Cowboys" a former drug lord explain that cocaine money built "half of Miami." That's just one example.

I suspect a lot of the heroin money from Afghanistan was laundered into the Big Banks now getting their asses kicked who used it to fund the suburban building boom (borrowing it from the drug bank at say 4% and then loaning it the subprime and Alt-A lumpenproles at 6%.) OF course the suburbs are bad in terms of energy and climate issues for reasons the readership of this blog does not need to have explained.

I don't think you can intelligently or honestly discuss ENERGY and BANKING without discussing DRUGS as the financial flows for the three are now so deeply intertwined.

You may be wondering "Okay but how does this connect back to Peak Oil?" Well for one thing, a lot of the big energy infrastructure projects are being financed with laundered drug money from off-shore money-laundering banks as these banks offer very competitive interest rates (in hopes of quickly laundering the dirty money into clean capital.) If you're a big energy company are you going to finance your pipeline, off-shore well or utility sized solar installation with a 20 year loan at 7% from a clean bank or with one at 5% from a dirty bank?

You might be tempted to say "I'm going to be ethical and go with the loan from the clean bank because I want to 'be the change I want to see'." At least that's what you'll say until you sit down with the company's accounting department to actually run the numbers: A $100 million oil pipeline or solar installation financed at 5% equates out to monthly payments of $66,000. If the project is financed at 7%, the monthly payments will be $77,500. Over the course of a year, that's a savings of $138,000. If your company's stock is trading at a price-to-earnings ratio of 30/1 then the difference between the dirty loan at 5% and the clean loan at 7% is $4,140,000 per year to your shareholders.

Bottom line is if you want to satisfy your shareholders - and/or keep your job - you're going to go with the loan at 5%, even if the bank is a suspected money-laundering outfit. The way the laws are currently set up, if you're a publicly traded company you're not going to get in trouble for taking the lower cost loan even if the truth becomes known.

I posted lots of links at the original but don't know how to imbed those here at TOD.

So that's what they mean when they say we're losing the war in Afganistan. Losing out on the drug trade!

Let's cut to the bottom line: What we are talking about is GREED. plain and simple whether it's drug money or lier's loans. Moral rectitude is no longer something that is valued. Over the year's I've come close to getting into some pretty dicey situations which led to try to live by this - Righteousness Pays with Happy Days.


Out of curiosity, I did a search for "lehman brothers and narcotics" and lookee-lookee what I found:

DEA Investigation Links Former Lehman Brothers Account Representative With Mexican Cartel
Accused of Laundering Millions of Dollars in Narcotics Proceeds.

LMAO! I'm sure there's lots more where that came from.

Any idiot can see the war in Iraq is about the oil. It's not like Iraq has too many exports other than oil for people to make gobs of money from.

But most can't see the war in AFghanistan is about the heroin. Which to me is funny as it's not like Afghanistan has too many exports other than opium for people to make gobs of money from.

So we invade the oil deposit center of the world and people finally get it that "yeah it's about the oil." (even if they understand the details) But we invade the opium center of the world, then see opium production go through the roof during our watch and people are unable to understand "yeah, it's about the opium."

In case religion fails as the opiate of the masses, we must stockpile the genuine article.

Opium is the religion of the masses?

"Religion is the opiate of the masses, and a comfort for the sorrowful"

Karl Marx

Opiates didn't have the bad rep then that they do today.

Any idiot can see the war in Iraq is about the oil.

I'll be the idiot then and claim it was over water.
(Why build 100 year bases for a 30 year product?)

Or lining the pockets of the military connected industries.

I tend to agree. The problem with the "it's about oil" argument is that it assumes a rational decision making process. Iraq has oil, USA needs it. Case closed? But - why was this logical train followed by such a disastrous and poorly executed decision to invade? Saddam was quite happy to sell oil, he wanted to sell more. The logical approach for the USA was to turn a blind eye to Saddam's human rights abuses and buy his oil, no questions asked (like they do with countless other favored dictators).

Instead, I think that the flawed invasion and occupation actually reveals an irrational decision making process. The story that Iraqis would greet the US with flowers as liberators, and immediately set up a friendly democratic state, points in a different direction. It points to the Iraqi exiles who shmoozed the Neocons and persuaded them Iraq was the ideal target for the PNAC project of domino democracy. This plan could also be sold on the basis of securing ME oil supplies, although the net effect has been to destabilise the region. And of course the industrial-military complex would be on board.

I think anyone who says "it's only about oil" is an idiot. Likewise anyone who thinks Afghanistan is about opium. Presumably, the Germans invaded France because of their desire to control the supply of Champagne and Camembert.


The problem was Saddam. The big Oil majors want to be the ones selling the oil and making the money as things everywhere else peak and go into decline. It's EXACTLY what Jay Hanson said would happen back in 1997 or so. That once we got close to the peak the U.S. would invade Iraq so that the friends of George Bush would be making the money not the friends of Saddam Hussein.

As far as Germnay's invasion of France being about wine: I don't know anything about this particular war but I bet 99/100 chance it was about either some type of lucrative resource and/or some type of lucrative trade route.

As far as Afghanistan and opium: you probably think it's just a coinkydink that the Taliban were able to almost completely eliminate it but that the U.S. using the best tech and best people somehow just "screwed up" and bada-bing bada-bang, the opium production goes through the ceiling? If you think it's about anything other than opium then I've got some Florida real estate to sell to you as it seems you'll buy pretty much anything.

Hmm...apparently you haven't noticed that Afghanistan is on the other border of Iran to Iraq.
Very handy is you did want to control a bit more oil as well as drugs.

The idea of single causation for any one historical event is a recognised fallacy, as a number of different influences may affect different members of the elite, and even chance events can have their input.

Even the siege of Troy can be seen either as for the love of Helen, or a socio-economic conflict to control the entrance to the Bosporus and important trade routes, and so on.

Exactly.. The reasoning is likely more complicated. The opium trade is a valuable asset to control, but so also is the distribution of the crude from the caspian basin. The control of the flow of oil is highly valuable politically and economically. After all, Afghanistan is right between Iran and other oil producing states, and China and Pakistan. After invading Afghanistan, there are milatary bases literally surrounding most of the main oil producing regions. The conflict in Georgia is most likely the Russian response to control the flow of oil from pipelines into Turkey. Its no surprise that we've been seeing anti-russian sentiment in the media!

And also not forgetting that possession is nine tenths of the law. Once you have possession you can make the law. Once you make the laws you have the potential to do pretty much as you like. Democracy anyone?


A confused and very weak argument, bob. You claim to show that "Iraq was not about the oil" by stating that it was "shmoozed ... Neocons {who were} persuaded ... Iraq was the ideal target for the PNAC project of domino democracy." but offer no proof that any significant neo-con decisionmaker cares one iota for democracy. The schmoozed neocons caused the disastrously comically under-manned under-planned post-war occupation, but not the incentive for the occupation in the first place, which I'm on record for having called as "the oil" a month before the start of the stupid event. It was clearly obvious then, and still is.

You may want to read up some more on PNAC, it wasn't 'Democracy' that they wanted to give the world. It was the US as the supreme military superpower and a stable middle east. According to them this could be accomplished by establishing permanent 'military presence' (100 year bases) in the middle east and the removal of the Iraq leadership, whether or not Saddam was the target.

I'm not saying it wasn't about oil, as a matter of fact I believe MOSTLY it was. But stability in the middle east could have been wanted for a lot of reasons. Ollie North warned us about Bin Laden long before 9/11/2001.

I used to assign things to 'conspiracy' a lot. I believe now that our leadership honestly believes that since they were elected/chosen/whatever to do the job and they are richer/smarter/more godlike than the peasant masses, that they will make decisions and no matter what follow them through because of course they are the right decisions. Iraq fits this description perfectly.

As for Opium in Afghanistan, when the Taliban was in charge the opium trade was all but destroyed there. Now the US is using local 'leaders' to help them fight the war on terror, much their money comes from the opium trade. Of course so does the Taliban's. I've been wondering if the troop increases there are due to actually trying to get the drug problem under control more than a need for more firepower.

As its obvious I am from Pakistan, close to afghanistan and there was taliban's newspaper published here and many people went to afghanistan from here to see how they govern between 1996 and 2001. All of those people reported that taliban had destroyed all the opium farms. Its an indisputed, well known fact that taliban destroyed all the opium farms, nobody ever doubted about it before you. Though taliban needed a lot of money to build war-torn economy of afghanistan and to buy weapons to secure borders they not used any money from opium.

If talibans were using opium money then they would have tons of money but they lived very poor lives (for eg ministers went to work on bicycles etc). Also if talibans were already using opium then how can its production be increased, it would only be sustained in that case. Remember that taliban had captured 95% of afghanistan by 1996 and for the next 5 years ruled a quiet peaceful country and all the war with northern alliance was at the northern border in only 5% of land occupied by northern alliance. Given that peace and 5 years of rule they would have cultivating and trading lot more opium than americans are able to do now in a war zone. So, the very fact that after american invasion opium production increased many folds proves that taliban were not using opium.

For opium and drug money, yes. But Afghanistan = Pipelinestan also!

Most, if not all major corporations have an ethics "standard". From my experience, this is little more than a sham.

I completed a stint last year in SE Asia. Although the corporation had many offices, they also had independent representatives.

The purpose of the reps was to wine, dine and provide prostitutes, etc. for prospective customers. As the deal closed, they also provided the kickbacks, the cost of which which were then passed on to the corporation as part of their commission. This was standard procedure in Thailand, Malaysia and Indonesia.

I returned to the head office in Singapore after such a experience and noticed a code of ethics in the foyer, next to the obligatory Mission Statement. Technically, the corporation had not violated their code, but the kickbacks were an open secret. I then realized I could no longer contract to the company.

Chimp: You have a great website-I just hope we don't hear that you got "depressed" and decided to jump out of a helicopter like that BreX guy. Keep up the fight for truth.

For those of use who are not proficient at searching LATOC, could someone assist in getting these links posted here? Thanks.

Ok this is something I know nothing about. (never have done cocaine or heroine but did have Fentanyl after a routine procedure once - nice!)
But trillions of dollars?!? C'mon.
The average dose is 300-500mg - lets say 400.
The average price is $71 per gram. So 2.5 uses per $71. So $28 per use.
$1,000,000,000,000 / $28 = 35.2 billion doses.
You said 'trillions' so lets triple that to 100 billion doses.
Assuming each heroin user uses the drug once a day, that is 100 billion / 365 = 275,000,000 users?
Can that be right?
To put that 'trillions' number in perspective, 86 million barrels of oil per day x $97 per barrel x 365 days = $3,044,000,000,000 or just over $3 trillion spent on oil each year (though this would be most ever since 2008 is highest price ever for oil, while heroin prices have plummeted)

Something not right here. Though it makes me think that there would be a positive feedback loop on the ratio of Heroin use/Oil use - e.g. the more heroin used globally, the less oil, as people would be crashed out on their basement carpets.

It's generally considered to be the world's third biggest industry, behind only energy and weapons. So yes, we're talking about numbers in the trillions over the course of 5 plus years. This is for ALL narcotics: cocaine, heroin, marijuana, etc. The best estimates are it is 2-5% of global gdp. Let's say 3.5%, that is 3.5% of 50 trillion which is just under $2 trillion. Over the course of 5 years of the housing and cre boom, that is $10 trillion that had to get laundered somewhere in the legitimate economy.

As far as the heroin/oil connection: not necessarily. If the person makes less than $15,000 a year, they generally end up in the prison economy which is very energy intensive portion of the overall econmy although I don't have stats handy.

It would probably be impossible to find a single large bank through which drug money does not pass. Just because a narco has an account doesn't mean the bank is in cahoots with him.

But trillions of dollars?!? C'mon.

Yes. Breadcrumbs for you to follow - Catherine Austin Fits and Mike Rupert. Toss in Mesa, AK. Mix with Richard Grasso meeting with FARC. Heat with some Stan Goff.

Add a dash of the comments of 'Poppy Bush' as drug running in case you wanna spicy meatballs. (You may leave that out however)

Another bread crumb: Peter Dale Scott, books and articles.

Excellent breadcrumbs.

A typo error:

It's MENA, ARKANSAS, not Mesa, AK. AK = Alaska, AR = Arkansas.

Especially recommended is Barry and the Boys by Daniel Hopsicker, and Compromised: Clinton, Bush and the CIA by Terry Reed (whistleblower / participant).

Guns flew south. Drugs flew north (Oliver North).

Also recommended: The politics of heroin by Alfred McCoy.

Mena, AR is why Clinton got to become President - he was trusted / blackmailed not to prosecute his predecessor..

The price of heroin used in this calculation might be the street price in NYC, but maybe not world wide. What about price in Calcutta or Singapore, or Bangkok? Or London, Rome, Paris, Athens, etc.? I think public data on heroin trade is very unreliable and the secret data that narcs use in planning there own work may be no better.


With the demise of the forest products industry in my county in northern California (which has essentially no manufacturing base) with under 100,000 people, the two major "industries" are wine grapes/wine making and dope growing. Estimates are that dope represents about $billion a year in economic activity.


We have a financial crisis and we're trying to eradicate the drug trade. Dumb!! We need to provide assistance and tax the hell out of it to pay for all those bailouts and all those wars. We are running out of things to tax, so not taxing one of the biggest industries in places like Mendocino and Humboldt county is not totally dumb.

EXACTLY, I say we make a legal system, much as alcohol, and some EXTREME penalties for operating outside them. Like three strikes your out except the taxpayers only have to feed you until the end of the week. Then after a year or so remove those penalties, or at least lower them a bit, and sick the IRS on anybody that operates outside the 'laws'. Dealers aren't afraid of the DEA but the IRS? everybody's afraid of them.

And to keep the cross the border stuff under control, if you are not an American citizen according to the Supreme court decisions about Guantánamo Bay you have no rights under the constitution, so if you are found with drugs in your possession, instead of sending you back to your country....

The billions we would save in jail space, policing gangs, etc. etc. could be spent on helping the 'hordes of addicts' that some worry about. And we would have a huge tax base also.

PS I am extremely against using drugs for me and my family and would not participate in this part of the economy, I believe most people would feel this way and the 'hordes of addicts' would never materialize. Then even if I am wrong so we all go into the 'Long Emergency' a little happier.

Booms in drug money laundering tend to coincide with construction booms, in case anybody here wasn't aware of that. Examples include Dubai which is both the money laundering capital of the world and the construction capital. In the 1980s, that distinction belonged to Miami. In the documentary "Cocaine Cowboys" a former drug lord explain that cocaine money built "half of Miami." That's just one example.

Another example (supposedly) is the boom along the Spanish Med coast in the run up to the currency switchover (when people were faced with having the origin of their peseta's being looked at - some people didn't want to say where the peseta's came from).

Drugs, Oil, and the bankers. Yes! May as well add terrorism in there too. They are all tied together. That is why I have always given my very highest recommendation to watch the The Truth and Lies of 9/11, Mike Ruppert's post 9/11 lecture. It's a great starting point.

As further reading, I would recommend "Drugs, Oil, and War: The United States in Afghanistan, Colombia, and Indochina" by Peter Dale Scott.

This book shows the connections between the three, the involvement of the CIA and the banks involved in the money laundering. Particularly interesting to me were the parallels drawn between what is known to have happened in Indochina in the 1960s and 70s with what appears to be happening in Afghanistan and Colombia today.

Yo Chimp,

M3 Report. All the latest horrors from Mexico, courtesy the National Association of Former Border Patrol Officers. May be of interest.

Theories of the illicit drug business being connected to international banks or the White House or oil services companies or Dick Cheney have been around for a long time. Unfortunately, they don't add up.

I suspect a lot of the heroin money from Afghanistan was laundered into the Big Banks now getting their asses kicked who used it to fund the suburban building boom (borrowing it from the drug bank at say 4% and then loaning it the subprime and Alt-A lumpenproles at 6%.)

You should learn how financing works before making these kinds of claims. The large homebuilders are public companies which borrow against their value - cumulative worth of their company as measured by their stock - in the bond market using Credit Default Swaps (CDS) to insure against risk. They do not borrow from banks. Smaller homebuilders borrow construction funds from the regional banks; it has been the only business these banks could find as the costomer loan business - revolving credit and auto loans - have been taken over by large, national banks. It is doubtful that Sovereign Bank or Suntrust ... or Wachovia ... are 'drug banks'.

Please provide sources if you can.

You also need to study how the mortgage market is structured. 'Drug banks' or other banks don't turn around deposits into mortgages. If they did so, the current financing crisis would probably not have taken place. Mortgages are originated then transfered to companies that 'deconstruct' the loans into sections and repackage those sections as bonds; the bonds are given high ratings by rating agencies then sold to investors. The investors have little knowledge of what it is - or was - they're buying.

While there is the cloak or anonimity to this process, this would be too dangerous to a criminal, since the 'counterparty' could be a person who would call the FBI. Commercial (depository) banks are highly regulated. Criminals deal with people they know and trust for this reason. Drug financing tends to be simple, cellular and personal.

Also, unless you really know what you are doing, you can lose your shirt in a hurry in the 'trading' markets. Criminals don't want to risk a big loss in a market similar to today's.

... a lot of the big energy infrastructure projects are being financed with laundered drug money from off-shore money-laundering banks as these banks offer very competitive interest rates

Again, this is nonsense. An energy company will finance a large project directly from the bond market, it won't borrow from a bank. Part of the financing will be Federal Agency subsidized with state- issued loans loans or loan guarantees providing the balance. These loans will be made from the bond market.

Part of the current crisis exists bacause a large part of the banking industry's core business - making loans to large (and safer) entities - has decamped for the bond markets.

The last notable bank caught up in a money laundering operation was Riggs Bank in Washington, DC in 2004. It was convicted of laundering funds for the account of the late Augusto Pinochet, for the dictator of Equatorial Guinea and for some Saudi diplomats. None of these accounts were related to drug trafficking.

Believe it or not, the government gats money from busting banks and others convicted of illicit activities, in the Riggs case, the fine to the Treasury was $25 million.

Banks in Miami have made money by processing remittances to immigrants or taking as deposits remittances from relatives in Latin American countries. The banks in these countries are unreliable and the Miami banks are substitutes ... for burying money in the back yard. The amount of remittances is very large; approximately $70 billion:

While the drug trade is large, the greatest amount of money is in the marijuana business, which is largely domestic or Canadian and Mexican.

Trying to put a value on street drugs is difficult, anyway, since drugs are usually easy and cheap to produce. So- called 'street' prices (cumulative) are more or less speculations, but would not reflect on global totals since producers do not sell the drugs on the street, but simply transfer uncut drugs out of the producing areas. The prices at this level is a lot lower than the street price. The cumulative producer price is about $12 billion, which seems a reasonable number:

It does not add to the credibility of the Oil Drum when conspiracy theories are recycled.

Theories of the illicit drug business being connected to international banks or the White House or oil services companies or Dick Cheney have been around for a long time. Unfortunately, they don't add up.

I look forward to you explaining the photo of Richard Grasso in the jungle with FARC leadership.

Go ahead.

It does not add to the credibility of the Oil Drum when conspiracy theories are recycled.

As you have such a solid grasp - do explain the Mr. Grasso photo.

(Huh - wonder why the photo is un-explainable? )

It does not add to the credibility of the Oil Drum when conspiracy theories are recycled.

The power and influence of the drug cartels in America is no hair-brained theory. Las Vegas has been one of the prime beneficiaries of drug money for over 50 years and if you think that "What happens in Las Vegas stay in Las Vegas" you are sorely mistaken. The sleaze has crept into every hamlet from sea to shining sea.

Sally Denton and Roger Morris wrote a definitive docu-book: The Money and the Power: The Making of Las Vegas and Its Hold on America, 1947-2000. Read this well researched and under-appreciated classic and then say you don't give any credence to conspiracy theories.

America may have never been Bedford Falls*, but it is clearly now Pottersville*.

*The fictional towns from It's A Wonderful Life

"...America may have never been Bedford Falls*, but it is clearly now Pottersville*..."

Oy'vai Joe...I'm afraid your right on this one.They are taking 'the pursuit of happiness' from the Declaration of Independence very seriously. This is what America was intended to be - believe it or not - this is our ideology.Like I have said before: a huge democracy comparable to Rome will lead to a new Emperor comparable to Nero - watch and see.

As for the current (and unprecedented) economic 'collapse', peak oil has everything to do with it.Energy = growth, and aside from all of the perusal on the excessive corruption within our war based economy, right now growth is impossible because we are clearly at the peak in oil extraction.We are witnessing (right now) an economic train wreck of Biblical proportions; and all of the hoopla regarding Indy Mack and Lehman Brothers is nothing more than a diversion from the real culprit for the masses to debate about.

Talk radio these days is boarderline insanity, they are to quick to point the finger at someone else. It's the Chinese...It's the Banksters...It's the Illuminati...It's the aliens...

No need to point fingers, however, we all had a part in it.
We have been deceived.
May God have mercy on us all.

That is likely why we are seeing declining oil prices, at a time when fundamentals would say they should be rising.

???? Most of the established fundamentals analysts have been sceptical of these high oil prices all along. Everybody in the oil industry I've talked to in the last year said they didn't believe these prices were sustainable. Everybody outside the oil industry said prices could only go up. Number one industry number cruncher PIRA has been the biggest bear all through the 140+ bull market, and they're now vindicated.

Obviously all the distressed selling (not to mention all the short spec money) is going take this market to rediculous lows, but anyone claiming that fundamentals say oil should be rising has not read many reports.

I seriously doubt that, huge restrictions have been put on money transfers between countries since 9/11. All important transactions are closely watched, I have a friend that got into trouble because of an substantial transfer of money between Haiti and Canada in relation to a family inheritance, the money is frozen and basically in limbo now. Having say that, I know there is an important shadow economy where drug related money is recycled in real estate projects (we have a lot of recent stories around that here in Montreal).

So far, the largest impact seems to be that Lehman Bother's has closed its carbon trading desk in Europe:

Less competition in this emerging market could have long-term implications.


Hopefully this will pull the plug on coal fired power projects in Nevada (Ely Energy Center), Texas (Spruce), and Virginia (Dominion). Also, it seems as though the aquisition of Merrill Lynch by BoA will give BoA too large and exposure in this area and we will see other cancellations. The Sierra Club is keeping track here:


I'm one of those people who keeps track of my car's gas mileage. I recently looked up my records up to see that gasoline was around (US)$ 2.80/gallon at the beginning of 2008. I noticed that when retailers complained of slow business throughout the year, it pretty much corresponded to energy prices at the pump.

For what it's worth, I concure with Gail's arguement. Unfortunately, many people outside TOD still think I don't know what I'm talking about when I bring this point up.

Maybe I should grow a beard to add an air (image) of authority?

Oh sigh.

People always told me to wait until I got gray hair. That would add an image of authority. It still hasn't happened though, and my children are grown.

I already have the gray hair... doesn't seem to help.


I could practice some ventriloquism. My gray tabby certainly looks more authoritative than I can ever get myself to look. (In which case the cat WOULD have my tongue.)


And they say that TODers are only full of doom & gloom. HA!

(2) As the companies who speculated in the oil market (all of them, not just the particular ones having problems today) try to unwind their positions because of margin calls, they drive down the price of oil in the futures market. That is likely why we are seeing declining oil prices, at a time when fundamentals would say they should be rising.

Could we go through this again for the hard of thinking such as me, please?

In one of the Ike threads, I think that Nate said that he estimated that the falls in the oil price were:

70% due to deleveraging
25% due to reduced demand / expectations of a slowing economy
5% (or less?) due to hanky panky to help the Republicans

However, I was also under the impression, in discussions over the summer, that Futures speculation was deemed to be only a small part of the oil price. So, is this speculation not futures speculation? or have I misunderstood things?


It is hard to separate the deleveraging and the speculating. It is looking more and more like speculators got caught and the top, and are a big piece of the deleveraging.

I don't think I ever made an estimate of how the split broke out.

Could you explain how the delveraging works? Which market(s)? or what entities? does the money come out of?


P.S. I think that it was Nate Hagen who suggested the percentages.

I was guessing. With the main point being that we can't just look at one piece of the puzzle (e.g. decreased supply due to hurricane) and automatically know the price reaction - there are many factors and the true 'explanation' (as opposed to the silly ones made up at the end of the day on CNBC) won't be known for months after the fact, at which time they will be crystal clear. Everything is of course clear in hindsight - that is part and parcel of how Black Swans operate.

Any particular Black Swan you are talking about here Nate? Complexity I agree, but black swan?

This isn't a real 'black swan'; what is happening is the predictable outcome of overleveraging and falsification of collateral value.

Fundamental economic values ... as opposed to prices ... are being reset. If values are set to closely align with function rather than status ... we Americans are all in real trouble. Massive investments have been made in status items. Now, these are looking to be 'mis- investments' ... or non- investments.

It will be interesting to see how our culture of 'luxury' aligns with current events. It's hard to sell luxury to the homeless. Certain outcomes include a large impact on New York City real estate and tax revenue for the city and the State of New York. Large infrastructure projects that require private funding will languish. Mergers and acquisitions will dry up ... a cash cow for investment banks is now gone. Commercial paper will likely take a hit as more defaults are now likely.

If the government wants to do something useful instead of looking like idiots on television ... a board needs to set up to unwind all the Credit Default Swaps and return the premiums to the buyers. The 'face price' of these things amounts to trillions ... the cash cost is probably fairly small since the majority were issued/purchased when the good times looked to roll on forever ... a year ago. The swaps would be returned to the sellers and the premiums refunded. The amounts unpayable after unwinding - due to the failure or insolvency of the issuing firms - can be covered (lent) by the Fed. This amount is probably less than the Bear Stearn bailout. It would empty the CDS reservoir before the deluge ...

We get to see what 'Moral Hazard' looks like in 2008. It's not risky behavior 'sometime in the future' but a line of people loitering at the Treasury Department loading dock. These guys won't buy a newspaper unless the Treasury 'accepts some of the risks involved'. Besides the usual gangsters and hangers- on, there are airline executives, the Big Three automakers, commercial banks, retailers, rail roads, governors of various states ... Hey! Isn't that Madonna?

The more things change the more they remain the same!,_1929

Everybody should be required to read these books in school.

Financial markets and energy, my favorite topic! Sorry to be late to the party...

My take: Of Bailouts, Hedge Funds and Energy

Speculators may have played more of a role in the oil price boom and bust than I previously believed (although the new Masters report and the CFTC report are at odds on the question), but what we're seeing now in the energy sector has little to do with questions of supply and demand for energy, and everything to do with flows of hedge fund money and bizarre beasts like credit default swaps.

Attributing the action to almost anything is difficult, though, because it's all so interrelated. The dollar has probably played as much of a role in setting the price of oil as futures speculators, but it's difficult to tease those factors apart. Ultimately you can only really point the finger at sentiment: either fear or greed. Fear has ruled the day for most of this year.

I expect there to be more widespread and indiscriminate selling of stocks in every sector until most of the deleveraging has been accomplished, punctuated by short broad-market rallies. And I think Roubini was right to say, in his Tech Ticker appearance today, that Goldman and Morgan Stanley are probably not long for this world either.

So energy stocks and hydrocarbons could be beat down even further from their current irrationally low levels.

Until all this mess is unwound, investing in the stock market is going to be only for the bold and the bulletproof.

My thoughts on the 1929 comparison:

As I noted over on the Lehman thread, worldwide oil consumption in 1939 was higher than in 1929:

The world was consuming more in 1939, because the world was producing more, and the US was a leading oil exporter. We were a primary source of oil for the Allies in the Second World War, but in 1939 we were less than 10 years away from being a net oil importer--more than 20 years before we peaked.

Big difference between 1929 and today: Our model (ELM), recent case histories and two years of annual worldwide data show an accelerating net export decline rate. Also, in 1929, millions of people in the US wanted to drive a car for the first time. Today, hundreds of millions of people worldwide want to drive a car for the first time.

However, the ELM suggests that the really bad news for financial institutions is still ahead of us:

I'd contend this is Lehman meltdown is the 3rd major financial crisis is just over a year. The initial sub prime meltdown really hit the first 2 weeks of August. Bear Sterns hit in Mar of '08. Take a look at the weekly NYMEX crude oil price chart on both of those:

Both entailed a massive liquidity infusion into the system. Both funded a flight to tangibles and oil got bid up.

This time its no Fed bail out and they'll allow the chips fall where they may. I'll contend the PTB (powers that be) know another bailout would mean more dollar pounding and oil and metals rallies. Cant have that again now.

That's the classic dichotomy to watch, will oil fall becuase of a disfunctional meltdown economy or will there be a flight to tangibles? Equities and derivatives are going down. Real world cash values for oil and metals are disconnecting from the bogus futures markets. Try going into a coin dealer and buying gold or silver for offical prices. You can't. The precious metals ebay premium is 30=50%.

The 54 cycle on Colonial Pipeline (now current) is trading 1.25 over the NYMEX futures. It looks like real world premiums are running 30-50% over the bogus futures in oil too.

Longer term, the flight to tangibles will prevail.

The bail-outs haven't stopped - AIG is getting government support, and the Merril Lynch takeover seems to have been engineered by the government, so presumably they will have to contribute, or if BOA gets into trouble, make an even bigger takeover.

How many cars were there in 1939 vs 1929? I think that answers the question, don't you? It was the beginning of mass production.

Speaking of 1929 (and the iconic stories of bankers leaping from high windows)...have you seen today's Non Sequiter cartoon? It is here:

(If somebody knows how to make it appear in the thread as a picture please do so)

Things are really getting deeply ingrained in the social consciousness when they start appearing in the mainstream funnies.

If somebody knows how to make it appear in the thread as a picture please do so

Thanks for posting this, Gail. I also think that the real estate collapse is about oil in another way - the massive run up in home prices that drove the economy in so many ways for so long came in part because we shifted the nearly-50% of the population that farmed at the beginning of the last century into the industrial workforce. Then, when the percentages of farmboys that could be sent into industry began to run low, we sent women into the industrial workforce and outsources, mechanized or abandoned all the informal economy that women and rural populations began to do. When we ran out of Americans, we globalized the economy and began shifting huge portions of the world's rural population into urban slums - and concentrated housing, even slum housing, can be completely disconnected from its ability to support life - from the actual natural resource capital tied to the land - the minerals, soil, trees and etc...

Historically most land and houses were tied to a metaphorical gold standard - over the long term, they could only be worth what the land could produce, plus a bit more for capital improvements. But cheap energy meant that just as money relinquished its ties to gold, a natural resource, so did most housing. But of course, the problem with not having any kind of economic anchor is that eventually, we have to ask the question - what is the real value of the thing, in the absence of infinite cheap energy?

Anyway, thanks for letting us explore this issue.



The value of a home site (let's say a vacant lot) is closely tied to its relation to work sites (aggregated as urban centers or sub-centers) mediated by the cost of commuting to and from the home (along with errands). When gas was cheap, commuting costs were almost an afterthought and many distant locales were developed en masse (think of people "driving until they qualified for a mortgage"). The approach was based on 50 years of suburban experience and seemed to work very well.

As gasoline stopped being cheap, distant sites actually lost value. People would no longer pay what they used to in order to obtain them (there are other housing options available). Most such lots were debt financed, and the value behind that debt has been evaporating. Those values will not return unless somehow commuting costs are brought back to previous lows and can be assumed to stay low (mortgages are long term commitments).

One could analyze the loss in value at just one distant home site, say -$20,000, and simply multiply it across all such home sites to arrive at a very large figure for the amount of real estate value lost (gone, *poof*) thanks in large part to the rise is fuel costs. We are now addressing the question of who do those losses affect; how are they covered?


I think you are right about oil being behind the massive changes in the workforce and the run up in industrial production. Oil is also behind globalization, which is another force we have encountered since WWII.

As oil supplies go down, they will have huge impacts on industrial production and globalization, probably operating in close to reverse the direction they operated going up.


What I find curious is that I've not found a person, in my area, who buys into peak oil and peak investment and the crash. They believe that oil prices have come down and that it was just a blip that they went up. Dito for gold - they're waiting until it drops some more before buying.

Roubini sums things up nicely (Windows Media movie):

The prevailing attitude is that this is just another bubble.

Up here (Canada) we've got a Fed. election coming and the Liberal party is pushing their "Green Shift" - but my impression is that nobody is concerned about global warming any more. We seem to be stumbling from one event to another. There is lots of complaining about gasoline prices (just jumped to about $1.30/L here; around 2x what it is in Mexico) but nobody is looking at the fundamentals. It's the blame game - the multinationals are ripping us off yada yada yada.

What I keep wondering about is how elastic is supply in the face of a depression?
What's happening with NG exploration and drilling in both the USA and Canada in the face of financing problems? Will the increased profits be enough to find the exploration ... to keep the homes heated or what?

I really hope that this doesn't get as bad as it did with dancing. We had a wonderful building with a massive sprung dance floor. But the building was changing hands so often that it became impossible (well more risky and uncertain) to book a dance far enough in advance to do the advertising. In the end - due to the instability of ownership and there being "no demand"; the place was demolished.

Agreed, praetzel, the ability of the producers to supply oil in a major downturn is an open question.
We're seeing now that equity can be destroyed orders of magnitude faster than even Helo Ben can print it. The rules of the game are:

Cash is king during a depression.
Economic theory works for price rationing, but it can't make predictions about scarcity-rationed markets.
As the velocity of money falls, all investment slows, even for energy and food production.
Inflation still happens for essentials, even in a broke, broken system.

Going long on energy at some point means burying a propane tank on your property, rather than playing the CBOE paper game. Sure, we'll all still need money to pay our property taxes, but the daily essentials of food and energy trump all else.

The lesson from Argentina's collapse:

Nelsone: Your linked article is one of the scariest things I have read lately. Sounds like the most important thing to do is to live near, very near, people of a like mind.

Actually to me nelsone's linked article reminds me quite a bit of how life was in rural Canada (and USA I hypothesize) in the 1950's.

Gail -
thanks for opening this necessary space for integrating discussion of finance & energy.

It seems to me that a further component of this convergence of events is H. Ike, & his ilk.

Consider the perspective from Houston, with its unique focus on the oil & gas industry.

Post Ike, there is no power across much of the city, phone lines are down,
numerous high-rise office windows are blown out, and a night curfew has been set up against looting.

Energy companies based there are unlikely to be able to respond via normal channels to events on Wall St,
where AIG, formerly the largest insurer, has seen its share price fall ~50% so far today.

If, as seems likely, AIG goes under, unmet claims for broken windows will be small beer.
Here on TOD Ike has been described IIRC as a 15 to 20$Bn storm.

So how would ex-AIG client companies & householders alike not only cover the storm-damage costs
(with credit facilities notable by their scarcity)
but also find affordable fresh insurance cover, without which their assets suddenly have no collateral value ?

And in amongst all this mess is those energy companies' potential to invest in the US industry's development ?



It's my understanding that AIG has been bailed by the Fed accepting equity for collateral.
There may be something like this going on in the takeover of Merril Lynch too, so as far as I can make out the Fed may have taken on up to another $90bn in doubtful assets - not a bad average over the last two weekends.
It could get expensive if this carries on.
I may have misunderstood though, as the financial shell-game - oops, financial industry - it outside my ken, just the way the bankers like it.

It could get expensive if this carries on.

"Yes, a trillion here and a trillion there ... and pretty soon you are talking about real money."*

* This is my updated version of the original quote ... "... billion here and a billion there..." probably by Senator Dirkson in the 1960's.

Anyway, before anyone beats me to the punch, I am copyrighting the following versions:

"... a quadrillion here and a quadrillion there ..."

"... a quintillion here and a quintillion there ..."

"... a sextillion here and a sextillion there ..."


"... a centillion here and a centillion there ..."

And maybe even:

".. a googol here and a googol there ..."

As you can see, I am expecting only modest inflation. Nothing like the Hungarian Pengo which traded at 460,000,000,000,000,000,000,000,000,000 to the dollar in 1946.

I'm totally optimistic that Paulson and Bernanke can keep inflation under 11,000,000 percent :)


Is that $46 gazillion or is it just a bajillion?


Natural catastrophes, like hurricanes, do put sudden stresses on the system that make the impacts of peak oil suddenly stand out. Having the oil offline will put more stress on the economy. Needing to do all of the repairs in the Houston area will take resources that could otherwise be used in other areas.

There are at least theoretically safeguards in the insurance arena. The parts of AIG that are US insurance companies (part of it is offshore insurance companies and non-insurance companies) are subject to post-insolvency assessment plans, intended to protect small claimants. They typically pay up to $100,000 per claim on most lines of insurance. This won't go very far in paying a big commercial claims, but it does provide some protection for homeowners (not that $100,000 will go very far in repairing some of the homes, either).

If there is big damage, virtually no insurance coverage, and no loans available for rebuilding, your are right that this could be a serious problem. I think that such a problem isn't likely to be widespread now. It looks like the federal government is loaning AIG money to bail them out. Also, I would guess that AIG doesn't write more than 10% of Houston exposure, so even if it did fail, the impact would only be partial.

AIG's American General division is headquartered right along the swollen banks of the Buffalo Bayou in Houston. Don't know their local exposure, but they must be kind of distracted right now.

...numerous high-rise office windows are blown out....

This in itself is a huge scandal. Skyscrapers are built to take up windloads according to codes

Guide to the Use of the Wind Load Provisions of ASCE 7-02

But why did the windows fail? Sometimes you have extreme wind conditions due to the positioning of skyscrapers. But that should have been checked out in wind tunnels.

Comparison of Wind-Tunnel Measurements of the Flow and Turbulence Fields in Arrays of Two- and Three-Dimensional Buildings

From here:

A couple of broken windows could have been caused by extra high wind suction at a particular point, bad workmanship during installation, material failure or similar. But a whole facade? That suggests a design error.

I am sure there will be endless court cases on compensation claims.

Madman talking head Cramer is practically in tears:

If Only the Fed Would Slash Rates

For more intelligent heads, listen to Aaron Task and friends:

Crisis on Wall Street: Roubini Predicts Another 20 Percent Stock Drop, Sale of Goldman, Morgan

He looks like he hasn't slept in a month. That's what Clinton looked like by the end of his presidency.

...the financial markets are struggling with Lehman Brothers' Chapter 11 bankruptcy...

Chapter 11 is reorganization. As a financial-services company, Lehman is not eligible and their bankruptcy will be handled under Chapter 7, liquidation. Since all the assets will have to be sold, some of them will be revealed to have a value of essentially zero. This may have consequences for other firms that hold similar assets. Such a revelation might be deferred almost indefinitely under a reorganization.

An open auction for assets is the atomic bomb that the industry has been trying to prevent all year. Bet the Feds find some way to intervene to prevent this from happening. Declare it all "national security related"? Hold the auction in an undisclosed location, Bush Pioneers only invited?

If the government simply froze the value of every asset in place to prevent panic, and trading ground to a halt as a response, how long would it take for the rest of the economy to be dragged down with it?

Super, the term you want (from a few days back) is "market state".

I appreciate this suggestion, but if the state sets market prices on an arbitrary basis, and also owns the mortgage industry when it is one of the "commanding heights" of the economy, then we're in a mixed-economy state.

However, we could have said something similar during the Nixon era when we had price controls. What's different, and important, is who benefits from the current version. Apparently, now the private owners of the economy meet ever more frequently with Bernanke to negotiate and then issue commands to the government to pre-empt the marketplace where they desire, and to hell with the rest of us since we don't vote on issues anymore.

It's not exactly government as "referee", since the rich are not acting as competing teams anymore. Also, referees don't charge into the stands with truncheons to silence booing paid spectators (us).

It's more like the pretend referees, and announcers, and promoters, of a World Wrestling Federation event. It's a fake in that the outcome is predetermined (all the spectators' money ends up in the hands of the WWF's owner and employees), but the actor-wrestlers can improv a big show of how they get there. The market is the supposed contest in the ring. If the promoters write scripts where actor-wrestlers who please the paying spectators win more often, the spectators pay more. That's a stronger economy. The referees won't interfere with this at all. The announcers will tell the spectators what they want to hear.

Now one might point out that the spectators actually have to have real jobs to make money to pay their tickets, but I can't figure out what any of us do to produce real value or what relationship that output has to our wages. Maybe we're all scalpers trying to trick each other into paying premiums on the tickets we're stuck with. It could work for a while.

Sorry, I was in a rush. "market state" is Bobbitt's term for the next step after nation state, where the mission of the state becomes "maximizing opportunity" and no longer community, commonwealth or greater good. The state doesn't set market prices, but pushes everything into the market. It has all sorts of ramifications on legitimacy of state, consensus, yadda yadda. [Email me cfm at dryki dot net and I can give you more references; you don't have email on profile.]

Yeah, I imagine they'll do everything they can to avoid or delay the dreaded "price discovery". But I would think the atomic bomb here is in the derivatives market. It's now a quadrillion-dollar tightly woven web of contracts, touted as a kind of insurance, except since it's mostly OTC and unregulated, nobody was assessing whether the "insurer" or counterparty would actually be able to pay up. Lehman is about to default on who knows how many of these contractual agreements, and the banks will become reacquainted with the phrase "counterparty risk".

With Bear Stearns, some said that it hadn't been allowed to fail for just this reason. JP Morgan was the primary counterparty for Bear's derivatives agreements, so if Bear couldn't hold up their end of the deal, it made sense for JP Morgan to get all their assets (plus $30 billion) in compensation. Nobody wanted to risk the domino effect in derivatives. I am actually quite surprised that the US didn't bail out Lehman for this reason.

The nest media seem to be reporting it as a Chapter 11 bankruptcy. For example, this Reuters articles says:

U.S. stock index futures were down sharply early on Monday, pointing to a steep fall at the opening on Wall Street after Lehman Brothers (LEH.N: Quote, Profile, Research) filed for Chapter 11 bankruptcy protection, heightening fears over the embattled financial sector.

Ah, I see the distinction now. The holding company at the top is the one that has filed for bankruptcy; since it provides no financial services on its own, it's eligible for Chapter 11. I look forward (with morbid fascination) to seeing what kind of reorganization plan they and their creditors offer the court. Gail, I'll bet you a small beer that they are eventually forced into Chapter 7 by the judge.

In the meantime, as others have suggested, there will some delay before they are forced to reveal how much worthless paper they are carrying on the books.

It could take years to totally unravel what is owed where, according to Pricewaterhouse, who are liquidating the company in the UK.

Over the last couple of days as I try to figure out this complicated environment my respect for Paulson has climbed - it is suggested that Bear Stearns had to be saved, as it was a bolt from the blue, and so this would have been the players first experience with an institution heavily involved in derivatives, and Frannie's collapse would have made the US debt unfundable as the Chinese and Japanese would not buy any more if they were allowed to fail, but the gap since Bear Stearns has allowed the markets to unwind their positions in Lehmans to some extent, so hopefully the calculation is right and no systemic collapse will follow.

These investment banks and the derivatives model are basically being folded up, to give way to far more conservative banking hopefully.

AIG remains a big worry, with perhaps $1 trn of positions stretching throughout the financial system.

With all due respect to you, my opinion of Henry Paulson (and Bernanke, and Greenspan, among many, many others) remains exremely poor. They created this Ponzi scheme, and now they don't know how to get out of it without putting you and me on the hook for it. Even though there is was no explicit federal bailout of Lehman, I guarentee every single one of us is gonna pay for the Big Boyz crimes.
They all ought to be breaking rocks on a chain gang someplace.

Gail - Great Post! Tonite on PBS News Hour they dedicated almost the entire hour to this issue. Uncertainty Hits Wall Street After Lehman, Merrill Meltdown

Nouriel Roubini an analyst with RGE Monitor quoted the darkest prediction I've heard outside of JH Kunstler.

It's not just about housing. This is a severe economic and financial crisis. And the only light at the end of the tunnel so far is the one of the incoming train, unfortunately.

1) ALL economic activity is work in the physical sense.

2) ALL work requires the flow of energy from a high potential source, through the work process, to a low potential sink.

3) The guidance of energy flow through the work process requires knowledge (of the process and its control model) and information regarding the energy potential available.

4) In the economy money acts as an information token representing the availability of energy to do work at the micro level.

5) Monetary policies have been crafted to disconnect the meaning of money as energy available to do useful work; money is now a commodity a-la Friedman. Money no longer serves as a measure of available energy. Though its flow, counter to actual energy flow, still acts to guide presumptive energy flow.

6) Fractional reserve banking, loaning some portion of an account to a borrower on the idea that the borrower will use that money as if there were energy to do useful work (unconsciously of course) and produce some additional wealth worked as long as net energy (ERoEI) was increasing over time.

7) Until at least the 1970s net energy had been increasing over time, hence the credit system worked because the debt could, in theory, be paid back in a subsequent time period due to the net increase in wealth-production potential.

8) With the advent of production of harder to obtain (lower ERoEI) oil, net energy gain started to decline (creating the top deflection in the peak curve). As net energy gain started to decline it became increasingly difficult to have an increase in wealth-production capacity -- it became harder to repay loans.

9) Since money value had been decoupled from energy available to do work the signal that loans would be harder to pay back was lost.

10) Sometime between the end of the 70' and into the 80's we found it necessary to continue what amounts to a re-financing scheme, chasing more debt to cover previous debt (note: this is also tied to incomes as evidenced in the growing need for two or more wage earners per household and a lot of corporate merger activities, etc.).

11) In order to generate caches of money to appear as if wealth was being created, market manipulations and speculation took on its own life. 'Sophisticated' schemes (slights of hand) have been invented to keep the illusion that wealth is being created -- now defined in monetary terms rather than hard assets with fixed values. But the wealth is just marks on paper (or registers in a computer memory). Real wealth has been in decline, e.g. the infrastructure decay.

12) With the peak of oil production (or plateau) the total net energy available to do work is starting its downward slide. All borrowing against a future when there would be more, not less, energy is futile. There is no PHYSICAL way that those loans can be paid back. All financial schemes that are based on debt being repaid are doomed to failure. The First Law of Thermodynamics is rather clear on this account. You cannot create energy out of nothing.

We humans are a smug bunch. We actually think that money is some social construct that has meaning beyond a physical reality. We've operated on that assumption and now the piper will be paid.

None of the financial geniuses that currently spout their theories are able to explain what is happening. They cannot predict what will come next. They talk about a "bottom" for this or that market. But there is no bottom as long as net energy is in decline. When total energy really starts to decline (post-peak oil) the s**t will really hit the fan.

Question Everything


Thanks George you said it all.


ALL economic activity is work in the physical sense.

Gail doesn't include this basic aspect in the key post but I think it's critical. Thinking in terms of dollars alone maybe muddies the concept. Imagine instead that all of a sudden our economy - based on countless slaves - now has a lot fewer slaves. We cannot do the same amount of work - let alone for the same cheap prices. All the houses of cards built on and requiring continued energy slave labor can no longer stay up. The thermodynamic analysis amounts to "case closed".

cfm in Gray, ME

The economic consequences of the plague were to be seen in the labour crisis with which the new century opened, and can be traced in the 30 per cent increase in salaries in the three years that followed it. Gonzalez de Cellorgio, an official in the chancellery of Valladolid who published in 1600, under the shadow of the plague, a brilliant treatise on the problems of the Spanish economy, accurately prophesised its effects: 'Henceforth we can only expect that everything requiring human industry and labour will be very expensive...because of the shortage of people for tillage and for all the types of manufactures that the kingdom needs.' The acute labour shortage, and the consequent upswing of salaries, were, as Gonzlez de Cellorigo appreciated, irreparable disasters for the Castilian economy...

J.H. Elliott, Imperial Spain: 1469-1716

A disaster for the ruling class, perhaps, but the rise in salaries post plague was said to eventually have led to the Renaissance by creating a middle class.

Thanks George. Great statement.

Some of us have known that money is another form of energy for many decades. The concept goes back to the Technocrats and has been expanded on by people like Howard Odum (Environment, Power and Society). That our government and financial institutions have ignored this truth for so long will make it much more difficult to teach the public the facts of thermodynamic life.

What we forget is that all civilization is solar powered. That's the result of the fact that humans are ultimately "powered" by plants, i.e., crops in the fields or animals which consume plants. We live in a world where the lowest valued commodity is "raw" land, or, as the saying goes, "Land is dirt cheap". But, solar collection is an area based process, and we ignore the solar energy inputs to our food system, which actually represents a massive quantity of BTU's, since plants are not very efficient in their conversion of light to stored energy. That modern science and technology has been able to increase agricultural output presents the illusion that we don't need worry about the solar collection side of agriculture, but, fossil fuels required to make the fertilizer, pump the water for irrigation and then process, preserve and ship the food to our plates. Without the fossil fuel, it's back to reality.

What we are seeing this week is just the beginning, IMHO. It's just a taste of life after Peak Oil really begins to impact the U.S. Yet, the U.S. is one of the few nations which actually has alternative energy sources, but we must begin to make the transition NOW, else there won't be enough mechanical energy available to build the alternative systems before TSHTF. I like to hope there will be enough time to make the transition, but I fear our delusional political process will preclude that from happening. If the public understanding leads them vote for the easy "Drill, Drill, Drill" solution, I think there will be no change before we slide off the cliff.

E. Swanson
Baby Steps on the Cusp of Collapse


The 2005 "Hirsch Report" commissioned by the US Department of Energy was a report about the implications of Peak Oil, prepared by the military / intelligence contractor Science Applications International Corporation. It concluded that it would require two decades of intense efforts to mitigate the impacts of Peak Oil, and that failing to do preparation and mitigation would have massive economic impacts. The report considered toxic, centralized technologies as tar sands and coal-to-liquids to be acceptable, and did not make much effort to suggest more sane solutions would be decentralization, relocalization and power down approaches. But despite this approach, it subtly said - if reading between the lines - that Jimmy Carter was right and we blew it when our society ignored the warnings of the 1970s energy crises.

Easy mitigation of the energy crisis is not possible because Carter was sabotaged. The same forces that toppled the Carter administration are still running the show: militarism, covert intelligence agencies, centralized energy companies and the global financial system.

Peak Oil and Climate Change timelines

We are now faced with the fact that tomorrow is today. We are confronted with the fierce urgency of now. In this unfolding conundrum of life and history there is such a thing as being too late. Procrastination is still the thief of time. Life often leaves us standing bare, naked and dejected with a lost opportunity. The "tide in the affairs of men" does not remain at the flood; it ebbs. We may cry out desperately for time to pause in her passage, but time is deaf to every plea and rushes on. Over the bleached bones and jumbled residue of numerous civilizations are written the pathetic words: "Too late." There is an invisible book of life that faithfully records our vigilance of our neglect. "The moving finger write, and having writ moves on ..." We still have a choice today; nonviolent coexistence or violent co-annihilation.
-- Martin Luther King, Jr., April 4, 1967

We know through painful experience that freedom is never voluntarily given by the oppressor; it must be demanded by the oppressed. Frankly, I have yet to engage in a direct action campaign that was "well timed" in the view of those who have not suffered unduly from the disease of segregation. For years now I have heard the word "Wait!" It rings in the ear of every Negro with piercing familiarity. This "Wait" has almost always meant “Never." We must come to see, with one of our distinguished jurists, that "justice too long delayed is justice denied."
-- Martin Luther King, Letter from a Birmingham Jail, 1963

G.M - Thank you for this. You have clearly stated the very complex manner in which net energy very simply determines our fate. I concur completely. And while I could never have explained the links as you do, not understanding the machinations of our financial institutions much at all, I do understand, and wish the masses could, that ultimately money is worthless, and only hard assets have real value, and only net available energy allows us to manufacture products or grow food or do anything else with those resources. All the money in the world can't buy what doesn't exist. We will collectively learn that in the coming decades. Starting about now.

I'm with you. I don't grok every complexity in every market, but overall I'm not sure I have to.

I have mentioned before that there is an interesting tangent to this discussion in that things that are built with energy have some intrinsic value based on the energy consumed in their manufacture. A house or a washing machine can in part be present-valued by the replacement cost in terms of current energy cost. Of course items like houses are also significantly valued by location, and washing machines by lifecycle depreciation and so forth. I have pondered before that the current notion of planned obsolescence for everything from cell-phones and computers to less obvious air conditioners and washing machines (where longevity has been traded for efficiency) must be continually revisited when trade-offs between replacement cost, the cost of money, and the cost of energy consumes are changing drastically. It will turn out that many things will not be affordable any more -- some will cost too much energy to build, some too much energy to operate, and some both; plus, and less obviously, some will fail the break-even test simply due to a lack of capital to build them or buy them on affordable financing terms.

As with any discussion of energy, the notions of efficiency and entropy must be considered. Much of the "market growth" in financials was due to derivatives. Borrowing the casino analogy from yesterday's discussions each new derivative round was another hand played at the tables, with the house taking a cut. When money is energy, though, not only can no more be created, but it's never a zero-sum game -- with each transition some is lost to the Second Law. A derivative is like a heat pump (which moves heat without directly generating it) that moves risk (another form of money) from one place to another without directly generating it, but taking some energy to run the machine as it does so. I imagine in the end entropy rules in this money game as well, and with every pass through the machine a little bit of 'real money', or energy-equivalence, is lost. This should also be true as the gamers fold, the casinos contract or collapse, the brokers will sell their yachts, the Wall Street restaurants will layoff valets and concierges, and the entire proverbial house of cards slowly falls. In the end, there will still be mortgages and houses (as long as there are physical houses and people that need them, some sort of solution will work out eventually), but the total value of the system will end up being less than if the games had never been played at all.

In the entropic view, the world financial system is a closed system and the laws cannot be broken. To really continue "growth" with its confines will require a redefinition of the system. If we can get space aliens to lend us money (now that the Chinese are tapped out) or tap a new store of energy we can push off the collapse and play some more rounds at the tables. Maybe if Bear Stearns had gambled on solar or fusion they might have had a chance........

[edited for thermodynamic law error]

During the century, events had conspired to disparage in the national estimation the more prosaic virtues of hard work and consistent effort. The mines of Potosi brought to the country untold wealth, if money was short today, it would be abundant again tomorrow when the treasure fleet reached Seville. Why plan, why save, why work? Around the corner would be the miracle--or perhaps the disaster. Prices might rise, savings be lost, the crops fail. There seemed little point in demeaning oneself with manual labour, when, as so often happened, the idle prospered and the toilers were left without reward...

The uniqueness of Spain the absense of a middling group of solid, respectable, hard-working bourgeois... In Spain, these people, as Gonzalez de Cellorigo appreciated, had commmitted the great betrayal. They had been enticed away by the false values of a disoriented society--a society of 'the bewitched, living outside the natural order of things'. The contempt for commerce and manual labour, the lure of easy money from investment in censos and juros, the universal hunger for titles of nobility and social prestige--all these, when combined with the innumerable practical obstacles in the way of profitable economic enterprise, had persuaded the bourgeoisie to abandon its unequal struggle, and throw in its lot with the unproductive upper class of society.

--J.H. Elliott, Imperial Spain: 1469-1716

Several responses to an interesting and insightful post:

1: Total energy is not actually in decline (yet). The financial slight of hand maneuvering were more around masking a plateau I think then an actual decline.

2: Not all economic activity is activity in the physical sense. Mental work that results in altering the physical laws by which energy and work are related is one example (think Manhatten Project). Also some economic activity is simply disconnected from physical reality entirely (creation of art as example). However, I think all economic activity must be paid for, subsidized by physical activity.

3: First Law of Thermodynamics's doesn't really apply, since in theory we could convert the planets mass to energy and live off 0.00001% of the earth for a billion years. The problems are practical problems of implementation not theoretical problems of potential.

Art is "information". Information is one of the "highest" forms of energy per Odum. It's not random, but highly ordered. All that mental work requires a highly developed infrastructure supporting it.

Information is one of the "highest" forms of energy per Odum

Seriously, information is not a form of energy. If it were, energy would have to be given off when information decays back into randomness. A piece of paper with fine prose on it doesn't burn any brighter than one with gibberish on it. Now, it does take energy to create information -- but there is not a good correlation between the quality (or quantity) of the information and the energy needed to create it. Good art doesn't necessarily take more energy to create than bad art.

Value is something else. Information can have value well beyond that of the energy used to create it -- if it facilitates all kinds of activities which eventually lead to the extraction of more energy. Entertainment can qualify, as it can cajole workers to keep toiling away in the mines. But is there really a good correlation between the monetary value placed on information and its true value? One could argue no, especially since value can be fleeting.

Seriously, information is not a form of energy. If it were, energy would have to be given off when information decays back into randomness.

Damn. That is good. I knew something about the eMergy model WRT 'information' was a problem - but that is a nice concise comment.

Are you remembering someone else's comments on eMergy - if so, can you share who?

Yeah, that was pretty sloppy, writing "highest form of energy" that way. Emergy is the right term. In my head I had a vision of all the energy required to support on painter lying on his back under the ceiling of the Sistine Chapel. No matter whether Michaelangelo did good art or bad, it took the concentration of a tremendous amount of energy - just like plankton, minnow, mackerel and tuna - to put him there. In that hierarchy, he as the artist, was at the top of the food chain. In the largely solar economy of the time, that must have been a huge commitment. Now it's just a few barrels of oil and anyone can be an artist.

Information would have an ROI, and if looked at in emergy terms, an EROI too. Tainter writes about education as having diminishing returns; a PhD isn't what it used to be. He argues that it has to do with the easy stuff being done. So yeah, some information is easier to create that others. Fox News, porn, Fantasia, my Zappa collection, the Bible.

Lots of those artists and lots of their art goes away when there is no surplus energy at the base.

cfm in Gray, ME

Yeah, that was pretty sloppy, writing "highest form of energy" that way. Emergy is the right term.

It was a quick 'summary' of one of the eMergy ideas - that 'human think'n' has a value that can be expressed with the same unit you'd use to describe a photon.

This website claims that all content is licensed under a Creative Commons License. Is it allowed to claim different conditions in a post? If so, which do I have to follow (they are mutually exclusive so I cannot follow both)?

Your metaphor of "altering the physical laws by which energy and work are related" is spot on.


Total energy might not be in decline, but total net energy available to do useful (economic) work has been decelerating since the 70's, and possibly before. It is net energy available that counts most. When we borrow we are betting that we will be able to do more useful work in the future that will both pay back the loan (with interest!) and suffice then current demand. As long as total net energy was growing we had the capacity to do additional work in the future. This, by the way, was the significance of a growing economy. But as soon as net energy started to grow at a less rapid pace, the amount of energy in future times began to fall.

As indicated in a response to Roger, below, another factor that kept us thinking everything was OK during the 80's and 90's was that we had enjoyed increases in work efficiencies (in prime movers, for example) over the first half of the 20th century (partly in response to the two world wars). So even though net available energy was tailing off, increasing efficiency helped mask that effect. Debt financing looked like a good bet. But the underlying reality was that we would not be able to accomplish more real work. The reason is that efficiency in mechanical and electrical system (and chemical too) follows a law of diminishing returns (see Carnot efficiency). The incremental improvements we see now are exposing the underlying reality of work. Even our best computational control systems (embedded systems) can only eek out a marginal improvement in most systems (the smart grid may be partial exception). We are heading into a limit on the amount of work we can accomplish given the energy sources we have to work with.

Not all economic activity is activity in the physical sense. Mental work that results in altering the physical laws by which energy and work are related is one example (think Manhatten Project).

You can take a look at what I wrote to Roger, below, but the essence is this: even mental work consumes energy (food). That is electro-chemical work at the level of neurons. It is work that produces neural structures representing concepts, and may culminate in actual mechanical work done by muscles. You can't "alter the physical laws", but a good brain can get a good amount of work out of an external system using the same amount of external energy. Better brains may produce good results in shorter time, just as a very fast computer can produce algorithmic solutions (with a good program) quicker than a slow one. But don't for a minute think that energy hasn't been used up. It is still an efficiency argument.

As long as we can't convert mass into energy effectively and safely and at scale the first law still applies. Even if we were capable of fusion power, would we use it wisely and not eventually produce so much thermal pollution that we'd still kill ourselves. Besides, more total energy would mean using up our natural capital that much sooner. Not a particularly wise idea.


Roger, with regards to energy being in decline, I was referring to the overall planetary oil production which is currently not in decline. Plateau perhaps, but not decline.

In between converting mass to energy and burning fossil fuels are various other types of technologies which rewrite the operating rules about how much energy the human race has available to it. Nuclear fission as one example of this, there are others.

In human development, improvement happens incrementally (subject to laws of diminishing returns as you state) but also explosively in paradigm shifting events.

I think your analogy of calories to neurons to discoveries is a little weak in my opinion. How many calories to produce the next breakthrough in physics? How many kilojoules for a Theory of Relativity? The analogy does not hold. The creation of information and insight is not quantifiable in the same way that you quantify how much gas to move a car. Scientific and artistic genius is a matter of luck, timing, and NEED, not energy-in, energy-out.


Specifically to oil production, the quantity of oil may have plateaued but the energy is declining due to worse EROEI. The oil sands, deep well off shore platforms and Nigeria are good examples.

The way I see this...

In anthropological/sociological terms, high net energy permits the creation of the social "super structure" that makes highly effective thinking possible for some significant portion of the population. Think of a university department where professors feed off the knowledge of their colleagues and improve their insights. Those departments need buildings, staff, and all the social support beyond subsistence labor provided by cheap energy sources.

A good discussion of this line of argument is given by David Holmgren at and discussed during my interviews with him:

I was about to say the same myself. It takes an enormous amount of surplus wealth to support an information age society. You could argue that most of the productivity of knowledge workers is diverted to frivolous consumerism rather than intellectualism in the arts and sciences.

Thanks George. I agree with your analysis.

One of the ways the financial wizards were able to pull of the big run-up in debt was related to declining interest rates. Interest rates were very high in the late 1970s and early 1980s. Once the (oil caused) inflation rate settled down to something reasonable, interest rates dropped.

With declining interest rates, financial types (including the huge numbers of MBAs being graduated from business schools) began teaching that leverage was a great opportunity. With lower interest rates, loans even looked affordable. The stock market also shot up, because the present value of future earnings looked a lot better thanks to (1) the lower interest rate used in the calculation and (2) all of the leverage and assumed profits that the new investment would provide.

Now, we are walking into a reverse of the above scenario. Interest rates have no place to go but up, as the real inflation rate goes higher, and the threat of default rises. Leveraging will almost certainly go down, reducing the anticipated growth rate. Lack of resources will cripple growth further, and in fact, because of the issues you point out, lead to a decline in real work done in the future. This does not look good for stock prices, or for the economy in general.

I hope the MBAs have alternative job skills they can put to use.

Thanks Gail.

I got an MBA (management and decision science) back in the late 80's. That was because I was a mid-manager in a mid-sized engineering/mfg company in Southern Calif. Eventually rose to CEO. Then realized I needed other "skills". Even though the company was a success, I was not comfortable with the milieu. Eventually decided the best place was academia, ergo...


Sounds like you are one who has many skills beyond an MBA. It is amazing how the US transformed itself from a country whose number one goal was manufacturing, to one who valued finance as the most important skill. Of course, it didn't hurt actuaries either, since there is a fair amount of overlap.

Without denying the vital contribution of energy to economic productivity I am skeptical about pure energy theories of economic value. Productivity is what matters. The productivity of energy can be increased through technological advances. When the bow and arrow was invented the productivity of the energy used in hunting was improved. When the scythe was invented the productivity if the energy used to harvest crops was improved. When the wheeled cart was invented the productivity of the energy used to transport loads from point A to point B was improved. Increasing miniaturization has increased the productivity of the energy used to process silicon wafers. And so forth.

It is also true that resources other than energy have important effects on productivity. For one thing resources other than energy such as labor, fresh water, land (in the case of biofuels) have to expended to produce energy, and the opportunity cost of dedicating these resources to energy production cannot be accounted for solely by net energy calculations. For another thing, the quality of the resources available to the non-energy producing part of the economy also affects productivity. For example, on a planet which had a lesser endowment high quality metal ores than we have on earth, the same reservoir of fossil fuels would have resorted in less productivity.

Don’t get me wrong, I am firmly convinced that the assumption of continuously increasing total productivity which is the foundation stone of our current economic and financial institutions is about to land us in world of trouble, but I think that there is lot more to story of economics than net energy.


What you call productivity is also accounted for in energy considerations. It is called efficiency (of process). During the first half of the 20th century we witnessed a tremendous increase in efficiencies of various heat engines and electric motors. That is why the decline in ERoEI was masked and led to a false sense of increasing wealth. Growth of efficiency is subject to the law of diminishing returns. For most heat engines and electrical appliances (except for digital electronics where Moore's Law still has some play) we have seen a tail-off of increasing efficiency since the late 20th century.

If you consider productivity in non-useful work, such as most of the so-called service industry, then you are looking at an illusion. The fact that stocks can be traded more rapidly, giving rise to more speculative trading as opposed to liquidity maintenance, doesn't translate into the more efficient production of hard assets. It is an accounting trick that has been used by economists to buoy their claims about the health of the economy. Now, as we can see in what is happening in the financial (and housing) markets we simply more efficiently shot ourselves in the foot.

If you really think there is something other than energy available to do useful work involved in work processes, then shut off the electricity and see how far efficiency (productivity) gets you.

...resources other than energy such as labor, fresh water, land (in the case of biofuels) have to expended to produce energy...

Labor is energy flow. People eat to move muscles and think. As with the above argument about efficiency, some people think better thoughts with the same amount of energy as others. But stop feeding them and see what happens (not to mention the amount of energy that was used up to educate them). Fresh water requires pumping in most part of the world, or long treks and human labor to obtain. More energy. Land cannot be accesses without transportation - more energy still.

There is no example of something that has economic consequences that you can name that doesn't involve the expenditure of energy. Give it some thought.


If you really think there is something other than energy available to do useful work involved in work processes, then shut off the electricity and see how far efficiency (productivity) gets you.

Labor is energy flow. People eat to move muscles and think. As with the above argument about efficiency, some people think better thoughts with the same amount of energy as others. But stop feeding them and see what happens (not to mention the amount of energy that was used up to educate them).

There is no example of something that has economic consequences that you can name that doesn't involve the expenditure of energy. Give it some thought.

All of these statements amount to the claim that zero energy = death. I agree absolutely. However, this statement is not the same thing as declaring an energy theory of value. Economic productivity is a synergy of energy, labor, and natural resources. Without energy the productive synergy is zero. But you cannot calculate the productivty from net energy alone. For example within several thousand miles of the surface of the sun there are huge fluxes of energy and have been for several billion years, but no economic production exits there as far as I know. Apparently some other resource is needed.

I gave four clear examples where technological advances allow the same amount of energy to be more productive. I did not claim that potential for productivity advances of this sort is infinite. And I certainly did not claim and do not believe that the “service economy” or the “information economy” will allow decades more of economic growth. We have shot ourselves in the foot. But this act of self mutilation did not occur because the idea of more efficient use of energy and other resources is completely delusory. It occurred because the rasion d’etre of our economic system is to maximize the short term flow of dollars. The flow of dollars is always acompanied by the consumption of energy and other resources, so that efficiency increases are leveraged to produce and sell more stuff. Via Jevon’s paradox increased efficiency causes increased depletion rates.
If on the other hand we created an economy whose purpose was to provide truly important good and services (e.g. food, clothing, shelter, sanitation, medical care, education) with as small a consumption of resources as possible, then efficiency improvements could be leveraged decrease our environmental impact.

One problem with promoting a narrow energy theory of value is that it encourages believers in the status quo to ignore other important resource issues. The solar enthusiasts never tire of informing us that the total solar energy flux on the earth’s surface is 10,000 times humanity’s current average power consumption. The nuclear enthusiasts never tire of informing us about the large total energy available from uranium and thorium. But what about peak phosphorus? What about peak metals? What about soil loss? What about habitat loss and species extinctions? What about the water table being pumped dry? What about increasing desertification and loss of land due to increasing urbanization? The picture which emerges from considering the total resource picture and from considering ecological damage from human economic activities provides a stronger case for voluntary simplicity than does a narrow argument based on net energy availability.

I think you have misunderstood me. I am not promoting an energy theory of value. Unlike many ecological economists who have played with that idea, like emergy or exergy, I am saying that the dollars should reflect the energy available to do useful work. I am not saying, for example, that you assign a price to an object/service based on the energy consumed plus a profit.

Value is based on perceived usage/worth to the individual and something may be so valuable that they are willing to forgo other energy expenditures to get that something. That's where markets come in.

In the end though, and in the aggregate, where micro meets macro economics, the total amount of work that is accomplished is based on the flow of energy through the system. That and the technical efficiency determine how much product/service can be produced.

I'm not at all sure where you are coming from when you talk about maintaining the status quo. Net energy available to do useful work is not the same thing as total raw energy. Raw energy needs to be converted to usable form (e.g. electricity) before it can be applied to deemed useful work processes.

As for depleting other resources, I fail to see any conflict. In fact I would argue that the true price of externalities is much easier to assess when put in energy terms. When you do that you can actually ask what it would cost (in energy, given the best available technology) to substitute a material resource. For example, in your mention of pumping an aquifer dry, you can ask, in advance, what would it take to pump water from the next nearest source.

Look. It really is this simple (though the details are devilish). Every time you move an atom or a bunch of atoms you will need available energy to do it. It is fundamentally equivalent to saying every time I want to grow a tomato or ship a tomato, or shop for a tomato, I will be paying cash to get it done. It's straightforward physics 101 without the superfluous economics mumbo jumbo.

Oh yes. Economic systems existed long before there was token money. Back in the day, the value was pretty straightforwardly related to energy. Maximizing some flow of tokens came much later when people forgot why they invented the tokens in the first place.


While YOU may not be promoting the idea of the energy theory of value, that does not prove the concept to be incorrect. You are using an engineering definition of market value, one which is based on strictly human valuation of the results of using energy for various human needs. As you mention, there's another point of view, which includes the non-human side of the Earth, call it Ecological Economics. Your discussion ignores the life support "services" provided by the natural world, such as the processing (or, recycling) of various waste streams produced as the result of human activities.

In the market based economic system, clean air and pure water from precipitation are taken as free goods, when they may not be so. We have grown accustomed to the Earth's climate as it has been experienced over the past 10,000 years or so, but that too may be about to change as mankind modifies the optical characteristics of the atmosphere.  Since the Earth has been in an Ice Age for most of the past 3 million years, with only brief warm periods as now, we must not take our Goldie Locks climate for granted.

When you write about producing goods or services, you miss the fact that these must also be consumed and the consumer also uses energy. Many of the "service industries" require that the consumer be able to travel to the service provider, such as the typical fast food restaurant, the pet groomer or the hair stylist. WalMart, Home Depot, the local mall or food supermarket might be thought as service industries, as they provide the retail services to the community. Without the energy to move the consumer to the point of delivery of the service, the service economy collapses.

Labor isn't just the result of the application of energy during the working period, but the worker must also be fed, clothed and housed the rest of the day. People need occasionally need medical attention to continue to function and the working man may need support past the years of his best output aka, retirement. The energy and dollar "cost" of the energy used by labor is much greater than the cost of the carbohydrate Calories required to power his/her muscles for 8 hours a day.

Of course, looking only at the dollar values obscures the fact that dollar values change with time due to inflation, etc. The energy accounting is less likely to change for basic processes, such as making steel or converting coal to electricity, with exceptions for improvements in process efficiency. Many processes are already near theoretical limits of efficiency, so for those, only scientific breakthroughs can produce changes.

E. Swanson


I suspect you missed my comment above about externalities. I actually do write quite a lot about the subject of balance between the human economy and the rest of the Ecos. And the energy available to do useful work can accommodate taking into account the use of natural capital. I am a big fan of Herman Daly, Robert Costanza, et al. I'm merely pointing out that my approach is not a value theory but a standardization theory. The money supply should be based on the net available energy (aggregate after ERoEI considerations). There is nothing incompatible between this monetary policy approach and energy valuation theories. The latter are, however, hard to account for and subject to a lot of argumentation.

Suggest you read some of my blogs before thinking I am somehow dissing energy valuation theory.


I think you have misunderstood me.

This statement could well be true. The only things I have understood from what you wrote is that you believe the following:

  1. Energy is required for economic production.
  2. All other things being equal less net energy implies less production

I agree with both these statements. If there is any other substantial meaning about the relationship between energy and economic production conveyed in you posts I have been unable to decipher it.

You wrote:

Look. It really is this simple (though the details are devilish). Every time you move an atom or a bunch of atoms you will need available energy to do it. It is fundamentally equivalent to saying every time I want to grow a tomato or ship a tomato, or shop for a tomato, I will be paying cash to get it done. It's straightforward physics 101 without the superfluous economics mumbo jumbo.

I understand perfectly well that work is force time displacement, and that you cannot move bits of matter around against opposing forces without expending energy. But even if useful economic work could be equated with the total increase in potential energy of bits of matter moved about in conservative force fields (It cannot.) economics could still not be reduced calculating the amount of available energy to power such movements. Extracting energy requires resources other than energy and the opportunity costs associated with the use of the those resources must be accounted for.

To illustrate the importance of non-energy resources to economic production consider the following hypothetical situation. You are alone on island. A liquid fuel source is available that just flows out of hole in a rock at a steady rate year in and year out. The total energy available to you is X units per day. You cannot calculate the total economic production achieved based on the value of X alone. It depends on the variety and quality of other resources available to you. It depends on your engineering and design skills and on your mechanical dexterity. It depends on your accumulated knowledge. All that you can talk about is the productive synergy achieved by combing energy, labor and raw materials. I have absolutely no idea what you mean when you talk about reducing the other elements of this synergy to energy terms. Yes, if the rate of fuel flow drops to a value X' which is less than X then your production will drop. But whether this drop will be disastrous will depend on all of the elements of the synergy and not just on the value of X'.

Economic productivity is a synergy of energy, labor, and natural resources.

Do not forget parasitic loads. Interest, governance, gaols, et la.

For those who might be interested, I've posted an expanded version of this comment on my own blog, Question Everything along with links to prior blogs where I go into more details in some of these areas.


You took the words, sort of, right out of my mouth.

I've been watching the discussion here for a few years, off and on, and more recently at Clusterf*ck and the Archdruid. It's been discouraging to see so many apparently alert people getting mired in and distracted by details - which, while important, inevitably tend to obscure the fundamentals. Lately I've seen a few people beginning to sort of sidle around the edges of the real heart of the matter. This is the first post (that I've seen) wherein someone actually says it out loud.

I would encourage everyone to consider also the Second Law, aka TANSTAAFL, especially in relation to interest and profit in general. Academic economists are notorious for piously referring to it in all sorts of contexts, but in reality, both conceptually and practically, their entire oeuvre is devoted to either denying it (conceptually) or circumventing it (practically). This denial and/or circumvention epitomizes human economic activity and has for hundreds of millennia.

And therein lies the connection between peak oil (or better, peak resources and environmental services in general) and the financial markets (or better, the pursuit of profit). Both, whether coincidentally or not, are hitting the end of the chain. We've used up the slack of cheap energy and new markets; learning to live with the chain will not be pretty.

Like Greer, I don't expect the reckoning will necessarily happen all at once (though we're going into unexplored territory now). But it's begun, and it's too late to do much of anything but duck as much as you can. In any case, as for me, I've been at the bottom of the food chain all my life and know how to survive, if it comes to that for me. I think this temporary conglomeration of matter/energy I call "I" will have re-integrated back into whence it came before we start dropping like flies, but you young'uns could see some strong stuff before your time is up.

Maybe, if they're paying attention, the long-term remnants can build on a better base than H. sapiens did ...

I would make a few additions to this concise and insightful post.

Economic activity is a complex and systemic exchange of physical resources. And thermodynamic principles apply regarding the energy required to move physical resources.

Conservation of mass principles apply regarding the resources, the actual stuff that is being moved. The things in our economic sphere, like cars, oil, food, aren't "created" so much as they are depleted from one area and recombined into another. This includes all us people walking around out there, made out of the food we've eaten.

And systemic, complex, and chaotic principles apply in how the process of economic exchange unfolds throughout a network of individual human agents.

So if money acts as an information token on the systemic (complex), interchangeability (thermodynamic) of resources (conserved matter), then the capacity of the network to process the information is also under consideration.

If the Rule of 150 applies, then each person in the network can understand or process roughly 11,000 relationships. While we evolved to be able to understand the relationships between all 150 human nodes in our local tribal network, our global society now contains 6.7 billion interconnected nodes.

The network doesn't appear capable of processing the information. The near-universal response to systemic problems, caused by over-complexity, is to increase the system complexity around the problem, yielding new problems elsewhere in the system.

Dunbar's number aka the Rule of 150 (wiki).
Social networking (wiki).
Chaos: Making a New Science, by James Gleick (amazon). Also available at your local library and on P2P.

Near as I can tell oil is only marginally involved in this collapse. The primary culprit is the massive amount of debt racked up by this nation, combined with the destruction of the manufacturing economy.

Simply stated, if a nation makes nothing, it is worth nothing and not all the fancy paper it generates can change that fundamental. Any economy must be founded on the basis of making THINGS that people need and want. If a nation does not do that, its money becomes worthless.

Forget about banks, they are ALL toast. What you are going to see happen next is an international repudiation of US debt. In other words, they aren't going to lend us any more money because this nation is a toxic waste dump of debt. When that starts to happen, as it did with the Germany in 1921, a flood of international dollars will start to return home as more and more fire sale assets are bought up with the flight from the dollar. There are 10's of trillions of those dollars out there and when they start to repatriate, as they certainly will, that will begin the great hyperinflationary depression that is now inescapable.

You can forget about the price of oil because it doesn't matter any more. Setting up soup lines and Hoovervilles will. And while I'm not usually a doomster, I see no way out of this massive debt default pegged by the Dallas Fed President at $110 tillion in US debt and unfunded liabilities and growing by the hour. Incredibly, that number does not include private debt which is another $38 trillion, 12 of which is in housing alone. There are a dozen more shoes to drop and as Roubini aptly put it, "We are only in the third inning."

I now reverse myself: $60 oil is in the works as the need for it plummets dramatically.

Our crystal balls seem to have broken.

If oil drops to $60/barrel then development should essentially stop.
Shortages will be even more severe a few years down the line.
Just about the worst of all possible worlds, I would have thought.

Development will stop anyway as a result of a lack of capital. One realizes that oil companies are in bad shape when you put aside their massive profits from the last price spike, but their reserves are declining dramatically and prospects for getting more grow dimmer by the day.

IMHO the peak oil debate just went in the dumpster (or more kindly on hold) for a long time to come. I expect BRIC oil demand will also be declining so we will see a very signifcant, perhaps even dramatic, drop in demand.

BAU has just come to a screetching halt but for unexpected reasons.

The 'oil companies' are almost irrelevant now.
What counts are what the State entities do, especially in Saudi and Russia.
With their conflicting pressures from the demands of their populations, particularly in Saudi, and declining revenues then you have an explosive mixture.

Low oil prices must impact future production, but a revolution in Saudi would do so even more.

The irony is that $60 oil would guarantee peak oil today. Once new field development is put on hold for a couple of years, there is no way that the mega-projects could every catch up again with mature field depletion. We will be at peak and no-one (except us) will ever notice.

And all as was predicted years ago...

Unless this $60 oil accompanies widespread gasoline shortages-the public might notice that.

Now is a good time for another post on building, expanding and electrifying railways and nuclear plants.
We should be reminded again how France will be an island of plenty in a sea of want because of same.

So you think having power and transport will help?
Or maybe it's a waste of time, and the true issues are philosophical.

I wonder how much oil is affordable to produce at $60/barrel now at the end of '08.

I marveled at the inability of producers to raise output as the price approached $150.

Looks like a good candidate for how this production plateau becomes a cliff.

A smile is my parachute. But I hope there's food to be found when I am on the ground.

Most of the oil on the market is $20/barrel oil. There hasn't been that much new expensive production added since 2001. If we cut consumption in the US by 20% rapidly, we should be able to force the price down close to that level.


research24, the US still grows food. The biofool hype seems to make some sense, if we see it as a deliberate attempt to raise the prices of the only commodities we here in the US can export.

I would go a step further and also state that wrapped up in all this is a market/capitalist economies inability to measure and understand wealth that is not represented by physical items that can be clearly owned.

It's obvious with a moment's thought that not all useful activity is making THINGS. How about ideas, scientific breakthroughs, computer software, music? All those intangibles are difficult to OWN though and hence difficult to generate a profit by.

Our current financial; system doesn't know how to value anything that isn't physical.

I suggest you beef up your knowledge on intellectual property laws, especially copyrights and patents, and their implication on wealth creation. They are intended to solve the very problem you refer to, although their effectiveness is controversial.

You should also check the open source/free software movement for a method to create intangible wealth without actually exchanging money for work being done. The classic text on the topic is a series of three essays titled "The Cathedral and the Bazaar". They are available on-line.

Main page:

The three individual essays are here:

The Cathedral and the Bazaar

Homesteading in the Noosphere

The Magic Cauldron

I think existing IP laws is an attempt by a capitalist system to adapt itself to owning things that fundamentally difficult to own. Not surprisingly, it's not working very well.

Once the cost to copy and infinitely reproduce an item becomes zero, the whole system of scarcity implies value starts to come unglued...

The Open Source system to me seems at the very least orthogonal too, if not directly antithetical to IP and capitalism in general.

I've already read all those links and more...

The problem is how wealth and profit are measured. Something that is not property belongs to all, and the total benefits are usually far greater than things that are property (especially private property).

What's terrible with our system is that only transfers of money are counted in counting wealth. Something that is patent-free (like penicillin) is considered worthless, even if it saves countless lives, while exclusive gated housing complexes (I don't consider them 'communities') are considered to have lots of wealth, even if they're a terribly hurtful (socially) and inefficient (resources wise) arrangement.

I would argue that the destruction of the manufacturing economy is definitely oil related. A major reason we lost the manufacturing is because we didn't have the oil to do it ourselves.

A big reason for the run-up in debt was to disguise the fact that we really didn't have current resources (particularly oil) to do the things we wanted to do. It is now becoming clear that we also don't have the resources to pay back that debt.

Well, certainly oil lubricates transport as well as the manufacturing operation, and so makes it easier to slide production around the globe as well. Labor costs certainly play a role, though even that has some oil valuation in it as well.

I think that when the trade press shifted from reporting on automation and the increased sophistication of production labor, to reporting on efforts to decrease labor costs and benefits and then a transition to low-cost overseas labor, is about when we started the long, slow decline (circa 1980's, as I entered the workforce). Later on in the 90's we learned that an "information economy" and a "service economy" could take the place of manufacturing.......and then we outsourced as much of those as we could.

Honestly, I'm not sure that the crash of investment banks, mortgage giants, and hedge funds will have a huge impact on the daily life of most American's, but the secondary effects of expensive energy and expensive capital coupled with excess debt certainly will. I don't really see a bottom until we can efficiently produce sufficient goods to maintain our standard of living with at least a neutral balance of trade.......and I don't see how that can happen without cheap energy and a transition of our workforce. At best we face a generation of systemic hardship, I fear.

A major reason we lost the manufacturing is because we didn't have the oil to do it ourselves.

A significant portion of manufacturing sector moved to China. Are you suggesting that China has greater energy resources than the US?

Along the same lines why is KSA not the world's premier mfg centre? Or Calgary?

The mfg moved offshore because you could replace $20 an hour labour (inclusive of benefits) with .50 an hour labour. This move also gave access to the world's largest market. GM makes and sells more cars in China than it does in the US.

Not only does the US political establishment not care a whit for the the welfare of the US worker, the US commercial establishment shares this lack of concern. The result is corporatism.

You need to provide more evidence for your claim as I do not see it to be supported by the facts.

Yes, but that is only part of the story. The actual owners of these cowboy Wall Street firms are just as powerless as American workers. With few exceptions (TD is notable) these financial companies are not being run as businesses at all, the structure at most is very similar to Enron's. Lehman Bros would never had run up 615 bill in liabilities and gone under if it still was a partnership, as it was for most of its lifespan. Credit default swaps, hedging strategys, you name it-these "business models" are about overstating current earnings at the expense of the companies' future earnings so the club can suck out capital at the expense of the owners and now the taxpayers. Turning the management of the USA over to Wall Street sharks was a monumental strategic error IMO-the country as a whole was pumped and now it is being dumped.


You are describing financial services firms and their problems. Do not see how this speaks to the claim that mfg moved elsewhere as there was a lack of available energy in US.

I think the move came about because it met the interests of the political class, the investor class and the top end of the managerial class (Cheney would be in all three). This group had no concern for US citizens beyond getting their attention for a couple of weeks in November every four years.

When Cheney says the "American way of life is non-negotiable" he is saying his way of life is non-negotiable. But he and his cohort were quite willing to negotiate the end of the American blue collar workforce. This analysis is along the lines of what I think you are getting that but still does not clarify what Gail was getting at with her comment.

A major reason we lost the manufacturing is because we didn't have the oil to do it ourselves.

Would you please explain this to me? I always thought gobalization increases and not decreases the need for oil.

I thought manufacturing was moved abroad because manpower is cheaper, environmental laws are weaker and oil was so cheap and abundant to make the long range traveling of goods immaterial.

I also thought that a raise in the price of oil and lack of supply would break some of the economic assumptions about transportation globalization is resting on, resulting in an increase of local manufacturing.

I thought oil was used mostly for transportation and the manufacturing itself used mostly coal, gas and electricity.

Finally I would imagine that if availability of oil drives the location of manufacturing, industries would move to oil producing countries and not to net oil importers. Does anyone have data on this?

Back before the 1974 oil crisis, we did use oil (and coal) to produce electricity. After oil became less available, we switched to nuclear and natural gas. So at the time that US manufacturing was king, oil was used for quite a bit of electricity generation.

If you look at this EIA Exhibit, you will see that oil and natural gas are the primary fuels driving the industrial sector. The commercial sector (things like office space and retail malls) uses a much higher proportion of electricity according to this exhibit.

Natural gas use for industrial purposes has definitely dropped, because the US price for natural gas was higher than that in other parts of the world. Manufacturing that used a lot of natural gas (like fertilizer) has moved off-shore.

Oil use for manufacturing has remained almost level since 1973, while oil use for transportation (from here) has risen by more than 55%.

I am not sure I fully understand how the decision was made to use our oil imports for transportation instead of manufacturing. Clearly, our balance of payments situation is very bad, with the choice that was made. If we had chosen to use the imported oil for manufacturing instead of transportation, we would have had something to sell that would have kept our balance of payments closer to level and prevented some of the problems we have today.

i don't think there was a 'decision'. we have 50% more people and we increase the amount of cars by 3.7 million every year. Lots more places to drive and fly to as well..

Gail, Thanks a lot. I like it when the discussion is backed from solid data like this.

The way I understand the argument is industries have been using oil at a flat level when transportation raised 55%. Therefore manufacturing was moved abroad because they could afford/find the oil at home.

But the same data could equally used to argue the reverse. Industries didn't increase their usage of oil because they were moved abroad for some reasons unrelated to oil. The side effect is the usage of oil for transportation had to be increased to handle the consequences of the move.

I don't have data, but I really think globalisation was driven by the desire to implement industries in the countries that offered the most beneficial conditions in terms of wages and regulations. It assumes unrestricted cheap transportation. Oil was not a constraint, it was an enabler because of pre-peak costs and abundance. Peak oil just wrecks the whole idea.

My understanding is globalisation is tied to intellectual property laws. In theory it doesn't matter if manufacturing is done abroad because the patents and copyrights ensure the product can't be copied by foreign startups and the money will come back to the US mothership. Therefore the balance of payments shouldn't be that bad.

But this assumes the cost of transportation does not weight too much. If most oil must be imported at high price, the balance of payments will be upset. As a subsidiary question, what is the share of oil imports in the trade deficit?

I agree with your analysis

The US shifted mfg to lower wage, low constraint locations and domestic growth came in service industries such as design, marketing and financial services which did not require significant oil inputs.

Essentially the US sought to transition to higher value added activities and allow lower value added sectors to relocate offshore. FF consumption patterns reflect this bias; FF availability was not a causal factor which is what Gail appeared to imply in her original post.

But you had oil to build suburbia and correlated infrastructure... Wasn't it instead because cheap asiatic labor and transport enabled you to invest whatever oil was available in suburbia, and "outsource" manufacturing to the far east, while at the same time going down the spiral of the financial markets?

Near as I can tell oil is only marginally involved in this collapse. The primary culprit is the massive amount of debt racked up by this nation, combined with the destruction of the manufacturing economy

I think its about rates of debt.... In point of fact I think its all about comparative rates

its the rate at which debt is created vs the rate of physical growth of consumption (energy for short) can be sustained to service said growth in debt

the manufacturing can be abroad..

simple questions

how many BOE was the average US/uk house worth in mid 1979?

how many BOE was the average US/uk house worth in mid 1999?

how many BOE was the average US/uk house worth in mid 2008?

is there a changes in BOE of energy consumption between 1979 and 2008 to account for change in debt level?

Just heard Bush speak concerning the markets. I nearly
choked when he refered many several times, to the looting of the treasury, as "ADJUSTMENTS". And had the gaul to suggest the cooking of books and every bean in them, as "DISRUPTIONS"

I now get an audio hallucination when hearing George Bush...."HEAD ON" APPLY DIRECTLY TO THE HEAD "HEAD ON"

My thought is a little different -- "Head on, stick it directly up your . . . " Giggle.

By the way, I can tell by the ticker that the Fed & Company is trying to shore up the dollar against a fallin g tide -- the forex price swings are wild.

Does the fact the S&P, Dow and NASDAQ are moving in near perfect sync mean anything in this situation?

(Aside... seems to be a head and shoulders reversal happening with neckline broken... could be a big drop...then another larger head and shoulders might develop...

wrgt elliot waves... did the top just before 11AM start a Wave3 down? Ifso...could be a big drop here.)


Might see a low around -3% followed by a bounce. If another low follows the bounce and goes below -3.2% or so, it might be the end of a larger head and shoulders and signal bigger drop to follow...

No, I have no idea what I'm doing. I just noticed the trend after having read about it recently and started goofing with guessing it as it developed this morning.... Ah... wish I were a day trader right now!



UPDATE: Market just took the bounce, but off a narrow head and shoulders neckline at about -2.6%... fascinating... Think I'll call the drop to that wider neckline at -3.2... but where from there?

Then again, it didn't break the neckline, so I guess it should go... up? New trend would put it up near a recovery at at least -1.2or so...?

UPDATE: I was posting around 2AM last night my time and took a little nap... that lasted till this morning... Sadly, I didn't post about the lower highs and higher lows I thought might be leading to a deep drop below -3%...

I can see why people get into this stuff. It's a bit addicting.

Economic Growth equals Energy Growth times Efficiency Growth.

Our economy requires growth. Energy stopped growing in 2005 and the economy stopped building momentum. Since the mid-1980's there has been a large gap between disposable income (dark blue) and oil (red). As oil prices closed that gap, more and more people were force to choose between paying for their commute to work and their house payment.

It is possible to re-tool transportation, to increase urban disposable income by about $3,200 per family, to transition beyond oil-based transportation. For those interested in the process here is a TOD posting on Performance Governing and a summary of actions.

If you back out of our trumped up $14 trillion economy - that is, subtracting the funny money paper game, what do you have left in terms of real production? I've seen one estimate of $8 trillion of honest money work. Then refigure for a reasonable inflation deflator and what you end up with is a little over $7 trillion.

In real honest money terms this nation has been in economic decline for a decade but has made up the diff with $11 trillion in borrowed money. Since we make far less than half of all we purchase, any effort to equate energy with "economic growth" is off base since "growth" is merely a government lie.

Or to put it another way, just because you print money doesn't mean that money represents anything real.

Chris Martenson has done an excellent job in his Crash Course in defining your concerns.

"As the companies who speculated in the oil market (all of them, not just the particular ones having problems today) try to unwind their positions because of margin calls, they drive down the price of oil in the futures market. That is likely why we are seeing declining oil prices, at a time when fundamentals would say they should be rising."

Whose fundamentals? The downturn in demand in the US has been quite dramatic. I am under the opinion that the demand in the EU has also decreased. What exactly are the fundamentals that say oil prices should be rising? (At this moment in time.) I live close to the coast in South Louisiana and right now there isn't any demand for oil in a bunch of refineries along the Texas & Louisiana coast. In fact the problem will be what to do with tankers scheduled to arrive over the next several weeks, depending on the individual refiner. I believe this is about 5% of the worlds capacity, that has been shut down or affected in a negative way.

As far as speculation is concerned perhaps you should read this article in today's Journal:

It is in the opinion section, but it is based on the CFTC's investigation as opposed to, " doubt speculating in oil futures," or your entire point #2 which the CFTC's investigation pretty much concludes the opposite of which you claim.

I don't doubt the logic of your argument; I however, doubt doubters that fail to offer data to support their doubts.

Good point about refinery utilization.

What we call fundamentals of demand are based on falsified government AND private data. Look at retail sales, for example. Totally bogus. Retail shops are closing up everywhere, yet they claim rising numbers.

How is that? Because they don't back out import price inflation which is up 21.6%. Take the latest retail number and adjust it properly and what we really have is retail DOWN 20%.

The same applies to nearly everything. Sorry to say, we can no longer trust most data, tho I think most EIA stuff is safe.

Whilst an off-line refinery may reduce demand for crude oil, this doesn't alter the fact that the products said refinery would be producing are still very much in demand and being consumed - at present, this demand is being met, as far as possible, from inventories.

However, product inventories are declining at a pretty rapid clip; my current estimate of inventory decline for gasoline East of the rockies is about 2 million barrels per day. Ouch.

It seems that until inventory numbers start showing a significant different between supply and demand at oil prices below $100 a barrel, it is premature to conclude that deleveraging, as opposed to supply and demand, is responsible for the price drop.

Well since the futures price of gasoline no longer reflects the reality of the situation on the ground (reduced deliveries from Gulf refineries into Mid-Atlantic pipeline distribution network), it will not be long before gas stations start running out of product.

This is perfect; market CDS implosion + gasoline shortages. Now all we need is a war with Iran then things will really start to get interesting.

It is similar to the lineups for toilet paper in Russia circa 1970s with Pravda blaring out "we have a glut of gasoline".

Great information and site. New member of the

welcome, mike :)

Nice post Gail, thanks! One question for you or anyone else who has a good answer: here when the price of oil has been going up, a lot of us were pretty quick to claim it was supported by the fundamentals (=flat production, increasing demand) and this wasn't the work of speculators. However, your first point seems to suggest that there was (is) a lot of speculation in the market but your second point suggests that it's driving the price of oil down currently. This is contrary to some commonly held political opinions.

How would you explain this? Was there some "irrational exuberance" in the price of oil previously? Or is it that the speculators only got involved later on (spring 2008) when the price really started increasingly rapidly? That last question is one that I mentioned a couple of times here on TOD earlier this year.

What should the price of oil be?

*edit* That last question is rhetorical. :)

The price of oil did go up a lot earlier this year. I am not one who hears the inside rumors regarding speculation. I think what Nate and others are saying is that rumors are circulating that AIG and some hedge funds were speculating on oil futures. The investors were highly leveraged and got caught when the price started to go down. In some cases, it was speculation in some other commodity (like gold) that got a hedge fund or other buyer in trouble. When the commodity started dropping and there were margin calls, the hedge funds (or AiG) had to sell something quickly, and oil was an easy commodity to sell.

Now, there is probably irrational exuberance on the down-side. Some producers will stop production, if they are not covering their marginal costs.

Chris Martenson's Crash Course
is extremely helpful for understanding scope and character (i.e. weakness and fraud) of the United States
debt-based monetary system. For those new to this venue, the course does a great
job explaining the relationship between money and energy, and presents in simple,
yet powerful messages, the entangled cascade failure that is finally now erupting
above the public attention threshold.

On Saturday, the chief executive of Eni, Italy’s top oil company, predicted that prices might rapidly drop as low as $70 a barrel.

The financial crisis finally took the wind out of the great oil rally. After a tumultuous weekend in New York, two of Wall Street’s most prestigious firms came to an end, with Lehman Brothers filing for bankruptcy and Merrill Lynch agreeing to sell itself.

Analysts said the market had become convinced that Wall Street’s meltdown could spread to other parts of the world, and that Asian economic growth would suffer, slowing down global oil demand.

“Investors seem convinced that global growth is done, and that will take the commodity cycle with it,” said Jan Stuart, an energy economist at UBS in New York. “People seem to think this is the end of the five-year oil bubble. Anything relating to energy is a sell at that point.”

The indifference to the middle class along with the prime directive interest in their base, the super wealthy and corporations, the Republicans deregulated the lending industry causing its subsequent meltdown. Simultaneously, energy costs have been rising. The mortgage meltdown and higher energy prices are cutting the legs out from under this economy. We are now into a period of very tight causing economic contraction i.e. recession. If the strict definition of recession hasn't been hit yet, it will soon.

We need leadership that will not replace sustainable lending regulations with short term corporate profit. We need someone more interested in the economic viability of the average Joe, than the CEO making several hundred million a year.

That is waht you need-what you are getting is an Alzheimers patient and a moose hunter.

You are mistaken. It was Clinton & Rubin who did away with Glass-Steagal for Rubin's buddies at CITI.

Supposedly the Clintons and the Bush family are almost kissing cousins at this point-hopefully all the members of the Bin Laden clan can attend the next lawn party.

It was a bipartisn reeming.... However, Phil "you're a bunch of whiners" Gramm really worked hard for it. Seems like most things that really screw over the US is done with bipartisn agreement.

The bills comprising the act were introduced in the Senate by Phil Gramm (R-TX) and in the House of Representatives by James Leach (R-IA). The bills were passed along party lines with Republican support in the Senate[1] and with bipartisan support in the House of Representatives[2]. It was signed into law by President Bill Clinton.
The banking industry had been seeking the repeal of Glass-Steagall since at least the 1980s. In 1987 the Congressional Research Service prepared a report which explored the case for preserving Glass-Steagall and the case against preserving the act.[3]

err.... does anyone know what CERA/Yergin is saying about oil?

What is that?

Allow me to paint another dimension of the oil price conundrum. We know that the sinking dollar accounted for around 15-20% of the price rise. The US gov. is in line for a $700 bn deficit next year on top of a trade deficit of $300-400 bn. That's an additional $1.1 tn of new borrowing at a time tax revenues are sinking. The real effect of the Lehman situation is how it affects confidence in US paper. Foreign CB's were leery before yesterday's action in which Japanese banks took a very big hit as they held a ton of Lehman paper. We are headed for a currency crisis as foreign central banks and others decline to buy more US debt.

This means that the only option available is monetization of the debt in which the Fed prints new money to buy new treasury bonds. That is hugely inflationary and is what will lead to the currency crisis in which the dollar is finally rejected as world currency. In turn, this will cause a massive devaluation/inflation of the dollar. Further, interest rates will rise dramatically just like they did in '79 to high double digits.

The USofA is going to default on that debt one way or the other as there is no way to service it any more than Bear, Lehman, Fan & Fred, Merrill, Morgan or Goldman can. Add about 1,000 more banks to that list that are scheduled to fail.

Can you guess what this will do to the price of oil? That is, the price WE have to pay, not the Chinese or Euros, but the hyperinflationary USA that now has to buy a foreign currency to pay for our oil.

This scenario is almost inevitable as there is no way out. We borrowed from the future to pay for the present but that future has now arrived. If you can find a way to escape from this, I'd sure be glad to hear it.

My guesstimate is 1.1 trillion for 2009 deficit. Re financing the debt through t-bill sales, there is credible evidence that this monetization has been underway for a while-supposedly they conduct it through offshore banks. I have no idea and little interest in what sort of controls (or lack thereof) the USA guv and Treasury has over the mint-nothing would surprise me at this point.

There seems to be some kind of assumption that the US is the only country with any financial problems.

Check around Europe. A lot of those countries have debt and had real estate bubbles (Spain etc...)

Japan just had a negative 3% growth quarter.

So which economies are weak and which are strong ?

The US still has a very large resource base. Which countries get hit more if there is a lot less oil to be exported ?

It may have a large resource base, but the amount of oil we import is huge, and we are not really able to pay for it. Why should the rest of the world let us continue to get away with this? They could put off the impact of peak oil for at least a few years, if they could cut US imports out of the picture. I wonder what Russia and OPEC are busy talking about.


Further, interest rates will rise dramatically just like they did in '79 to high double digits.

Therein lies the dilemma. The US can either protect the currency in which case interest rates rise and there are very negative follow on effects for the domestic and commercial real estate markets or the US can allow the dollar to decline in which case the cost of all foreign inputs rises and the balance of payments continues to worsen until the country is on the brink of default.

The other problem is that foreign sovereign wealth funds may want to purchase the best of what is left and that will create an interesting political furor.

I wonder why the IMF does not step in and administer a strong dose of the harsh fiscal medicine they have meted out to every other nation in this position. First off, you cannot afford the 1,001 foreign bases, the adventures in Iraq and Afghanistan, low tax rates, socialized mortgages, social security, medicare, ethanol, farm price supports. It would be an interesting key post that looked at what the IMF has done elsewhere and how this same treatment would impact the US.

"If you can find a way to escape from this, I'd sure be glad to hear it."
A response that I have given to this question before is that there is a global threat to the food supply and holders of dollars are looking to a US food surplus as an insurance policy. This particularly applies to China.

China is a net exporter of food. They don't need any food from the US, the only reason they buy rice & grain from us is so they can use that land to grow more expensive food products that they sell to us.

But look at the trends (in particular, available acreage) and consider the uncertainties in agricultural production. I'm sure the Chinese leadership does.

But there is Al Capone's law - "A gun and a kind word take you much further than just a kind word" that can be brought into play to those that refuse US paper.


Has anyone an idea how much will take until the financial mayhem will propagate to Europe?
I'm specially interested in Eastern Europe but I guess it's more vulnerably than the rest of Europe, more American money invested and a poorer financial discipline!

ASPO USA Sacramento 21-23 Sept. will include railway re-emphasis in the Peaking Oil solution set. Please note ( articles 374 & 1037 as executive summary.

Many Americans remember (or heard about)the railroad Co. in their home town, and maybe in their neighborhood. The electric railway interurban lines, freight branchlines as well, were guarantors of commercial connectivity. Moving people by day, assuring victuals and goods got to the warehouses and perishables to downtown produce terminals by night. The US rail mainlines are models of efficiency, backing away from the local role they used to play such an inseparable part of. Cheap energy opened the door to Just-In-Time and trucking; long-haul and "warehouse-on-wheels", prompted by punitive inventory taxes. Say goodby to JIT...Hello "Long Emergency"!

Railway is back in vogue worldwide, with projects in the EU, China, Russia, Asia, South America and OPEC African nations aggregating $trillions. Under the radar, US branchline & shortline RR entrepreneurs are putting the feeders system back to service. But not fast enough. The financial crisis, coming thru the door with energy problems, requires responsible electeds & wannabes to cram on rail technology awareness.

Railway is America's Guarantor of Societal & Commercial Cohesion thru the Oil Interregnum. Expect a flurry of excuses to downplay railway rehab & extensions, but the energy efficiencies and ease of link to renewable energy maqke expanded rail matrix a no-brainer. As American wealth dissipates into the mortgage whirlpool, money looking for a haven will find renewable energy & rail expansion a long term partnership better than gold. Gold in fact can be called in by frantic officials; railways happen to serve politicians and the citizens alike when they are kept running!

"Rail Transport And The Winning Of Wars", By James A Van Fleet, is a basic RR logistics read, from Association of American Railroads (202-634-2100). "GCOR" the RR rules compendium, download free. "ELECTRIC WATER" by Christopher C. Swan (New Society Press 2007), tells of postcarbon methodologies for home power & regional transport running on renewables; -The Retail Railway" as a neigborhood employer and local business.

Serious & practical ones, familiar with previous referenced info, can proceed with obtaining their respective locale's "Rail Map Atlas" from ( and alert the planners down at the County seat that it might be a good idea to get local rail served warehousing again. State officials reading and heeding can get mentioned info into the hands of the office adjutant at the State National Guard, groundwork for re-commissioning of the Railroad Operating & Maintenance Batallions. They will be needed, and shall form critical human resources, rail savvy and able to move into private sector rail expansion.

President wannabes, maybe even the sitting President #43, need to consider practical hardware issues, such as freezing steel scrap exports, allowing ample feedstock for relit rail rolling mill at Steelton, PA, for example. Come ON, Gentlemen & ladies!

We have entered into the last hour of trading Mon 15th
Sept 2008. This is the "tale of the tape" as they say in boxing circles. What ever happens in this final hour, will determine the next few weeks, months, years.
If the bleeding gets worse....expect real damage short and mid term. If it can be staunched, expect the
sun will come out tomorrow.
I personally am singing..."I made a railroad, made it race agaisnt time, now its all done, Hey buddy can you spare a dime"

I thought you made a good call looking for a fall in the market of around 15% today.
The fact that there has not been anything like it indicates to me that we have probably had massive intervention in the markets, and that can't go on forever.
Otherwise it is just weird that the fall the last I heard was greater outside of America.
They are probably intervening more than the Europeans.

Don't forget that this is still the dotcom/MTV generation market, the same people who said recessions were passe. The ones who decided they would rewrite the laws of economics to suit themselves. You'll have to peel the stocks out of their cold dead hands. ;-)

Dave, watch what happens in Euroland and Asia tomorrow.

I came across the wit and wisdom of Warren Buffet today, writing in 2002 on the derivatives market which 'like hell, is easy to get into but difficult to escape' - here is the article which quoted it, but the linked pdf is well worth the read too:
Wall Street crisis: Is this the death knell for derivatives? | Business |

It's nice that Mr Buffet remains optimistic on the American economy, as his bank balance says he may know a bit more than the rest of us!

Yes, either that or his bank balance may be dependent on the rest of us thinking he believes what he says.

I suspect and firmly believe we will now see a further
decline of 7%- 10% in the next few days/weeks. The severity of the situation needs time for the markets
professional investors to digest. As I said upstream, the finale hour would determine the direction moving forward.
You are witness to history as it accures here. The only analogy I think is fitting is, the fall of Rome.

I called a broker at Lehmans to discuss the situation......I called "HEY WAITER" but he was busy with the table next to mine, something about a fly in the soup!

I am sure the Lehman's waiter had an overleveraged CDS on that fly and was attempting to verify its death before informing his counterparty that his tranche had expired.

My bet is that it is US investors pulling their money from just about everywhere. The more distant and the less liquid the market is, the more it will suffer... And I guess overseas markets are viewed as more risky, so the liquidation there is more brutal. This is what may keep the dollar for collapsing so far - if people are changing european stock for treasures for example, this may keep the dollar up for a while. I wonder what will happen after this is over.

Brother Can You Spare a Dime
There is an interesting movie by the same name

DJIA Energy vs. Financial Markets Scorecard:

Imminent GOM Hurricane: -11
Imminent Financial Tsunami: -504

Down over 500. Yikes.

the connection as i see it is this

the ability to negate inflation (if you like) by mopping up financial profits is a process of consuming cheap energy to produce things so as to bring meaning to the value of the "printed cash"

once cheap energy no longer exists the rate at which the de-leveraging has to take place at runs out of kilter withe the rate at which it was predicted to take place at.

hence bankruptcy

the net energy thing means there is no growth to handle the supposed wealth.

you can go on inventing virtual money as long as it coincides with the rate at which you can increase (energy) consumption

its that simple

the drop in efficiency (dreaded EROEI) complicates the ability for markets to "see"

One, and most important thing, you will never hear on
CNBC or from Paulson, Bernanke, Greenspan, WSJ, is, you can't lose money in a never "gets lost" ...someone else gets it.
Its like placing flyers around the neighborhood for a lost cat. Cats don't get lost, they leave. The billions and trillions of $ didnt evaporate like a Boeing 757 hitting the pentagon....their in someone elses pockets...just not your pockets. The post war baby boomers entire life savings and investments, along with any surviving parents..has been "harvested"
You are left to glean what fell in the dirt.

Bon Appetit

That's untrue. Resources can be miss allocated and become worthless.
A house which has been built too far out in the sticks in the last boom will cost too much due to rising fuel prices, some of the surrounding areas get abandoned, the householder defaults and soon the whole suburb is worthless, not to the householder, the bank or anyone else.

This is true in the case of a simple market transactions where a dollar moves from one player to the other and the total number of dollars are conserved.

The problem being faced now, however, is that of credit being destroyed. In our fractional reserve banking system, almost all money in existence was created by a loan being issued somewhere to someone. Money is created like magic by opposing ledger entries on the bank's books. As such it really doesn't exist independent of faith in the borrower's promise to pay it back. Once confidence is lost in this bargain, money that came into existence as a debt obligation is simply destroyed: it vanishes into the thin air from whence it came. In a highly leveraged system, defaults can set off chain reactions of defaults and produce a cascading collapse in trust.

So, yes, trillions can simply disappear by cascading failures of financial debt obligations, which can be triggered by falling market prices of core assets used to underwrite these debt-money pyramids.

Value evaporated today in the stock market too, yet only a small fraction of total shares changed hands (and some likely of those did more than once). House values, stock values, debt values, inventory values -- all of these are necessarily notional, based on what people agree they are worth through sale transactions. Unfortunately, it seems that our assets can evaporate while our debts are persistent. :)

Our money is based on debt, not assets. It doesn't work that way.

What we have is what is real-trees, houses, land, factories, etc. Even these may not be worth what we think they are worth, if they require oil or electricity to make them usable, and they suddenly become unavailable.

Money is mostly promises to pay. If these promises cannot be met, the money is worth nothing. Regardless of the money, all we have is what is real. We can make promises to pay in the future, but if the resources aren't there in the future, the promises will never be kept.


Were not all of your predictions predicated upon rising oil prices.

Oil prices are down and look like they are heading down more.

The US dollar has recovered substantial ground versus the Euro.
There was the part about falling US dollar and Saudi's switching to a different currency for quotes.

The problems of financial over leveraging and housing bubbles and the resulting issues are a Savings and Loan style mess but all the oil related parts of your forecasts do not seem to be happening.

ie. the rising demand for oil and falling supply of oil.

In terms of financial condition, Japan has about 180% debt to GDP ratio.
Italy has about 115% debt to GDP ratio.

If doomers were to play the country debt obligation game, Italy and Japan have older populations are are heading to social security - medical cost issues sooner.

So what is currency that is going to replace the dollar ? Euro ? Yen ? Yuan ? Gold ? Petrodollar ? KWH ?

Of course oil prices would drop when no one has money to buy it. I don't think any of the OD front-pagers would have denied that.

But now how is economic recovery possible? Oil prices will rise dramatically as soon as we have a little money to buy it, crashing us right back down.

You say of course oil prices would drop, but if you read Gail's predictions that is not what she has said. She said oil would go up. Ace has said that oil would not go below $102 for average monthly price ever again.

So it seems that Oil Drum contributors have staked out positions that disagree and deny your claim.

The Renminbi?

I once suggested currencies issued by individual states.

Maybe a basket of currencies with internationally agreed ratios of each.

So ... I'm having trouble seeing how this system doesn't completely go crashing down now.

BOTH parties are fiddling while Rome burns.

The top diary at DKos right now is 'McCain Camp's Fiorina calls Tina Fey "Sexist".'

Who the heck are they, and why are we not trying to mitigate collapse to minimize suffering?

The only segment of the economy that looks like it has a chance to me is lipstick stocks.

Bush is the captain and McCain is the first mate( with Sarah as the sexy/psycho secretary) in this US version of the Posiden Adventure(Hell Upside Down).

But they won't let Obama out of steerage.

Video footage of McCain choosing the moose hunter

What can anyone do at this point ?

What would exactly would Obama or McCain do tomorrow ??

Be the scapegoat for all of the problems.

Not sure why anyone would want this.

Obama will put Volcker in change.

Vote Obama, you stupid soon-to-be paupers.

McBush-Paulson has no 'moral authority'.

Paulson put his old firm Goldmann Sacks in charge of the latest manipulations/shenanegans.

Those guys are rolling all the bad shit CDOs thru GS setting up a kind of financial Giant Blackhole.

Maybe the pimple will burst before the election.

Volcker will clean house. He's believable.

I'm a bit late to the party here, but I think that the timing and impact of this financial crisis could not have worse implications for peak oil:

In large part, I see the financial/credit/housing crisis as separate from the energy crisis. To be sure, they are linked in some ways, and energy prices have exacerbated credit/housing issues, but I think they are fundamentally stand-alone phenomena. Even if Oil prices had never gone above $30/barrel, I think we would still be facing a very similar financial crisis right now. At most it would be delayed by a year or 18 months from our current position.

So what? Here's the key: the current (short-term) iteration of the credit crisis can be solved. And, if the Federal government continues to let select firm (like Lehman) fail, it will be resolved. It will be painful, but financial institutions will return to solid banking, credit, and devleopment practices. There is great fundamental resiliency in the American (and global) economy, at least for the time being. However, in my opinion the lasting impact of the credit crisis will be that it acted as a smoke screen to keep us from addressing the much more severe, much more fundamental, much longer-term energy problems facing humanity. We are experiencing a temporary reduction in demand caused by a fudnamentally fixable financial crisis. This is having two effects: 1) we are not focusing the necessary political will on addressing our future energy problems while we still have sufficient surplus, high-EROEI energy to do something about it, and 2) to the extent that we are trying to address underlying energy problems we are being hamstrung by tight credit markets in our efforts to build out renewables. This--not any named hurricane--is the real perfect storm that is currently brewing. Recovery from this financial crisis will be painful, and it may not result in a world that favors the US as much as it once did. We will, however, recover from the FINANCIAL aspects of this crisis. It might take 24 or even 48 months--precisely the amount of time where I think we have enough surplus energy, enough high-EROEI oil and gas to really embark on the massive renewable buildout that could effectively mitigate peak oil. Instead, we will focus on fixing banking practices, focus on fixing the housing industry, etc. such that exactly when global (and to a lesser extent US) energy demand is really picking up again (and with lower elasticity this time, as the easy conservation fruit will have been picked) we will begin the downslope of global oil production.

I think the public is missing the key to this crisis. This is not "the Crash." This is the event that distracts us from out last (or at least best) opportunity to effectively mitigate the coming energy crunch, the event that locks in the slow crash scenario... a bit more on this here (from 5 months ago).

Jeff, to comment on your thoughtful post,analysts are talking in terms of this crash being as bad as the 1929 crash including, notably, Greenspan, who since he did as much as any man alive to create it may know what he is talking about.

This would seem to indicate a much more protracted period of recovery, perhaps 10 years, which also makes sense when you compare it to the 1990's Japanese crash which had similarly overvalued assets.

Even after this period, grave damage is likely to have been done to the underlying structure, with vast debts built up.
These factors might take 30 years to work out, if we avoid on-going collapse.

On the other hand, it is not clear to what extent this will infect the BRIC countries.

The effects there may even be so limited that oil shortages will come into play again fairly soon - we will just have to wait to see.

From what I can tell, affordable oil has been a key to every past economic recovery.

Oil may have dropped because the economy is going off a cliff right now, but how can there be a recovery if oil prices shoot up every time we start heading in a positive economic direction?

Welcome to the Devil's Seesaw

I generally agree with Jeff but for an important missing element. The Wall Street finance is run by extremely complex computer models. The people who run these banks and their salesmen and managers do not understand them This massive,heavily interlinked counterparty relationships have created a system that defies all traditional notions of economics due to massive hedging. All risk is hedged, but all hedged in the same way. The system is extremely fragile to the ten sigma event, which is the one that the computer modelers didn't think of or stress test.

It was this whole computerized derivatives scheme that created the illusion that money could be generated endlessly through endless generation of credit. And the worst of it is that the Fed is part of the whole scheme.That's why Greenspan was so enamored of derivatives and said so many outrageous things.

Where I disagree is the recovery part. If you do the math you will see that there is no way to recover from this unimaginable amount of debt. Moreover, when the dollar finally collapses below the level of most other currencies, those trillions of foreign dollars will come rushing home a la Weimar Germany. I'm afraid a hyperinflationary depression is in the works.

Moreover, when the dollar finally collapses below the level of most other currencies, those trillions of foreign dollars will come rushing home a la Weimar Germany.

I think this could be better expressed as "When the US economy collapses (due to the unwinding of a finance based economy and unrealistic over-reliance on credit) other holders of dollars will repudiate the dollar and the international value of the dollar will plunge making all foreign inputs to the US economy vastly more expensive than they are now."

In Weimar Germany the impact on the population resulted in the rise of "strong leadership," and an increase in militarism that lead directly to WWII.

Your comments about a financial mess, being a distraction from the real crisis( peak oil) rings true.
I challenge on your thesis that wind power only appears to have a high EROEI. Your link noted that costs for installing wind power in Texas has increased. One reason given is the cost of new transmission infrastructure, the other the increase in the cost of steel, a major input to wind turbines and towers.
Some of these costs are because wind power is new to Texas and growing very rapidly(25% per year). The rising costs of wind turbines is due to a shortage of manufacturing capacity not related to costs of energy.
The increased cost of steel is due to the rapid growth in China, putting pressures on iron ore and coal supplies. The EROEI is still 20:1, and not directly related to costs of NG or coal in the US which is still relatively inexpensive compared to oil prices. Wind power is competing with NG and coal generated electricity, not oil.
A financial crisis may have a more direct role in reducing the available funding of wind or solar energy( at least in US). This may also reduce the long term response in US to higher oil prices by reducing the replacement of low mpg vehicles. However, less expensive small cars often have higher fuel economy, so a mild recession may assist in increasing average mpg. A prolonged depression. however, would probably stop almost all new vehicle sales, but give a very big reduction in VMT.


I am going to politely disagree that the fundamentals say that oil should be rising.

Oil is a commodity. It is not terribly useful as a store of value so it's value comes from how it is used - as an energy source. Therefore, the price is determined primarily by supply and demand.

Evidence strongly indicates that global oil supply remains roughly flat after 4 years (rising every so slightly over that period). Given that supply was nearly static, demand had to have risen in order to drive prices up.

For prices to be falling now, there can either be the situation you postulate, or (Occam's Razor...) the simpler explanation of falling demand. In my opinion, with over 800,000 foreclosures in the US this year alone, with Europe already officially in recession, with China attempting to stimulate its economy (not something you do when an economy is booming)... all signs point to reduced global demand as the primary driver of falling prices. If this is so, prices can continue to fall well past the full unwinding of paper positions simply because demand is down.

Exacerbating that situation is evidence of the power of demand right now. Because of Ike, we have clear data that indicates a shortage of refined product. We also have refineries down and unable to process crude so we have a glut of crude. So what happens? The price of crude continues to fall while the price of refined product rises due to shortage.

It is my opinion that the global capital markets are not the primary movers of the price of oil, neither on the way up to $147 nor on the way down to $94 where I saw it today. The primary driver is demand and demand is down badly due to the current credit mess. Further, demand will remain down, even if oil drops back to $10 per barrel, so long as this credit catastrophe continues to unwind. We are witnessing credit destruction on a scale almost unimaginable a few years ago. Right now the world is experiencing deflation, hard, fast and in the face deflation. That deflation is going to continue to destroy credit, which will destroy more borrowers, which will destroy more lenders, all leading to fewer jobs, no wage growth or even wage contraction, and consequently vastly reduced demand.

This does not invalidate peak oil. It just means that the economy is going somewhere that many of us did not expect - towards a deflationary depression. If the global economy arrives there in full, oil could cost far less in absolute dollars yet far more as a percentage of available income.

While I appreciate your thesis, you appear to ignore the direct consequence of a debt implosion in your own conclusions - reduced demand, leading to lower prices, instead attributing lower prices to financial manipulation.

I'm sorry, but I don't buy it.

There has been a disconnect between the actual price of some commodities and the paper (virtual) price. Examples are gold, silver and currently gasoline. With such a disconnect, supply of and demand for the actual product become irrelevant to the paper price. The price of refined product (gasoline) is in freefall on the financial markets currently, far lower than the actual wholesale price of gasoline. Gasoline is in short supply right now (see the top article re rationing) but you would never guess this looking at the financial market price.

I have to agree with you. The run up was, I think, justified given the fundamentals early in the year and what we saw with future supply in megaprojects, Russia, etc. When we got over 120-125, though, I thought things were going a little wacky. I expressed to my wife the wish that I had a trading account with a good bit of cash so I could short oil.

Now,I was one of those saying this wasn't speculation, but I may have been wrong about that. There might be more intentional and unintentional speculation driving things than I thought. Again, up to 125 I thought this. But after the run to 147 and the drop since? Something smells. Eau de Election, perhaps? A little PPT?

What has happened in the fundamentals, I think, is that the fundamentals have changed and a bit of overshoot on the drop. Demand destruction has been much-discussed here at TOD, but few of us really expected the degree of destruction we are seeing. Call it the Youtube Effect: People are watching all the economic doomsday predictions there, seeing it in their daily lives and seeing the bull excreted by BuCheney/Paulson, et al. about a "fundamentally strong" economy, etc., etc., and are scared out of their minds. And others had just been priced out of the market for energy and food. Something had to give.

I think that oil is fundamentally under-priced now, but that real demand destruction will catch up to that underpricing and, thus, oil will go lower. The question now is, is decline going tocatch up to demand destruction? Or, are those economies that are still growing going to continue to do so long enough to re-balance supply and demand and push prices back up?

Inquiring minds want to know...


Grey Zone - while I agree with your main points (and have written often here that demand destruction would cause a large reversal in crude prices), demand for refined product has NOT dropped 42%, as prices for reformulated gasoline and heating oil have, from their peak 2 months ago. Unless stopping gas sales due to fear of gouging by the stations who are paying high cash basis is ubiqutous, I think you might see an increase in gasoline demand the next 2 wednesday reports due to hoarding, topping off, repairs etc. trumping loss of business from the hurricanes. But I suppose the futures markets often know something we do not -perhaps the pump shortages mean that 'demand' is still high but that 'actual consumption' dropped...

Historically there has been a 1 for 1 relationship in price elasticity of oil demand. Refined product as you say above has DROPPED in price, not risen. If this was all about demand destruction why wouldnt airlines and transport companies be trading down in kind....In the longer run drop in demand from deflationary credit unwind will exert a larger impact on oil prices - but right now, oil demand has hardly dropped commensurate with prices - this is deleveraging from financial firms pure and simple. AIG has HUGE short swap/long futures oil position on - if they go under oil gonna dump (unless they are out already - the futures will tell you when they are done)

This is all such a lesson that short term price signals don't give us much good information on long term health or lack thereof of a stock/commodity/system.

Proof please, Nate, of the 1-1 association? I have asked that question before and no one, including you, had an answer when I asked. My question was simple - how much demand destruction does a $1 rise in price cause? And there were numerous people at pains to point out that the relationship was not linear at all.

The wild swings we are seeing now are a predictable outcome of a finite resource for which we have not found adequate substitutes (yet) and were predicted here on this blog a few years ago (by others, not myself).

Everyone keeps trying to map what is happening using old tools and old modes of thinking. Maybe, just maybe, it is time to step outside the traditional box and ask ourselves where this can end?

I wouldn't disagree with most of what you are saying.

I expect a credit implosion to lead to a deflationary depression, unless the government continues to try to prop up everyone, in which case it could be hyper-inflation. Now that the government has decided to step back, I think we may very well see the deflationary depression scenario unfold.

Regarding the price of oil, I think it will depend on how much of the world follows the US into a deflationary depression. Oil may not be priced in dollars any more, either.

Oil is rising in the sense that it is taking a bigger piece of people's incomes to buy a similar amount. This is likely to continue to be the case, because it is becoming more scarce and underlies most economic activity. People's incomes will drop as well in the depression. It is only a question of which resources become relatively more valuable. Oil producers will not stand by and let prices drop below the cost of production--US imports will be cut off before this happens.

I tend to agree. There is too much waste in the US (and that includes Bush and Cheney :)) that can be taken out of the system. The US uses twice as much oil/$GDP as does the UK,Germany and Japan.

There is a good likelihood that the US economy will contract (I think the current GDP deflator is understated and the US is probably in recession) and that means lower oil usage.

I think this means that demand for oil from the US will drop. When demand from the single biggest consumer of oil falls it means lower prices.

I also think that the climb to 147 from 100 in 6 months and when markets correct they will also swing too much in the opposite direction.


I totally agree with what you said, the current oil price fall is clearly demand related. In addition, there is a good evidence that supply is still growing. I don't buy the speculation thesis either, there are little evidence in the data to support this, on the contrary data shows that investors in the future market are trend followers (price changes lead trader changes in position).

Not surprising, Asian markets are tumbling after Wall Street had its tumbler. Shanghai, Taiwan & Tokyo already down 5-6%.

The timing of this blowout left the US markets first to flutter since yesterday was a banking holiday in much of Asia.

My observation has been US markets tend to rise again soon after taking everybody else down for a dip.

Paulson suggests there is behind-the-scenes cooperation among the world's central banks to coordinate strategies "to maintain the stability and orderliness of our financial markets."

On Friday, the central question was whether "Lehman Brothers" was too big to let fail. Wondering if international investors/central bankers are coming to similar conclusion about an institution even older and grander: is the United States really too big to let fail?

When an investment becomes an endless "money-pit" invariably people will throw up their hands and say to hell with it. Let's pull the plug and start afresh.

Has the 600 lb gorilla called the US economy outgrown its welcome? After a while, someone will grab a tranquillizer gun and put it away.

Should be interesting to see how long foreigners continue to back US borrowings.

"Should be interesting to see how long foreigners continue to back US borrowings."

Well, I think that really is the question. Either they do, and we try to inflate our way out of this mess, or they don't, and then we go through a very painful deflationary consolidation, which I think everyone wants to avoid at all costs. My guess is that our foreign creditors will try to prop the dollar up as long as possible, but it may be beyond their control.

Today the yen went up to 103 per dollar (from 107 just two days ago). That is fast. The yen carry trade is unwinding.

Up until now the BOJ has struggled mightily to make sure that this wouldn't happen (by supporting the dollar).

But the mood here in Japan seems to be different now I think, what with the Lehman failure going to cost Mizuho and Aozora (and other banks) billions. If their yen assets are worth more that will help to offset the dollar losses. The idea is restore value and use the money for necessities, not merely supporting trade anymore. Also there is an election coming and there seems to be some lack of direction and confusion over who will take over.

Plus the US isn't buying Toyotas like it used to (propping up trade and those factory jobs was one reason the BOJ supported the US$). (Gee I wonder WHY the Americans aren't buying cars anymore!!!!)

It's a kind of turning inward here.

People are worried simply about their own prospects and not about the dollar anymore. It's like "too bad! We can't help you! We have our own problems!" Which they do obviously have, with several bankruptcies of big construction firms, retail sales of department stores down 5 months in a row, etc.


I am asking more than commenting, trying to "model" what is happening in my mind, so bear with me:

In the boom days, only a few billion dollars could be used to guarantee hundreds of billions. Just today I saw a statistic that showed that the FDIC had only about 10 billion dollars on hand, but it is the insurance for possibly 5 trillion in deposits.

When things are going good, that’s fine because there is very little risk of much going wrong at the same time. But when things turn bad, a lot can happen at once. What was formerly considered respectable cushions in the case of unexpected events is now seen as completely imprudent. Credit ratings agencies who viewed a bank, insurance firm, brokerage, etc. as perfectly sound a few years ago suddenly begin downgrading the same companies, even though the company may still have the same margins of error now they had then. The business press which had been perfectly comfortable with the firms contingency funds a few years ago now turn against them. The firms are accused of “incompetence” for doing exactly what they had been being praised for only a few years earlier (“you can’t expect to make money if you leave money under the mattress, you have to have it out there in play, earning money…”)

This makes the investors nervous. They pull in their horns, and take money off the table. They reduce leverage, pay down debt with any spare capital. Many of them had made fortunes in the 1980’s and ‘90’s anyway, so they can afford to sit off to the sideline on cash and bonds and wait. This creates financial gridlock, a sort of coma takes over the economy. The money is still there but it is parked.

The question is, wait for what? The assumption seems to be that the investors (and all of this applies to both institutional large investors and small investors) will come back into the equity and “risk” markets when (a)confidence is restored in the economic system and (b)they view stock/equity/asset prices at absolute bottom price. This is the so called “blood in the streets” investing tactic.

For the average investor, the question becomes, how will we know and how low can it (asset and equity prices) go? What sign will tell folks that we are at bottom?

It is almost impossible to predict. After the 1970’s recession (which should give us some indication as to how long the downturn can last, as stock and asset prices (“risk capital”) failed to grow for almost 12 years, while “safe” bonds and cash grew in some of those same years by double digits), the rebound in the markets came almost completely without warning. In 1982, equities and other risk investments began to grow, and did not look back (except for the short downturn in 1987) until 1999. It is to this date the longest running bull market in history and it came completely without warning. In fact, it came against almost all opinion and advice as “The Death Of Equities” was the mantra of the day.

But for those who were there, who had the nerve to buy early and buy as much as possible, it was rewarding. Fortunes that changed lives were made. Ray Kroc, the founder of the McDonalds chain once said when asked the secret of his success, “You can get it wrong a lot of times but you only have to get it right once.”
But to be fair, fortunes were also lost in miscalling the markets. It is called “risk capital” for a reason.

So as the kids always ask from the back seat, “Are we there yet?”

There is no way to know. I predicted earlier this year that we would see the Dow at 9000 points before I would consider coming into the market hard (with certain possible exceptions) and will stay with that prediction (based entirely on gut feel and a little bit of history). I am also of the view that house prices are NO WHERE NEAR low enough yet. In many markets in the country they have dropped very little. As to oil, I guessed a floor of no less than $100 per barrel for this year when many were betting it to go to $200 per barrel, and I may be wrong on that one. Oil at below $90 per barrel strikes me as insanity given the world situation, but who knows?

As I said at the start of this post, I am trying to model the future and decide what to do, and for now, I am playing the “safety” angle, bonds and bond funds, and pay down the debt, in other words, I am one of those parking my money as much as possible. I may not win but at least I can’t lose unless I am completely wrong and miss a fast turn upward, in which case, I will have been too conservative once again. It won’t be the first time, but like so many baby boomers, time is becoming a major factor for many of us.

Gail, I'd say you hit a home run with this thread.

Lots of insightful, thought provoking comments.

The TED spread spiked hugely yesterday:

I guess it's pretty certain that this was caused by Lehman folding, but will it recover, and if not, will it cause a chain reaction and cause other bank-ish businesses to fold?

*Note* I originally posted this in the DB, but moved it over here as it's more appropriate.