Why are oil (and gasoline) prices so low?

We all know that oil prices are lower than they were in the recent past because supply is greater than demand. In fact, OPEC oil ministers are meeting this week to try to fix supply, so it will be more in line with demand.

All of this seems a little strange, though. We are going into the winter months, when demand for oil normally rises because many people around the world heat their homes with oil. We are using somewhat less gasoline in the United States, but apart from the hurricane disruptions, not very much less than earlier this year. While we are going into a recession, it doesn't seem to have hit with full force yet. What other factors may be involved in the current lower prices? In this post, I will discuss factors besides those we usually think of as supply and demand that may be involved.

Figure 1. EIA Chart of WTI oil spot prices - One measure of oil price

While this post is primarily about oil prices, the decrease in oil prices can be expected to have an impact on gasoline prices as well. The drop in retail gasoline prices has not been quite as dramatic as the drop in oil prices because gasoline prices are affected by other factors in addition to the price of oil. Robert Rapier has a post talking about some issues affecting gasoline prices. See also my article from July Why isn't the price of gasoline even higher?, talking about the differential between gasoline and diesel prices.

Figure 2. EIA Chart of Weekly Gasoline retail prices

1. Credit problems of oil intermediaries

The oil industry has many more players than most of us are aware of. The International Oil Companies use contractors to do many functions that we think of as oil company operations. Oil is shipped by oceangoing vessels and by pipeline. Refiners are often separate from the oil company that produced the oil. Gas stations are often independently owned.

One of the issues is that sellers want to be sure that they are going to be paid for their product. They are unwilling to sell to buyers with poor credit. This is removing some players--and some demand--from the system.

According to Credit Woes Hit Supply Chain, Push Prices Down:

"The credit crunch is putting on a brake at every level of supply," said Antoine Halff, deputy head of research at brokerage Fimat USA. "Levels of credit are evaporating, so producers and refiners are having a hard time selling--they want to make sure their customers are good for the money," Halff added.

Also, from the same article:

Shippers - who bring tankers from the ports to consuming countries - are also seeing a reduction of available credit, with some of them going under as a result. . . [This is] leading to a scarcity of available capacity for shipping.

If an oil company can't ship the oil, it can't sell it. We also read that banks are involved in the process:

To make matters worse, some of the major investments banks that are currently under stress--such as Morgan Stanley (MS)--are also an important part of the oil chain. "They hold storage, are active physical traders and some of them actively participate in the physical delivery process," said Petromatrix's Jakob.

2. Liquidation of positions by hedge funds and other speculators

Hedge funds have been under pressure from several directions to liquidate their positions in oil:

• Investors in the hedge funds have been disappointed in their performance, and are liquidating their positions. Oil futures are easy to sell, so the may be sold first.

• Hedge funds are highly leveraged. In the past month, many of them have received margin calls because of declining values of the securities they held (oil futures, stocks, bonds). Again, oil futures are easy to sell quickly.

• Banks are under pressure to reduce their lending because of their low reserve margins, and because of concern that hedge funds may not be good risks. They have been putting pressure on hedge funds to reduce their leverage.

Since hedge funds and speculators realized early this year that the price of oil was rising, most of them had net long positions. When there was a need to sell these futures contracts (because of margin calls or for other reasons), the sales of these contracts tended to bring down the price of oil.

3. Hedging of future oil prices by oil companies

Once oil prices reached high prices (say, > $120), even for long-dated futures, it made economic sense for oil companies to lock in future sales at those high prices. To the extent that oil companies locked in future sales using long-dated future contracts, this would add sellers to the long futures market, changing the balance in the futures market. The addition of sellers to the market would tend to bring down futures' prices.

I understand that long-dated futures contracts are quite illiquid, and that oil companies may not, in fact, be using them for these purposes. Does anyone have any real-life experience with oil companies using futures contracts to lock-in long term prices? It would seem strange to have contracts whose benefit is primarily for speculators.

4. Rise in the value of the dollar

We read in a Bloomberg article:

Oil Falls More Than $4 as Dollar Rally Dims Commodities' Appeal

Oct. 21 (Bloomberg) -- Crude oil fell more than $4 a barrel as the U.S. dollar rose to its highest in more than a year against the euro, dimming the appeal of commodities as a currency hedge.

Oil climbed earlier on expectations that OPEC, supplier of 40 percent of the world's oil, will reduce output at a meeting in Vienna this week. Investors looking for protection against the dollar's decline earlier this year helped lead crude oil, gold, corn and gasoline to records.

``The strengthening of the dollar is the main factor pushing most commodities lower, and oil is always the leader,'' said James Ritterbusch, president of Ritterbusch & Associates in Galena, Illinois.

Basically, the higher the dollar, the lower the price of a barrel of oil (measured in dollars). The dollar is high now, so the price of oil is low. One analysis showed that one quarter of the increase in the value of oil from $20 barrel in 2002 to $147 in July 2008 was because of the falling value of the dollar. Since july, the price of oil seems to decline as the value of the Euro declines relative to the value of the dollar.

5. Trend Trading or Systematic Trading

Many investors use computerized programs that attempt to analyze an investment's momentum, either up or down. These programs are designed to buy more of an investment, when the price of the investment seems to be heading upward, and to sell the investment short, when it is heading downward. If a large number of hedge funds, pension funds, and other investors have computer models that do the same thing, the simultaneous buy and sell orders will tend to reinforce the upward or downward trend in prices. These programs may have contributed to the unusually high oil prices seen earlier this year, and the big drop in the past month.

6. Drop in Asian growth

One of the reasons for the run-up in prices earlier this year was the concern that Asian demand was growing rapidly, and that world oil supplies could not keep up. There may have also been some stockpiling of oil prior to the Olympics. Now there are indications that growth in Asia is starting to cool, and we read articles such as this one:

Asian meltdown may force oil to tank

The fact is, unlike many other commodities, “Asia is important for crude oil because its marginal demand is entirely coming from Asia,” said Michael Lewis, global head of commodities research at Deutsche Bank. The bank estimates that in 2009 as much as 360,000 barrels per day of oil will be required by China, which is lower than the 450,000 bpd for the current year. At that rate, “China will be responsible for 80 percent of global crude oil consumption growth,” said Lewis.

Similarly, industry estimates put India’s oil demand at 100,000 bpd in 2008 and predict it to remain unchanged for 2009, even if the country’s gross domestic product were to slip marginally from its current 7.5 percent.

Hoping that Asia and particularly China and India will not falter due to the global meltdown may be optimistic under the current conditions.

7. Small size of the oil (and other commodities) market, relative to the rest of the market

The amount of commodities for sale is tiny in comparison to the dollar value of stocks, bonds, derivatives, and other investments. If investors get the impression that commodities are a good source of diversification, or are likely to rise more than other investments, it doesn't take very many of these investors to raise (or lower) prices in oil markets. Investors tend to read the same investment advice, and hear the same forecasts, so may tend to make similar decisions.

Research by Morgan Stanley indicates that commodity markets tend to move together. In the past, commodities have tended to follow long cycles, but "peak everything" may change this pattern.

Figure 3. Graph of commodity trends by Morgan Stanley, shown in a Financial Sense University post.

8. Increased volatility when supplies are very tight

When supplies are very tight because of peak oil, both the supply curve and the demand curve are nearly vertical. A small change in demand (or supply) can result in a huge difference in price.

Many years ago, whale oil was used for lamps until it became depleted. Historical graphs show that its price was very volatile, once production passed its peak value. The price of petroleum is likely to be very volatile post-peak also.

Figure 4. Price and Production of Whale Oil

What's Ahead?

Certainly, we can expect more volatility.

There is room for a difference of opinion on the course of the dollar near term. On one hand, the United States is doing less badly than some other countries in the current financial crisis. If this trend continues, the dollar could rise even higher than it is currently, as investors look for safely.

On the other head, we have been reading speculation about alternative currencies, such as this one, regarding a tri-polar currency. It seems likely to me that eventually some change will occur that will make the value of the dollar drop substantially, and raise the price of oil.

In the not too distant future, we can expect a fair amount of "shake out" among smaller companies in the oil business, with many of the less well capitalized being acquired by others or going out of business, as indicated by this article:

Falling Prices, Credit Woes Threaten Small Oil Firms:

Most at risk are small outfits focused on exploration and production that urgently need cash to keep drilling. Even a few months ago, these companies had no trouble borrowing money and selling stock to finance operations, based solely on the value of their reserves. But with access to capital drying up, their funding opportunities are dwindling rapidly.

Between problems with credit, and the cutbacks from OPEC, the supply from oil is likely to drop significantly in the next few months. This drop in supply should put upward pressure on the price of oil.

All of the cutbacks related to credit are hard to follow through the system. There is a possibility that some of them will show up in unexpected places, leading to shortfalls and/or price spikes.

I do not expect the problem with long-term credit to ever really go away. (This is the subject for another post.) Because of this, long-term supply is likely to drop even faster than previous analyses have suggested. Assuming no major changes in the monetary system, this would seem to imply higher prices, long-term.

In response the question in the title:

Heck if I know.

Here's what I do know: It's a suicidal response.

It cements Peak Oil by putting a halt to additional drilling programs.

It kills alternative energy program developments.

We're moving from the slide to the cliff and this accelerates the progression.

The most surprising thing to me (but probably not to The Automatic Earth folks) about the credit meltdown is the extent of the collateral damage to the food & energy producers. So, not only does this have negative implications for future energy supplies, it's also a big negative for food supplies.

In any case, based on the HL models, Saudi Arabia is about 60% depleted, Russia (at least their mature basins) is about 80% depleted, and Norway is about 70% depleted. These three countries accounted for more than 40% of total world net oil exports in 2005. Saudi Arabia is going to show three straight years of annual production below their 2005 rate, Russia has resumed its production decline, and Norway is in long term decline.

Tell me about it. My dad and two brothers are oil men. I'm a farmer/rancher.

I'm sitting on a silo full of corn and a tapped out credit limit at the local bank. Do I sell the corn for more than it will cost me to replace it so I can plant more, or do I sit and wait for people to get hungry enough to allow me a profit on the work I have already done?

My dad/brothers have leases for natural gas projects now in moth balls.

They're preparing to drill a few potential oil wells, but I'd say this is just momentum at work--they had already been planned and initiated before the price collapse. The leases were expensive, acquiring a drilling rig and the necessary pipe and casing was also difficult and expensive.

Being Austin Chalk type wells he's drilling, potential production comes in a flurry and goes away quickly.

$145 oil was too high, too fast. $70 oil works for existing production but not so well for new hard to find and expensive future development. Existing production as we all know is in decline.

Hell, buying existing 3-D seismic studies run $40,000 a square mile in these parts.

In situations like this, the "winners" are those who lose the least. Look at the bright side. You and your family could be in the auto, housing or finance business.

In regard to my little corner of the oil patch, I'm doing the same thing that I was doing at $140 oil and at $20 oil, looking for small, but commercial overlooked conventional oil fields.



Here's a big factor; coordinated interest rate cuts have reduced the profitability of the Yen (and Dollar) carry trades, where investors borrow @ the low rate in Japan and invest the funds in other countries with higher yields. The across the board reductions in interest rates are having a strong effect world wide on commodities:

Interest-Rate Cuts

The currency may also drop as the Australian central bank cuts interest rate to revive growth, reducing the yields for holding the nation's assets, Shah said.

The Reserve Bank of Australia is expected to cut its benchmark lending rate by 0.5 percentage point to 5.5 percent on Nov. 4, according to a Bloomberg survey of 16 economists. The rate stood at a 12-year high of 7.25 percent in August. The country's interest rates made Australia a favorite for investors seeking higher returns using funds from a country with low borrowing costs.

The risk is exchange-rate fluctuations can erode profits.


Here's another take from the Japanese viewpoint:

``We can't rule out the possibility that our accommodative policy has had some influence on overseas financial markets,'' Yamaguchi, who is currently an executive director at the central bank, said at a parliament hearing today in Tokyo. ``Some people say one side effect of our policy is the yen carry trade,'' in which investors borrow cheaply in Japan and put money into higher-yielding securities abroad, he said.

The central bank kept interest rates near zero percent for five years through July 2006 to spur economic growth and counter deflation. The monetary authority has since raised the benchmark overnight lending rate to 0.5 percent, still the lowest among the industrialized world.


Carry trades tend to cancel the benefits of accomodative policies as they encourage investment outside the countries that initiate the policies in the first place.


Thanks! This probably explains part of the change in currency valuations.

I don't watch currencies in general. I watch the Yen-Dollar exchange rate. I've been puzzled by recent stories about the dollar going up in value, because it is definitely going down against the Yen.

I've also been puzzled by the reaction of gold & oil. It seems to me the dollar is dropping in absolute terms, just not as fast as Euro. It is notoriously difficult (impossible, really) to put an absolute value on a fiat currency. The closest thing is probably to use gold & oil. What I thought should have happened is that gold & oil stay relatively flat against the Yen, go up a bit against the dollar, and go up a lot against most other currencies.

That hasn't occurred. Since (like most people) I'm convinced I know more than the market when it comes to prices of things, it has led to some bad trades and a lot of cursing at the irrationality of the market (rational==agrees with me; irrational==does not agree with me).

There has been quite a bit of discussion about an apparent disconnect between "paper gold" prices and prices of real gold, if you can find it. The real gold is about double the price of the paper gold. See this CNBC Video showing Jurg Kiener, CEO of Swiss Asia Capital. He tells CNBC's Maura Fogarty & Rebecca Meehan that if the paper market collapses, gold prices may double very quickly.

...or do I sit and wait for people to get hungry enough to allow me a profit on the work I have already done?

<sarcanol> Don't worry about evil, wicked profit. If food keeps going up, there will be price controls after the election. People prefer shortages to earning and paying for what they consume. </sarcanol>

Well then, shortages they'll get.

Like I said, suicidal behavior.

Plant a green fertilizer like alfalfa.

Like Westexas, I was genuinely surprised by the collateral damage in food and energy. It isn't that I wouldn't have anticipated declines, but I wouldn't have thought them to respond so quickly - in fact, I have the sneaking suspicion, at least with food, that the declines in price are a little over rapid, and that we won't see more volatile price changes.

Biofuels will obviously be the big factor in food prices in the coming years - best hopes for the end of the ethanol boom.


Sharon, I don't understand your statement ". . . we won't see more volatile price changes."

The recent decline in food prices is not unusual in the history of agricultural markets. Food markets tend to be highly volatile because of demand inelasticity, time lags, and variable weather, to name a few reasons. Financial crises, I think, tend to increase volatility of food prices. Current financial (and eventually economic) crises seem to me to set the stage for a further increase volatility rather than the reverse.

I'm not an expert on food prices, but I have studied--and taught--economic history, and the price volatility of agricultural products is notorious.

Over the long-term, food prices will rise as oil prices rise. But along with the long-term trend I think increasing volatility is likely, both in oil prices and food prices.

By the way, I very much enjoy reading your posts and comments.

Could a drop in demand from restaurants be part of the drop in price for food commodities? No job means no lunch break at McDonalds. No job means no payday dinner at the local steak house.

Undoubtedly you are correct that decreased buying of food by restaurants has contributed somewhat to the decrease in demand for certain foods, but it hasn't had a major impact on the prices of wheat or corn or soybeans. Why not? Because people have not cut back on eating: Rather what they have cut back is their spending on food by eating less frequently at restaurants. I like eating at some restaurants and I hate waiting in line for a table. A couple of years ago, waiting lines were common. I haven't had to wait for a table for the past year and a half.

I have talked to one TOD reader who sells high-end lettuces to restaurants. He said he has decided to discontinue this, because there is less demand for this kind of thing. I presume he will switch to growing something that grocery stores would be likely to sell.

I was not surprised by a drop in a oil prices brought about by the financial crisis, nor by the financial crisis itself -- many, many people saw that coming. But I was surprised by the extent of the drop. In that respect,

8. Increased volatility when supplies are very tight.

is the most relevant point, the whale oil anecdote most interesting. If the tendency is for production to follow a bell curve, and demand to follow an undulating curve, well, somewhat sawtooth like, overlaid on the production curve, then price is apparently A*gap + B. What's surprising is how big a multiplier A is.

Not only is the market totally irrational (blind is perhaps more accurate) in the long term pricing of finite resources, it is totally irrational even in the very short term pricing.

One of the several things gov't should be doing is taxing the gap to smooth the price curve and assure that it goes only up, fast enough to reflect depletion, both to gather revenues for the necessary restructuring and to send the right message about the need to restructure.

Edit: I will be very surprised if the low oil prices lasts even a year, given all the countervailing forces.

Yes. The volatility is really something. If I were working in the oil and gas industry, I wouldn't know how to plan. If people are buying oil futures on margin, they are really getting slammed (unless they are short). One wonders what secondary fall-out there will be, from the volatility alone.

If I were working in the oil and gas industry, I wouldn't know how to plan.

In the absence of any certainty about the future price of oil, you would tend to delay starting any project that needed, say, $80+ oil to turn a profit. Which is what, most of the new projects?

One wonders what secondary fall-out there will be, from the volatility alone.

Fewer participants in the market, leading to even more volatility. At some point, the market is pricing itself; the effect of the markets' lack of stability rather than the worth of the participants' products. I suppose a lot of liquid players in energy are waiting for a trend with money in their pockets.

Since trades in one market are often hedges against trades in another, the imbalances wrought by negative real interest rates on one hand and the unpredicability of risks on the other spills from interbank lending or currency exchange into commodities, for example. A few months ago the trade 'Du Jour' was short financial stocks and long commodity indexes. Hedge funds poured billions into that trade. Then .. the Chinese post- olympic surge failed to take place. There was a short-covering rally in bank stocks. Hedge funds started getting redemption demands and that particular trade collapsed.

This is a stupendously wicked market. Everyone is getting killed, the best place to be is on the sidelines.


The oil patch hasn't slowed up too much yet from the drop in oil prices. Companies don't adjust their pricing forecast based upon short term swings in prices. Even when prices hit $147 most operators were using $70 -80/bbl in their forecast. And even then many dropped prices around 10% for years 2 and 3 with a minor inflation rate afterwards. We tend to use a yearly average price in running our economics. I would suspect most companies have dropped their price some lately. A few, like my client, are considering slowing up drilling activity some but even with that we'll still be running at record levels. Truthfully, a little slow up wouldn’t hurt. It might help drop rig and steel rates some. These factors have started cutting into the bottom line pretty good the last 6 months.

Now if prices stay down here through the winter that would be a different matter. But as far as a significant slowdown in drill I would attribute much of that to the credit crisis more so then oil pricing.


I have a little bit different observations from my side of the oil patch. I am the finacial analyst (aka moneyman) for the exploration dept. of a mid-sized permian basin player. We are definately cutting way back on what we will drill next year. The slowdowns haven't happened yet... we are still drilling wells that were approved earlier this year, but as soon as is feasible, we will be releasing rigs not under contract and our drilling pace will drop by over 50%.

I appreciate your on-the-ground feedback. This is the way we see what is really going on.

This is where it gets scary.. if a large amount of small scale workover/step out drilling is postponed or cancelled over the next couple of years, that will show up as a significant decline a couple of years out.

see www.binaryseismoem.weebly.com

We have to take into consideration technological progress.

It reduces AE program development, at least. Back when oil was still $20/bbl, we still had AE programs and AE was still growing, albeit at a lesser rate.

The United States has much more to worry about than its credit and banking problems. Jim Willie, who has been forcasting the collapse of the United States Banking system for several years, in a recent interview he says the US DOLLAR has months left, not years. Also he states foreign countries already have another world currency planned. Its just a matter of time before it is put into place. The US DOLLAR is not going to be the world currency much longer.....dropping the USA to a third world status very quickly.

You have to admit, we have been buying Oil and Goods with worthless monopoly money and toxic financial instruments for the past several decades. What are we going to trade for that Crude Oil now?

Here is Jim Willie's Interview:


some of the factors you cite are forcing functions, related to supply and demand but not the root cause. imo, the forcing functions are overriding fundamentals.

a story on the mainstream media today claims that today's (so far) drop in price is because demand concerns are trumping opec expectations. if this is true, how can it be anything but speculation ?

***** caution wild oscillations ahead *****

If we continue to use May, 2005 as the index world (C+C) production rate, 74.2 mbpd, the cumulative shortfall between what we would have produced at the 5/05 rate and what we actually produced increased in the second half of 2005, through 2006, through 2007--and through July, 2008, 2008 production is now flat at 74.2 mbpd (preliminary EIA data, subject to revision). I wonder how much money the industry spent in order to basically keep crude production flat? And what happens if we can't maintain that spending rate?

"74.2 mbpd" (or 860-odd barrels per second). That's still a lot of barrels, right?

Regards, Matt B
Hey, just logged on and noticed I've just passed my first anniversary here. Should I celebrate? Or should I ask myself if I've learned (or acted upon) anything?

Ans: Nowhere near enough, sadly, though it did take me ten months to discover Al Bartlett. Average Joe, average IQ, slow learner.

Such is life.

Yeah, and I am sure that is why the US dollar has been sinking...NO! It has been rising against foreign currencies for some time now. Now at a seven month high.


To get a better perspective take a look at the US dollar vs. foreign currencies since 1975 look here.


Try to keep things into perspective. As other economies grow and countries become more prosperous the US dollar may not be the "world currency" just as the British pound is no longer the be all and end all of currency. Still I would not exactly call the pound a third world currency would you?

Finally, I think you may have missed that quite a few countries are also having a bit of a banking problem and it is obvious you haven't compare their "bailout packages" compared to GDP vs. the US.

"When the tide laps at Gulliver's waistline, it usually means the Lilliputians are already 10 feet under."

To paraphrase Churchill, the Dollar is the worst possible currency -- except for all the others.

The only realistic alternative to the dollar is the Euro, and their problems are, if anything, far worse than ours. A poll a year ago showed that 70% of Germans wanted the Deutschmark back; and I'm hearing rumors that they may expel Italy from the currency union. Germans don't want to pay to bail out Spanish banks. European banks are leveraged far more than American banks (very surprising to me, since I assumed they would be more highly regulated); and of course they bought all our mortgage backed securities (God knows we didn't have the savings to buy too many of them.

Japan has been fighting off a deflationary recession for two decades, and China is utterly dependent on massive exports to Europe and the US -- which are drying up very quickly.

At the beginning of the year I considered diversifying to FDIC backed, Euro based CDs, but as I examined their unenviable position, I realized that the dollar isn't that bad after all.

What about the honest, real and universal currency gold?

It's not honest(doesn't prevent the issuing of Mortgage Backed Securities, Credit Default Swaps, fractional reserve banking, dodgy loans; doesn't track the size of the economy at all...).

It's not real(few actual, useful applications outside of jewelry and gold buggery; nowhere near enough of it to support the world economy without fiduciary money which enables expansion of the money supply regardless of what gold is doing, which is presumably what you're trying to prevent).

It's not universal or currency(try barterting for something with gold and you'll find that fiat money is preferred unless you're willing to pay a huge premium).

Its funny that while capitalists are worried about increasing govt control they don't care about total govt control because of fiat currency. When your govt can print as much money as it like then basically your value is no more than that of a slave and your country is no better than a socialist, fascist country.

please note that as far the general public is concerned gold is just another fiat currency . yes I know you disagree BUT I can't tell if that gold piece you gave me is real unless:

its a gold coin - backed by a government there and can be faked.
(so how do I know its real ? I have to have faith its real AKA fiat currency )

or has a note from the supplier that its real

so the note is on faith AKA fiat based therefore gold is fiat

do not forget joe beer keg has an IQ of 100 ( sometimes less :) )


Willie's scenario, along with Bob Moriarity's who I believe also sees the same, pose very frightening implications if proven correct.

Willie's sources appear to be spot on:

ECB's Nowotny Sees Global 'Tri-Polar' Currency System Evolving

All I can say is we're living in historical times indeed.


Gail wrote:

We are using somewhat less gasoline in the United States, but apart from the hurricane disruptions, not very much less than earlier this year.

This is actually blatantly misleading.

There were no major disruptions in July (the last month for which we have revised US gasoline consumption data).

July 2007: 9.64 million barrels per day
July 2008: 9.07

That's a decline of 6%.

When was the last time we had a decline of that magnitude in July? 1979 (-9.8%)

The fact that you are a nice old lady won't stop me from giving you a very public drubbing if you are not more careful!! :-)


So demand goes down by 6% and the price goes down by 50%? The current oil price is driven by hysterics. We will have shortages if the perception driven price stays low, then we will have hysterics in the opposite direction.

That's the general consensus here. The question is, with ever growing volatility, how far past the peak must we be to see it in the rear view?

Don't overlook the fact that that 9.07 bpd of gasoline included about 700,000 bpd of ethanol. That's probably up close to 300,000 bpd over last July.

So, demand is not only dropping, but gasoline's share of that demand is dropping. One insight into this might be the fact that diesel demand is dropping a bit slower than gasoline demand (hence the widening spread between diesel prices, and gasoline prices.)

At least, that's the way it's looking to me.

You are right about the increasing use of ethanol. My impression is that they really maxed out the use of ethanol during the shortage following the hurricanes. I believe most of the "blending components" included in gasoline are ethanol, so you can see what happened from this EIA exhibit.

The developing world is using more diesel than gasoline, and Europe has always used predominantly diesel to fuel its cars. That leaves left-over gasoline that they are willing to sell at relatively low prices. When we take up some of the demand with ethanol, that reduces the demand for gasoline further.

One thought I had was that I might have added another item:

9. Reduced oil demand due to Hurricane Gustav and Ike.

With all of the disruption and closed refineries, US imports of crude oil and other items dropped way off following the hurricanes. It can be seen from this EIA exhibit, US imports of crude oil and petroleum products were averaging over 13 million barrels a day. Once the hurricanes hit, our imports dropped to something more in the 11 million barrels a day range.

This temporary decrease in US imports looked like a demand drop to the world export system.

The loss of the gasoline and other products in the Southeast also temporarily added a downward push on the economy of the area, contributing at least a little to the economic problems we are seeing now. I was just reading today that Georgia's job losses were second highest in the nation in September (after Michigan).

All I know is that the Merritt was packed last weekend and this was the first time I had seen it like this on a non-holiday weekend in a couple years. MY guess, based on anecdotal evidence, is that we are backfilling the drop in demand as we speak.


I understand someone who sells SUVs and other big cars says that demand is back up. It doesn't take long.

All you have to do is look and you will see there has not been any fundamental change in the rolling stock. There are a few more Fits and the odd Smart Car hear and there but there has not been any real fundamental changeover to more efficient cars. Nor has there been any fundamental change regarding driving, culturally. I don't hear people making value judgements about gas conservation. I heard people saying they were driving less when gas was 4.39 in NYC. Now I don't. I see the demand destruction as cyclical, not secular. Price will go back up because low prices will reignite demand.


All you have to do is look and you will see there has not been any fundamental change in the rolling stock.

Define "fundamental". From the EPA:

"Based on publicly available sales data...subcompact, compact, and midsize cars have been the only vehicle classes to have met or exceeded sales projections by automakers, while sales of midsize SUVs, large SUVs, and large pickup trucks are 15 to 25 percent lower than automaker projections. It also appears that 4-cylinder engines have gained market share from 6-cylinder and 8-cylinder engines."

Roughly speaking, 10% of the market has shifted from large to small vehicles. That may not meet your criteria for "fundamental change", but it's certainly a significant change, and it means that a substantial portion of the current demand reduction is long-term.

The portion of the drop in demand which was caused by "high" prices at the pump can be expected to substantially reverse now that prices are "low" again. That was a simple behavioral change, not a structural change. It didn't go on long enough for significant structural change. Offsetting that will be a general tightening of belts due to actual job loss and fears of job loss.

"I understand someone who sells SUVs and other big cars says that demand is back up. It doesn't take long."

Last weekend I stayed at a hotel on "Auto Mall Road" in Tucson, a 3/4 mile auto dealer extravaganza leading to the Tucson Mall. And from Friday through Sunday it was worse than dead. I could jaywalk across the 6 lane highway without bothering to look over my shoulder.

It was truly astonishing.

If the rest of the country is this way, GM and Ford won't be around by next summer.

MPG with ethanol blends is worse than with straight petrol, so 1 bbl of ethanol does not displace 1 bbl of petrol, but X < 1 bbl.

Any idea as to what X is? I suspect it's as low as 0.2.

I think ethanol has about 2/3 of the fuel mileage of gasoline.

Gasoline is not very good for fuel mileage to begin with--diesel is better.

Ethanol BTU's produced are more commonly about 70% of gasoline BTU's, varies according to process used, so some ethanol BTU's might be 2/3 of the gasoline BTU's.

In 2007 the United States consumed about 142 billion gallons of gasoline.

The EPact law requires 21 billion gallons of cellulosic ethanol by 2022.

The EPact law caps grain/sugarcane ethanol production at 15 billion gallons.

Up to about 10 percent of our gasoline additives may be made from corn or other food sources.

Total ethanol might supply 25% of our needs by 2022 according to EPact standards, yet the cellulosic ethanol cost estimates vary, I read a recent operating cost figure of $6.00 a gallon, have not seen it in operation, nor did I get an estimate of effects on wood products prices, or forestation regrowth, costs of wood delivered, cost of interest on capital invested, administrative, employee costs etc. It seems like the government has invented a way to drive up prices at the pump.

During a peak within the last few years the United States supplied about 21 million barrels per day of petroleum + products. I recall it from reading the Weekly Petroleum Reports.

Recently the United States supplied little more than 18.7 million barrels of petroleum + products per day. The drop in products supplied was accompanied by huge inventory gains. Inventory gains are normal in mid-October, less likely during the winter blasts of January.

The drop in oil + products consumption seems to be more than 20%, more than the yearly change of ethanol production. Thus you have a situation where $4.00 gasoline scared people to the point of changing their habits. Not only in the United States, but likely elsewhere in the world too.

Feb 5, 2008 ... It calls for the production of 36 billion gallons of biofuels—mainly ethanol and biodiesel—annually by 2022, with 21 billion gallons coming ...


On a monthly basis (before the Hurricanes hit) the lowest recent product supplied was 19,412,000 in July from here.

The comparison to a year ago tend to slide downhill:

Jan 08 / Jan 07 = -2.2%
Feb 08 / Feb 07 = -7.2%
Mar 08 / Mar 07 = -3.9%
Apr 08 / Apr 07 = -3.7%
May 08 / May 07 = -4.3%
Jun 08 / Jun 07 = -5.6%
Jul 08 / Jul 07 = -6.4%

The 18,400 was for a while after the hurricanes, when some of us (I live in Atlanta) were going without. It wasn't the price of the gasoline. It was the fact that there wasn't any.

Several months ago TOD posted a link to a study testing several recent models of cars. I do not recall where the study cane from but the mileage results under controlled conditions were suprisingly high.

Mileage results in this test were much higher than I would have expected given the relative heating values of ethanol and gasoline.


in the real world, with real people, driving real cars running on a 10% ethanol blend your 0.2 is, probably, pretty close.

Many of the "newer" cars running on a twenty, or thirty percent blend will get pretty close to the same mileage as on straight gasoline. There are some cars that won't do as well.

What is wild is that gasoline consumption drops a huge 6% YOY and the USA YOY goes from importing 66% of its oil to refineries to 72% now. The drop in domestic oil production is outpacing the drop in gasoline consumption.

The drop in domestic oil production is outpacing the drop in gasoline consumption.

US oil production is up this year, regardless of whether you want to look at YOY of the most recent month (July08 vs. July07) or year-to-date vs. the same period last year.

It's worth checking data rather than making assumptions about it.

US oil production is up this year

Post-Gustav and Ike, not true. Down almost a half a million b/day currently.

Just because post-hurricane stats have not yet been published does not alter reality.


Just because post-hurricane stats have not yet been published does not alter reality.

And neither do temporary disruptions make a trend. Arguing there's a downward trend between 2007 and 2008 based on one week's hurricane-disrupted oil production is misleading at best.

The fact of the matter is that an apples-to-apples comparison - US crude production, pre-hurricane disruptions - shows no decline. That's not to say that US crude production is not in long-term decline - it is. All I'm saying is that the original claim - that US oil production is falling faster than US oil consumption - is contradicted by the available data. (Factoring hurricane disruptions out of both production and consumption, of course.)

That's like saying Galveston remains the same when you factor out hurricane disruptions.

Pitt: I read it off the weekly report released Wed-domestic oil supplied to refineries (YOY change). Good thing you don't make assumptions much.

I read it off the weekly report released Wed-domestic oil supplied to refineries (YOY change).

In that case, what you're seeing is post-hurricane disruption; don't mistake that for long-term decline.

The data and graph here, from that same weekly report, shows that the majority of this drop has already been restored, and that the large majority should be expected to be temporary (based on similarity to 2005, where the 4-week average dropped by 26% (end Aug to mid-Oct), but recovered to 95% of pre-hurricane production by May06, and - despite ongoing decline - was up to 99% of pre-hurricane production by Dec06). (Interestingly, the weekly report's historical data disagrees with the IPM monthly data; the weekly is consistently higher for 2007 and consistently lower for 2008.)

(Speaking of imports, for crude or crude+products they're down significantly YOY (~-0.5Mb/d), on a 1-month, 2-month, 3-month, 6-month, and YTD basis.)

I'm not saying that US production is not going to continue its long-term decline. All I'm saying is that the original claim - that "[t]he drop in domestic oil production is outpacing the drop in gasoline consumption" - is either (a) directly contradicted by the available data, or (b) misleadingly attributed to natural decline when it's the effects of hurricane damage.

Good thing you don't make assumptions much.

I don't. You'll notice that I've backed up everything I've said with links to the relevant data, as well as often checking robustness by looking at several different time-periods. You, by contrast, didn't provide any evidence for your claims. When pressed, it turned out you were making generalizations based on a few weeks worth of hurricane-affected data.

That is one reason why it's important to provide evidence: you can see when data is being misinterpreted or misrepresented. As it was in this case: temporary disruptions from hurricane damage are not a reasonable basis from which to make claims regarding ongoing trends.

"It's worth checking data rather than making assumptions about it."

If you subtract the extra day for Feb. it amounts to a whopping 1.038 million barrels for the first 7 months. That amount was almost lost in August alone before the hurricanes.

I expect that by year end we will be down about 60 million barrels of total production for the year, or an additional 6 days of imports.

The difference between this year and last is statistically insignificant (35,860 vs 35,892, through July)), probably well within the margin of error of reporting. It is just noise on a long-term downward trend.

To be fair, Gail wrote: "not very much less than earlier this year."

In that, the statement is roughly accurate (EIA data):

Jan: 8,814 thousand bbl/day
Feb: 8,842
Mar: 9,069
Jul: 9,072

I suspect the point she's trying to make is that total product supplied in the US is about the same now as it was during the months with oil above $100/bbl. In other words, demand may be down significantly compared to last summer, but it's not down as significantly compared to the time that oil was reaching mid-$100s prices. Pause and think about it a moment. What might matter more when considering the present oil price: How much gasoline was consumed in the US last summer relative to the time of $130/bbl oil (Jun/Jul 2008), or how much is being demanded right now relative to the time of $130/bbl oil? It's a question worth consideration.



Ask yourself, when did the market first have very good statistical evidence of the very substantial decline in consumption in July? Only 3 weeks ago when the EIA released the final July number. The early estimates made at the end of July didn't show a sharp decline at all. Thus, the numbers were subsequently heavily revised down

But, of course, June consumption was off big too. When were those numbers known? 7 weeks ago.

But traders don't just sit around waiting for the EIA's numbers. They use everything they can get their hands on. And there were indications....nicely documented in the Drumbeats that a shocking change in US consumption was afoot. Most traders have no seen anything like this in their adult lives, if at all. It hasn't happened in 30 years. The light dawned gradually.

At least some of the other factors Gail mentions play a role, too. Especially the current Panic.

But for reasons unknown, Gail is profoundly unwilling to give changes in consumption their due. In fact, she doesn't like to explain trade fluctuations in terms of market mechanisms at all.

At times I've even suspected she is a Marxist. Which would be great, as I'd love to see an explicit (updated) Marxist perspective on things. But it should be done in the open.

[BTW the revised august consumption number will be released in a few days and it will rock your world]

Sure-Gail is a Marxist and your buddy Hank Paulson is being forced to do his thing because of the mess Bill Clinton made (or was it Jimmy Carter?)

If I want to write a post of < 2,000 words, I can't cover every topic at the same time. In this post, I am trying to discuss factors other than what we usually consider a decrease in demand that are affecting price.

The reason changes in consumption are not being discussed is because that is not the topic of this post.


I do not know how you, westexas, and the rest do it. It takes me an incredible amount of my limited free time to read the posts here on TOD. First I have to read and try to understand the main post of up to 5,000 words. Then, there is the trudging through all the comments. Hundreds sometimes. Sometimes the reaction is "huh"? and I have to re-read it carefully. Othertimes it is "You're an idiot!" and I mentally list all the reasons why. Perhaps it is because I am not 'in the biz' so it takes a bit more for everything to process. Regardless, I know I use more mental energy here than I do in most parts of my day and I certainly learn more here in an hour than I did in every hour in college. (Anything with Stuart's or Khebab's name should be available for Professional Development Hours!) Thank you and the others for all your hard work!

You are welcome. We enjoy it!

Marx says that the laws of survival of the fittest(free market competition) will lead to the concentration of all wealth in the hands of oligopolies and mass production techniques will swell the working(or non-working) poor; the polarization of these two classes(class struggle) will lead to World Revolution.

The Panic of 2008 has and will eliminate a lot of competitive players from the market, concentrating the remaining wealth in fewer hands. Mass production of housing has created a glut. The next step was to make phoney credit available to the masses so they THINK they can afford to buy those houses, unloading junk on the proletarians. In terms of actual wealth, therefore the 'proletarians' has become poorer(but 'debt rich'), while the rich become even richer.
Marx would conclude that market economics are illegitimate, a complete con-game, designed to trade Manhattan Island for silly glass beads. If the system self-destructs, that is to be expected.

Did YOU expect the market to meltdown?

They had Nassir Taleb(Black Swan) and mathematician Benoit Mandelbrot on the PBS Newshour last night--experts on chaos theory. They haven't a clue what's going to happen and think things are wildly out of balance.

And yet you still look for market based explanations, which tell us precious little even when things are going well.

Well, when in doubt blame it all on the Marxists(or Gail).

I have been a fan of Benoit Mandelbrot for a long time. I bought the hardback version of his (Mis)Behavior of Markets when it came out in 2004. The quants putting together structured securities should have read his book back then.

I just did find this document.

The American Wage Structure 1920 - 1947


Thomas Ferguson James K. Galbraith

August 1998

What this document describes is comparative wages between and across industries and groups factored for social phenomena such as unionization and strikes, overseas competition and entry into the workforce of women and immigrants. It is interesting to me that the term of this examination covers the period that I maintain was actually the Great Depression, not just the period from 1929 - 1939.

If you scroll down the pages you can see that wages across almost all industry groups were flat; after a sharp decline caused by the panic of 1921 and the rebound in 1922, there was practically no increase in wages during the period of 1922- 1929.

In the meantime, the Gross Domeastic Product for the period 1921-1929 increased from $68 billion to $101 billion (in constant dollars).


Marx was partly right, concentration of wealth is destabilizing. Without earnings, the working public cannot afford to buy the products that they make. Without accumulated wealth, there is no money to 'trickle up' to the investment class. The (predictable) outcome is collapse. But ... that's not the issue here, exactly:

The Panic of 2008 has and will eliminate a lot of competitive players from the market, concentrating the remaining wealth in fewer hands.

This is where Marx is incorrect. The consolidaton within industries is rather the collapse of the uncompetitive into each other. Between and among these business organisms, there is little real wealth, only debt denominated in ways that cannot be clearly calculated. The risk value often exceeds the 'book' of the combined businsses. Rather than making the remaining participants in the shrinking markets more powerful, it makes the system as a whole more vulnerable. At the bottom, there must be some wealth to concentrate.

Here is where the joke of the producing class is on the wealthy. As from 1922 onwards to 1929, this country has had near- flat or declining wages since 1982. At that point the real wealth generation went 'on vacation' and the public started its credit binge. Low interest rates enabled the binge and allowed the financail markets to escape the boundaries that declining investment capital would ordinarily impose. Debt is magical ... for awhile.

Now, the investment class needs the productive class more than ever ... and they are falling out of work! How ironic!

PS; the Ferguson/Galbraith paper credits the rise of unionism and the effect of government hiring during the WWII period to compress wage disparities and bringing a long term period of prosperity. "The Great Compression"

Good work !

Given that we are probably at the end of multi-decade trends that primarly started after the end of world war two its good to look at stuff like this.

The debt trend for example probably extends all the way back to WWII but would be difficult to pick out clearly in its early phases by the late 1970 and 1980 it was obvious and given a big kick when we left the gold standard.

Although we look at some of the short term issues facing society right now in the bigger picture the birth and death of the baby boomer generation following WWII and the policies associated with this generation is also happening right now.

Its fascinating to watch everything start coming to a head at the same time.

Another trend that started about 1970 was a trend toward lower and lower cost labor.

First women were added in this country. Then we started to add labor from abroad for manufacturing. More recently, we have been adding labor from abroad for services.

This really is part of the flat or lower real wages in this country, and the need for debt to finance a growing life-style.

Right we forget about this. And even as jobs where exported overseas over the last several decades businesses that remained in America moved to using illegal aliens as cheap labor. So your right the first trend was women entering the work force then a growing number of illegal immigrants.

Pretty interesting mega trends overall. What really funny is it succeeded in replicating the mistakes of the past as the workers became unable to also be consumers.

One thing I've never really grasped about American capitalism is this obsession with driving down wages. I know its good for short term profits but the absolute fixation on driving down costs with a focus on wages is just weird.

Germany of example gets a good name for fine engineering etc but they don't have this myopic focus and generally the rest of Europe does not. Also I don't see it in Japan.

Maybe its not unrelated to the increasing use of oil imports which meant over this time period money was not being recycled into the US economy but being sent abroad.
Over these same years that the US has been so focused on cheap labor more and more of the other costs of production was money that left the US first for raw materials then eventually for finished goods leaving only the so called service economy.

For Japan imports have been constant so it was not changing.

For Europe they had the North Sea and Russia although not technically part of the EU is economically welded at the hip so overall the EU's energy/trade balance has only altered recently.

Not sure if this is a real correlation but the differences between the policies of the US towards workers and the other advanced countries is striking.

One thing I've never really grasped about American capitalism is this obsession with driving down wages. I know its good for short term profits but the absolute fixation on driving down costs with a focus on wages is just weird.

I see this as a part of the "market always knows best" mentality the US has.

In almost every corporations, wages and benefits are by far the largest part of the expenses in absolute dollars. When a corporation is required to drive down the costs, management will find most effective to focus on the largest expenses first. Of course this is at odds with the macroeconomic requirement that workers need money to be consumers. But corporations have no responsibility to implement macroeconomic policies. Their responsibilities are to manage their own costs and revenues.

This is a case where the best policy at macroeconomic level doesn't always result from the cumulative effect of microeconomic best decisions from the decision maker point of view. This happens when there is an imbalance in power when workers negotiate working conditions with employers. There are times where corporations have more ability to force down wages than employees have freedom to find better jobs elsewhere. If you apply free market policies strictly, over time you get a trend of wages going down and depletion of the consumers ability to consume.

The remedy would be to have policies that give workers more power to negotiate their wages. Investing in education to beef up the competency of the workforce and make it competitive against offshore outsourcing is an example of such policy. But in the US this kind of government action is viewed as "socialism" and is considered to be bad.


The point you seem to miss or not care a hoot about is the fact that $2.50 gas is even less affordable than $3.50 gas for a huge portion of the population.

There is no positive in this.

It is not giving the right message at all.

At times I've even suspected she is a Marxist. Which would be great, as I'd love to see an explicit (updated) Marxist perspective on things. But it should be done in the open.

This is a truly peculiar comment. Marx himself would not have been averse to explaining "trade fluctuations in terms of market mechanisms" in some cases. So your Marxism detector is seriously flawed.

I am a Marxist. It means I concur with some of Marx's ideas. I'm also a Darwinist, I concur with some of his ideas. I'm also a Shumacher(ian?)(ist?) Same reason. Also a peak oiler, a peaker in general. I could go on and on. We all carry intellectual baggage, if that's what you want to call it, of one sort another.

One could turn around and start guessing what the influences on your thinking are. But it would be quite pointless because what's at issue is what you say and whether it is right, not what lurks behind what you say.

Marx, BTW, is dead, so don't hold your breath on an updated perspective. People who call themselves Marxists today cannot agree on the time of day, any more than can Catholics.

I do not get hysterical about one month with a 6% reduction in gasoline usage. In the whole scheme of the world's supply of oil, I don't see one month's reduction of the US gasoline usage during summer months, when there is a lot of discretionary driving, to be all that earthshaking. My point wasn't that there were no changes in demand; it was that the changes in price seem out of proportion to usage changes. I also talk about the inelasticity affecting price in point 8.

When we look at the weekly gasoline consumption amounts, comparing 2008 to 2007 from the weekly survey, which is all we have to look at recently, this is what we see:

The drop-off, to the -3% and -4% reported, started in the summer, when there is a lot of discretionary driving. The big drop-off, to -5%, came during the disruption following the hurricanes. The hurricanes started right after the summer, so we really haven't had much of a chance to see what driving would be in the absence of hurricanes.

I'd venture to say that there are at least 2 reasons why this dramatic falloff in consumption ... not seen in almost 30 years.... makes you uncomfortable.

1) Lower prices mean people worry about peak oil less and you are in the peak oil worry business. Fair enough, you are an activist.

2) If US consumption can fall rather rapidly (as it did in the early 80s), peak oil will be less of catastrophe than many believe. Yes, there's the rub.

Many in the peak community have yet to come to grips with the fact that demand can plunge. This has implications, among other things, for household planning. One doesn't have to worry as much about a more fuel efficient vehicle if one believes there is going to be a global recession.

Say I'm trying to decide whether to wait for the new electric cars on the way from sources domestic and foreign. The fact that people are cutting back and gas prices are falling is a big deal because it means that perhaps I can afford to take my time and hold out for better technology.

2) If US consumption can fall rather rapidly (as it did in the early 80s), peak oil will be less of catastrophe than many believe. Yes, there's the rub.

It may be (and I have no evidence to support this supposition) that there are the easy, low pain changes that Americans can make to reduce consumption, and that's what we have seen this and in the 1980s. There is enough wasteful use under normal, low oil price times that cutting out that part is pretty easy.

That doesn't automatically mean that cutting further would also be as easy. Presumably each decrease in consumption will be more difficult from the last, because one would assume people tend to cut the less painful things first.

You are missing a couple of points:
1. The first 10% or 15% is relatively easy and painless to conserve.
After that the demand becomes very inelastic.
2. Eventually declining exports catch up with conservation.

Not necessarily. With time, new technologies that use much less oil (or none at all) come to market. Conservation might be quite a bit easier in 2013 than it is now.

Rail is cheaper than trucking. But it takes time to increase an inventory of locomotives and rail stock. Structural changes (which offer the possibility of enormous savings) take time.

But, yes, if we had to cut 30% over the next month alone, then the first 10% would come easier than the next 10% and so on.

RE net exports. Depending on how technology, conservation, recession work out, it's possible that decline in demand will outpace a decline in net exports forever. We'll see.

The problem of course is that our model, case histories, and some current examples (e.g., Mexico & Venezuela) show that net export decline rates tend to accelerate with time.

Some Net Export Decline Rates:


2005: -6.4%/year
2006: -6.5%/year
2007: -16.4%/year
2008: -32%/year*



1998: -3.7%/year
2007: -10.2%/year


2002: -2.5%/year
2007: -8.9%/year

News Item Regarding Russia:


In addition, energy production is already stagnant, and export volumes declining. Russia's crude oil exports fell by 5.9 percent during the first eight months the year, the researcher writes.

As time goes on, we are, IMO, going to see more and more exporters showing accelerating net export decline rates.

Of course, Saudi Arabia has shown a year over year increase in net oil exports, but I estimate that their net exports in 2008 will be about 8.4 mbpd, versus their 2005 rate of 9.1 mbpd, not exactly a promising trend.

Unfortunately, it is not as easy as getting the latest gadget or gizmo to save us. It takes about 15 years for the US vehicle fleet to turn over. New vehicles get sold to others, then other, then others until you get to my 1980 POS ford ranger that I plan to drive until the wheels fall off.

Also, new ideas tend not to work in strange and unpredictable ways. Then we have the problem of scalability. And who is going to maintain all these fancy new toys? (let's not mention who will be able to afford them with the resession/depression). Don't get me wrong, new tech will help, but it is a thin reed to rest your hopes on.

It takes about 15 years for the US vehicle fleet to turn over.

True, but misleading. DOT surveys show that over 50% of driving is done by vehicles which are at most 5 years old. Consequently, substantial fleet turnover happens relatively quickly.

The good news, Mad_Man, is that our entire fleet can use E30 quite efficiently. That will give us some time.

1) Lower prices mean people worry about peak oil less and you are in the peak oil worry business. Fair enough, you are an activist.

It's not just about people 'worrying'. If lower prices send false signals about future supply, the ensuing complacency could be detremantal to peak oil mitigation and planning.

2) If US consumption can fall rather rapidly (as it did in the early 80s), peak oil will be less of catastrophe than many believe. Yes, there's the rub.

Not necessarily. Superficially, falling consumption seems like a good thing but it all rests on the manner in which it occurs and the wider economic implications. If (when?) 'demand destruction' affects the poorest disproportionately or causes a debilitating economic depression the results could indeed be catastrophic. Falling consumption is not good for the growth on which the current economy depends.

As someone posted in a previous drumbeat, here's the U.S DOT federal highway administration estimate for total miles driven:

Yeah, there's a reduction, but for 2008 YTD so far it's ~3%.

Also, here's the monthly averages:

Again, there is a reduction, but for urban highways we're still in the noise for summer months and hurricane season (i.e. statistically I'd say you can't tell if the reduction is due to hurricanes or it happens to be July or September when people drive less than June). Looks like a lot of people didn't take road-trip vacations this year, but month on month data does appear to correlate with a reduction in demand that is persistent.

but also there does appear to be a consistent, but small, reduction in demand.

(quotation since modified)

More evidence that peak oilers are soooo resistant to accepting the reality of declining oil consumption.

Small? It was a fracking earthquake in the automotive world and we now have all three NA automakers on death watch. Basically dead in the water.

Take a look again at that hook-shaped graph. Most here have seen nothing like it in their adult lives. Stare at it and be amazed. (and it's a 12 month average, btw, which dampens the affect of recent declines).

With falling prices, of course, demand could increase again. But what we've seen so far this year is truly historic and the ground is littered with corpses.

I'm not resistant to the reality of declining oil consumption. The reason I said "but small" is because I was trying to emphasize that it's not 6% as in July 2008, more like 3% persistent reduction with periodic interruptions during hurricane season. After reviewing it I changed it because it read the way you seemed to interpret it, so I apologize for that.

Secondly, you say three auto makers are on death watch and there is a huge decline in consumption, but what is it you think that peak-oilers have been warning about for years and years? Believe it or not, I think that this is TSHTF as "we've" always said. Obviously it's not playing out as the Mad Max scenario or as anybody quite envisioned it, but I think that if you're trying to use this as proof of a cornucopian viewpoint is correct, you're not going to convince anybody -- the economy has partially collapsed and it's a good bet that geologic constraints on oil production had something to do with it.

I do wonder though if demand will increase again and what it will do with decreased prices. I'm guessing it won't recover completely because people are looking at their savings and retirement accounts and are going to say "Why don't we take that vacation to state park again instead of driving X hundred miles to Florida."

If the usage had kept going the way it was headed up until 2004 then we would now be at 3200 or so. It is not just 3% down it is 3% down from zero and 7-9% growth that did not happen over the last few years.

The first 10% is easy. Well we can go down another 7% easy and that drops oil prices to $20/barrel for two to four years and that is even with reduced production from OPEC.

More time for more biofuels.
More time for increasing percentage of fuel efficient cars, hybrids and electric cars.
More time for more nuclear power worldwide.
More renewable power build up.
More time for oilsand production increases [some slowdown in projects but that means projects go ahead at an orderly pace with less exhorbitant worker wage inflation]
More time for Bakken supply ramp up with pipelines built.

Thus a more orderly transition can be realized.

The thing that catches my eye more on this graph is not the little hook at the end of declining demand...but the steep curve going from 1983 to 2007. How much more can the little hook go down I guess would be the question. We still consume a lot comparitively (to the rest of the world).

I would be good to see this graph by country. Worldwide.


One problem/issue with following the VMT is it is a lagging indicator. Meaning, the traffic counts are dropping faster than this graph shows. Just today, I put together a presentation using this data (same graph in fact) when I noticed the July 08 counts for Florida (latest available) is lower than the five previous years. The individual state data only goes back to 2002/03. While my 12 month moving total shows a dip, it does not show the inertia that is behind this.


My impression is that truck mileage is going down faster than car mileage. This would be the case if we are building fewer houses, and don't need to transport all of the materials and furnishings for them. As far as I know, the DOT data combines trucks and cars.

I would agree that if it is a 12 month moving average, it is more of a lagging indicator. I thought some of the data I had seen was simply on a quarterly basis. I found Bureau of Transportation Statistics monthly data, but it is only through January 2008.

My impression is that truck mileage is going down faster than car mileage.

I believe it is too. Diesel usage is plummeting, though it takes a bit of work to dig it out.


In Florida, diesel is down from 1.8 million gal per month, to 1.6 million (if I remember correctly)

The trouble is trucks and cars are not usually broken out. The only public report I know about is just for Florida and comes out once a year (in April). The “T” factor is the percentage of trucks.


How much of the 6% is due to the housing crisis? New contruction: contractors and employess with their pickup trucks, illegal immegrants on job sites, materials and appliances etc.;resale housing -travel by real estate agents etc.

It will be interesting to see if the demand destruction continues or if it was a one time occurence.


Considering that work trucks generally run on diesel, I wouldn't expect that to be that large of a factor. However, you're right that it's plausible enough to look into. Does anyone know where we could find those sorts of statistics?

Believe it or not the congestion from said work trucks probably causes a significant increase in demand. Congestion has been a huge problem the last few years.


On the road sections covered by the NGSIM data, we found that traffic congestion typically lead to an increase of fuel consumption of the order of 80% while the traveling time has increased by a factor of up to 4. We conclude that the influence of congestion on fuel consumption is distinctly lower than that on travel time.

To translate it increase fuel consumption by 80%. No construction traffic less congestion and the people who don't like looking at the real number believe we are going to keep having these wonderful drop in fuel usage.


On a tangent with less people committing to suicide loans for homes almost doubling their housing costs vs rent a lot more people will have higher cash flow monthly same of course with those that move from expensive home loans to renting. And as you can see above you get increased productivity as congestion drops.

And finally in some cases what we take to be less traffic around us is probably often simply less congestion. The long housing boom has caused us to forget what its like with a functional road system.

Who you callin' old, buster?!? She can't be much older than me! :)

According to the EIA's latest PDF, the 4-week moving average for finished motor gasoline for the period ending 10/17 jumped by 81K bbls/day. For a 4-week moving average to jump like that implies about a 324,000 barrel delta between the week that fell off and the week that was added. That's the first increase after 8 decreases, and it occurs at a time of year when consumption is normally dropping.

Total petroleump products supplied saw a jump of 102,000 barrels/day, though total products supplied usually does increase slightly this time of year (about half that much).

The decline in consumption we saw through July was caused by high prices. That is entirely different than a decline caused by economic meltdown. Unfortunately, the numbers between August and now are completely FUBAR by the hurricanes, and almost nothing of value can be said about them, except that they were affected by the hurricanes. No one really has clue what the effect of economic meltdown + much lower gasoline prices has had on consumption, and they won't until the hurricanes are far enough behind us to mute their effect.

You can get most of the week by week numbers from here that are shown in the PDF on an averaged basis. I tend to use the week by week ones instead of the moving averages because I can see better what I am doing.

When you click on the view history, it gives you an HTML history that is not in a very nice format. You can also download an Excel history that shows week by week amounts in a long column.

Oil is a marginally priced commodity: Absent hedging, the price of the "last barrel" (or perhaps, million barrels) determines the price of all the barrels, due to oil's mobility and fungibility. In an era of very tight supply and stupendous global growth, the competition for that last barrel is intense, and amplified by "speculators" betting on it continuing. Fast forward to a deep global recession, vast deleveraging, speculators liquidating positions, economies shrinking, and all of a sudden nobody wants that last barrel.

So: We have price spikes, followed by economic upheaval, followed by demand destruction. But wait, there's more! As Westexas points out, large fields are depleting rapidly, net exports more so. After a period of reduced oil prices, demand will creep up again, crossing the ever declining production/export line, and the price for that last barrel will shoot up again. So we've got a nice little roller coaster ride:

Globabl Growth + Depletion --> High Prices --> Economic recession + lower prices --> Demand recovery + Depletion --> High prices again

And so on. A cycle of deflation followed by inflation, and over again. Enjoy the ride folks.

You forgot the baseline cause of the spike and canyon effect: "Hooray, the energy crisis is over (again)!" Those that can afford todays new discounted gas prices - the expense account crowd - can go back to their hummers and SUV's and we can forget investing in future supplies. There's no capital anyway.

All the alternatives are effectively bankrupt - yet again - at least if they are marked to market and not subject to floor contracts with no counterparty risk. All new exploration, except the most basic infill variety, is over or at least considered rampant speculation. All of this sounds familiar.

Here's a good example: Future North Sea oil production has been discounted to zero on the markets. Wow. that's great! Free oil...if you can just put in the templates and platforms. Demand does not seem to have really gone away, just evaporated at the margin. Just wait until that marginal demand returns.

Sure, China's growth rate is decreasing. It may drop to as low as 8% this year. Due to wealth effects, Geely Auto still sees demand for their small cars growing at 20% per year. I know, they'll use the vegetable oil they use to fry sweet and sour chicken balls and India will rely on the proven incendiary power of vindaloo curry. That's a lot of chicken balls...

There is another possibility--it is certainly possible that things simply 'unravel' and go from bad to worse. More specifically, a long-term deflationary trend is now possible; if prices continue to drop and businesses fail, we could see something quite unexpected: No recovery. We would enter a long, indefinite period of disruption so severe we could only look to examples of collapse where people are left bartering and those in debt, or close to the financial edge, face homelessness, etc. A new world currency would certainly be a sign we've entered a more bizarre, greatly-impoverished world economy. Previous historical disruptions such as this have seen war, fascism, and revolutions as nation states fight over resources and markets to satisfy, and occupy, increasingly desperate populations.

Then again, chaos theory, as mentioned above, suggests that prediction is not possible given the complexity of these circumstances. (I find it hard to imagine even my own circumstances a year from now, much less those of a nation or the world.)

It is my hope that governments (or 'the people' who potentially hold all political power ceded to their 'representatives') have the wisdom to address these issues in a manner that doesn't exacerbate financial insolvency, social inequality, peak oil, and global warming. And if those governments fail to swiftly address these problems, may they be replaced just as swiftly. There isn't much time or leeway for error and corruption.

Gail, we are not using "somewhat less" petroleum fuels recently. We are using significantly less. Here is the link to the latest EIA report:
Granted every source I look at varies a bit but it looks like about 8% less compared with the same period in 2007. We are consuming the same amount of Oil as we consumed in 1999. Good thing too. We now are producing less than 5 million BPD. The last time we produced as little as 5 million was 1946.

We are using quite a bit less petroleum products, but the petroleum products we are using less of is petroleum products other than gasoline.

I think at least some of this is delayed demand, with people not filling up their fuel tanks with winter heating oil during the summer. I am sure that there have been huge cutbacks in the building industry this year, and this is carrying over into related industries, as people buy less furniture and other goods. Perhaps what I should say is that government statistics are not yet recognizing a recession very clearly in their data. (This is, of course, mostly do to bogus inflation adjustments.)

The purpose of this article was not to analyze precisely how much US demand had dropped off. The point is that there are a lot of other issues affecting prices as well.

The main reason that a recession has not been officially announced is because of the way data is gathered and time lags in aggretating and correcting this data.

Recessions have never been announced during the first quarter of the recession. The informal (not correct, but close) definition of a recession is at least two consecutive quarters of negative real GDP growth. Suppose we went into a recession beginning in the third quarter of this year, as I'm pretty sure we did. The recession is continuing on now in the fourth quarter. The recession will not be officially recognized as such until some time in 2009 (maybe February) when the fourth quarter data is complete.

By the way, for most purposes it matters not a whit whether you use official numbers or Shadostats numbers: They tend to show equal changes--different amounts but identical trends.

To elaborate a bit more on the lower distillate stocks, this is the graph from this week's This Week In Petroleum report.

The place we use home heating oil is in the Northeast, which is part of "East" on the graph. We were reading earlier this year that people were not filling up their oil tanks, because of the high cost. Now, when we look at the East's inventory, it looks decidedly light compared to the previous two years. I wonder if credit issues causing intermediaries to cut back on inventories of home heating oil.

Massively complex systems with many feedback (negative and positive) loops and many inertia (creating time lags) are inherently impossible to predict. Any index parameter such as prices become volatile and unpredictable as a key forcing function drives the system toward bifurcation (attractor switching or phase shift). So the only thing you can say with any confidence is that prices will be volatile.

In the current context my suspicion is that the slow down of energy flow through the economy, due in part to peak oil, but also due to declining net availability resulting from falling EROI, is more like a braking function. Same argument. Suddenly applied brakes in one part of a complex system can have catastrophic effects in the system as a whole.

The problem with trying to track price as an indicator is that there are still far too many phony dollars in circulation. And thanks to the recent flooding of so-called liquidity and equity infusions, there are actually many more phony dollars. We are, after all, trying to keep the bubble from collapsing! Prices in dollars are simply too distorted (both upward and downward) to give us a hint of reality.

What we need to follow is the total amount of net energy available to do useful work (what engineers call exergy). That is the reservoirs of energy that is ready to drive our prime movers and heaters needs to be monitored in order to know how much actual work we can accomplish in future periods. And we need period over period tracking to see if we can do more work or less. The rate of change of that parameter will tell us better what to expect in the future.

For what it's worth!

Question Everything


That is a very good point about massively complex systems and many feedback loops. It is hard to predict precisely what will happen.

One thing I worry about is that there will be business failures that interfere with our ability to deliver food and petroleum products to people. We recently have been reading about a drop in the availability of "debtor in possession" loans. This may mean that companies will be forced to go out of business, rather than reorganize. There may be some that will be bought by other companies that are in better financial shape, but we can't count on it.

Another factor in the complex system of liquid fuel supply which was omitted from the analysis is the role of ethanol in holding down gasoline prices.

Even as Gail was posting about hurricane related shortages and price "gouging" in the Southeast, gasoline and ethanol prices were dropping in the upper Midwest.

Corn prices, like crude oil prices, have been cut approximately in half thereby reducing the feed stock costs of ethanol plants which have increased in number over the past year. The ethanol mandates and increasing E85 use, mostly in the upper Midwest, reduce the overall demand for gasoline and put additional pressure on gasoline prices.

This may appear insignificant to some, especially ethanol opponents, but gasoline prices are set at the margin as in all free markets. If a single gallon of gasoline fails to find a buyer, the price will fall until one shows up. This is true for corn, ethanol and other commodities that are freely traded.

Another term for "massively complex" is "chaotic". The recent gyrations in the financial markets are not unlike severe cardiac arrhythmia, or the irregular beating preceding a heart-attack.

If you are a fan of Mandelbrot, you may like his "Geometry of Nature", and you may also like "Chaos", by James Gleick. Nassim Taleb, author of "The Black Swan", is also influenced by Mandelbrot.

Like I said, $50 oil.

The reason is simple: look at what the relatively limited demand destruction did at the beginning of 2007! This is much worse.

As I never tire of saying: Oil is a commodity, and like all commodities it's price will have its ups and downs. We should all be aware here of the long term supply outlook for oil, so we should know that the long-term trend is going to be toward increasing prices. Thus, while there will be ups and downs, there will be more ups than downs, and the ups will be up more than the downs will be down.

It is now becoming clear that the price run-up in oil earlier this year was a case of overshooting the trend line. It is becoming equally clear to me that we have now overcompensated by undershooting the trend line. The overshoot didn't last long, and the undershoot probably won't either.

A word of advice: NEVER base a forecast on future oil prices on the basis of just a few months of price data!

As for gasoline, while one might think that its price would be almost perfectly correlated with oil, there are apparently several reasons why it is not.

It is now becoming clear that the price run-up in oil earlier this year was a case of overshooting the trend line. It is becoming equally clear to me that we have now overcompensated by undershooting the trend line.

But what are the real-world consequences of these vagaries of the free market? Are they, as ROCKMAN argues above, minor in regards to domestic oil and gas production? Or are they, as unrepentantcowboy argues, extremely disruptive to domestic oil and food production?

And are free markets the best means to achieve optimal oil and food production?

Of course this country has never really had free markets, as the libertarians are quick to point out. From the early days of westward expansion, with its massive land grants and other incentives to railroads and free land to pioneers, to special tax breaks for oil and mineral companies and a plethora of subsidies, protective tarriffs and supports for farmers, the federal government from the earliest days of nationhood has promulgated policy with a specific outcome in mind.

Beginning in the early 1980s, however, there was a shift in the kinds of endeavors that merited backing from the federal government. Before federal subsidies had to do with securing new territories or enhancing manufacturing, energy or agricultural outputs. But beginning in the 1980s, the fair haired boy became the banking and finance industry, including its twin brother, real estate. From this point on, huge federal bailouts and subsidies flowed to that sector and other sectors--manufacturing, energy and agriculture--were abandoned to cope with "the free market" as best they could.

And of course they didn't cope very well.

This is all symptomatic of a country that has its priorities reversed. And nothing is more emblematic of this than who the country chooses as its leaders.

Nine of China's top ten leaders are engineers. And Putin, although he has a law degree from the University of Lenningrad, in 1997 defended the equivalent of a Ph.D. dissertation at Russia's St. Petrsburg State Mining Institute.

Meanwhile back in the United States, it is lawyers, financiers and economists who have their hands on the levers of power.

No one should be surprised at the eventual outcome.

Besides Ben Bernanke, can you name one other economist who is in a leadership position in the U.S.? Paulson is no economist, and I can't think of one single Senator or Member of the House of Representatives who has even an undergraduate degree in economics. (It is true that Ronald Reagan took his bachelor's degree in economics--and note how inflation fell during the Reagan administration.)

Even though I would dispute the underlying assumption inherent in your question, which is all but nonsensical, a couple of examples are:




My point is that there is a world of difference between an economist and a financier. Economists rarely go into politics, and I think it is unfair to point at economists as the kind of guys who got us into our mess. With the exception of the Federal Reserve System (which largely reacts to events rather than causing them), the rule is that economists advise, but they do not make policy. Politicians tend to listen to economists when and only when the economic advice suits their prior purposes.

There is no doubt but that some economists have given some bad advice to policy makers. However, economists have given much good advice, e.g. about the benefits of raising the gasoline tax, which politicians refuse to listen to. When I was a graduate student in economics, some forty years ago, there were already articles published on the beneifits of a stiff tax on gasoline to deal with external costs associated with driving.

By the way, some economists are aware of and concerned about Peak Oil (e.g. Econobrowser, Herman Daily, other steady-state economists), and I'd be interested if you can find any recent quotes from economists denying the importance of oil in the economy or denying the reality of Peak Oil.

I do not assert that economists are blameless. Their worst sin, in my opinion, is that most Ph.D. economists are lousy teachers who cannot even get across to their freshman students the difference between "demand" and "quantity demanded." Most people who post or comment on TOD have had at least one course in economics, but few show evidence of understanding the most basic fundamentals of economics. Hence we get abominations such as "demand destruction," which is an inherently ambiguous and worse than useless term, because it makes no distinction between a decrease in consumption based on rising prices (other things staying the same) and a decrease in demand, in which case the whole demand curve shifts downward and to the left.

Economists aren't going to get out of this fiasco without a black eye. To try to downplay the role economists played in this train wreck is tantamount to trying to downplay the role provocateurs played in a lynching.

The issue of causality, however, is probably one of the best defense strategies available to the economists. And your deploying it indicates rather formidable rhetorical skills on your part. Don't be surprised, though, if it fails to resonate with most people.

Not only do you have a problem with constant conjunction (every politician or financier advocating free market fundamentalism has a free-market fundamentalist economist, highly credentialed and bedecked with prestigious awards, joined at the hip), but there are an army of people out there ready and willing to make the argument that it was indeed the egg that came before the chicken, that it was economists who first cooked up all these hair-brained theories and subsequently sold them to polticians. Here are a couple of examples:

The most influential of these critics was the most improbable of tenured radicals, Harvard economist Martin Feldstein. Balding, diminutive, and bespectacled, with an unassuming demeanor and amused smile, Feldstein looked every bit as threatening to the established economic consensus as a Chihuahua to a Doberman. The Doberman, however, didn't stand a chance. Feldstein was prolific. He was a skilled teacher, commanding huge audiences in his introductory economics course, which he turned into a running pitch for neoclassical economics and its then-unconventional prescriptions. I remember taking his course in the early 1990s, surrounded by hundreds of young, smart, impressionable freshmen in the grand wood pews of Sanders Theater. The stained-glass windows gave the auditorium the feel of a church, and it was of sorts--the church of neoclassical economics. Our bible was Adam Smith's Wealth of Nations; our catechism the laws of supply and demand; our spiritual leader an unexceptional-looking professor in a drab gray suit whose high forehead glowed angelically under the theater lights.

Feldstein also had the ears of influential polticians. Rising stars in the invigorated conservative movement may not have read or understood his hundreds of articles, but they did understand that Feldstein was providing a sophisticated and credible version of what they were arguing: government was too big, too overbearing, too inefficient.

Jacob S. Hacker, The Great Risk Shift


Milton Friedman, a conservative economist whose work combined emphasis on the nation's money supply as the key to inflation with a staunch belief in the market as a self-correcting mechanism, began to sell these positions within the Republican Party. So did other colleagues from the academic seat of American free-market economics, the University of Chicago.

From Barry Goldwater and Ronald Reagan in the United States to Margaret Thatcher in Britain, conservatives harked to Friedman's and the Chicago School's essential message: that government interference with the operation of the market was ill-advised and doomed to failure. They also took quiet and secondary comfort from his defense of speculators and greed, a tolerance welcomed by party contributors. By the end of the 1970s, Friedman was proably the world's most famous economist, and two of his admirers, Thatcher and Reagan, were on the cusp of power.

Kevin Phillips, Bad Money

Contrary to popular belief, Milton Friedmann did not advocate strict laissez faire. Quite the opposite: He (and now, his co-author Ana Schwartz still does) advocated strict control of the money supply by set rules and the abolition of the Federal Reserve System. Now if you are going to argue that the Fed played a big role in getting us into our current financial debacle, then I agree with you. But so would Milton Friedman! He believed that both inflation and recession were mainly caused by bad Fed policy. He was opposed to using monetary policy as a discretionary tool. He thought that fiscal policy in the absence of co-ordinated monetary policy had little effect. He blamed the Great Depression on bad monetary policy set by the Fed (which was mostly run by bankers, not mostly by economists, in 1929).

Before people criticize Milton Friedman, they should read a few hundred pages of what he has written. For example, he advocated 100% reserve backing as far back as 1943 (if memory serves). He pointed out the accident of history that caused health insurance to be provided by employers and thought the system was irrational and should be changed. He advocated the negative income tax as a measure to fight poverty.

Contrary to popular belief, Milton Friedmann did not advocate strict laissez faire.

Now I think you're just being disingenuous,or outright dishonest, because what you say flies in the face of practically everything that has ever been written about Friedman, or by Friedman:

A global public followed his restatement of a libertarian political philosophy that insisted on minimizing the role of government in favor of the private sector...

Influenced by his close friend George Stigler, Friedman opposed government regulation of all sorts, as well as public schooling. Friedman's political philosophy, which he considered classically liberal and libertarian, stressed the advantages of the marketplace and the disadvantages of government intervention and regulation, strongly influencing the outlook of American conservatives and libertarians. In his 1962 book Capitalism and Freedom, Friedman advocated minimizing the role of government in a free market as a means of creating political and social freedom.


Wikipedia is flat out wrong about Milton Friedman. I've read most everything which he has written, and the Wikipedia entry is full of laughable bloopers. For example, neither Friedman nor Stigler (who I have also studied closely) opposed public education! On the contrary, they pointed to the excellence of U.S. public higher education in contrast to mediocre primary and secondary education. According to Friedman, the reason primary and public schools had such dismal results is that they lacked much competition from the private sector.
Stanford has to compete with U.C. Berkeley, which tends to create excellence in both universities. On the other hand, Consolodated Public School has a near monopoly on its students. When there is no competition, the service of education gets worse.

What Friedman did advocate was tax subsidies (no laissez faire there!) to promote private primary and secondary school education--so as to provide competition and hence cause improvement in the public schools. He reasoned that parents would tend to send their children to the best schools, regardless if they were private or public, so an excellent public school can draw students away from mediocre private schools, as well as vice versa. I think there is a lot of logic to Friedman's position: Nothing else has helped U.S. public schools, so why should we not experiment with his proposals and see if they actually work?

Monetarism has never been tried. On a small scale, with charter schools, something similar to what Friedman had in mind has been tried, with generally encouraging results.

I wonder who edits these wikipedia entries?

It might be good if you worked on editing them.

I understand it is sometimes difficult to get things changed, especially if a group with a particular interest is editing a post, but it wouldn't hurt trying to get it correct.

Thanks Gail, that is good advice. I thought that Wikipedia had some overall editorial mechanism to keep people from posting false or wildly biased entries--but maybe not.

Experience is that Wikipeadia has quite robust editorial systems based on appointment of voluntary editors who are supervised to act as independent arbitrators and requesters of references.

Not sure about the economics area though. Perhaps no-one expert in economics has time for such? (too busy trying to get their fat out of the present markets they've created? ;<)

BTW, you're going to find that, regardless your opinion of Friedman based on whatever, broad consensus opinion places him squarely at the centre of this entire mess. Reganomics, trickle-down, deregulation, etc. etc.

"broad consensus opionion" is flat out wrong if it blames Friedman or Friedman's ideas for the mess that we are in.

If we had followed monetarist policies
1. The price level would tend to be stable with no inflation.
2. Speculative booms would rapidly be choked off by rising interest rates.

In the thousands of pages that Friedman has published, I challenge you to find a single reference to "trickle down" economics or anything that be could construed as trickle down economics. On the contrary, Milton Friedman recognized that there would be both winners and losers in a capitalist society--and he advocated a negative income tax as a superior alternative to current welfare programs to protect the "losers." That, in my opinion, is about as far from trickle down economics as you can get.

Reganomics was mainly based on the theories of a lightweight economist named Arthur Laffer, who believed that the answer to all economic problems was to cut taxes. (You may recall the infamous "Laffer Curve.")

Have you forgotten the affirmation: "I do solemnly and sincerely and truly declare and affirm that the evidence I shall give shall be the truth, the whole truth and nothing but the truth." Your assertion that the crisis was caused by faulty monetary policy also isn't the whole truth, as is pointed out here by Brad Setser:

Many have highlighted the role that loose US monetary policy played in supporting the housing boom. And there is no doubt much truth in this story: pushing rates down to help “clean” up the bursting of the .com bubble and holding them down for several years certainly helped induce the rise in home prices and the housing boom. At the same time, this story leaves out what to me is a crucial part of the story: the housing boom didn’t end when the Fed reversed course and raised long-term rates. The really risky loans were made in late 2005, 2006 and early 2007 – after policy rates had increased. Private institutions kept on lending – in part because they decided that it was safe, in a world of low assumed macroeconomic volatility – to take on more leverage and more credit risk to keep profits up...

In retrospect, the fact that (reported) bank profits didn’t fall as the Fed raised rates should have been a clue that risks were building. An inverted yield curve isn’t good for institutions that borrow short and lend long – but it initially didn’t seem to have an impact on financial sector profitability. It is now clear how the financial sector kept profits up: it took on more risk, as it shifted from borrowing short to buy safe long-term assets (Treasuries and Agencies) to borrowing short to buy risky long-term assets.


You are correct that faulty monetary policy was not the only cause of the mess we are in. Nevertheless, I believe it was a necessary and sufficient cause, and that although lax regulation played a part, this part was secondary to the massive oversupply of money and credit that the Fed created in the years both before and after 2000.

With the best regulation and the best enforcement of these regulations in the world, we could still have inflationary booms and deflationary busts. So long as the Fed creates excessive amounts of money (as it is doing right now), we have a long-term tendency toward inflation. If these periods of excessive ease in monetary policy result in inflationary asset booms (in stocks or housing or anything else), which they will, then we surely will have abrubt and huge declines in asset prices from time to time.

In my opinion we should try monetarism. We never have (though some Fed members have been influenced by monetarism) implemented monetarism. Nothing else has worked. Monetarism makes good sense to me.

But you're misconstruing what Setser is saying. He says the Fed reversed its easy monetary policy beginning in the middle of 2004, which can be seen here with the Fed rate increasing steadily from 1% in June 2004 to 5.25% in June 2006:


He then says the "really risky loans were made in late 2005, 2006 and early 2007 – after policy rates had increased."

Your explanation is this: "So long as the Fed creates excessive amounts of money (as it is doing right now), we have a long-term tendency toward inflation. If these periods of excessive ease in monetary policy result in inflationary asset booms (in stocks or housing or anything else), which they will.."

But your explanation doesn't square with the facts. By 2005, 2006 and early 2007 the Fed was no longer creating "excessive amounts of money" as you assert. The Fed had already reversed that policy. But the asset bubble kept on inflating. How was that possible?

The asset bubble continued to inflate becasue, as Setser goes on to explain, it was foreign central banks that "kept on lending to the US (banks) despite large ongoing deficits – and poor returns, after taking into account the currency risk – on their dollars."

In other words, these were private transactions between privately owned US banks and foreign entities. If Setser is to be believed, and I believe US current account and federal balance sheet figures will bear him out, then the US government was not involved as you erroneously assert. The Federal government played no role in blowing this asset bubble up in 2005, 2006 and 2007, but it likewise did not step in to prevent it from being blown up, or "pop it" as popular vernacular would have it.

But of course now that this triumph of the free market, this libertarian wet dream, has blown up, the government and the tax payers have to come in and pick up the tab. As Setser cited, "what looked to be private lending turned out to be public spending."

I do have to wonder if you have ever read even one page of what Milton Friedman wrote.

How can you accuse Friedmann of being laissez faire in light of the well-known fact that he was the chief proponent of a negative income tax to deal with poverty?

After the decline in production of oil has begun to bite, I suggest that we try the negative income tax, because it is a better way to redistribute income than is the current hodge-podge of antipoverty efforts, which have clearly failed.

To try to downplay the role economists played in this train wreck is tantamount to trying to downplay the role provocateurs played in a lynching.

That made my day. :) Hmmm, this is something like the third reference to lynching that I've heard the last two weeks. Must be on peoples' minds.

"But what are the real-world consequences of these vagaries of the free market? Are they, as ROCKMAN argues above, minor in regards to domestic oil and gas production? Or are they, as unrepentantcowboy argues, extremely disruptive to domestic oil and food production?"

I suggest an Oracle or prayer to answer those questions. How about time will tell? Try getting as much information as you can and then act on it? As both a retired farmer, among things, as well as a long retired mini-oilman I favor Rockman. If you buy the prevailing opinion of many around here it doesn't really matter; you are screwed anyway.

"And are free markets the best means to achieve optimal oil and food production?"

Food: That should be a no-brainer. Which countries have had the most trouble feeding their populations? The US, Canada, UK, EU, Chile,Japan, S. Korea et al or the Soviet Union, Red China, N. Korea, Cuba, Dem. Republic of the Congo, Sudan, Venezuela, or Haiti? Who has freer markets the former or the later?

Oil production: Who has let politics interfere with oil production? Mexico, US, Nigeria, Iran, and Venezuela as compared with Canada and Brazil? Again a no-brainer.

Politics has interfered with oil production in Saudi Arabia to the extent that Saudi politics is nothing but about oil production. They can pump plenty of oil.

Britain was quite free-market in its oil production---probably the most.

And yet they depleted the bulk of their oil in the highest-tech fastest way possible during a time of $20/bbl oil in the 1990's.

The US was very free market in domestic on-shore oil, and as a result it successfully exploited its oil before anybody else. And as a consequence it hit peak oil before any other significant oil producer.

Free markets certainly encourage current production at a more rapid flow rate.

For agriculture (up to some point and modulo acquifer depletion), that works better. But that's because plants grow back.

Oil doesn't.

Because of non-freemarket and non-economically motivated (at the time) regulations U.S. restrictions on offshore and other oil, the US will be able to exploit it and use it during a period when it will be more valuable.

In theory, when considering pure private goods without externalities or monopolies or other market distortions, the operation of supply offered by many sellers against demand by many buyers is an elegant way to optimize the pricing and production of scarce resources.

The rub comes on those many provisos:

"pure private goods" - Which arguably applies to oil once it is in the barrel or tanker or storage facility, but not necessarilly when still in the ground; in that latter case I would argue that it might more properly be considered a common pool good. A case could also be made that the distribution systems of refined products to consumers share a lot of characteristics with public utilities, and thus border on being toll goods. Advocates of neo-liberalism would argue that if privatization of pure private goods is a good thing, then expansion of privatization into common pool goods and toll goods and even public goods is even better. I beg to differ, just as I would differ with state socialists that advocate the expansion of the public sector beyond public goods and into the public ownership of toll and common pool goods and even some pure private goods. It is possible to have a "third way" public ownership of toll and common pool goods that is based on a cooperative structure rather than on either government control or private sector control. It is not at all obvious to me that either corporate or government ownership of toll and common pool goods has been successful in balancing the need to manage these resources efficiently AND also managing them in a manner with is most consistent with the general public good.

"externalities" - Of which oil is chock full of them. Climate change is only the latest in a long list. Clearly, oil pricing fails to account for the many and substantial externalities associated with its extraction, transport, refining, and use.

"monopolies" - We are not still in the bad old Standard Oil days, but concentration of power has been a continuing problem in the oil industry. Where NOCs operate, there is definitely monopolization at the national level. While the global marketplace is generally freely competitive, the existence of a number of large NOC players does tend to create some distortions, as does the operation of a few very large IOCs like BP, Shell and ExxonMobil.

"other market distortions" - Oil and oil products like gasoline are subsidized in some national markets, and heavily taxed in others, to mention just one example.

The bottom line is that I don't believe that the oil market is in the least bit representative of a true "free market" at either the national or global level, nor do I believe that the marketplace for oil is likely to or is able to become truly free. Thus, I don't accept criticisms of the obvious flaws of the oil market as a legitimate indictment for all free markets for all goods. Neither do I accept any criticisms of any governmental interventions in the oil market as being unwarranted. The global price of oil at any given moment might very well be distorted and not representative of what a true equilibrium price should be. Nevertheless, relative MOVEMENTS of the price over time still tell us some useful information, especially when looked at over the long term.


I am here to ask you to open your minds in the future. To step back from the situation. To think outside the box and perhaps listen to other points of view and not be blinded by what you hear from the "experts".

I made two posts back in June declaring that oil was in a bubble at near $150.

Here are the threads with my posts(you can search for "kahunabear" to see my posts):


I explained that it was a mania driven by speculation. I acknowledged that we have a limited supply of oil and that developing alternatives is a good thing for the long term, but the short term price was more driven by money.

I was RIDICULED. The responders were so sure they were right and I was wrong. They came up with all sorts of logic based on physics and other nonsense to explain why I was wrong. They used genius while ignoring the obvious forest. Yes, the trees would grow to the sky! Just about everyone was bullish on oil at $150.

Here are some of the responses to my posts:


lets bet on it - I'll purchase a future long, you go short


kahunabear, if your pea brain has an attention span thats long enough, see if you can watch the following video at google video:

That's the funniest thing I've read all week.

Ben Bernanke, George Soros, Timothy Geithner, Sam Bodman, George Bush, Dick Cheney, Boone Pickens (and I could go on and on) say this is not a speculative bubble (although there is always some "froth") but a fundamental supply/demand problem. Please write to them and tell them they are wrong, arrogant and you know better. Better still bet all your money on oil falling to $10.



Wow, gross ignorance coupled with denial of basic physics coupled with self-immersion in a faulty worldview.

You could not ask for a better example of why the world is screwed. You are it, sir!

Kahuna: Good call-however, I don't remember that everyone here was bullish at $147-IMO the general feeling was that a correction was in store but the size of the correction caught most off guard. I could be wrong-I don't remember what the price polls at that time said. Don't spend all your loot at the same place.

Brian, Yeah, you are right, sorry if I implied that everyone here was bullish. The market itself, many of the responders to my posts and Goldman Sachs projecting $200 oil (though I wonder how they were actually trading it) were bullish.

Good point about GS-you could do worse than assume they are always shorting all their buy recommendations-good guys to have running the USA-now they are calling the firm Government Sachs.

Yes, it is an inscestuous good old boy network that we are relying on to save us after THEY got us into this mess. All the while, they lined their pockets and diluted the value of our corporations by taking huge stock options grants. Finally, after they have completely bled the corporations they "lead" almost dry, they take their huge golden parachutes to finish the job. All bestowed on them by other good old boys on their compensation committees.

I say, "our coporations", because we have been lead to believe that by putting all our retirement money in mutual funds we will be investing in America and our future. What a farce. The fund managers are in on the deal. They stay fully invested while never questioning the raping of their holdings by these robber barrons. Why protest when they are making massive mangement fees?

Well, the averages are about where they were 10 years ago and that is not adjusted for inflation. It also doesn't consider that the averages have been rejiggered to replace losers with winners over time.

WAKE UP AMERICA!! The country is being stolen by the 2% elite. Oh, and by the way, I consider myself a conservative capitalist. Unfortunately, capitalism has been replaced by some mutated crony capitalist model that gives all the profits to the 2% and leaves the losses for the proletariat. It resembles socialism more everyday.

Methinks you confuse socialism with corporatism. (Think Germany, Italy circa 1935)

I don't remember what the price polls at that time said.

The polls did OK while the price was going up. But they were wrong a number of times when the price was coming down. And, when the poll finally turned bearish, it was wrong again. Currently we have no poll but the last one was wrong http://www.theoildrum.com/node/4559 even though the trading range was made to look like the broad side of a barn. Ah, volatility!


PS Oil just traded below $67 so if we were running a new poll with the same broad trading range, we might see the lower range ($85/1.3=$65) broken soon.

You know, even a stopped clock is right twice a day. I didn't see anything in your posts about the stock market tanking and people's retirement funds getting wiped out nor two hurricanes in a row taking out all GOM production and refining and price caps being put in all the SE U.S. without a rationing scheme in place. None of that is due to speculation. You say you're not here to gloat, so stop it because you made no predictions worth gloating over. You might have been right about the price direction but many of us did actually think that there was a lot of speculation that was causing the massive price increases except that we found ways to say that less arrogantly.

I think the stopped clock argument would work a lot better if I had been calling a bubble for the last 5 years. If you access my profile, you will see that I have been a member for a while but prior to today, I made only 3 posts all in June.

As far as predicting future events, I certainly am not psychic and make no claim to be. I do claim to be good at identifying bubbles. In fact, they are usually pretty obvious and most 10 year olds could recognize them. So, if I am gloating, I am gloating that I can do what a 10 year old can do. We humans are interesting in that we are highly illogical at times and back up our lack of common sense with highly intelligent arguments to justify our need to follow the masses.

I truly do hope that I can convince a few readers to open their minds a bit. That's all.

Ok, maybe I am doing a little gloating, but hey, controversy gets people to read the post.

What is interesting is that the current rise in the US dollar is parabolic (straight up), much like the rise in oil price earlier this year. Similarly, the rise is mostly justified by observers, rather than noting the likeliness of its dramatic and shocking reversal.

OK, your call was impressive. Now what do you predict for the future? Do you think we are at the bottom? What do you think the price will be a year from now?

I am no guru, just a guy who likes to try and point out bubbles to the blind crowd followers who love to follow gurus and ignore that irrational parabolic moves are unsustainable.

And, as you can see from my post below, the idea is 2% while executing it for a profit is 98% of the job. Also, picking the tops of bubbles is all but impossible. Whether it is CROX shoes, bloated internet stocks with no business plan or over priced houses, they usually go on much longer than anyone thinks. Though I think the bubble was obvious, I got lucky calling the top.

That said, this bubble has popped. When they do pop, the tendency is to think that they are cheap after they have fallen 50%. Then, I'll be darned if they don't end up going down 90-100%. I inevitably try to catch the falling knife to find it has pierced my heart.

In a circus like move, I tried to catch the falling knife today and I bought some calls on USO. Does this mean oil has bottomed. I doubt it and this is not advice. I would like to see it bounce, but this was mostly a gamble. I like to call it a "hedge", makes me feel better. If the world economy continues at the pace the market is predicting, we very well may reach my facetious $10 inflation adjusted price. God help us all if it happens. Oil shortages will be the least of our worries.

The difference between internet stocks, houses and oil is that oil is a physical commodity that is the lifeblood of our civilization. We can live without internet stocks and without easy credit to buy houses - but we can't live without oil. There is every indication that we are at peak production and perpetually declining exports. There is no substitute for oil that is scalable. On the other hand, there is no upper limit on the number of internet stocks or houses we can create as long as energy is available.

So don't you think that the comparision of oil to financial & housing bubbles is inappropriate?

Yes, it is different in all those ways. But with regard to the bubble we just witnessed and the human behavior that drove the market price, I think it was exactly the same. So, I would say we are both right.

LOL..........i'm going to be dancing the same Jig as you when Global temps drop and AGW turns out to be hot air! Now rate me down bitches!!

Seriously though, arrogance is one of mans greatest sins. We are all guilty sometimes. I was probably one of the ones ridiculing you then.


Gee, kahunabear, I was not replying to your call for oil falling. I was replying to your self-immersion in a market based worldview which ignores all other data outside that worldview. Note that I made no statement about the price of oil.

Nice of you to pull that out of context and gloat over it when you even claimed you were not going to gloat. Well that makes you both a liar and a hypocrite as well, doesn't it?

P.S. How's all that money you made shorting the market? Hmmm?

All you do is call names instead of making coherent arguments. Whether it is out of context, well, the posts are all there for anyone to read.

If you had read mine, you would see that I completely acknowledge that we are screwed long term on the oil supply and am glad this bubble has at least made us explore alternatives. My biggest fear is that "market based" forces will cause us to abandon them.

Multiple views can be correct. It is not black and white. The point of my post was to point out what I felt was a shorter term error in market pricing, while acknowledging the long emergency. The keyword there is LONG. Bottom line, you disrespected me first and continue to do so, not even considering my arguments.

As far as the money, well I made a nice chunk early on, then trying to avoid the volatility of the oil price, switched to playing refiners long, thinking the crack spread would improve. That was a mistake and I gave back most of what I made. I have, however, had only minuscule losses in this economic downturn by following my bearish "market based worldview".

Cheers and Peace

Said by kahunabear:
I explained that it was a mania driven by speculation.

You have not established that speculation was a factor because the price swinging wildly up and down does not prove speculation as the principal cause. The value of the U.S. dollar, increased crude oil production from Saudi Arabia and apparently demand destruction correlate with the bubble. I'll make a guess that the U.S. dollar began strengthening in July 2008 because U.S. banks began increasing their loan loss reserves in anticipation of mortgage defaults reducing the currency in circulation. I remember reading a series of detailed comments by a trader on TOD that speculation in the crude oil futures market can not drive price beyond small, short-term amounts. There are an equal number of shorts and longs, and the speculators trade fictional oil.

BNN this morning had a segment on exchange rates saying that changes in central bank policies are causing huge price swings.

CDN $ trading this AM at about $0.80 US.
IIRC, it was about $1.06 a few months ago, so around 25% drop.

Also, I've been hearing about "day rates" for services/equipment starting to decline.

Costing for oilsands projects:

Labour - CDN $
Royalties - CDN $
Concrete - CDN $
Equipment - US/CDN $ (mostly)
Steel - US/CDN/Asian

All this probably means that future oilsands project costs (in US $) will trend lower.

The exchange rates have more of an impact than most of us would like to think--and they are not easy to forecast.

Whatever's propping the $US right now, its not fundamentals. Looks to me like "just another bubble".

It does seem clear that supply and demand are still the biggest factor. I put together a chart showing global oil balance (using EIA data) over the last few years and compared it to price. There seems to be a good relationship between these two factors, but with about a six month lag. That is, once supply fell short of demand starting in 2005, oil prices started going up. Price increases became very steep in the first half of this year as second half of 2007 oil balance became quite bad (2007 oil shortfall averaged over 1 mpbd). And as the oil balance corrected itself early this year, prices are coming down again. Has anyone seen a good multifactorial regression analysis of the relationship between price, oil balance, dollar/euro ratio, inventories, etc.?


One thing you did not list was political influence. If there is a perception that something is being done about consumption, the price may reflect this. Deliveries to the SPR where halted in May. Energy legislation to do with tax credits was passed together with the bank bailout. There is, for example, $7500 credit if you buy one of the first quarter million PEHVs. The idea that consumption will stay low could have an impact.


I suppose that if there is a perception that something is being done about consumption, price may reflect this. I am more inclined to expect that Tam Hunt, above, is correct, in that changes in price tend to lag changes in the supply/demand balance. According to Tam's fits, by 6 months.

I think the problem is that talk is cheap, so people (especially overseas) are not likely to give it too much weight. Where there are real changes (change in filling the SPR) it may have an effect. The effect is likely to be pretty small, since the amount being added or not added is very small.

I agree that the SPR effect can't be large, and similarly, the drill booboo drill stuff can't make a difference. But it comes after CAFE went up and if it is followed by stronger action on conservation, it may set a tone that reduces volitility and discourages exploration for expensive-to-produce oil.


I'd add today that when the market goes down when OPEC announces a cut, then politics might have an influence. People are betting that demand has more choices than supply I guess, choices that could be made clear through consumer government action just as OPEC government action shows its choices.


Well, I have noticed one thing: No one is talking about "Triple Yergin Day", at least for awhile.

I also noticed that no one commented much on Gail's attribution of price change to the hedge funds and speculators. Everytime I have mentioned those guys I was told they effectively didn't exist!

More surprising than the drop in the price of gasoline to me is the drop in the price of propane! I have actually considered getting together an investment group and buying or building some storage tanks for propane to hold in reserve at these prices. Stunning price for a clean and portable fuel.

Which brings me to a question: Why does it seem that everydody is hoarding "worthless" fiat money, but nobody seems to be hoarding oil and petroleum products?


Roger: Are you aware that the guys that are currently hoarding "worthless" fiat money are the same guys that have gotten trillions of taxpayer dollars recently because of their investment ineptitude (and their political power)? With their track record, that is ominous.


I suspect you already know the considerable expense associated with constructing such storage facilities. Much capacity already exists such as the salt dome storage in the Gulf Coast to allow NG storage for peak winter demand. But there are ten's of millions of small gasoline storage facilities ready to hoard when the pressure is there. They're the gas tanks in every vehicle in the US.

Many examples exist but the most recent was in the aftermath of Ike here in Houston. Folks would sit in lines at gas stations when their tanks got close to half full because they feared letting the level get any lower. Do you normally fill up at half empty? Probably not if you're like most. But if you think there will be a shortage you might. And so do most. Multiply 5 gallons times 100 million vehicles nationwide and that's how much (a half billion gallons) could disappear from inventory in just a few days in the case of a national panic.

Some might call that hoarding and others might call it being cautious. But the net effect is the same.

Which brings me to a question: Why does it seem that everydody is hoarding "worthless" fiat money, but nobody seems to be hoarding oil and petroleum products?

It is a sunset phenomenon typical of an empire in decline. It happened in the final days of the Spanish Empire:

The Castile of Gonzalez de Cellorigo was thus a society in which both money and labour were misapplied; an unbalanced, top-heavy society, in which, according to Gonzalez, there were thirty parasites for every one man who did an honest day's work; a society with a false sense of values, which mistook the shadow for substance, and substance for the shadow...

Gonzalez de Cellorigo was almost alone in appreciating that the fundamental problem lay not so much in heavy spending by Crown and upper classes--since this spending itself created a valuable demand for goods and services--as in the disproportion between expenditure and investment. "Money is not true wealth," he wrote, and his concern was to increase the national wealth by increasing the nation's productive capacity rather than its stock of precious metals. This could only be achieved by investing more money in agricultureal and industrial development. At present, surplus wealth was being unproductively invested--"dissipated on thin air--on papers, contracts, censos, and letters of exchange, on cash, and silver, and gold--instead of being expended on things that yield profits and attract riches from outside to augment the riches within.

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

And it happened in a decaying British Empire:

Granted that you are the clearing house of the world, [but] are you entirely beyond anxiety as to the performance of your great position?...Banking is not the creator of our prosperity, but is the creation of it. It is not the cause of our wealth, but it is the consequence of our wealth.

Joseph Chamberlain, British colonial secretary, statement to bankers in 1904

One of the key things that HAVE to happen is the margin requirements for oil and gas contracts need to be moved from 5% to 50% having 5 % allows for manipulation of the markets with relationship to actual supplies and deliveries.... it is a utility NOT a commodity .. oil companies can manipulate 1,000,000.00 in oil and gas with just 50,000 dollars.. on a large scale 1000000 manipulates 20,000,000.00 in oil and gas....this needs to be changed to 50% marginrequirements ..which still allows for investment and return ..but not total manipulation and will keep prices very very very stable....

This is part of our too much debt problem. Maybe if debt becomes very difficult to obtain, and very expensive to service, the problem will go away on its own. I doubt our government officials will do much about it.

I finally hit on this in this post.


If you assume that Energy is related to money via this equation.

Eused = Number of transactions * Energy Embedded in transaction

Then its really easy to explain energy usage vs the economic cycle.

New construction has a huge embedded energy vs the sale of a used house even though the price differences between selling a new house vs a used house may be marginal.

You can also see that driving to the store to buy a loaf of day old bread for one dollar vs a fresh loaf does not change the velocity all that much.

This is independent of the nominal prices and independent of the nature of the goods if the transactions shift towards gasoline over say buying a flat screen TV does not matter.

It also shows why new housing construction stands out with its high embedded energy.

So if this is the correct equation then chances are that the embedded energy of the basket of transactions carried out in a economy is probably fairly constant with the exception of removing excess new construction.

Once thats removed further changes in energy usage are probably far more sensitive the the number of transactions or velocity of money.

Thus going forward for demand declines to result in low energy prices the velocity of money or number of transactions has to decline faster then the depletion rate of oil.

Obviously loss of credit will slow transactions for example as people are forced to use cash instead of more debt their transaction rate will drop or is it all that obvious ?

Driving around looking for a new house probably consumes a much gasoline as driving around looking for a job
they differ in the embedded energy used up when you finally buy a new house with debt vs finally getting a job. However in both cases the energy used is the same minus the energy embedded in the house.
I'm asserting that in both examples for this example your purchasing the same amount of gasoline.

These transactions are identical even though the economic conditions that cause them to occur are radically different.

Certainly in a growing economy the transaction rate is increasing and the embedded energy is growing esp in the form of new construction. But in a economic recession it looks like growth stops for sure but Eused declines slowly as the volume of transactions and embedded energy don't change nearly as fast as the absolute prices paid.

Basically your spending every penny you make regardless on a number of different transactions each with its own embedded energy. As long as you continue to spend every penny you make and most of the transactions average out to a similar amount of embedded energy per transaction then the total energy used does not change. For example if your poor and spend most of your money on rent and gasoline and food but spend it all.
Then your landlord who has more money buys a flat screen TV with his profit or goes for a drive.
The final difference is only the embedded energy in you not buying a flatscreen. In this case both parts are important the transaction never took place and thus the embedded energy of the unbought product need not be used. However even though this transaction did not happen i.e you where to poor the total number of transactions you did engage in may result in about the same energy usage. Eusage could care less if your purchasing food because your hungry or a flat screen. As long as the transaction rate remains high profit moves up the economic ladder where the transaction rate is less sensitive to economic conditions.

Ones even more interesting is that price differences for a lot of goods and services are created via brand names and marketing the embedded energy of the products differ little. I.e the energy used to build a Chevy is similar to that used to build a BMW. So a shift from buying BMW's to chevy's may dramatically decrease the amount of money that moves but if I'm right about my energy equation it has no real effect on energy usage.

So instead of thinking of demand for oil as being inelastic its better to look at it as being difficult to really change the N*Eembed = Eused equation once the most onerous offender new home construction is eliminated despite seemingly dramatic changes in economic conditions.

This fits perfectly with all the data I have looked at.

Just to give one more example foreclosing on a used home then selling it involves more transactions than if the home was sold directly. It thus takes more energy than a simple sale in a stable economy.

Just one example of how energy and economic activity may be related in a counterintuitive way but its clear using my hypothesis.

You are ignoring some of the structural changes that occur during a recession. As well as the direct reductions in construction and manufacturing that use less energy, and the workers laid off that no longer commute to work, structural changes occur over a longer time-frame.
For example one partner no longer working full-time or working less part-time hours is going to have more time to cook and less money reducing "eating out", switching from high value restaurant foods that may have traveled longer distances( sea foods)to cheaper local foods. Selling the second car may result in once a week shopping or traveling more by public transport, or if its a gas guzzler, parking it more and using the higher fuel efficient car more often.
The longer term structural changes will be using less energy by; selecting a smaller( and cheaper) replacement vehicle, leaving a large foreclosed house and moving into a small apartment, not taking an overseas vacation( or having a local camping holiday instead), conserving energy to save on electricity and heating fuel bills, adding insulation to save on fuel, watching local(free) sports, music events etc rather than attending big(expensive) national games, national bands etc or staying home watching TV rather than attending in person.
Another effect now that the baby-boomers are reaching 55-65 age, some will go into early permanent retirement, leaving the labor force, and living a much more modest( lower energy) retirement than the past more wealthy generation( more traveling). These people may not return to labor force and will have a permanent lower expenditure.

I'm not ignoring them simply questioning how much fuel you really save in the end.
I'm questioning because all the data I can find shows VMT to be stagnant in declining economies. The difference this time around vs past recessions was the shear size of the bubble. Its no surprise that instead of heading towards stagnant VMT we can get a decline.

Looking at Eused= Number of transactions * embedded energy shows that the energy efficiency increases your claiming may well be a lot more modest then we thought.

Given the current declines I'm willing to bet that January's energy usage will be 1-2% lower than last years and as we enter 2009 we probably will see this difference drop even if energy prices rebound like I think they will. I'm not saying your wrong but I am saying that these changes are probably a lot smaller in magnitude then most people expect.

A larger effect is of course if we have really had significant out migration of Mexicans back to Mexico the problem with this of course is lack of documentation on both sides so its tough to figure. Of course if its large we should see Mexican gasoline demand remain robust as these returning workers will have money.

My point is everything I've read has not gotten me excited about the recent drop in prices and the reasons for it. So far the data point to it being a unique one time event associated primarily with the housing bust. Its going to be a hard slog to get the demand curve to shift downward from now on out and this implies strong support for oil prices when supplies become strained which could literally be in a matter of weeks not even months.

The Opec data I have shows two surges we are entering the backside of the second one and so far at least it looks like Opec shipments will be down dramatically over the coming weeks. You have quite a bit of fuzz because of the time lag for sailings to reach the US but as of right now by the end of Nov the US will be having problems meeting demand.

A number of interesting events happened at the same time to result in the current low oil prices as far as I can tell almost all of them are one off events with the exception of some of the scenarios your describing. I don't disagree I'm just saying when I started looking at transactions and the energy embedded in them once new housing construction is excluded it hard to get large net contractions in the amount of energy used to support the remaining transactions. Stagnation seems fairly easy to achieve just quit building houses and growing but going below stagnation is very difficult.

In closing and I might as well say it here there is a strong chance for one last surge of exports out of the Middle East but if it does happen I don't expect it to be as large as the last two and the reason I expect its possible would be clearing out the remaining storage before war with Iran so if it does happen its not a good reason to get excited.

I continue to hope that I'm wrong about and attack on Iran and now I'm really hoping that the fragile state of the economy will force and attack if its planned to be called off.

I know this is somewhat off topic but combination of strong surges of oil imports with a crumbling economy and the obvious fact that regardless of what we do we will hit the wall within a few years gives me the willies. The people in power are well aware that we are now playing the end game. If you look back and read my post I've said all along using my war scenario that the goal was to reach a oil price of 70-80 if they planned and attack on Iran. I did not believe they could do it and I've been proven wrong. But they managed to do it. Lets just hope I'm wrong about the reasons. Maybe its the election maybe its to help spur the economy etc. KSA alone has a good reason to work aggressively to drop the worlds oil price since it bolsters their claim it was all speculation they have years of goodwill now to use as needed if oil prices begin to increase strongly.

Given that a incident with Iran is highly probably over the next two years if not with the US then with the Isreali's and the resulting war would disrupt oil supplies for years or the economy can really take a nose dive leading to a real and serious drop in oil demand KSA could well have dodged the bullet of ever admitting to having peaked for a decade if ever.

Again this may seem off topic but its not all of these events are intertwined and KSA is deeply involved in the world economy at all points financial, oil influence etc etc. Regardless of the outcome of the election or if and attack on Iran happens the goodwill KSA has captured with the recent price movement is priceless.

They have no reason now to ever admit to peak oil given the projected lifetime of the worlds economy before it collapses of its own accord.

They have no reason now to ever admit to peak oil given the projected lifetime of the worlds economy before it collapses of its own accord.

The numbers will be hard to hide; so you must be counting on the collapse to happen very very very soon - if not already. Small comfort in that, eh?

Your theory about net emergy or exergy not decreasing so much - I'd suggest that very small and forced decrease over the past few years is a large part of what has caused the global economy to collapse: the resources are not there to prop up the money. All that fake money has to go away because there is no real natural wealth to underwrite it. Once one partner's fake money goes bad, it all goes bad because it's all based on the same logic. The realization by the first player that "there's not enough to cover this - no more growth" is all it takes. We talk about overshooting population, but we overshot the real natural economy with the fake financial economy too. I can't imagine how to put numbers to it beyond a per capita and I don't even know how to gather that data on my own.

Emergy/capita defines a level of technology, society and economy. More people staying home to cook dinner is a large qualitative change that ripples all over. There won't be Credit Default Swaps in a slower economy. Nor will there be two EVs and a biotech chicken in every garage because there won't be enough energy surplus to support that technological and social hierarchy. When more people garden, Monsanto's biotech will vaporize; it depends on an infrastructure of greater emergy, not less.

cfm in Gray, ME

Good post, memmel.

A number of interesting events happened at the same time to result in the current low oil prices as far as I can tell almost all of them are one off events

I'm guessing that all the recent downturn in oil price beyond $120 / bbl in June-2008 dollars is due to hedge funds and industry players forced to liquidate any fungible assets to cash involuntarily, the majority of it not speculation but legitimate forward hedging of commodity.

Rats, I wish you hadn't reminded me of someone planning to attack Iran. I preferred to let that nasty little possibility drop off my radar.

In the graph depicting whale oil production, there appears to be a step-change in price just after peak (shown by using two hand-drawn lines--fit by eye--to depict in stark form):

This prompted me to wonder if oil prices will undergo a similar pattern? And that, perhaps, the recent price escalation and volatility just might be the shift upward in such a step-change. By simple extrapolation, where does that put the peak in world oil production? Also, this whale-oil analogy suggests that crude-oil prices won't always trend upward... They'd level off at some point, but remain high, and probably quite volatile. I suppose this would mean that, for such a reality, substitutions would have to be at least somewhat effective.

Just some basic induction.



Very interesting Gray. Any hint to what might have caused the step change? Political factors? Change in consumption demands?

I have some thoughts regarding future oil price and above ground issues which might produce similar step changes. Not the least of which (OPEC finally becoming an effective cartel) we might see develop in the next few months. I wouldn't necessarily bet that the OPEC members will have sufficient discipline to pull it off right now but the potential becomes more likely as we approach PO closer IMO.


July 7, 2008

"In my view, the problem will emerge a few months from now, as a) economic demand softens further, b) planned production hikes actually emerge, and c) weakening price momentum encourages speculators to close long positions instead of rolling them forward. At that point, I expect that net speculative positions will plunge by 10-15% of open interest and we'll see a sudden glut on the market for spot delivery. It should not be surprising if this speculative unwinding takes the price of crude below $60 a barrel by early next year."

That is an interesting post. The part immediately preceding your quote explains his view of the impact of speculators:

It's sometimes suggested that hedge funds, commodity pools and speculators don't actually drive up the price of oil, because they don't actually take delivery of the physical product – instead rolling their futures contracts over indefinitely or until they close out their positions. From an equilibrium standpoint, however, this argument ignores the zero-sum nature of the futures market. Producers have an interest in selling their output forward to lock in a predictable price. Similarly, bona-fide hedgers (such as transportation and industrial companies) have an interest in buying their oil forward so they can plan without concern about future fluctuations.

To the extent that the speculators begin to take one-sided trend-following positions, their purchase of a futures contract crowds out the purchase that a hedger would otherwise be able to make from a producer.

It doesn't matter that the speculator has no intent to take delivery. What matters is that if the speculators are unbalanced on one side, the producers will have satisfied their need to pledge future delivery. Moreover, because they can lock in a high price, they will be inclined to sell more for future delivery than they otherwise would. Meanwhile bona-fide hedgers will be inclined to buy less on the forward market than they otherwise would. You can see this combination of effects in the commitments data, as a tendency for commercials as a group to become net short following significant price increases in oil.

When it comes time for the speculators to roll the contracts forward, they have to sell their existing contracts either to someone who is willing to take delivery, or to a producer who sold the oil forward and can now clear that liability without actually producing the stuff. Given relatively high spot demand and tight supply, these rolling transactions have worked fine to this point, without driving prices lower.

The post then goes to the section you quoted about the mismatch in net speculative positions, and the price drop.

Ahh but this works both ways. If the speculators are now net short vs the commericals then the entire trend is reversed.

Also this ignores that a lot of commercial oil buyers have closed out losing hedge positions and taken the loss. A lot of airlines and who knows how many real oil purchases have closed out. Preferring to take the paper loss.

And if speculators are now net short one would expect the prices to be suppressed just as much as they acted to and extent to increase them. The coupled with real oil buyers leaving the futures market results in lots of money changing hands and a low oil price and no real oil scheduled for future delivery. I.e far fewer players exercising their futures settlements to actually receive oil.

If you get the feeling that the futures market may now be quite disconnected from real future demand then your thinking the way I'm thinking.

This sort of disconnect makes sense when you have fast price movements esp downwards as a lot of the former market for oil futures simply leaves.

This is one of the reasons for the volatility of the commodities futures markets in the first place they tend to overshoot on the downside and work best as market prices are increasing even with speculation. The simplest reason is why buy futures when the price is falling ?

That's an interesting observation. One classic point that peak oilers make: substitution of fuels.

That is, the modern petroleum business gets its start in 1852 with the discovery that you could create kerosene by refining petroleum and with wells dug in Oil Springs, Ontario in 1857 by James Wilson. In the same year oil production in Romania from near surface deposits reached 2000 barrels a year. Drake's oil well in Titusville was dug in 1859 from a business formed in 1854. These are all very close to the whale oil peak in ~1845. Maybe it's just me but it looks like after the "step" there's a couple of wild price swings and then things stabilize a bit with the exception of the big dip in the early 1870s. I'd say it's reasonable to assume that as kerosene derived from petroleum gradually replaced whale oil in lamps, it would cause the whale oil price to stabilize somewhat because there was an alternative fuel. The next question is, what replaces petroleum? So far the only fuels that look to be being used are ethanol (with it's very low EROEI) and natural gas (with its storage complications).

*Edit* And the natural question, what happens to oil price if there is no practical substitute?

Don't get too caught up in the eroei, Gwydion. It's a, somewhat, transient situation. For example:


Thanks for the link!

My first reaction is that the only thing keeping a net positive EROEI on ethanol from corn is that they can sell the by-products as animal feed. If they are now converting those animal products to another questionable net energy production process (gasification) they aren't improving anything.

Why aren't they just burning the biomass directly to heat water? Wouldn't that be more efficient than converting it to natural gas first?

The thing is, Gwydion, Field Corn, basically, IS cattle feed. Somewhere around 90% of field corn is used to feed livestock (cattle being the predominant user.) We use a little field corn for corn meal, corn flakes, etc, and high fructose sweetener; the rest we either feed to livestock, here, or export to feed livestock, elsewhere (mostly Mexico, Canada, Europe, and Asia.)

The DDGS your refer to are the parts of the kernel that are Not starch, or CO2. The cobs that Chippewa Valley are using have traditionally been left in the field. It's important to realize that they have very little "fertilizer" value.

As for "gassifying," versus burning directly, all I can say is "gassifying" works better. Perhaps some of the engineers on the board can give an expert view into the mechanics of it.


Thanks for revised graph. It is very interesting.

It seems like once whale oil was much more scare (post peak) it sold for a higher price. I presume there wasn't huge general inflation (or it has been corrected for in the data), or we might have seen more of an upward trend post peak. The existence of substitutes no doubt made a difference also.

I think you would, probably, get a step function like that when it becomes obvious to a certain group of people that the supply of the product has "Peaked."

Gail wrote:

While we are going into a recession, it doesn't seem to have hit with full force yet.

This is another place in which this article is misleading. The market anticipates the future, it doesn't simply reflect current conditions on the ground.

There is nothing to prevent me from renting tanks in Cushing Oklahoma and buying oil for storage in order to sell into a market I anticipate will be stronger a month from now

Similarly, if I have oil in storage, there is nothing to prevent me from dumping it on the market if I anticipate lower prices ahead.

While we rightly fault it for not looking decades or centuries ahead, the market does actually always attempt to discern the near term future and contains mechanisms that force prices changes now in response to changing expectations of the future.

So, if the market comes to expect a world recession next year, it will begin to sell off now. It is incorrect to think that because there is no deep recession yet, the market can't be responding to the threat of one. Au contraire, it always has an eye on the future.

Incidentally, that's one reason why markets are volatile, the future is hard to know.


Al Husseini, now working for Morgan Stanley, just forecast a fall in total world oil demand in 2009.

Oil Demand May Drop to 83.5 Million Barrels in 2009

Perhaps oil is being sold out of inventory, thus depressing demand for crude.

I never see figures for oil in inventory on TOD, so I've assumed it's a small amount, but is that true? And anyway, one only needs to sell a small amount out of inventory to depress the price a lot, given the price inelasticity of oil.

It's my impression that there is a tremendous demand for cash right now, even at the cost of insanely large losses on investments.

Here in South Africa our currency has plunged by 1/3, even though our banking system, which has always been tightly regulated, is much healthier than the US's. Commentators are putting it down to overseas investors desperate to take their money out of the country. The story is being repeated in smaller economies around the world.

If there is such a demand for cash, people are likely to sell any physical oil they have as well, even if the price is low.

Some years ago the SA govt. sold their strategic oil reserves, saying they could always buy more. Hmmmm. Maybe the US govt. is doing the same thing to fund the bailout?

How closely is your currency correlated to gold? I am told that the main reason for the decline in gold prices,in spite of the amount of fear that exists, is that gold was being driven up largely because of it 's role as a destination for petrodollars.


I understand that is happening in smaller countries all over. I heard today that the Norwegian Krone is being dumped, and they have oil reserves and oil production. It doesn't make a lot of sense. Maybe its the idea that the US economy is too big to fail.

I haven't heard about countries selling strategic oil reserves. I know that banks were involved in some trading, and may be selling some of the oil that they were holding in inventory, helping to hold prices down.

A lot of diverse causes and effects are being discussed here on pricing of everything, but probably the most important is the debt cycle and unwind. It tends to trump all the other normal supply/demand laws and trumps all the other cycles when the down side of a long debt build gets going. So in a time like this, it's useless to figure a PE ratio for a stock or to figure likely production of anything and compare it to likely demand. The main thing that sets pricing is the flow of debt money in the volatile ratchet-down of debt levels, and this will steamroll about all the normal market workings that are useful in forecasting most of the time.

You may very well be right. The amount is so huge, and most companies rely on debt.

Karl Denninger had a good comment regarding the impact of debt on profits in his post today:

Running on free cash flow alone, most corporations would make 20% of what they make today - if that much. This, of course, collapses the "E" side of the balance sheet, which means that the "P" in P/E has to come down.


I find your explanation most compelling, especially in light of your chart and comments of the other day.

I live in Mexico and the situation here is even crazier than it is in the US. The Mexican government has actually managed its business quite well, having accumulated something like $100 billion in forex, mostly in U.S. dollars.

However, Mexican businesses have not been so prudent. They have borrowed heavily from US banks in dollar denominated loans. It's my understanding that Wachovia was big in the Latin American market, and now that they are no more, as loans to Mexican companies come due they are not being renewed. They must be paid. So there is a scramble to buy dollars.

The Mexican government is auctioning off $400 million of dollars per day, but it is not nearly enough. In today's auction, for instance, they sold the $400 million for a maximum exchange rate of 13.46 pesos per dollar, but there were bids for $939 million:


The exchange rate just a few weeks ago was below 10 pesos to the dollar. Today it closed at 13.92. Several large Mexican companies have already declared bankruptcy. It's a real blood bath.

Of course, like you say, none of this has anything to do with Mexico's GNP, with its current account, with the health of its central bank or with any rational measure. People are selling anything they can lay their hands on to get dollars.

I read somewhere earlier today that dollars in this market are like insulin to a diabetic. And there just happen to be a lot of diabetics out there right now.

Why are oil (and gasoline) prices so low?

The market got a little ahead of itself, and it first corrected, then over-corrected.

The markets are a herd of rampaging wildebeast, and at the moment they are all furiously running in the "down" direction. This will continue until it doesn't.

There were speculative positions on the long side which were unwound, both because of credit/margin issues, and because the herd was rampaging towards "down".

As first the US, and then the rest of the world's economies slowed a bit, supply momentarily exceeded demand. Since we were so close to the edge of available supply, this had a larger than expected (though perhaps not larger than justified) impact on price. Demand ordinarily dips a bit this time of year, anyway, during the space between maximum gasoline consumption and maximum heating oil consumption. There was a small degree of demand destruction caused by rising prices, but (as I noted above), that can be expected to substantially reverse as prices drop.

OPEC has not responded by cutting production by a million or two barrels per day, as one would rationally expect, to support the $100 price. The emergency meeting which was scheduled for just after the US election has now (that McCain's campaign looks utterly hopeless) been moved up to before the election. I'm sure that is just a coincidence.

As we enter our brave new world of declining production, we can expect this sort of tug-of-war between declining demand and declining supply. At the moment (and by moment I mean a very few months) we see the demand drop in the lead. It won't be long until supply drop overtakes it.

What we can be sure of is that wildly volatile prices and credit issues will combine to accelerate production declines.

In the near future, I expect consumption to stabilize at a level similar to where we are now, OPEC to defend $100 by shaving production a bit, and six months from now (depending on the severity of the winter) decline will have caught up to consumption - i.e. surplus capacity will be near zero (or whatever functional minimum exists). My prediction from earlier this year of a $150 to $170 trading range by the end of 2008 may not happen (I haven't given up on it, yet, as I expect this dip to be very short-lived), but I would not be at all surprised to see $200 sometime in 2009.

I apologize for not having read all the comments, but I read quite a few, so I hope I don't repeat something well discussed.

I think the main reason oil is falling so much has very little to do with oil, per se. You need to understand the mechanics of the financial system, and in particular, deflationary spirals, in order to get a handle on the current situation. Oil is not the only thing that has fallen precipitously.

Prior to the "great unwinding" that we are currently experiencing, leverage used by banks, investment houses, hedge funds, shadow banks, and personal households was tremendous. Just way too much. I won't venture to guess how much on average, but investment houses were running 30x-40x leverage, Fannie Mae was over 70x leverage. Basal II allowed banks to use their own models and they went from 8x-10x leverage up to over 12x, and then off balance sheet accounting brought it higher, but no one knows how high. Home buyers used to typically run at 5x leverage (20% down) but some were running at over 50x or 100x leverage.

As prices start to fall, for whatever reason, some people get margin calls, or foreclosures, or whatever particular market mechanism is designed to protect the lenders against loss. That means forced selling. This forced selling causes prices to fall further. If it's sporadic, nothing untoward happens. But once prices fall in earnest, all across the board, then it snowballs out of control. IMHO, at this point, the snowball is now an avalanche and is totally unstoppable, no matter how much the government throws at it. It's too late to rescue. Consider an example: Oil falls 50%. Even at 2x leverage, you would be wiped out at this point.

The next thing to understand then is that deflationary spirals often last for a long time. The major damage comes swiftly, but then prices keep falling, at a slower rate, and slower, but longer, and you get these long tails. In Japan prices are still flat, 19 years after their snowball turned into an avalance. The great depression was from 1929 to 1942 or so, a good 13+ years, until WWII really.

In 1929, there was no intensive economic monitoring, no measurement of the money supply, money was pegged to gold, and the rather new Fed didn't try to expand the monetary base.

In Japan, they decided to try something different, to lower the interest rate and try to re-inflate the system. Japan has a fiat currency tied to nothing, so they thought maybe it would work. It did not work.

Today the Fed is throwing money around like crazy, but like Japan has already tought us, it is unlikely to make any difference.

What will happen, and this has not yet started, is inflation. As the lion's share of deleveraging comes to be overshadowed by the increasing velocity of the new money put into play, the direction of the US dollar will turn around. Commodity price inflation that we have seen over the past few years may have been supply/demand related. But what we will be seeing over the next few years will be related to an over-supply of the medium of exchange. Just since mid September they are being created in earnest.

When people borrow money, banks create that money out of thin air. When they pay it bank, banks don't destroy it, they keep it. If they go bankrupt or get foreclosed on, banks don't get paid back, but the money supply doesn't change, just the owners of the money changes.

The current rescue efforts, from about mid September, are now creating lots of dollars. They take time to drive prices, and while credit markets are frozen, they don't have any effect.

This coming inflation is very unlikely to cause hyperinflation or to cause the USD to fall into obscurity. But it will probably be fairly severe. I know a lot of people are piling into cash right now, and my heart goes out to them, if everyone goes out to the balcony, and it tears loose from the building.

Some people suggest gold, and I won't argue with that. Gold will do well. But many equities are screamingly cheap at the moment, and the benefit there is that equities actually create new real-economy value (like my maid), while gold just sits there and looks pretty (like my trophy wife).

The reason the dollar is so high now, in this first phase, is because the unwinding leverage all needs to be paid back in USD, so USD is in high demand. Even if smart players can predict the coming fall of the dollar, they can't do anything about it. They don't want dollars, they need dollars. Unwinding leverage doesn't give you many options.

Most inflations are coincident with growing economic activity, but this is not necessarily so. Economic activity is the usual driver of more borrowing, the driver of a larger money supply. This time around, the driver is government and Fed intervention. So we get the inflation, but without the economic activity. In fact, the severe volatility we have experienced, and will continue to experience, is very harmful for running a business... it's extremely difficult to plan around severe volatility. So the real economy will contract significantly, and all the while, prices will rise.

I hope this helps explain things a bit.

And I want to give a big thanks for all the brilliant posts I've read on this website about supply/demand fundamentals on oil, they have definately helped me. I hope my post helps someone.


I don't know what you do for a living, but your overview strikes me as very well balanced and astute. I know people in the financial community that have not figured it out (or even attempted to) nearly as well.

I think your following statement is exactly on point:
"I think the main reason oil is falling so much has very little to do with oil, per se. You need to understand the mechanics of the financial system, and in particular, deflationary spirals, in order to get a handle on the current situation. Oil is not the only thing that has fallen precipitously."

What this implies is very disturbing to some folks here, however, and that is that "peak oil" per se had almost nothing to do with the current economic problems.

Now before anybody screams, saying this in no way undercuts the essential reality of peak oil, peak oil theory, or the fact that oil fields have, do and will continue to deplete, and will have to be replaced by newer large fields due to the fact that it is certain that the "low hanging fruit" of oil fields that deliver oil cheaply and easily have probably already been found and at least partially depleted.

What we are discussing is an issue of timing, not of fact. The facts of peak oil are pretty well established, but the "when" of such an event is the problem, and when it comes to investing and financial planning, being wrong in timing can be as damaging as being wrong in fact, a lesson we learned in the 1970's.

We are being shown once more that price has virtually nothing to tell us about peak anything, one way or the other. This should bring us no comfort. Attempting to plan becomes all the more difficult when the financial convolutions of the marketplace obscure the real nature of materials and energy supply and demand.

Right now, we have only the pattern of history to use as any guide at all, albeit not a perfect one, it is the most useful one we have.

I agree with your assertion,
"What will happen, and this has not yet started, is inflation", but again, timing is the issue. When will said inflation begin to show up in a serious enough way to disrupt the economy even more than the economy is now disrupted?

We can assume that, as in the 1970's, the stock market ("risk" capital) could stay very low for a very long time, compared to it's prior all time highs. The NASDAQ has already stayed down nearly 50% for half a decade once adjusted for inflation, and right now shows no sign as yet of rebounding to it's all time highs very soon. But at some point, it will, it just may be awhile. If inflation kicks in, the NASDAQ, DOW, S&P and other exchanges could go up in nominal dollars but still lag infltion and interest rate returns considerably, making them losers for perhaps another half decade or more once adjusted for inflation.

And there is another problem: That great demographic "bump" known as the aging baby boomer. These people are nearing retirement, and nearing the age that almost always calls for additional health care expense, which was to be paid for by invested money and the returns from it. There is no other way to say it, they were counting on that money. As people are disappointed year after year in the returns they get from their invested money, 401K's, and supposedly safe diversified investments such as ETF'S (Exchange Traded Funds) and mutual funds, we can sooner or later expect a repeat of headlines such as the one we saw in the 1979:


But in 1979, the largest investing class in history was still in their 20's and early 30's and would have decades to make up for the lost time and money of the 1970's. This time, they are in their late 50's and early 60's. If this recession and market stall lasts as long as the one in the 1970's, they will simply not have the time to make up for the lost money. Peak oil will be the least of their problems. Unable to maintain health care and cover rapidly inflating living expenses, the aging boomers will be in a life and death fight with good old fashioned poverty.

This explains why the U.S. Treasury Department is pulling out every stop and every trick to avoid a 1970's duration recession (never mind the 1930's, a '70's repeat would be enough to do the deal). The boomers are essentially fighting for their life, or I should say "we are fighting for our life" because I am one of them. It also explains why the problem of "money hoarding" will become a larger and larger problem to the economy, as leery investors decide to protect what they have, rather than leverage upward.

This may actually create a lifestyle that many at TOD see as closer to a correct one, as elderly people attempt to move closer to hospitals, local entertainment such as theatres and orchestras, and into smaller homes, condos and apartments in an effort reduce costs, and rely more on local efficient transportation (electric cabs and limos for inside city center transportation?) All of this may well occur with or without peak oil due to purely economic issues. Oil consumption will drop, whether there is another trillion barrels in the ground, or another five trillion. It is now almost certain that the modern high technical western nations have already peaked in oil consumption.

At some point, risk capital will begin to grow, the stock markets will begin to rebound. This will be caused by a new generation of young investors and the need to modernize American infrastructure, energy systems and IT (information technology) if the modern western nations hope to survive as prosperous nations (and everything said above about the U.S. applies in even greater force to Europ and Japan, as they have a financial and demographic situation even more vulnerable than the U.S.). But the next age of economic expansion of the type we saw in the U.S. in the 1980's and '90's may very well occur too late for the aging boomers to enjoy. It will be the recovery and expansion that our children and grandchildren will build and enjoy. For the rest of our lives, we will live in a different era than the one we have known. This was not caused by geology, but by bankers, investors and by an age demographic that has been built into the Western economies since WWII.



Peak oil's impact is going to be long-term, slow motion. I'm afraid that those who think that the entire economy is going to collapse the moment we come up a few barrels short have got it wrong. Peak oil didn't cause this economic downturn, but what it is likely to do is to dampen or prevent any recovery. As I explained in my other post above, I don't see this as a "V" shaped or a "U" shaped recession, but rather "L" shaped - or rather, a series of Ls in a staircase. It is that long term direction downward that very much will be caused by peak oil.

As for we boomers, I am afraid that most of them are going to be "aging in place", they just don't know it yet. Those who are lucky enough to manage to hold on to their homes are going to discover that there are not enough buyers around for them to sell, and that even if they can sell they are going to have trouble finding anything they can afford anyplace where they should really want to be. Quite a few aging boomers are going to be finding that they are going to have to turn their homes into duplexes, or build accessory apartments, or just take in roomers - not quite the retirement they had in mind.

Many of us are going to have to keep working for as long as we can, and then keep on working on at least a part-time or self-employed basis at something just to bring in a little bit extra. Forget the extended travels in Europe, too; most of us are going to have to really scrimp and save, I'm afraid.

Thanks for the praise, and let me just say on peak oil that I don't disagree with that theory at all. Oil is harder and harder to find, and requires more and more investment. But as Dave Matthews says "if you hold on tight to what you think is your thing, you may find you're missing all the rest." Some may be holding too tightly to the view that peak oil is the driver of everything. I may be holding on too tightly to the monetarist inflation theory.. or at least I got my timing way too early. I really didn't expect this deflation, I expected Ben Bernanke to increase the money supply right off, but he swapped assets instead. It was a neat idea; too bad it didn't work. It was Michael Shedlock that changed my mind on what is happening, and I highly recommend his blog at http://globaleconomicanalysis.blogspot.com


Great analysis.

One thing that I think a lot of people don't understand is that it is possible for price deflation to be occuring amongst entire classes of goods or assets (housing, commodities including oil, securities, etc.) while price inflation is occuring amongst other classes of goods or assets. It is also possible for prices for some things to decline even during a general inflation of the money supply. Everything does not move together in lock-step. One must really step back and take a broad-picture view of the aggregate to understand fully what is going on.

I think that you are right that we are going to see a comprehensive de-leveraging, and that this is going to deflate asset prices for a long time. I also think that you are right that the US government is going to have no choice but to monetize the debt and inflate the money supply as a consequence. This will certainly result in a decline in the US$ exchange rate relative to other currencies. This in turn will increase the cost of US imports (especially for oil). While it is also true that it decreases the cost of our exports, we are already exporting just about all of the Boeing jets and military hardware that the rest of the world wants; while we could possibly increase our agricultural exports a little, most of those who are most in need of them can't afford them, even with a cheaper US$. Thus, either our trade deficit is going to balloon even further, or the US is going to have to start living within its means and cutting way back on imports. The thing we should all fear, of course, is that this decision will be made for us by exporters refusing to accept dollars in payment any more. I don't know if that will happen or not, but it will be a disaster if it ever happens.

I agree with what you had to say about stocks. Even when stocks are taking a beating, I still believe that it is wise to diversify and not pull every last one of your eggs out of that basket. The good news is that stock prices have come down to the point where p/e ratios are getting more reasonable. I do believe, however, that value investing is definitely the way to go. The US has multiple huge problems, many of which are being flatly denied and ignored; at best, our national leaders are just slapping band-aids on the crisis du jour and kicking the can on down the road. This gives me no reason at all to think that boom times are just around the corner. I thus do not see this as either a "V" shaped short recession or a "U" shaped longer one, but rather more of an "L" shaped long-term decline. Things will eventually level off, and might even wiggle around up and down for a bit. It is more likely, though that what we will see down the road a few years is not a recovery, but another downturn to yet lower levels. We might very well just be starting a long term stair-step descent. Thus, I am of the opinion that one would be very well advised to consider this to be the death of capital gains, at least. There is still something to commend some stocks, however: dividends. There will still be lots of opportunities in this economy for well-positioned, well-run companies to make profits, and to distribute those profits to their investors. It is not at all evident to me that income from interest payments is ALWAYS more secure than dividends - it all depends upon the entity making the payments. Also, it is not always true that interest yields are going to be higher than dividend yields. That has tended to be the case up to now for most companies, because most investors were more interested in capital gains than in dividends. The economy is now changing, it is a new game, and dividends are now likely to matter a great deal. Value investors have always put a lot of weight on dividend yields, and I believe that this style of investing is the right one for these times.

I totally agree. Making money on capital gains produces no real-economy value, and so the real economy will (is?) adjust to eliminate such a non-profitable profession. As a result, perhaps dividend payments will increase back to traditional levels, rather than the currently popular reinvestment of earnings.

I live in New Zealand, and down here companies pay out almost all of their profits as dividends. It's wonderful.

and the rather new Fed didn't try to expand the monetary base

I guess that's true, but that "rather new" creature from jekyll island also didnt increase the money supply and cause a 5 trillion dollar real estate bubble during the roaring twenties. What's coming down now is much larger than what came down during the early 1930s. I estimate we need to increase the money supply by about 12 trillion in order to stop a deflationary collapse. Can you imagine a 22 trillion dollar national debt? lol. It aint gonna happen. So the entire economy will be destroyed. This is all being done by design. I dont know why people are orders of magnitude off in their calculations... I mean, I know why the Fed is off, because they work for the bankers to steal america's wealth. But I do not understand how so many well-meaning people cant see it. The Fed TRIED inflation, 5 years ago. It failed, when the housing bubble popped. If they are going to do it again they need to do it bigger, at least twice as big, to 2.5 times a big. I say 2.25. What is 5 trillion times 2.25? That's where I get my number from.

In 1929, there was no intensive economic monitoring, no measurement of the money supply

Are you sure about that? Can you guess the ratio of newspaper articles dealing with the money supply vs all other news articles in 1929? Do you think that this ratio is higher or lower than it is now? (Obama/McCain garbage doesnt count!)

No I am not sure. In fact on reflection, I probably overstated things. However historians have pointed to the fact that there is no evidence the Fed was in possession of currency deposit ratio information (Elmus Wicker). A lack of evidence is not proof, so again, no I'm not sure.


Thanks for your insights. The thing that struck me was

The reason the dollar is so high now, in this first phase, is because the unwinding leverage all needs to be paid back in USD, so USD is in high demand. Even if smart players can predict the coming fall of the dollar, they can't do anything about it. They don't want dollars, they need dollars. Unwinding leverage doesn't give you many options.

That is probably the reason the yen is also high now. It is also being unwound and being paid back.

It seems like there is an awfully lot of debt to unwind. I wonder if it at some point stops being an orderly, long-lasting unwind and transforms into something else.

Long term, post peak oil, there is no way we can maintain much long term debt. It will just be too difficult to pay back, with more and more limited resources. We somehow need to get from where we are not to a very much less leveraged future. It is difficult to envision how this will happen. A little bit for years and years, won't do it in my opinion. It seems like there has to be a break somewhere.

One small but possibly not insignificant factor in the plummeting oil price is the withdrawal of small investor money. Over the last few years, small scale private investors were given the opportunity to invest in commodities through a new type of financial product, an Exchange Traded Commodity, a type of Exchange Traded Fund (ETF) wrapper around a basket of commodity futures contracts, the price of which would more or less track the commodities. Not wanting to miss out on the commodities boom, many smaller investors entered the market via theses products. The risks of these products were not made clear to the investor until major financial problems with AIG arose over the last few months. AIG is one of the main counter-parties in the futures contracts that many of these ETCs held. In September, AIG had to be bailed out by the Fed, and trade in all of the AIG related ETCs were halted for a short period, spooking many investors. Investors had also begun to pay more attention to the counterparty risks of owning any ETC, not just AIG's, and ETCs began to lose their shine, even those that shorted the commodities futures markets (which BTW have done quite well recently). I wouldn't be too surprised that the counterparty risk issue that now plagues the banking industry has also had a powerful impact on smaller investors who've pulled their money out of the commodity futures markets and are now simply sitting on cash.

Just a small comment regarding tar Sands projects and availability of possible future financing.

We have to realise a IN-SITU project is very, very less capital intensive than most other projects such at deep off shore drilling outside Brazil or Tar sand mining.

Below you have some more detailed information that is vital when analysing financing options available relevant to small Tar Sand In-Situ projects:

Bank Loans Have Not 'Dried Up'

Contrary to many comments, consumer and industrial loans actually increased in the latest week. Troubled giant banks have cut back on lending, but smaller banks have picked up the slack. Consumer and real estate loans dipped insignificantly through Sept. 17, remaining much higher than they were a year earlier.

If all the recent hysterical chatter about lending being "frozen" or "shut down" refers to anything real, it is not about banks loans (through Sept. 17) but about such arcane financial markets as asset-backed commercial paper or loans between banks. But this too is mainly about financial firms, not Main Street. Non-financial commercial paper increased from $156 billion at the start of the year to more than $204 billion from Sept. 3 to Sept. 17, dipping only modestly since then.


There is money for most smaller businesses and projects at the smaller banks except for residential development. The true credit crunch is at the top for larger projects. Want to do a $3 million deal? If you have a reasonable project, it can get financed. Want to do a $300 million deal? Lot's of luck, for reasons we note below.

Most of the smaller banks have plenty of capital and are looking to put it too work. Rich guesses there are about 4-500 banks (5% of the total, with concentrations in states with bad housing markets) which are in some level of financial stress, meaning they need to raise capital or reduce lending. His guess is that we will see about 100-150 banks fail over this cycle. He would be surprised if we saw more than 3 top 50 banks fail. Most of the larger banks, if they get into trouble, would be absorbed by better capitalized banks in search of market share.

In fact, Rich is quite bullish on selected bank shares. 86% of the banks/thrifts in the U.S. made money in Q1 2008 and almost 50% earned more in Q1 2008 than they made in Q1 2007 (i.e. they made more money after the credit crunch than before.) But nearly all banks stocks have declined in sympathy with the problems brought on by the credit crunch. Over times, growing earnings will make for a rebound.

So, middle America and middle American business, except for construction, are not by and large experiencing a credit crunch. The smaller banks are not cutting home equity lines and Rich says they are not experiencing abnormal losses. That is because they are local bankers who know their customers. It is the banks which offer home equity loans and have brokers do the lending without really having any incentive to make sure the loan will be good which are the ones in trouble. Securitized home equity loans and second mortgages are showing significant losses.


Thanks for the insights!

First time commenting here. Off topic, but somewhat relevant:

Automakers Apply Brakes to NASCAR

An excerpt:

"The U.S. enjoyed a pretty robust economy that enabled the sport to grow, but that has changed significantly in the last six months," said Terry Dolan, manager of Chevy Racing. "And it's probably going to drastically affect what the sport may look like 12 months from now."

Lots of things may change!

I read some months ago that the IEA when they release this year's "World Energy Outlook" in November will for the first time take a hard look at oil reserves - the supply side. Previously they reportedly focus mainly on demand side and assume supply will always cope and titrate up or down to demand.

This may mean they downgrade OPEC oil reserves such as Saudi. If so - won't that lead to a sudden spike again in oil price?

Then again maybe the IEA won't do this. Anyone know?

We will have to wait and see. I am guessing they will do a little but not too much.

The amount of hedge fund money out there (as I've been harping on last few months) is staggering. Any single popular position, combined with leverage, can destabilize markets. When SEC and Treasury change the rules (often), this exacerbates the problem as the natural 'other side of the trade' evaporates. Many large hedge funds (e.g. SAC and Paulson) are in cash. Many others are being liquidated - we won't know how many until early next year but I guess its in the hundreds and the amount of money is in the hundreds of billions.

The above chart shows the correlation between hedge fund returns (the hedge fund aggregate index), equity market returns, and the Euro/Yen cross rate. The Yen/Carry trade, being unwound at breakneck speed due to above mentioned issues, is causing all markets to selloff, including oil, as traders, speculators, etc. all gravitate towards neutral positions. This morning again - dollar down vs yen and up vs Euro. The dollar rally (against all but Yen) has been nothing short of spectacular. Some of this is flight to quality in uncertain times. I think a good deal of it is hedge funds closing down carry trades. When they close down a trade with borrowed money, they close out what they had bought with it - energy stocks, etc.

This quarter will be remembered as a global margin call. Many are talking about sub $50 oil now due to further liquidations. (I disagree, because OPEC won't stand for it because now even they are losing money (if they include depreciation, etc.) at these prices. Ultiamtely, the larger the 'margin call', the lower our future energy production will be. And most readers here know the implications of that.

*(Note - chart is 2 days old and had $/euro at 1.31 - today it is already at 1.275)

Great chart Nate.

I think this drives home a huge point. We tend to focus on fundamentals by the very nature of the oildrum. I've done a hard look at the fundamentals and unless we enter a depression it looks like demand for oil in the US will drop slowly if at all from here on out. Thats my position.

But whats important in the short term is what the market is thinking about and many people have attributed these wild price drops to the market anticipating a deep recession or depression. I'd suggest looking at that chart that the market is thinking about what they are going to do today and tomorrow and the real long term thinkers are looking into what they are going to do next week.

Given the vast amounts of money moving in various directions and what I said above its probably fair to assume that all markets are currently insane they are not really moving based on anything except people trying to cover their ass.

It will either settle out or crash fairly soon probably in a matter of weeks. But in the interim using any of the market moves going on right now to justify any fundamental argument beyond the obvious that demand has fallen somewhat this year is ludicrous.

So either the markets stabilize and we can get back to worrying about peak oil or we worry about where or next meal is coming from.

Btw this is a perfect example of what I posted about before. When complex systems crash they inherently lie about there state. The current situation is the perfect example. By lie I mean what we think is happening is probably not the true situation and know one knows the truth. Thus I use lie to mean lack of knowledge of the truth and misleading data about the situation. This is exactly what happens as complex situations enter into collapse. In fact this misinformation is actually the driving force for collapse. How long it will take is unknown but this scrambling of information or lies if you will is a HUGE signal that our economy will be undergoing massive changes over some fairly short time interval.

It could be days, weeks, months, or years but if you think about it as some sort of massively sculpture interconnected by springs, stiff brittle rods, and heavy weight that just got whacked by a 10 Earthquake then your on the right track. This thing is vibrating like a bastard connecting unconnected events and shattering formerly will known connections that turned out to just be brittle rods.

Dried beans and rice are flying off the shelves, but survivalism gets old real fast. I would venture to say that people need a sense of purpose, and there are many, many people without one unless they have work to do.

So what positive work can people do that delivers to them at least the basics of Maslow's hierarchy of needs + electricity + transport? We have a spoiled industrialized world used to nice amenities, and not many people currently subscribe to the celebration of loss as much as the clinging to material things. How are bankers supposed to peacefully deal with property rights when people can't possibly pay off their debts?

Also, the news seems to be prepping the market for some sort of terrorist attack. What would that have on the markets? Have economists factored in WMD to markets if any are deployed? Or is that when the survivalists get to say "I told you so"?

the news seems to be prepping the market for some sort of terrorist attack.

Iran? Last kick of the neo-cons before getting booted?

ya know, I am just a simple individual. So who the hell cares if OPEC cuts production. When they cut production they also cut their income. Letum do it, they'll soon realize their own needs and resume current levels. And who the hell is it that keeps on saying we'll raise the prices to our own people?
Let's just send those greedy bastards on a 3 week all expense paid trip to the poor house. They put us there by raising oil prices and I just hope that they all lost everything they gained and more with their greed. Raise the prices again and we'll cut consumption again. These oil companies have amassed profits never before seen in history and they're still trying to get more. It is apparent that these oil giants don't give a rats ass about anyone or anything but their own padded retirement accounts.
I hope you idiots lost everything, and if you didn't you should.

besides the Supply and demand, was the question.

politics . ( Fedzilla , hear what Allen Greenspan said today? Asleep at the switch?)
"tsumini" hear that. Sounds more important than oil. If you can't buy it , what good is a cheap price.

war. (actually helping it flow in Iraq, see the Barrels/per day , can't do that with well heads burning)
Weather (sure but it is/was localized)
stronger dollar? sure, some.

does it matter?
and like commodities are not turbulent? (both price and supply?)

Cheers for less oil consumption.
Now we can have a little extra in the future .
Pray for continued conservation ww.

I now drive a very tiny car (can afford any) but drive a little 2 door sports coup. 30-35mpg.
I installed a heatpump (5c/kwh hydro power) and a pellet stove.
My thermostat is at 68.

BTW: how many times have we heard this threat. 10 times, 100 ?
how many times are you going to listen.
I say SHOW ME !

The result will be the wasting of this precious resource.
But not by me. It is in my blood now.
I help tune EFI systems and am darn good at it , and help others for free. That is my contribution to Earth.
Everyone can do something, but it helps to shoot the TV.

it helps to shoot the TV

Absolutely! I did that 2 yrs ago (limit now is news [BBC, CBC, some CNN] and comedy, weekend evenings only). Always did lots of reading anyway, used bookstores very valuable.

Real $US oil has traded in a primary bull market channel since late 1997, doubling about every 4 years. The current retracement hasn't gone close to breaking that yet. It would need to trade in the mid to low $50s for a couple of months to decisively break the pattern.

This sort of behavior in a heavily traded commodity shouts physical supply-demand mismatch, especially when the real price was essentially stable for the preceeding 20 years. The current wash-out has yet to alter that meaningfully.