Why are gasoline (and oil) prices so low -- and where are they headed?

Why are gasoline prices so low? And why do they continue to drop? The recent drop in oil prices has truly been extra-ordinary. Gasoline prices are down almost as spectacularly, and the price of diesel is down is well. If we look at the graph, it doesn't look at all like anything we have seen before. What is happening, and where is this headed?

Figure 1 - EIA Graph of West Texas Intermediate (WTI) Crude Oil Prices, through 12/2/2008

I am becoming more and more convinced that the drop in gasoline prices has a huge amount to do with all of our credit problems (which in turn are related to limits on the oil supply). These credit problems are causing more and more defaults on debt and more and more bankruptcies. These defaults and bankruptcies have a double impact on oil prices--partly from reduced demand, and partly from distressed sellers disposing of futures contracts at low prices, because they are easy assets to sell.

We often hear that "soon" oil prices will hit a bottom, and start shooting back up again. I am less and less certain that this will be the case. Instead, I am concerned that we may on a relentless path to a point far below the point where energy companies can expect to have any chance of making money. We may be on a path toward more and more bankruptcies and defaults of all types--energy companies, owners of commercial real estate, homeowners, financial institutions, auto makers, airlines, and many more. If this is the case, there will be a huge strain on governments, and some may find it necessary to default on their debt.

In order to ultimately get past this crisis, it may be necessary for governments to establish new currencies in which debt is severely limited, and at the same time unwind the debt in the existing currency. I expect that a huge amount of derivatives of all types will need to disappear as well, so that financial assets start bearing a close relationship to physical resources.

Supply and Demand

Most of us who have taken any economics courses have some idea of the expected workings of supply and demand.

Figure 2 - Graph from Wikipedia. Caption says The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D), along with a consequent increase in price and quantity Q sold of the product.

The theory is that in a competitive market, price will act to even our supply and demand imbalances. If supply is too great, price will drop, and more users will find themselves able to purchase the products and use them at the lower price, bringing supply and demand back into balance again.

Is oil priced too high, or is credit too unavailable?

I think what we have happening now is a mixture of (1) supply and demand of the physical product, and (2) credit issues, both of which are focusing on commodity prices of all types--oil, natural gas, coal, copper, corn, and many others. With respect to supply and demand of the physical product, when the US was busy building huge numbers of houses to keep the economy going, and workers around the world were buying many new cars, there was a great deal of demand for these commodities. Once we started building fewer houses and cars, less oil was needed for manufacture and transportation. This type of physical supply and demand is what we expect to underlay a curve of the type shown in Figure 2.

The second problem is debt, and it doesn't work as nearly as rationally. Debt, and the repayment of debt, works as long as there is a growing economy, because with the growth, there are funds for a reasonable percentage of debtors to pay back their debts with interest. When a government senses that the economy is not growing as fast as it would like, it can encourage more and more debt, to try to keep the economy going. It seems to me that since 2001, we have had a considerable amount of government encouraged debt, to try to get the economy to expand faster than its natural rate.

It is not entirely clear what the impact of the growth of credit on real GDP is. One estimate might be that an additional dollar of debt adds an additional dollar of real GDP. One could debate whether this relationship is correct, but clearly there is some impact. Using total debt amount estimates from economagic.com, this is a rough calculation of real GDP, without the inclusion of debt:

Figure 3. Calculation of US Real GDP, adjusted for growth in credit. Click for larger image.

Figure 4. US Real GDP, adjusted for growth in credit. Click for larger image.

Based on the calculation shown in Figure 3, and graphed in Figure 4, there has been no real growth since 2000. Instead, we have been seeing more and more debt-based pseudo-growth.

Without real expansion, debt will eventually start to unwind--there start to be too many defaults. The debt probably would have started to unwind on its own, because of the slowed growth rate, even apart from the oil price increases. The increases in oil and food prices between 2005 and mid 2008 helped prick this debt bubble, but the underlying debt set the stage. The underlying issue that slowed the growth rate was limitations on resources. These resources are not becoming more abundant, so it seems to me that it will be virtually impossible to get the real growth to increase again to the point where it again makes sense to have very much debt. I would argue that it probably never made sense to have the level of debt that we have had in the past few years.

So what does this have to do with the supply and demand curve? Oil prices can be expected to keep dropping, as long as there is more and more credit imploding, resulting in fewer people being able to buy products made with oil. Given the huge amount of debt outstanding, and the lack of growth to make this debt "repayable", more and more defaults seem likely.

We can ask ourselves, "At what price of oil (or of gasoline) will credit stop imploding?" since the answer to that question will tell us when the price of oil can be expected to start rising again. I believe the answer is, "Whenever governments can figure out a way to get the economy to start growing fast enough so that debt (and its repayment with interest) 'works' again." I would argue that governments will never be able to make this happen. We have reached a point where resources (oil and other finite resources) are in such limited supply that the best we might be able to hope for is a level economy for a while. More likely, we are going to see decline. Because of the lack of growth, we are at a point that we need to unwind the debt we have, and learn to live without the vast majority of it.

What does this mean going forward?

To me, Figure 1 is truly scary. If the price of oil and other commodities continues to drop, we are likely to see more and more energy companies going bankrupt. Some of these may be large--we have heard rumors about the financial problems of Glencore, a large privately owned international trading company. The economies of Texas and Louisiana are likely to take major hits, as will Russia and some Middle Eastern countries. Even with the low energy prices, many of the problems the US has are likely to continue (too few houses and cars being built to "pump up" the economy, declining prices on homes and commercial property, and many workers laid off).

The amount of debt we have outstanding is extremely high. The debt shown in Figure 3 is not really all of the obligations of the US public and US government, since it excludes things like Social Security and Medicare liabilities. According to one web site, the amount of debt Americans have outstanding is $53 trillion, plus unfunded governmental promises (including Social Security and Medicare) of $64 trillion, and plus trillions of dollars of related to derivatives. Not counting the derivatives, this amounts to $386,091 per person. I don't know whether these numbers are precisely correct, but it is clear that with limited resources and a declining economy, there is no way that amounts similar to these amounts are going to be paid in full.

I am sure that the Bush and Obama administrations and other administrations around the world will try to fix the problems, but I fear many may not be successful. If they somehow are successful, the current oil price collapse may lead to a rebound, but it is likely that we will still have to face the need to unwind our debt later, even if we somehow make it past our current crisis.

I don't know whether it is necessary to go through a full economic collapse and restarting process, to get past all of this debt. I find it hard to imagine that governmental leaders will sit down, look at the situation rationally, and start thinking about how to unwind the debt. But eventually, and I fear, sooner rather than later, we will need to get rid of most of this debt, and start over again with a monetary system that is more closely tied to resources and discourages debt. It is possible that forward-looking leaders could even start the new monetary system before the old one is phase out. The new monetary system might, for example, start out as more of a rationing system for food and energy products, and eventually be expanded to cover other products as well.

I am afraid I don't have all of the answers. My problem is that when I see a trend line based on oil prices pointing almost straight down, and I can't see a good reason for prices to suddenly start rising, I start worrying that the consequences of the current price collapse could be far worse than any of us on The OIl Drum have been talking about.

These are a few of my recent posts that are related:

Impact of Credit Crisis on the Energy Industry - Where Are We Now?

An Overlooked Detail-Finite Resources Explain the Financial Crisis

Jeff Rubin: Oil Prices Caused the Current Recession

Oil Prices - A Little More of the Story

Why are oil (and gasoline) prices so low?

It seems that if you built the actual supply/demand price relationship curve.... It would appear nearly vertical since May 2005. A 1 million barrel change either way is a $100 change price. A lot of things in nature go asymptotic at the limits.

Bill O'Grady at AG Edwards foretold of this about 3 years ago.

Does it have to be any more complex than that??


Exactly, the current chart for oil is not that unusual for those who follow charts. Many stocks looked about the same after the dot.com bubble. Having followed the corn/soybean market for many years, it is not that rare to have soybean prices go to about $15 in a blow off and then in a relatively short time fall back down to under $5.

When 500,000 people lose there jobs in a month and most of them drive to work there is a large reduction in oil demand. If they each used 2 gallons/day for commuting, that's a reduction of 1 million gals/day in demand.

Add in the observation that many have parked their low mileage vehicles and switched to smaller cars and demand is reduced further. Since prices are set at the margin in a free market, one extra gallon of gas causes the price to fall until a buyer is found. The same thing is true for an extra bushel of corn.

Commodity collapses such as this can take years to stabalize and form a base before retesting the old highs. After the collapse of 1980 it took 28 years for crude oil prices to again match the inflation adjusted price of 1980 during the July 2008 spike.

I tend to disagree with your premise that it will take a long time.

If you look at Figure 2, I think at 85 MMBPD we are near the upper limit on Q. P is moving violently. A little delta Q plus or minus gives a lot of delta P. It will be a roller coaster ride of epic proportion....

I don't know how else the peak in Q would manifest itself.... is it not the only way???



FF and x, I haven't seen that a 1 mbpd change means a $100 price change. So far a 15% price change for a 1% change in supply or demand seems to continue on the mark.

Did you see the comment the other day from the TODer in the shipping biz? He was pointing out that the drop in price meant that ships were moving faster, because costs of crew, etc. were outweighing costs of fuel. And he said that this shortening of the pipeline had, in effect, put an extra 2 mbpd on the market.

Plus, diesel has been controlling the price for some time, and we've had a sharp drop in diesel consumption in the U.S. over a very short time.

Add in the extra production reported for October and the normal 15% for 1% model gives you the makings of a slide to something like $zero.

OPEC will cut on the 17th. And contango is now at a record. We are looking at a bottom forming, and that's a very good thing.

A bottom forming? Well, prices blipped up today, but this global recession is barely out of the crib. Remember 1998? Oil hit $10 a barrel. Remember 1980? Oil demand fell by 11 percent in three years (globally).
I hate to say it, I try to be optimistic, but this global recession looks much worse. Where is refuge from this downturn? Europe? Asia? North America? South America? Manufacturing? Retailing? Real Estate?
Nada, nada, nada. Oil demand could easily fall by 10 percent (maybe more), while supplies rise by 2-3 mbd in nex couple of years.
I see honking gluts of crude to the moon for years and years.
Oiil may hit $10 a barrel again. Increases in crude oil demand will be long and slow in coming, if we are lucky to get any increases at all within three years.
Oil is deader than yesterday's newspaper.
We might want to re-think hytseria about supply. Price seems to moderate demand, especially above $100 a barrel, while stimulating supply. Add in recession, and you get glut-a-rooni.

One thing is clear, production is inflexible, not demand.

The oil industry has become much more concentrated, with the great bulk of production in the hands of a few dozen national producers. An oil minister's worst nightmare is for his country to cut production - for any reason - and watch prices rise as a result, with his adversarial neighbor reaping a windfall. Meanwhile, his own country becomes more and more vulnerable, because its income has been reduced because of low production.

As a result, the countries pump as much and as fast as possible. 85 million barrels every single day is a lot of oil. That oil has to be sold and however low the price must go to clear that day's market, it will be cleared. If the production does not leave the country, the outcome is the same as a cut in production, so sales strategy and promotion are a part of the production process as well.

Of course, there are unintended consequences, some of which are well known. The low price reduces investment in new production, repairs and maintainence or petro infrastructure and the production of alternative energy sources. A less well considered outcome is the loss of income to our suppliers; these countries are the source of much of US stimulus and bailout funding, as well as customers for USA- made goods and services. The highly valued dollar becomes an additional difficulty. The possibility that declining revenues might result in domestic unrest - and Al Qaeda attacks on oil infrastructure - also increases.

What is infuriating is the deleterious effects could be avoided by the government placing a floor under oil prices or, at least gasoline prices. $4 dollar per gallon gas would give the government policy leverage with our suppliers and encourage conservation and help finance alternatives. It would demonstrate someone in Washington knows what they are doing and that hard choices can be made, rather than have the choices made for us by circumstance.

SfromV-- from your lips to G-d's ears. A gasoline tax to dampen demand and build infrastructure. I recommend incresiong the federal gasoline tax by 50 cents a gallon for next eight years, while cutting taxes on middle class.
I am not so sure production is inflexible -- just slow. And subject to lunatic thug-state politics.
A good reason for USA to go it alone, energy-wise.

Where is refuge from this downturn? Europe? Asia? North America? South America? Manufacturing? Retailing? Real Estate?

Refuge is so last century, so very very over.

Not only is refuge for wealth over, but also for people. Even the top GM executives have no place to run, no place to hide! And now, in the cruelest cut of all, no jet to take them there.

Ah, well. "We will always have Paris." But of course Bogie - uh, Rick - really meant, "We will always have Paris, in our memories."

Hmm bottom forming ?

I don't think so at least with the way I read the charts. I think oil will have to go to 30 before a bottom forms. Now that its blown through the support level at 50 the next one is at 30. It could turn now but thats pretty doubtful.

And to be clear I continue to assert oil could readily hit 150 or more in a matter of weeks just depends on when the market wakes up and what the real demand supply situation is.

But I'm pretty sure that in the interim we should see 30 first. It will be interesting to see it turn before it at least touches 30.

Now if the market blows through 30 god knows what the floor price would be I don't think we have any other fundamental base for a floor forming.

However I think that if we do hit 30 like I suspect we will see some serious cuts in supply that are probably unwarranted. We have a little resistance at 40 but I suspect the current bear market rally in the stock market will falter and this will work to allow oil to bust this temporary support level at 40 sending it on down to 30.

I don't think this bear market rally in the stock market will really take off until we see the bond market bubble collapse so I think we will see a number of still born bear rallies.

Whats worse however is if oil does punch through and head for 30 its going to send North American NG to 4 which is going to devastate the US UNG plays.

Now if this is the "real" bear market rally then oil could turn now and stocks turn first and that takes out the bond market. In any case we are certain to see yields turn around on the bond market eventually it get very volatile as the interest rates drop so I can't see the bond bubble lasting much longer.

Also although I think the current oil market is dysfunctional it is betting that KSA can do nothing to control the slide in oil prices and I really think that prices will continue to decline at least to 30 now until it becomes obvious that we do or don't have enough oil. So once the market answers this question it will become functional again.
It as three low price equilibrium points 50, 30 and say 15 although I've got no idea where the last one is. If we have plenty of oil it will settle on one of these three. If not then we don't have any long term stable points until we hit 200.

Really sticking my neck out I think we will smash below 40 before the end of the week and potentially see 30 in the next two weeks.

Your technicals are all technically correct. I think there's a whole different explanation for the bottom falling out of the market. KSA is run by a royal family who don't need to maximize short term oil revenue as much as they need to do maximize their influence on energy markets and prop up diversified investments in US securities.

It's just naked monopoly power. Destroy the energy competition, get back any money lost on mortgages (Allah be vindicated), and help orchestrate another spike. I wonder how their US managers have been redeploying KSA assets during this bloodbath? My suggestion is "follow the money". Easier now that there's so little left.

KSA is run by a royal family who don't need to maximize short term oil revenue as much as they need to do maximize their influence on energy markets and prop up diversified investments in US securities.

Can you imagine if KSA was run by the Taliban? They would have no hesitation in stopping oil sales -- they'd probably consider it a virtuous move.

No wonder the U.S. will do anything to support the current rulers.

Did you see the comment the other day from the TODer in the shipping biz? He was pointing out that the drop in price meant that ships were moving faster, because costs of crew, etc. were outweighing costs of fuel. And he said that this shortening of the pipeline had, in effect, put an extra 2 mbpd on the market.

It could only be a brief burst of extra supply, or extra congestion at the receiving dock. In the long run, ships only transport what buyers buy.

Faster ships mean fewer ships can supply the same demand, which means fewer cargoes are on the high seas at any one time, which means a reduction in on-the-seas storage, and more competition for cargoes, so shipping rates should decline.

It depend also to the fact that the price is dependent on the last buyer's price and the prices converge to this price level very fast.
As soon as there was a reduction in demand of oil, the price would collapse.

As the major market and the richest one was hit by a crisis, the acceptable price dropped for many people. So the unsold oil needed to be sold off at lower prices.

Also, a big part of the high price levels of oil were the gut of money made available from the FED and other Central Bank via the Real Estate bubble. People with money in hand looked for place where put the money in investment outside the real estate and many invested in oil contracts.

Here is the curve you are referring to (it includes monthly average composite aquisition costs for crude oil relative to C+C production).

Price Curve

It includes data up through September 2008 when the price (and production) had begun to fall back down the curve.

That's asymptotic.

That's peak oil.

Thank you.


Is that US costs? Refinery acquisition costs? FUD?
If refinery acquisition costs, it tells us nothing, other than we were in a financial bubble, or rather, because we were in financial bubble, the true meaning of this graph is unknown.

(I sent you an email)

Thanks for the emails.

The cost values are the composite monthly refiner aquisition costs.

These are found at: http://tonto.eia.doe.gov/dnav/pet/pet_pri_rac2_dcu_nus_m.htm

They are actual costs (not real, chained to a particular date or year). It really does not matter which cost data one uses from the various options the EIA uses...you get the same type of curve.

I could have just as easily run the data with the WTI spot market price average (one of the daily values I track) for each month compensated for delay and autocorrelation and I still would end up with the same general curve.

It is worth noting (since you can't see it explicitly in the data) that the "curve" is really an average of a curve path that shows hysteresis. That is more evident at lower production rates.

"a curve path that shows hysteresis"

What do you mean by hysteresis here? Is the way down different from the way up?

Yes, that is what hysteresis implies, as in certain electronic waveforms. This also comes up in thermodynamics, where a non-reversible cycle leads to losses as in an inefficient non-ideal Carnot engine.

As noted by WHT, yes, it's a different path down. It's not a huge difference but it appears when you plot the path rather than just the points.

It is a concept that has real life applications. Your home's thermostat and HVAC is an example of a control system that operates on the basis of hysteresis.

Is "asymptotic" the correct word to us to describe the situation? If you do use the term, then you are implying that there is a daily production rate that we cannot exceed. So that something like 1/(x-xmax) turns into a singularity at the x=xmax asymptote.

It is a correct concept. What it suggests is that the differential cost (or incremental cost) of that next barrel of oil becomes not only larger but possibly infinitely large when a limit is reached.

If the supply, or more accurately the rate of supply, were infinite then this uptick would be an anomaly.

There are several ways to look at it:

1) It's a (short-term) capacity issue...that if we really had the capacity to just add another 5, 10 or even 25 million BPD, the curve would not curve and instead we'd have a zer-slope or slight negative sloped line with scatter to it. What we really ran into, besides a financial bubble, was a place where all the spare capacity was "used up" and to the extent that fields and refinery were available, they were running "flat out." Given a couple of more years the real sustainable capacity will be significantly increased so that we do not run up against these limits in the future.

2) It's a short-term capacity issue created artificially. In other words, people would like to produce more and have the capacity to turn the valves much further open than they were/are. They refused to open the valves to drive the price to higher levels rather than flooding the market and causing the price to go down (dramatically) or increasing the flow so that the marginal/increment cost remained the same once a price point was reached.

3) This is the peak (geological) characteristic: as production flattens or declines, prices go up (and eventually and incrementally destroy demand). Too rapid a rise causes a widespread collapse and it may not allow a restart of the economy on the way back down (like an aircraft with insufficient thrust to overcome gravity, the climb will stall and then begin a fall. If you have enough time and distance, you might gain enough lift to regain controlled flight. If not, you "crater.").

Bill O'Grady of AG Edwards February, 2005

“It has been our argument that the market has run out of
excess capacity, and the reason prices have increased so
much this year is because we traveled up the vertical
portion of the supply curve……..It is important to note
that being in this portion of the supply curve cuts both
ways. When demand is rising, prices rise very high, very
fast. When demand declines, prices fall, very hard, very


3) This is the peak (geological) characteristic: as production flattens or declines, prices go up (and eventually and incrementally destroy demand). Too rapid a rise causes a widespread collapse and it may not allow a restart of the economy on the way back down (like an aircraft with insufficient thrust to overcome gravity, the climb will stall and then begin a fall. If you have enough time and distance, you might gain enough lift to regain controlled flight. If not, you "crater.")

Interesting way of putting the situation!

You talk about not having enough lift to regain controlled flight. I wonder, with all of our debt related problems, if this is not a second impediment to rising again.

Now you know one reason why "entertainment" like the TV show "Survivor" might have been created and been so successful...to get people accustomed to the idea of whom might be "voted off" or tossed overboard to "lose weight" and regain controlled flight.

Of course, on the way down you can imagine you are in controlled flight whether you are or not. Its only the sudden stop at the end (and the crater that is formed) that is the problem.

If you have enough time and distance, you might gain enough lift to regain controlled flight. If not, you "crater."

Gaia like crater.

Very nice graph. I sent a copy to The Oil Drum staff, in case any miss your comment.

Lots of possibilities here. Factor in what Krugman had to say about such a curve regarding multiple equilibria that Khebab pointed out further below in the thread:

Just for fun, I created a quick plot of the number of bushels of corn required to purchase a barrel of oil (using the $/bushel cost) plotted against annual average oil production since 1960.

You can see the artificial peak of the oil embargoes of the 1970's in the data. But notice that on a commodity swap basis it is (in general) costing using more corn (equivalent) as the production flattens as we approach 75 million BPD of C+C.

Corn for Oil(2)

Of course, one othe things noted about the agricultural production is the yield (and the variation each year). Here is the amount of land area production required for a barrel of oil using the cost equivalent method above.

It's the number of acres of corn production required for a barrel of oil, considering both the yield and the respect price of corn and oil. The curve is slightly different indicating the effects of lower yields in the early years. However, the general characteristic is the same.

Acres for Oil

A picture is worth a thousand words!

Is that inflation adjusted?

Is there anywhere I could look at the raw data for it?

No, but this is:
(I don't go with fancy backgrounds, or non-zero scaled axes)

Not quite so impressive. The loops pre 1986 are the two OPEC oil shocks. The run-up after that remains pretty startling

Data from:


Mine is more cool, because it has "The Wall" in it. ;o)

EIA data.



I look at this graph and I see two completely different curves -- a hockey stick and a pointy football, and I think, what's going on?

Could it be that one curve is driven by the buyer's demand for oil, and the other curve is driven by the seller's demand for cash?

It remands me of the butterfly curve with the strange attractor, where a point goes round and round on much the same orbit, and then without warning flips onto a completely different orbit for a while, then flips back again.

The point is, these flips between orbits are completely random, although once the orbit is established it is fairly predictable.

Which makes me think -- betting on the oil price is a risky business. You can never guarantee if you are betting on orbit A that it won't switch to orbit B.

Inflation adjustment is shown in a post above this one. I would point out, though, that part of the effect we see is the fall of the dollar relative to other currencies and then its sudden rise. I will post those separately.

I would also point out that inflation adjusted data does not provide much insight into different periods of time that may refelct completely different social-economic conditions at both micro and macro conditions. The Raleigh of 1973 where in just going two miles from the campus I was in to rural/agricultural farmland is a thing of the past. And the OPEC oil embargo price shock of 1973, where gasoline prices at the local Starflite gas stations went from $0.199/gallon to $0.439/gallon (where you fed dollar bills into a vending machine type reader) does not necessarily reflect a "constant" expenditure percentage for our lives. What we saw this past summer(2008), in terms of cost cause and effect might be similar, yet other forces were at work then and now.

BTW, the background is the Delaware Bridge on the way to the NJ Turnpike.

The raw data I used is:

Refiners Aquisition Cost (composite) found at:


The monthly production data are from the Monthly Energy Review, specifically Table 11b (Under International Petroluem) at:


That's the "easy" data to retrieve. I'm working on (in my spare time) extracting the cost and production data even further back in as fine a resolution as we have here (that requires more time in the NCSU Library). The EIA has annual values available.

Here is the same data converted to € from 1994 to present.

Euro Oil Cost Scatter

The production data and the cost data all on one chart with $ and €.

IPM (10-2008)

Regarding 'starting over with new monetary system', the situation in Zimbabwe (shown here in pictures) is like its from a science fiction novel. New $200 million notes issued this weekend, after discontinuing the one hundred billion dollar notes last month.

I think you are right that debt/credit, or lack thereof, is going to underpin whatever our future social (and financial) system looks like. The impacts on future energy infrastructure are ominous. Already we are seeing massive cutback on natural gas capex, from drops in demand and drops in price well below drilling profitability. Today, Dow Chemical announced 20 plant closings. I have an essay on 'natural gas armageddon' in the queue, as the drop in rigs is about to go off a cliff because Henry Hub is below $5.7. Given that we deplete at close to 40% per year in aggregate in North America, a production cliff will soon follow unless prices go up soon, and alot. (Note: I was supposed to have this for today but my computer crashed so Gail wrote the above piece on very short notice - thanks Gail)

Ah, but producers know the price drop has gotten out of hand, so contango has gotten out of hand as well, and both producers and speculators are now taking oil off the market and storing it for December 2009. They are locking in $57 for their oil by doing that, which means they are locking in an 11% profit. Which means the spot price will be coming up. Which should alleviate some of this deflation pressure.


Both producers and speculators are now taking oil off the market. The price has moved up sharply this morning, and the buck is sharply down. About fr1gging time, as I'm sure you'll agree.

Im not worried about oil (as much) - a) it's an international market and b) it depletes (overall) at less than 10% p/a. Natural gas is domestic market and there is no real contango to speak of until you get to the back years. Since its depletion profile is 40% per year, we have a real problem if enough rigs are layed down. Plus many of the larger producers are hedged. What happens when their hedges come off?

Same here the NG situation is far more important. But as I tried to show in my long post below the question we should be asking is are the commodities markets actually functioning at the moment ?

For some reason it seems that people have made the assumption that we can have our banking system lock up yet the commodities markets continue to function smoothly. If our commodities markets are actually broken and dysfunctional then it makes little sense to even look at price at the moment. We probably have no clue what is happening and neither does the market.


The cost of a letter of credit has tripled for buyers in China and Turkey and doubled for Pakistan, Argentina and Bangladesh, said Uwe Noll, director of country risk sales at Deutsche Bank AG. Banks are now charging 1.5 percent of the value of the transaction for credit guarantees for some Chinese transactions, bankers say.



Just as the heating season is about to begin, dozens of local oil delivery companies are threatened with closure amid the deepening credit crisis.

At least 23 oil companies in the region have recently been denied a credit line to buy oil, or have had their credit line reduced, said Chris Cooney, president and CEO of the Brockton-based Metro South Chamber of Commerce.

The credit crunch stems from the ongoing troubles of major U.S. financial firms and is one of the main reasons for the government’s $700 billion bailout plan.

The crisis has been growing for months, and oil delivery companies are among the newest victims, Cooney said.

Many depend on borrowing money to fill up their tanks, and if they can’t do that, they will quickly lose customers to other companies.

“They’re in jeopardy of being put out of business,” Cooney said.

Stoughton-based Murphy Coal and Oil is one of the companies affected by the problem, a representative said, though she declined to provide any details or give her name.

Cooney, who wouldn’t name the companies because they’ve asked him for confidential advice, said the situation started in early September.

Now what happens when a market is disrupted ?


Banks are either refusing or tightening up credit conditions in a long chain that starts in the ports of oil-producing Middle Eastern and African countries, goes through tankers and refineries and ends up in gas stations in Europe and the U.S. Less crude is being purchased while buying is increasingly being concentrated in the hands of a smaller number of companies - mostly oil majors and large retailers - that are able to bargain for lower prices.

"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.

"The oil trade relies on credit lines, so the freezing of credit is making the system less optimal," agreed Olivier Jakob, an analyst at Petromatrix.

Cash-rich majors are set to gain more bargaining power with national oil companies, as the latter are now less willing to deal with credit-starved smaller players, said crude traders and an oil industry banker. "Those who don't have their own oil (as possible collateral) are in trouble. Nobody wants to sell to them," said the banker. In contrast to pure traders who rely on letters of credit or credit lines for spot cargoes, oil majors are both buyers and sellers, meaning they have their own cash and crude reserves.

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. On Monday, For instance, well-known Swedish company Svithoid Tankers went into liquidation after facing an immediate liquidity shortage. Global shipping loans dropped 23% to $13.31 billion in the first half of 2008 from the same period last year, according to data from Reuters Loan Pricing Corp., leading to a scarcity of available capacity for shipping.

"Even with the credit crunch, there is still a capacity crunch," said Drewry Shipping Consultants Ltd. in a report last week.

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. A large refinery such as U.K. chemicals producer Ineos Group Ltd.'s Grangemounth in Scotland relies on supply from Morgan Stanley. Earlier this month, Ineos itself faced speculation that the company could be close to breaching the covenants on its loan agreements, though the company has said this wouldn't happen.

Indeed, refiners appear to have been affected even more than traders. In a report last week, the International Energy Agency said refiners who rely on letters of credit to facilitate product exports are finding these "increasingly difficult to obtain," the Paris-based agency said, and that higher interest rates are reducing their ability to maximize the value of production. "Were such practices to become widespread it could potentially lead to some refiners cutting runs for financial reasons, despite apparently healthy product margins and demand for products," the IEA said.

How on earth can we even talk about supply and demand with this much disruption in the market ?

Will it settle out sure it will. All of the commodities are consumable at some point the supply chain will clear itself of all the imbalances caused but disruption of trade and the smoke will clear. Obviously I think we will find that not a lot has actually changed from earlier this year but that not important right now whats important is to recognize that the global trade network for all goods and services is currently not functioning well. Its suffered a massive disruption and it will take time for it to establish new business lines. Probably given the shear scale of the disruption we won't see a return to normality until outright shortages start appearing in certain areas around the globe. This will be shortages of oil, oil products, food and various finished goods.

Once we start seeing these and then see them clear then we know the markets are now functional.
And back on topic to Nates post this will in my opinion happen with a vengeance in the North American NG market.
We will see very low prices for NG probably touching 4 dollars followed by tight supplies and then and only then
will the market begin to correct and re-establish a functional market. Oil I expect to go to 30 now before a bottom
forms and I fully expect the same thing incredibly cheap oil coupled with tight supplies in certain regions.

You are premising your argument on the financial markets correcting. What is it that will make the financial markets correct? It seems to me that there is so much debt (and derivatives) that need to unwind, that it will be almost impossible to get the financial markets to correct. Somehow they need to reconnect without all the debt, and I don't see how that can happen in the near term.

No I don't expect the financial markets to correct. For them to correct the banking system would need to be cleaned out the loans written off and the banks obviously made healthy. I expect our current financial crisis to become the new black. With little credit available.

Lets consider two different types of markets under financial crisis i.e broken markets. One for durable goods in excess and one for needed commodities. In both cases we assume the markets are broken i.e financial issues makes it difficult for former buyers to secure financing.

In both cases the primary effect is cash is king. Your not worried about the price you get your worried about the buyer paying. Lets say this effect is order of magnitudes larger then any other. In a cash is king type market prices are driven down very low as wannabe buyers are unable to enter the market. From a macro economic stand point the velocity of money or number of transactions falls through the floor. Market price becomes irrelevant as sellers are simply trying to find worthy buyers. The demand situation becomes a enigma.

From here we have a divergence as commodities are generally sold according to very basic needs this includes oil and food. For a given economy and given population the oil and food needs are fairly constant. I.e supply and demand do not change much. Prices are set on the margin but lets not even look at prices yet.

In the case of consumable goods what you would see is that the market will begin to clear the cheap goods as they are consumed. Supply and demand are probably imperfectly supplied with the cash buyers getting a inordinate amount of supply while credit based customers seek new financing. Eventually of course they are forced to accept onerous financing terms or face shortages. Generally this means that depending on the supply chain buyers of commodities are forced at some point to buy using some sort of financing. Money is always available for a price. This is simply a market in turmoil thats becoming reestablished under a new financial scheme. Once it does "real" demand can again become important. No one really knows what this is for sure but until willing but unable market participants secure funds its impossible to tell. Given the critical use cases for food and oil government intervention at some point will happen in various countries to ensure supplies. Exactly what happens is on a case by case basis but the financial system is robust and it will reestablish itself.

Now for durable goods that are in excess you can just about forget it. They will fall in price for a long time until the excess supply is liquidated credit will not be extended and the market remains in a cash is king situation for ever.

As you can see what I'm saying drives a market back to functioning is when all potential market participants reestablish funding for critical commodities this is effectively forced and actually fairly quickly depending on the timescale of the market. By this I mean generally since these are critical markets they have a number of buffers built in to protect against shortages as these buffers are drained down the forced buyers will reemerge.

Now all I'm saying is that nobody can say anything about the current market its simply dysfunctional. I can't and the pundits proclaiming demand destruction are simply fools. All you can say at the moment is that most of the global market is dysfunctional because of the financial crisis. Once the various markets have established new means of funding then they will begin to operate. This does not imply that we go back to the old ways instead its a better bet that hard money loan shark type credit will become increasingly used with exorbitant interest rates. We can also expect direct government intervention in some markets with generally the use of printed money and the certain results of that approach.

Now I have no way to prove that the markets are currently dysfunctional and for the most part simply not operating.
However I can say that if I'm correct then we will see a paradox occur nominally low prices for oil and food and spot shortages start appearing throughout the globe. Thus a dysfunctional market can only be proven in a sense after the fact once it results in shortages. The cash is king effect smashes prices and blocks people that need the commodities but cannot afford them. To some extent the fact that commodities are selling at or close to a loss is also a indicator. But thats not clear cut.

Now as far as oil goes I said you don't really know the truth until the market clears well this depends on the market for oil it works on a four month cycle closely aligned with the seasonal variation. We are in the Nov-Feb winter season thats really half of Nov and half of March. The first point at which you can really say that the market for oil has almost certainly stablized would be near the end of Feb early March.

I expect us to get a clear signal sooner but I'm guessing on that using basics you have to wait till you have in a sense cycled through and exhausted supplies bought earlier. It takes time to ensure that any participants on the sidelines because of financing needs solve their problems and meet their base needs.

The oil market will clear and so will the food markets the participants have no choice. The final price at that point will depend on supply and demand and the new market equilibrium established. Maybe its low prices maybe its high time will tell but we simply don't know yet. Now I will say this given that the problem is the number of customers or demand is whats unknown and the natural direction is down if the market price spikes like I expect before March then its a safe bet that supply does not meet demand i.e a price spike is indicative of a supply shortage its not certain but its a fairly good signal. If the market is actually well supplied then I suspect the outcome will be some nominal prices between 30-50 a barrel out well through March and then for some unknown time after that maybe years.

Thus the longer it stays low the higher and higher the probability is that the market is well supplied and all market participants that need oil have the financing to buy oil.

Moe, you are correct on the locking in by speculators and hedge (wealthy ones) investors, but of course you know what that means...they make 11% while retiring middle class baby boomers now attempt to retire on half the money they had only a year ago and are having trouble making 2% after tax returns...this will be the biggest transfer of wealth from the middle class to the wealthy in the shortest amount of time in known world history, plus the several trillion dollars in cash and protection given to the financial community by the federal government.

It has amazed me that the anger of the fifty something year old baby boomers has not been off the charts, as everything they have invested for over the last 25 years is being wiped out, and now "peak oil" is being used as a cover.

This financial crisis has NOTHING to do with peak oil. Do you think the banks, hedge funds, and speculators would have behaved one bit differently if commodity prices had never went up? They caused them to go up, continuing to jump in and out of markets from the dot com days, to the housing boom, to the Asian bond bubbles to the commodities boom...this crisis began on the day the repeal of Glass Steagall occured in 1999, and if you want to blame somebody for this catastrophe you can look back to Phil Gramm and the Republicans who voted for that repeal in a party line vote. Without turning the wolves at the crooked banks and thier trillions loose on the what had been relatively stable markets and creating a "market for volatility" that the hedges and speculators jumped on, the massive moves in collateralized debt or in commodities would not have been possible.

This was a looting operation pure and simple and now the banks and hedge fund thieves are attempting to use "resource constraints" as some kind of cover. It's deplorable and I for one resent the posters on The Oil Drum (including the respected ones like Gail) helping the bastards disguise this massive theft from millions of Americans.

Oil prices will go back up and possibly with great speed, as will other commodities, because due to the way the game is now played, the more volatility the better for the speculators. This will only get worse and worse until they have killed the goose that layed the golden egg, that being the American and possibly the global economy. This is occuring because we are ALLOWING it to occur. It has nothing to do with resource "constraints".


Pretty well sums up the situation.

because due to the way the game is now played, the more volatility the better for the speculators.

Exactly. For the hedge funds and huge wealth pools, volatility is a benefit because they can afford to analyse it, research what causes bottoms and tops (if they're not causing it themselves), and cream off the assets of simple long-term investors.

If you are (or were) "in the market", unlike me, how confident were you that your stop loss trigger settings (or your mutual fund manager's) were fully confidential from those who could short your stock, then arrange a perfect drop to collect your stocks at one penny below?

The "market" has been just a dirty casino for years.

Then why are hedge funds losing money at record rates? Why is the entire banking system on its knees, begging for government bailouts?

Money is being destroyed in vast quantities, and a lot of that money is (was) being held by hedge funds, investment banks like Goldman Sachs, and ordinary banks like Citi. There is a transfer of wealth happening, but only because governments have been shoveling taxpayer money to these crooks. But that is only cushioning their losses. If these folks were geniuses, they wouldn't be insolvent.

With the help of governemnts (mainly the US & Japan), the financial wizards thought they had created a scheme for huge, endless, risk-free profits. They were wrong, and the entire system has now blown up in their faces. Imagining that these same people manipulated the bust as well as the boom is, IMO, delusional.

They thought they could forever fleece the sheeple and suffer no consequence themselves. Not exactly known for deep introspection....

I pretty much hate the banksters, hedgies, and finance crooks more than anyone as they have sucked the profits out of everything including the future but they didn't cause the diesel shortages earlier this year that more than doubled my operating costs.

This was a looting operation pure and simple and now the banks and hedge fund thieves are attempting to use "resource constraints" as some kind of cover. It's deplorable and I for one resent the posters on The Oil Drum (including the respected ones like Gail) helping the bastards disguise this massive theft from millions of Americans.

Your anger is understandable but misdirected. Yes, it is a looting operation, but not pure and simple. Capitalism has been around for a while now, capital has concentrated into ever larger blocs, and those large blocs have tightened their grip on the reins of power, even as they wage war to the death with each other and other powers. Crisis is endemic to capitalism, and exploitation of crisis by the biggest and strongest players is endemic to capitalism.

Standard texts paint this idyllic image of the thrifty entrepreneur building up his business through thrift and hard work, and this is America. But the road to the really big money fast is to use other people's money, leverage it to the hilt, and skim off the top. And you need to avoid risk by taking out insurance, swaps. But the ultimate risk insurance is an in with the feds, owning them outright if possible. And it is the inevitable logic of capitalism that it work out this way, especially in a country where there is no organized opposition.

Actually, its far worse than I've just presented. Intertwined with all the above is the military-intelligence-industrial-financial complex. You focus on the screwing of the boomers. Yet it's far, far worse than that. The boomers (and the middle class generally) are being destroyed financially, yes. But they are not yet being bombed.

However, none of this is all that new. What is new, and that's where I come the defense of TOD, is that the world's ecology and its resource base are now at the tipping point. The games that could be played before can't be played again, not with the same result. No more New Deal. No new American Century. And this is because the resources for it not there, or in diminishing supply.

I've lost plenty of money -- the investor in me is smarting. But there's a lot more at stake here than money. It's survival for my children, and grandchildren -- and yours. We'll need to start thinking beyond our portfolios. We are being robbed of much more than our portfolios. The deepest problem is not the looting. If only they were Somali pirates, you could pay them off and they let you go. But these guys will not let go of the helm -- they will destroy us all.

I do not know to what degree oil and resource shortages played in triggering this crisis. But they did no more than trigger it. Its roots lie in state-monopoly capitalism. Major parts of the third world have been in crisis for decades and longer. It was possible to export depression and keep the home front intact. That's no longer possible. But resource constraints ARE going to play a major role in the outcome. That's what's new.

"We'll need to start thinking beyond our portfolios. We are being robbed of much more than our portfolios."

Thank you for saying that.


Well played. What I wonder is this. Was there a way to bail out the people without bailing out the banks. Wall street, of course, and its lackies like CNBC and the rest of the general media, tell us that, despite the disgorging of trillions of dollars, that this was all necessary to save the likes of you and me, assuming we are not already beyond saving. Or is this one big sham? My gut tells me that there was another way, a way that somehow got money directly to the great unwashed, that could have bypassed Paulson's buddies, the guys who were and maybe still are making 25 million plus. Not much time was spend analyzing alternatives before the great trillions were unloaded. Most of us spend more time evaluating what car we are going to buy.

Said by tstreet:
My gut tells me that there was another way, a way that somehow got money directly to the great unwashed, that could have bypassed Paulson's buddies, the guys who were and maybe still are making 25 million plus. Not much time was spend analyzing alternatives before the great trillions were unloaded.

For the subprime crisis the economy could have been bailed out from the bottom up and cost far less than the trillions of dollars that the U.S. government has already spent. Using loan officers of banks the government could have helped people pay their mortgages. In exchange the government would get fractional ownership of the house based on the amount of money taxpayers ultimately pay toward the mortgage. The government also would get seniority over the bank and borrower (government would get its fraction paid back first) when the house is eventually sold. This would have spread the governmental payments out over the lifetime of the mortgages, 20 or 30 years, people would remain in their houses, defaults on mortgages would plummet, mortgage backed securities would be worth their full value and the credit default swaps would not have been triggered. The price of houses would be allowed to correct downward placing the loss principally on the borrower. Lending practice would have to be cleaned up to prevent a reoccurrence.

"Robbed of far more....."

Yes we are being robbed of being told the TRUTH.

The news media are not telling about the people and the absolute pain they are surely enduring.

Loss of job? This can easily mean starvation. So where is the ugly stupid news media in all this? Lying. Failure to be honest and really report the news.

Coming off their feeding frenzy about the balloon they tied to Obama's tail...they can't I suppose now tell us how really really bad it is.

So we still seem to live in a make-believe word. Seems only the Denningers are screaming and TAE of course.


"Robbed of far more....."

Yes we are being robbed of being told the TRUTH.

The news media are not telling about the people and the absolute pain they are surely enduring.

Loss of job? This can easily mean starvation. So where is the ugly stupid news media in all this? Lying. Failure to be honest and really report the news.

Coming off their feeding frenzy about the balloon they tied to Obama's tail...they can't I suppose now tell us how really really bad it is.

So we still seem to live in a make-believe word. Seems only the Denningers are screaming and TAE of course.



Couldn't agree with you more when you say "state-monopoly capitalism", I think Naiomi Klein says "Corporatism" in her book "Shock Doctrine". Although the corporatists appear to have been caught mostly with their pants down on this downturn and are now having to eat their young to survive.

BRAVO!!!! Would that I could uprate this post 100 instead of just 1...

There's a dissertation worth of research to be done on the role of the ICE and big Finance pushing markets both up *and* down. I suspect that in a run for liquidity, big Finance executed a big sell-off. And it didn't hurt that Pemex started selling their projected 09 production when the price hit $100/bbl. My understanding is that by the time they finished their sell-off (at 90% of projected 09 production), the price had fallen to $70. Now we have a contango, but it looks like the players are running out of room for storage. That doesn't sound like peak oil so much as peak bad finance.

Said by ThatsItImout:
Oil prices will go back up and possibly with great speed....

I do not see how the price could rise with great speed because the price would exceed the funds available to refineries to purchase the oil. With tight credit, they would not be able to obtain loans nor letters of credit. This would force refineries to purchase oil based on their available cash rather than how much they need causing demand for crude oil to decline (price goes down) and a shortage of refined products (price goes up). The rate of increase of the price is limited by the ability of the refiners to purchase the oil. Except for short term spikes, I suspect the rate of increase in price that occurred earlier this year is close to the maximum.

I don't think you can say it has "NOTHING" to do with peak oil. The cost of living was rising sharply throughout 2007 and the first half of 2008, for reasons that have everything to do with resource constraints (not just oil - also arable land and water).

This rising cost of living must (as in 'how could it not') have had a hand in the bursting of the subprime bubble, which led to the financial crisis we know and love.

It seems to me that you're too busy looking at the fine details of how people are screwing each other to see the bigger and ultimately more important picture of how we've screwed the planet (overshot its carrying capacity, as William Catton would put it) and now the planet is starting to return the favour.

This financial crisis has NOTHING to do with peak oil

If the US hadn't peaked around 1970 and was still increasing production even now, what do you think the financial situation would look like today?

A good way to create a new currency is to base it on the market forces.
Say a currency backed by gold and/or silver.
So the governments and central banks would unable to inflate the reserve of money with printed paper.

One of the things I noticed in the above pictures of Zimbabwe is that most of the people in the pictures seemed to be giving genuine smiles.

Man, if I received a 50 Billion Dollar bill in my change, I'd be smiling too!

I thought at first that maybe these Zimbabwe notes may have some value as "collectibles". - However, upon checking, mementos of the German Hyperinflation of the 1920s are still available today at modest prices...

Hi Gail: Denninger makes the observation that the increasing debt leading to increased GDP is almost broken-as you can see from your chart, the additional dollars of GDP resulting from each additional dollar of debt have decreased steadily over the years-eventually each additional dollar of debt actually DECREASES GDP as the debt burden has overwhelmed the economy. Jim Willie labels this a DISLOCATION. The bottom line is that the USA needs a major devaluation of the currency sooner or later because mathematically this just doesn`t work at all-the USA dollar value is one of the last insane bubbles IMO.

I think the problem is that everyone needs a devaluation. The US is no worse than many other countries, and some of them are much worse. Somehow, we collectively must get out from all this debt, and get moving again.

If we don't use debt to fund major projects, they can only be funded through savings or cash flow. This will mean a very different kind of economy. The government will need to play a bigger role in major projects (and not by floating more debt--by taxing constituents).

I have a hard time seeing this happen, until governments try and try again to make more debt work.

I don't see how deflating the money makes a difference.

What we have is 4% of the population producing food. 16% producing health care. 20% doing finanace. The rest... ~60% are esentially reselling Chinese goods.

This is what overshoot looks like. An economy based on "marketing"???

What essential goods do 80% of the working population provide?

It doesn't fix the fundamentals-try to understand that re the levels of debt there are only two choices: 1.default 2. devaluation. The fundamentals are a mess as you state.

Deleted.... same as my short rant above.

So... Drupal has a hickup, gives me a database error return when I submit, then double posts... and someone thinks eliminating the dupe is bad???


"everyone needs a devaluation"
what that means is gold and commodites go up
this is what happend in the 30s

"A devaluation?"

No..we are in a death spiral....sooooo
We needddd ummmmmhhhh OH ROADS!

Yes we need to rebuild the roads. Yes by Jimney that will take care of it..Those road crews paydays will surely SAVE THE USA.

Where pray God is this man(Obama) coming from? I hope the light breaks thru to him soon. Ohhhh and lets not forget the Auto Makers.....we need new vehicles to drive on those new roads or rebuilt ones.

To me he is not making sense.

Airdale p

I'm confused about this comment. Surely there are 3 different ways for the government to get money to do things: (a) Tax (hits the targeted taxpayer); (b) Borrow money from the market place (increases demand so increases interest rates, hits other borrowers, and perhaps future taxpayers); (c) Print money (hits holders of money and lenders). When they print money they "borrow" it from a special account, but that is just keeping track of how much money has been printed/unprinted: it isn't any sort of "debt that has to be repaid". At the moment the government can print a lot of money before it even prevents deflation, and surely it has as much obligation to prevent deflation (which impacts the borrowers who are poor) as it has to prevent inflation (which impacts lenders who are presumably better placed to cope).


"(b) Borrow money from the market place ..."

Remember, borrowing does not really "Get" money. It sort of postpones getting it. The purpose of getting money is to pay for something. When borrowed, the paying for something is deferred at the original cost plus the additional cost of interest.

The government can tax or print. Considering the the current debt and spending, how much could taxes be raised to generate a budget surplus now to pay down debt? Even without interest, how much of a surplus could be created per year? 100B, 200B? how long would it take to pay down a 10trillion dollar debt at 100 Billion surplus per year?

The US Government is printing money now. They are injecting it into the economy by buying back 10 year Treasury notes. That is US debt that is being paid back without running a surplus. If you think that this creates a different bit of debt somewhere else that needs to be paid back, then we disagree about a matter of fact.

Stoneleigh (who predicted lower oil prices) had this comment yesterday:


The depression we are headed for will be global. Everyone will be reducing demand involuntarily due to a collapse of purchasing power. Remember that demand is not what you want, it what you are ready, willing and able to pay for. As the credit bubble implodes, taking the vast majority of the effective money supply with it, demand will fall dramatically, but so will supply as falling oil prices make more and more projects non-viable. We will also see a significant impact on supply from lack of maintenance, fighting over control of infrastructure, sabotage by those with nothing left to lose and piracy in an era of neo-mercantilism. The result will ultimately be far higher oil prices that will price ordinary people out of the market almost completely.

As I recently said, while I am not surprised by price volatility, I am surprised at the depth of the current decline. In any case, as I said a few days ago (and as I suggested to my own family members), it's probably past time to start thinking about contingency plans for extended family members to consolidate in one location, as in the TV series "The Waltons."

As you implied, the truly scary thing about Figure One is that the energy business is probably the healthiest sector of the economy (excluding I suppose the niche businesses that are thriving from doing things like cleaning up foreclosed houses).

However, some historical perspective. Even at current prices of about $45, oil has risen at an average rate of +12%/year since 1998 (average annual price of $14). In contrast, GM stock has fallen at about -30%/year over the same 10 year period.

Also, three top 10 net oil exporters--Norway, Mexico and Venezuela--are in terminal or long term decline, probably joined now by Russia, with Saudi Arabia showing a year over year increase in net exports that will be about about 700,000 bpd below their 2005 rate. My guess is that at the current worldwide net export rate, the world will burn through about 30% of all remaining cumulative conventional net export capacity in the next five years.

I think that it is possible that a combination of involuntary + voluntary net export reductions will cause the average 2009 price to be above the 2008 average price of about $100.

I think peak oil will, ironically, protect us from an endless deflationary spiral, and spur the transition to a healthier, more sane economy than we've seen in the past.

"My guess is that at the current worldwide net export rate, the world will burn through about 30% of all remaining cumulative conventional net export capacity in the next five years"

could you expand on that comment. show how you got that number

I agree with you - I think a major gap in our understanding is that the decline rate - 5% 6% 7% you pick it, is always calculated on the 85MBD number, whereas you should start there - 5% of 85 is 4.25, but then take the 4.25 out of the available excess capacity of 47 MBD

so the real decline rate that will hit us is 4.25 / 47 = 9%

price is determined on the margin, on the available excess, or global export capacity. it gets really scary if you take 7% and go out 3 years. the global export goes from 47 to 31. this would create a shock situation with panic hoarding

Let's start with an assumption of about 1,100 Gb of remaining conventional total liquids production (which we have to use for net export numbers). Slightly more than half of total world oil production is (net) exported. For the sake of argument, let's assign 600 Gb in remaining production by the exporters. Current annual net oil exports are about 16 Gb.

Let's go back to my original Export Land Model (ELM). The initial conditions were consumption equal to half of production at final peak. Production decline rate: -5%/year. Consumption Increase: +2.5%/year. If we assign some reserve numbers, only 10% of post-peak production would be exported from Export Land; 90% would be consumed locally.

Khebab's middle case, if memory serves, is that about 25% of the remaining production from the top five net oil exporters would be exported; 75% would be consumed locally. For the sake of argument, let's assume that 40% of remaining total production from all exporters would be exported, with 60% consumed locally. This would give us, based on the above assumptions, about 240 Gb of remaining cumulative net export capacity worldwide, which we are currently burning through at the rate of about 7% per year (16 Gb per year). Five years X 16 Gb = 80 Gb. 80 Gb/240 Gb = 33%.

You said that eventually we will need to get rid of this debt. How will that be done? Paying it off, or just getting creditors, including China, to write it off. Perhaps we could restart the tradition of the biblical Jubilee.

Regardless, you paint a picture of negative to zero growth at best. Given the probable decreases in investment in new oil supplies and the abandonment of current projects, supply issues will eventually make the price of oil snap back with a vengeance, strangling in the crib any attempts at renewed growth. It is critical that the incoming Presidential administration understand that. Obama's approach, which I gleaned from his interview on Meet The Press yesterday, is that times are too hard to do things like encouraging alternatives with carbon or gas taxes. So, in his view, we wait until times are better to do anything about our carbon dependency (other than the usual bromides like higher mpg and building standards).

However, planning, such as it is, going forward will continue to be based on the growth paradigm regardless of whatever analysis people like you bring forward. I would suggest that it would be prudent to plan based on a zero, negative, or very limited growth paradigm. That is, what kind of society should we have if we can't count on growth anymore to try to buy off the poor with promises of trickle down economic benefits? Or do we just let the jackals determine how the spoils are "shared"?

It's looking to me like it's, simply, a function of "Recession," "Busting the Commodities Bubble," and Ethanol.

Just for the record, I do not see that we ever had a commodities bubble. We had a functioning economy, which is a very different thing.

We wouldn't have had a housing bubble either, except that the top 1% hogged all the profits from decades of productivity gains for themselves. That's what made getting more people into home ownership unsustainable.

Also, I don't think ethanol really has much of an effect on oil prices. The price of oil has been controlled by diesel, not gasoline. What ethanol has had an effect on, for good or ill, is gasoline prices.

The price of a gallon of gasoline has dropped $0.45/gal more than the price of diesel in the last year. We, also, use twice as much gasoline as diesel. It looks to me like Gasoline is driving the bus.

Moe, what would, in your opinion, be the result of increasing the demand for gasoline by about 8% (roughly the amount of ethanol we've added in the last couple of years?)

The "we" must refer to the United States, since in Europe, diesel usage far outweighs the use of gasoline. There have been a fair number of weeks where we were importing virtually unwanted refined gasoline from Europe by tanker.

Boonjug, since you get approx. 22 gal of gasoline, and only 12 gal of diesel (within fairly close parameters) out of a barrel of oil, I guess I could have been referring to the World.

The interesting country might be China. That's where the growth is and they use 2 gallons of diesel for every one gallon of gasoline.

Just for the record, I do not see that we ever had a commodities bubble. We had a functioning economy, which is a very different thing.

You could argue that if the front side of the curve was more rational. It's a far harder arguement to make given the rapid rise in commodities prior to the summer.

It seems to me that debt will mostly go away through defaults, unless the government can somehow figure a way to engineer hyperinflation. There is a real chance of governmental change, if it gets to the point where a government must default on its debt.

We take current governmental structure as a given, but huge changes beget other huge changes. If governments fail to deal successfully with the current debt situation, I can imagine some of them being replaced. Some countries may subdivide into smaller organizations (for example, individual states or groups of states are possibilities for the United States). Others governments may merge.

We think of peak oil as being the ultimate problem, but I expect that much of the world will consider imploding debt to be the ultimate problem.

We think of peak oil as being the ultimate problem, but I expect that much of the world will consider imploding debt to be the ultimate problem.

The "ultimate problem" is a human population in gross excess of the biosphere's carrying capacity. The exploitation of reduced carbon has allowed this population hyperinflation and the consequences of pumping massive amounts of oxidized carbon into the atmosphere and surface ocean will end it. Debt implosion and even peak oil are mere symptoms of the "ultimate problem" of human overpopulation and its consequent environmental impacts.

The "ultimate problem" is a human population in gross excess of the biosphere's carrying capacity. The exploitation of reduced carbon has allowed this population hyperinflation and the consequences of pumping massive amounts of oxidized carbon into the atmosphere and surface ocean will end it. Debt implosion and even peak oil are mere symptoms of the "ultimate problem" of human overpopulation and its consequent environmental impacts.

You're right, but this has been true for millennia already. The fall of the Roman empire could be attributed to peak wood, for example. What's different this time around is that there's no more land for the empire to expand into, and after oil there's no "better" fuel for the empire to exploit. This is only one of hundreds of bubbles we've blown since the dawn of history, and it won't be the last, but for the reasons you gave it's probably going to be the biggest.

This is only one of hundreds of bubbles we've blown since the dawn of history, and it won't be the last...

I wouldn't be so sure about this.

I'm no history expert, but I'll list a few: Egyptian Empire, Roman Empire, Ottoman Empire, British Empire, Spanish Empire, Viking Empire, Incan Empire, Aztec Empire, Mayan Empire... many came and went due to resource exhaustion and environmental degradation. Unless there is global nuclear war, I'm just as certain that after this American/Oil Empire, there will be dozens and dozens of other huge empires, gradually trending downwards in size and scope.

If you have a response to this, please let it be more than "nuh uh."

Viking empire? Where the Vikings ever organized enough to have an empire?

yeah maybe "empire" is the wrong word. we could say "viking conquest," oh ye of short reply

I'm just as certain that after this American/Oil Empire, there will be dozens and dozens of other huge empires, gradually trending downwards in size and scope.

If you have a response to this, please let it be more than "nuh uh."

Just curious, on what exactly it is that you base your certainty?

I think I'm willing to entertain a certain darwinsdog's like skepticism to that point of view.

Anyways I propose that the answer to why it may not happen this time around, might be somewhat along the lines of, not one of those empires had come up against truly global limits to growth. It seems we may be reaching those limits now.

Then again a huge empire may be a relative thing. Maybe when the world's population hits the one billion mark again after a couple of centuries of growth from the few hundred thousand that will start from scratch in a decade or two?

My certainty comes from the fact that there have existed empires of one kind or another, almost continually, since agriculture began. Just as we are hitting limits to growth before colonizing the stars is feasible, the Roman empire hit its limits to growth before colonizing America was feasible. In both cases the limits were "global" but our world happens to include the entire planet, while theirs included just a continent or two.

Rome collapsed, and civilization reorganized itself around lower-energy economic activity, during times which saw the rise of many smaller empires.

When the oil empire falls, unless there is a global nuclear war, the people of the world will not simply vanish. They will have no choice but to reorganize into whatever society works without fuel. History tells us that without fuel, oceans are not crossed without high-profit cargo such as gold, spice, or slaves. Things will probably move in that direction over time.

When ocean travel is expensive enough, it is possible for a small empire in China to exist almost totally in isolation from a small empire in America - as did happen for thousands of years.

So, I'm certain these things will happen because 1) it already happened a lot and 2) we won't have the fuel for a planetary empire again.

darwinsdog, I know I can always look forward to your cheerful optimism ;-)

It is physicaly possible to replace most of the oil use with more electricity and preference changes in consumption. And electricity can be made from many sources. The most important resources are an industrial infrastructure, enginering and workman skills and stable institutions making decade long efforts with multiple generation payoffs doable. And the people who can do the work now both want pensions and a future for their kids so what is stopping us?

You said that eventually we will need to get rid of this debt. How will that be done?

I think of an example: Imagine you lend some money to your neighbour who wants to open a new business. But one day his enterprise burns down and your neighbour is completely broke. The only thing he can do is tell you "Sorry, your money is gone".

So I fear there is only one way out:
To admit that our System is Down and needs a Reboot.

I think rebooting the system is a good analogy. We need to hit Control - Alt - Delete and start over.

I think it's an absolutely rubbish analogy. Where are those keys for a start? Where is the outside operator pressing the keys? Where is the power supply and the operating system pre-set-up to load on reboot.

I think much of the coming depth of the situation is precisely that we can't just "reboot" like this. In the interval that "the system is down" we all starve. Also consider the related matter of the huge difficulty James Watt had getting his steam engine made, because no-one then had the tech to bore with the required precision. One business partner went bust before Boulton took over. (I live here within sight of the factory and house of Boulton by the way!)

Your idea of a parallel money system starting up (such as rationing coupons) is interesting, but historical experience indicates that governments are useless at managing fundamental system crises let alone declines, and so the odds are we'll need to prepare our lifeboats instead.

The situation you outline is very sobering. Good work. Its said that a population oh humans needs about 80 years to repeat a disastrous decision, eg. 80 year intervals between serious tsumani caused deaths in earthquake-prone shorelines (local people loose the memory of previous events, start settling vulnerable shorelines), 80 years between major investment disasters (1930's to present)

Wired magazine, in an item about Harry Dent etc. includes

In 1992, the year Bush lost the presidency to Clinton in large measure because of the stupid economy, Harry Dent Jr. published The Great Boom Ahead, a book that made many see Dent as more of a fool than a savant. The last seven years, however, have proven his detractors the foolish ones.


Bull markets end when a generation stops spending and stops being more productive as workers. Our growth boom will end around 2008 or 2009, as the boomer generation begins to cut its spending. We'll see falling prices, high unemployment, and massive consolidation in industry. This depressionary economy will last for about 12 to 14 years, from approximately 2009 to 2022. By 2022, if not before, the stock market will bottom out. Then it will turn up and grow strong again when another generation takes over.

"Its said that a population oh humans needs about 80 years to repeat a disastrous decision"

This fits in well with the Kondratieff long wave, which commonly averages 50 to 60 years, and is sometimes referred to as a two-generation wave. One generation, say for example the Great Depression, is badly burned. Their children, the older half of the Baby Boomers (born 1945 to 1955), heard the stories and took note. The next generation, the younger half of the Baby Boomers (born 1955 to 1965), is too far removed to hear the stories, because by the time they are adults their grandparents have died off. The current generation, born in after 1985, has not really known hard times but are about to learn.

I have long suspected that the economic growth of the past few years has not actually been growth -- as in creation of value above consumption of value -- but has been economic voodoo conjured up by financiers and traders and the like. Of course, their karmic powers were weak to begin with, and Shiva loves a riot, so that spell could not hold and here we are.

But, I don't understand why all the articles that point out these things often speak in terms of "fear" of this reckoning. Perhaps it's a matter of perspective, but I sense that in many cases the rhetoric that paints this financial unravelling as terrifying and awful is often a matter of political correctness. It's wrong, after all, to say anything against the Machine, though we're not exactly sure why.

For those who are psychologically dependent on the financial system, I imagine this would be a strain. But as a young person (early 20s), who has not developed that dependence, I find this all fantastic. The disruption of hegemonic control by an elite few. The unraveling of the megastate of the US Empire. This calls for a celebration.

I'm going to suggest that these are all good things and that they should be celebrated rather than feared. Could it get worse than a global empire that monitors our phone calls, feeds us propaganda and toxic food, wages war on plants, poisons the air, water, and soil, and wages resource wars that destroys countless lives?

Hooray for the death of the Empire!

I am not sure your lack of fear is warranted if your livelihood is dependent upon having a reasonably functioning economy. If there is no dependency on your part, good for you. I take your point that we could use a bit less empire, and I take that as positive.

The vast majority will be experiencing a fair amount of suffering and deprivation if this develops into a depression and stays there for as long as it did in the 1930s. Continuing the current trend of extreme income inequality will mean that even in a more benign economy, say zero growth, the poor, lower middle, and middle classes will be in for rough sledding.

I am still curious though. How is that you are not dependent upon the financial system. Or were you assuming that the economic system would continue on just fine while the financial system imploded? I understand that at your age you may not be dependent upon the stock market, but unless you are independently wealthy, you still need a job.

Do I need a job? Yes, at the moment.

But do I need a job in order to live, and live well? No. I can identify wild plants, know a thing or two about gardening, silviculture, and mushroom cultivation. I'll eat fine. I know a little about herbs and medicine.

I don't have a complete background of skills necessary to take care of all of my own needs at this point, but I'm on my way. Just like the death of the American Empire, I'm not going to learn these things overnight.

For those who desire to have the internet, xboxes, cell phones, cable tv, fast food and air conditioned houses as integral parts of their lives, I imagine this will be a tough time. For those who are cool without those things, this period in time will be a time of opportunity as the map opens up to new possibility.

I'm not naive. I know it will take a lot of work on my part. And I know this Depression will bring chaos, shortages, and suffering to most of society, my own life included. I don't expect I'll dodge all the bullets whizzing about, but I'll this failure of the Corporate System provides us with an escape hatch from dependency of them. if this period means that folks will come through stronger and more reliant on themselves and their communities rather than dependent on impersonal government and corporate entities, huzzah!

As a young adult a "real job" in the mainstream economy is the last thing you need. Provided that you're healthy, strong & adventurous, what you need to do is to hit the road and see the country if not the world. Work in the underground economy doing honest labor for which you're paid in cash, when you need it, then move on. Jobs are for oldsters for whom security has become more important than freedom. I speak from experience here. Have fun while you still can!

Many thanks for the encouraging words. Trust me, the last thing I want is a career or a regular job. As it is, I have a part time job to save up some money for the next year. I don't know how much traveling I'll be doing but I will be homesteading it up on some family land, planting an orchard, starting a garden, and playing at self-sufficiency.

I was gladdened to see Gail mention local currencies. Apparently these are becoming popular:

I am working on a local currency based on food right now. It works by accepting Federal Reserve notes to purchase grains and dry beans and placing them in storage. Credit slips are given that denote the US$ purchase price, and how many pounds worth of food it is worth (e.g., $10 will buy you 12 lbs of pinto beans or 15 pounds of triticale or 14 pounds of white rice...etc.).

These values are locked in for a year from the date of issue of the credit slip, but if not redeemed by then can be traded for new credit slips with current prices. The goal here is to create a currency with a decent "store of value" backed by something tangible (and an alternative to gold, which I have never been able to convert directly into food).

Buyers of these credit slips are encouraged to use them as a local currency by spending them for all kinds of goods and services. Anybody can show up and "cash them out" for food. What we want to happen, over time, is for a lot of currency to stay in circulation. This would allow us to create a large food buffer.

If a run on the "bank" happens in a crisis that wouldn't be a problem because we'd actually have enough food in storage and then some because we will always sell for a slightly higher price than cost to cover overhead and build the buffer even faster.

Because we are using food to back the currency, there's no tax burden on our side (but it does exist for other exchanges that may occur). And we can offer food at a lower price than can be had in stores, even when buying in bulk. In fact, we may become a local distributor to the local stores at some point.

Anyhow, that's the idea. Might be initiated within a month of two.

Thanks for your comments about the local currency! Having them backed with food sounds like as good a plan as any. It is not clear we have much say as to how much oil or natural gas we will have.

It seems like we need a back-up for our currency that has so many problems.

Sounds very interesting backing with food.

Our local currency is the HOUR backed by labor.


Hi Jason


Is this written up somewhere else in detail?

It sounds kind of like a "large scale food storage co-operative." Would this be a fair description?

Although it seems there's something else in addition, namely, the circulating of the paper link to the food in storage.

My Qs:
1) Have you purchased insurance for the food itself - (while in storage?)

Or, another way to ask this is: have you given any thought to what happens if there's an unforeseen problem with the food in storage?

It occurs to me that gold is (perhaps) less prone to accidental spoilage and loss, which may be in the "plus" column for it, (although, of course, your point about not being able to eat it is, of course, quite valid).

2) Also, curious about the "flow rate" of the stored items. Do you plan for them to be used up and thus re-filled at a fairly constant rate?

It's an interesting idea to have more than (what I've heard - no link) - "The average supermarket has only a 3 day inventory on hand."

Gail -- As I first began reading your piece I thought you might end up proposing a bail out for the oil industry. Maybe some of the boys and I in Houston should jump in a hybrid and start heading for DC.

But seriously now, there will be some bankruptcies in the oil path but probably on a small scale compared to other sectors. More likely, as history tends to repeat itself, we’ll see more consolidation through acquisition of the weak by the relatively healthy. My client is one of the largest unconventional NG players in the country. Cutting our rig count for 2009 by 40% will be mimicked by most of the other players IMO. We’ll be drilling out of cash flow and not borrowing. Not that the credit lines aren’t available but the cost of credit combined with near term uncertainty of NG prices is too much to roll with. Chesapeake is an even worse example: Statoil (the Norwegians) have already started picking over their bones. If Chesapeake can’t scrape sufficient capital together to follow through on their part of the Statoil JV they should become an even more likely takeover candidate IMO.

The first employment casualties will likely be the drilling contractors and other service sector companies. This will be a tough cumulative blow for the economy. Many of these blue color jobs garnered high pay (and thus added significantly to the tax base, housing market and consumable goods sector). Making it worse, those skills don’t transfer well to non-oil patch jobs. Deep Water contractors will hang in there a little longer given the significant time lines of such plays. But if prices stay low for a couple of years they’ll start seeing significant drops in cash flow also. There are still dozens of Deep Water rigs (at $700 - $800 million a pop) under construction with deliveries over the next 3 years.

But this oil patch recession will be different in several ways from the past. As others have pointed out, much of the increase in NG supplies has come from the unconventional NG plays which will start to suffer a significant drop off almost immediately. In the next 18 to 24 months we may see increasing NG prices in the face of continued low drilling activity and a prolonged national/global recession. Though not certain by any means, NG deliverability may decline faster then demand. Given the large residential demand for NG this would only inflict more pain on an already suffering society. Even if the economics for NG drilling bloom again I doubt there would be a similar mad rush as we’ve seen the last several years. First, there will certainly be fewer players. Second, investment capital will likely continue to be scarce/expensive.

Internationally, the US majors are already insignificant due to the continued expansion of NOC’s. Better take your best shots now: won’t have Exxon et al to kick around much longer. We might also see something of an increased migration of capital expenditures by the large US independent operators. When times get tough it’s typically easier to make a better margin overseas. Only time will tell how the NOC’s tolerate/need these companies.

Average annual US crude oil price at the wellhead (2008 will be around $100):

Could it get worse than a global empire that monitors our phone calls, feeds us propaganda and toxic food, wages war on plants, poisons the air, water, and soil, and wages resource wars that destroys countless lives?

Could it get worse? Hell yes. It will get a lot worse. You will be missing the good old days of empire.

Some of the wisest words on the web there.

If we look at the graph, it doesn't look at all like anything we have seen before.

It doesn't?

whats your point?

you need to be more voluble and loquacious

My 1,002 words weren't enough? :)

How about "It does, in fact, look like something we have seen before. It's debatable whether or not (or to what extent) is is the same... but it most certainly looks the same"


The amount of debt we have outstanding is extremely high.

Given the way money is created, wouldn't the amount of debt bear some relationship to what has been derived from grinding up the entire planet? With a massive amount of waste - in a thermodynamic sense - of course, for the heat and gray goo. To pay back that debt, to unwind it, is not within our means. Only Maxwell's Daemon could return the ice caps. [A heavy burden to lay on my two boys, Maxwell and Griffin - the daemon and the winged lion.]

The amount of money has to bear some relationship to real world physical assets, yes.

Nature never gets paid. The current economic crash is a global margin call on remaining natural resources, on nature herself (or what is left of her). We're going to default and nature will get left holding the bag. Too bad we forgot that we too are nature.

Nature never gets paid. We can't address this within the current paradigm, because the bulk of our tools make it worse. Metaphorically, we have to move to cash. We have to live on the Income Statement, not the Balance Sheet. And somehow, we have to bring the Balance Sheet back to a stable point. How do we put the ice caps back?

Nature never gets paid. Sustainability isn't "from this point forward", but we have to clean up the mess too.

How do we return the species destroyed? How do we start to pay back nature? Because if we don't, we perish. And that work is probably at least another whole order of magnitude more effort than simple this-point-forward sustainability. Concentrating energy and leaving alone low entropy resources and sinks - old growth forests and fish stocks probably the easiest to conceptualize. Rip out dams if that's what it takes to keep the salmon running because the emergy in a species and a bioshed is enormous.

Paying back doesn't mean in exact kind; humans are the best soil builders. Perhaps that's what we do.

I don't know whether it is necessary to go through a full economic collapse and restarting process, to get past all of this debt. I find it hard to imagine that governmental leaders will sit down, look at the situation rationally, and start thinking about how to unwind the debt.

Obama wants to build more. In general, that seems to me the worst possible course of action. Every mile of road and every bridge will make matters worse. Look what they do to the Income Statement.

Look what those roads and bridges do to the Balance Sheet. They take low entropy, turn it to goo and facilitate the taking of more low entropy to make yet more goo.

There are specific situations where we could build more roads and bridges - where the net emergy produced, including nature - is positive. My intuition, however, is that dropping bridges and ripping up roads might have more of a positive impact than any new ones we might build.

Of course, that's not thinking "rationally".

cfm in Gray, ME, Way Out In Left Field

My hopes for Obama, whom I voted for enthusiastically, are deteriorating by the moment. Some of his plan is good. But his plan for roads and bridges is like the heroin addict who says he just wants one more hit at the needle before he quits. He does not seem to know that we are running out of time. However, the American people will not abide a leader who is truly planning for the future and fully taking nature, or the end thereof, into account. So my disappointment is nothing personal. It just goes with the territory.

Meanwhile, China is implementing Alan's railway plans big time.

Yep, in high speed rail:

In rail networks to remote provinces:

All backed up by better infrastructure and money to raise people's disposable income:

While they may be moving wisely in regards to rail, the current reports both internally and by the UN suggest that they aren't going to have soil or water enough to keep going. I'm not trying to China-bash, I actually think it is more useful as a metaphor than anything else - in some senses, all our efforts in re:transportation and other infrastructure are failed if we don't deal with the organic infrastructure that underlies them.


Nature never gets paid. The current economic crash is a global margin call on remaining natural resources, on nature herself (or what is left of her). We're going to default and nature will get left holding the bag. Too bad we forgot that we too are nature.

Good point. We started trying to fudge the balance sheet, thinking we could take more and more resources from nature, and we ran out of places to grab from. Now we have to get along with much less resources, and like you say, try to get things back into order again, without all of the debt that cannot really be repaid.

This article amounts to gross misinformation.


The supply/demand works in free market. In oil markets, free market is disrrupted by OPEC quotas.

So what do OPEC quotas do to your graph?

A quota sets a constant Quantity Q of supply, so it would change blue Supply curve to a vertical line. Therefore the drop in demand drives the price along the vertical distance between D1 and D1.

If the quotas were very generous and the vertical line were somewhere at the left right side of the graph, the drop in price would be only slightly larger than drop in demand.

However this is not the case. Now imagine that the vertical line would be far left in the graph, perhaps 10% of the range. Then a small drop in the demand would create huge drop in price. This is exactly what has happened.

If a natural free market price stabilizes at a point, where dSupply/dQ = dDemand/dQ, or more clearly dSupply/dPrice = dDemand/dPrice, then OPEC restricts the oil volume to 1/sqrt(80) of the free market volume and drives the prices sqrt(80)times the free price.

We have this intervening variable of credit that seems to be running amok in the equations. With all of the debt defaults, there are more and more being knocked out from being buyers of oil products. We also have sellers of oil futures because of credit calls. The credit unwind has only begun. If increasing credit has acted to bump up real GDP, decreasing credit is likely to cause real GDP to drop. We have so much credit that needs to unwind that the potential drop is huge.

Gail again energy is unique along with food.

Increasing credit increased the velocity of money not just the supply. I use the example that the average American houswife with bags of HELOC money purchased thousands of dollars of high end goods on each shopping trip. With this supply of credit gone the same housewife spends 20 dollars at Walmart for toilet paper.

In both cases the amount of fuel burned is roughly the same but you have a false efficiency on the up side as each trip resulted in far more transactions or higher transaction amounts on the upside of the credit boom and far less on the downside.

I point out this graph.


Obviously we still have a ways to go on the velocity side of the equation which means the GDP will continue to shrink over time.

I'd say that the biggest impact right now of the credit crunch is actually not the loss of credit itself but its impact on the transaction rate or the slowing of transactions worldwide. Needed or not its currently irrelevant.

I think people are wrong in a lot of ways to focus on the credit deflation or changes in the overall money supply at the moment since changes in the velocity of money are actually swamping the other factors.

Credit problems are a huge force in this loss of velocity but its the velocity of money itself thats driving our economy. Or rather the change.

Until the velocity of money stabilizes we don't really know what shape our economy is in. I expect that it will eventually fall back to closer to the 1.67 norm.

What this means for the US is we will increasingly see oil make up a larger part of our GDP as the transaction rate and amount per transaction slows in fact I'd not be surprised for the US to find out that almost all the efficiency gains that have supposedly happened where simply a side effect of the higher velocity of money vs the historical norm.

So what this means using my house wife example is lets say during the good times she made 10,000 transactions for 10,000 dollars of those transactions only 100 where for gasoline. Now she makes 1000 of 1,000 dollars transactions and lets say 90 of those are for gasoline.

In her case the velocity has dropped ten fold but now oil accounts for .09 vs .01 even though it declined by 10%.

But the main point is when you smash the velocity of money this badly the entire system is shaken as I've been trying to say. Credit deflation is a secondary problem the primary problem is the market has absolutely no clue about its overall size. The slowing velocity of money causes a massive shrinkage in the overall global market its orders of magnitude larger then any other effect.

Think of a star imploding into a black hole the credit problems are akin to the layers of gas blown off into the nebula surrounding the start while changes in the velocity of money are related to the far larger event of the star shrinking into a black hole. Most people are watching the violent explosions of blown off layers and thinking thats the problem while the real problem is forming all around them as a relentless shrinkage.

What will the price of oil be once this is done ?

That depends on supply and demand all we know for sure right now is that expenditures on commodities will make up a larger precentage of the transactions that people engage in as frivolous transactions are stopped. We can be sure that the transaction rate will be lower and that gasoline transaction will make up a larger portion of the money spent.

I argue that since most of the actual expenditures on a price basis where concentrated in new houses and new cars which are big ticket long term debt items most of the slowing velocity is in this area and related industries. Sure its huge but whats important is when people stop buying new cars and overpriced houses there cash flow actually improves dramatically on average. This is offset to some extent by job losses but given that a house today is normally twice the price of renting and new cars generally have a several hundred dollar premium over keeping a old one I'd argue that the cash flow situation of the average consumer is actually going to be a lot better.

Now credit esp long term credit will continue to deflate and many consumers will default on credit card debt but purchases of commodities are driven in my opinion more by short term cash flow not overall credit availability.

So not only will the velocity slow but in general the consumer will be better positions to buy food and gasoline without credit as they pull back from major purchases.

We cannot get price out of this but if I'm right then the credit bubble will continue to unwind for quite some time but the velocity of money will bottom out fairly quickly and the demand for commodities will flatten i.e the day to day economy will function pretty much the same as it always has.

This demand will be balanced at some price level by supply.

This is why focusing on the contraction of the credit supply is probably not a good predictor for oil demand.

I think there is a fairly big credit component in the purchase of commodities.

Factories don't expand without credit. People don't buy cars or houses without credit. A lot of road construction is financed by debt. Even food production often uses debt to buy equipment, fertilizer, and even land. I think that quite a bit of the drop in commodities use has been in the manufacturing sector, and as you have said, transporting all of the building materials to building sites.

No doubt and I've argued the point that a lot of the reduction in VMT and oil usage in general is related to the slowing construction market in particular housing. This uses a lot of oil.
However housing construction has been slowing for a while.


And of course the infamous VMT chart.

VMT and housing construction are in my opinion closely correlated from 2003-2004 to the present.

None housing related VMT had probably flattened or was even in a slight decline from 2003 onwards thus if you removed the influence of the housing bubble from about 2003 forwards you would probably had seen a flat to slightly declining VMT reported. Of course when housing finally crashed the VMT followed it down. However housing construction is now dead we can expect no further changes because of housing.

I as you know have proposed this several times. But understand that the entire time that VMT growth has been slowing then declining until the last six months the price of oil has been increasing. We eventually did get a true real bona-fide drop in VMT that started in 2005 to the present and oil prices increased most of this period.

The rate of dropping did finally steepen at the end and this probably has resulted in a slight oversupply of oil on the market since the previous decline rate was not sufficient to result in lower prices.

If you include US population growth then its probably a good bet that with housing now out of the picture the base demand is probably somewhere near 2004 levels one could even argue 2003.


2003-2004 data is in fair agreement with product supplied this year. Understand guessing this is beyond inexact.

Here is the population growth.
0.88% so you have a intrinsic increase of say 0.88% per year or given this is and estimate lest say 1% simply because new homes are also farther out i.e suburbia is in expansion. 1% is in good agreement with the longer term growth on the graph.

I don't see that asserting that 2003-2004 oil usage levels are a reasonable "bottom" is a bad estimate if anything its likely to be slightly low.

As I said of post this a number of times. But the take home message is that prices increased almost the entire time that VMT growth slowed then declined. If the recent sharp decline has resulted in a global oversupply its minimal and further more future demand declines are doubtful.

What should the price of oil be ?

Thats yet to be determined and depends on the global demand. I'd say that the higher oil prices caused real demand destruction in the poorer countries and that this demand will rebound with lower prices. China and India are still growing if slower. Export land is still in force the exporting countries have seen a slow down in the rate of increase in demand but its not negative to my knowledge.

If the oil market is oversupplied right now then its a very slight oversupply based on all the fundamentals I could find. If spare capacity does exist because of the oversupply the majority of it is in Saudi Arabia so they should be able to control the price of oil.

However I think they can do the math as well as I can and I think they are wise to go slow reducing oil supplies are they could easily cause a fairly serious oil shock/shortage if they are not careful. This is under the assumption that the real supply and demand balance is actually very tight and the dysfunctional market is not working correctly at the moment.

But again I stress no one really knows the exact situation at the moment to many factors are currently causing the oil market to remain dysfunctional. They simply have to clear. I do think the surges from KSA where unsustainable and they certainly came during historical low periods for the market and no one seems to want to include the effects of the hurricanes this summer in any demand calculation.

Certainly the shortages in the SouthEast also influenced the oil supply and VMT. I'm still a bit amazed that so few people seem to be willing to correct 2008 data for the short term influence of the hurricanes.

I certainly found the fact that oil prices did not respond to the hurricanes almost amazing but hey it happened.
The drop in demand and inability to offload without price increases certainly allowed the natural surge after the supplies where finally moving again to influence price even lower.

And of course last but not least all the hedge fund unwinding etc.

All of this stuff is either short term or in the case of housing now in the past and for the most part the hedge fund unwinding is in the past. Throughout all of this right to the last six months oil prices where increasing.
Looking forward simply using the population growth rate in the US as a metric we can expect that US demand will be flat to slowly increasing the number of large short term factors that have roiled both the financial and oil markets are becoming history. A new less leveraged economy that uses a lot less debt is forming.

I think the odds are very good that this new humbler economy will soon find it still does not have enough oil.

Nice and actually true.

But credit and margin calls are no explanation why the price dropped 4 times (75%) on 5% drop in demand. What amplifies the 5% percentage drop 15 times?

My car consumes gas always "long". I was never able to make gasoline by driving in reverse :-)

Therefore, credit calls can only discount inventory, but as long as oil gets used up, they would have to return to about 5% drop in price within the few days that the inventory adjusts. Besides crude inventories actualy rose!

So, why 5% drop in demand causes more than 5% drop in price, against to what the demand/supply graph would suggest?

Because the graph is wrong!
Why is the graph in picture 2 wrong?
Because this is free market graph, while oil is regulated market graph, by means of OPEC quotas.

How does a good quota-based graphp look like?
A vertical line, Q=const for any price.

How does a price move in the correct graph when the blue supply curve is corrected to be a vertical line?
If the vertical line is within the left 10% of the graph, then mere 5% demand decrease can actually cause huge drop in price.

I believe that this is the true nature of price phenemona we are witnessing. The evidence points volume fixing, not credit problems.

Volume fixing, or volume constraints, or as Krugman would say, volume reduction as a method of investment with regard to a scarce commodity. It could be any one of these things.

Petrus - a supply constrained by physical limit (peak oil etc) would also produce a near-vertical supply line.
In practice quota and geo is much of a same. The quota only works because Russia and your cat can't suddenly supply an extra 10m/d to the market.
Interesting to see in those graphs further up how the ready supply limit was lower, around 60m in the earlier price-hikes.

Good point.
Even the IEA is warning that for OPEC an inverse supply price elasticity may apply - resulting in a vicious circle of reduced oil supply and rising oil price.

Greenspan/Bush policies ramped up the U.S. construction industry and economy and accelerated the world economy to new highs, which drove oil prices very high. Greenspan/Bush easy credit policies added fuel to the fire. It then all predictably collapsed, and many warned about it years in advance. These "brilliant" leaders drove the U.S. and then the international economy into the dirt. The Bush boondoggle-friends-get-rich Iraq war with trillions wasted on phony contracts added to the corruption, avarice, greed, and disregard for humanity which trashed the world economy.

Meanwhile, I heard that Alan Greenspan says he thought the financial institutions would regulate themselves. He must have had a different college education than most, or maybe he lives on a different plant. This is even worse that the Savings and Loan scandal of the Reagan administration in 1985,


which I used an example of government corruption/stupidity in teaching policy evaluation for 20 years. In both cases lax government regulation allowed a few to rip off the public and then the nation and world suffer horrendously in paying for this nonsense, and in both cases many saw it coming and put out warnings to change government policy. And the Enron scandal was just a few years ago. Did Alan Greenspan really think institutions could self regulate after that one too???

As a history undergrad major, I know that the only thing we learn from history is that we don't learn. Nevertheless,to see this same type of nonsense occur in less than a quarter century is just ridiculous. A lot of people are now out of jobs and will be homeless as a result. And a lot of people lost wealth rapidly, with no time to figure out how to adjust their investments. And many had investments that they knew would collapse, but couldn't move the investments for legal reasons. And just like the Savings & Loan scandal, many suffer, and the guilty will mostly put money in the bank, instead of going to jail where they belong.

They are just as bad as those who evade taxes and are sentenced to years in federal prison. Obviously if I knew about the S&L Crisis/Scandal and Enron, then Alan Greenspan did too.

We should blame Bush, Greenspan, Congress, and the corrupt banking and financial institutions for this malaise, death, and destruction. Business ethics is an oxymoron. Blaming high oil prices is like blaming the bullet that killed someone, instead of the assassin.


Cliff Wirth

As a history undergrad major, I know that the only thing we learn from history is that we don't learn. Nevertheless,to see this same type of nonsense occur in less than a quarter century is just ridiculous.

.. or rather, we learn that the fix is in, again and again and again ;)

First I'm surprised at all the experts on world oil demand that seem to have popped up out of the woodwork.
They seem to also have and uncanny ability to calculate oil demand down to the barrel.

Lets start with at the top.


* Wheat down more than 6 pct, lowest since April 2007
* Corn, soy drop to 15-month lows
* Commodities benchmark CRB index hits six-year low
* Ample global supplies of wheat and feed grains
Meanwhile, USDA reported 207,600 tonnes of wheat sold for export last week, a marketing year low and well below estimates for 350,000 to 550,000 tonnes.

Its a good article but I only want to look at that one number.
Thats a significant slow down in wheat orders. Now we can all kinds of discussions about the underlying reasons suffice it to say they are complex lets see if demand for wheat really dropped that much.

Some spot checking shows that Pakistan is not swimming in wheat.


For Egypt we get a interesting tidbit.


Egypt's state-owned wheat buyer, the General Authority for Supply Commodities, said it bought 30,000 metric tons of Russian wheat for $160 a ton, free on board. By contrast, the cheapest French wheat was offered at $181 and the cheapest U.S. soft red winter wheat was offered near $182, according to a breakdown of bids.

"U.S. wheat is just simply unattractive pricewise," said Terry Reilly, analyst for Citigroup.

Then this.


Nov. 28 (Bloomberg) -- Wheat rose after Egypt, the world’s largest buyer of the grain, bought supplies from the U.S. and on a report that the North African country had suspended imports from Ukraine.

Egypt yesterday agreed to purchase 55,000 metric tons of wheat from the U.S., the world’s largest shipper. It also banned imports of Ukrainian grain until June 30 because of poor quality, the newspaper Ekonomicheskie Izvestia reported, citing a statement from the General Authority for Supply Commodities, Egypt’s main state buyer.

“With less wheat on the market from Ukraine, we could get some of that business, thus increasing our exports and making our wheat more valuable,” said Jason Britt, president of Central States Commodities Inc. in Kansas City, Missouri.

Wheat futures for March delivery rose 7.25 cents, or 1.3 percent, to $5.6125 a bushel on the Chicago Board of Trade. Futures still have dropped 58 percent since reaching a record $13.495 on Feb. 27. The market was closed yesterday for the U.S. Thanksgiving holiday and shut at noon today.

Obviously more is going on behind the scenes if you get a faint whiff of cold war then your probably on target.
What we don't see is that demand has changed dramatically.

We continue to spot check the grain market and we find another interesting tidbit.

The credit crisis is spilling over into the grain industry as international buyers find themselves unable to come up with payment, forcing sellers to shoulder often substantial losses.

Before cargoes can be loaded at port, buyers typically must produce proof they are good for the money. But more deals are falling through as sellers decide they don't trust the financial institution named in the buyer's letter of credit, analysts said.

"There's all kinds of stuff stacked up on docks right now that can't be shipped because people can't get letters of credit," said Bill Gary, president of Commodity Information Systems in Oklahoma City. "The problem is not demand, and it's not supply because we have plenty of supply. It's finding anyone who can come up with the credit to buy."

Hmm that does not seem like a demand problem to me this seems like a financial problem.
Egypt seems to still have credit while it looks like other parts of the world with less financial power may
be having problems buying wheat.

A quick jump off of wheat but to spot check Rice.
Prices down and various market forces at work for rice i.e fairly complex.

Finally back to supply and demand and price. What I see as I look around at the grain markets is dislocation more than anything else. Consider checking the price of flour in a Baghdad market after a suicide bomber has struck.
The market itself i.e the buying and selling of commodities and transferring them all over the world has had a bomb go off in its midst. One has to wonder how functional is the global market place ? If its having serious problems simply functioning is it even able to correctly meet supply and demand ?

Well if a market is having problems functioning what one would expect to see is all kinds of delivery problems grain piling up in certain places and not making it to some markets while the largest strong buyers are able to procure grain at steep discounts.

Next lets move to oil.
And lets ask ourselves the most important question we need to ask right now. Is the oil market still functional ?
My opinion is that at this moment the market itself is not functioning. Attempting to make supply/demand prognosis using a dysfunctional markets price movements is foolish.

Now I believe that the current financial crisis will become the norm not the exception simply because we will not clean up our banking system. In time new financing will be developed for the various commodity markets with hard money lenders or government loans replacing letters of credit from banks. This will get the commodity markets moving again and at that point the newly stabilized commodities markets will again reflect supply and demand.

Right now what they reflect is and inability to actually execute transactions leading to imbalances all over the long global supply chains for commodities. I'd be happy to be proven wrong and be shown that the world markets are functionally smoothly and that the price drops are just a simple supply and demand problem I doubt it.

Given that we are entering winter I think that it will not take that long for the market to begin to function if it does then some people will starve.

I agree. I think you are saying quite a bit of what I am saying. The messed up markets are a major problem, and I am having a hard time seeing them get better. We have a complex interconnected system. Assuming that prices will pop back up again and fix the system is assuming a whole lot.

First and foremost I'm saying given the current situation nobody knows. Thats the most critical piece of information.
No one can divine what will happen to oil prices give the state of the market today.

I'm simply saying that with a bit more thought the right answer is in this particular case I do not know.

Now and I explained it in another post we do know that the world economy was spending a lot of money foolishly.
500k crap homes in California for example. Everyone driving a Mercedes with heloc money etc etc.

I've also explored extensively the pattern of gasoline usage in depressed regions of the US the result is it tends to be flat and related to demographics and insensitive to price.

In fact you can look at previous recessions as a guide.


We can dig into the details later but in general demand drops off sharply then resumes.

For the current discussion the key point is that gasoline and miles drive are both closely related to cash flow i.e how much money you have each month. Two things influence this having a job of course but second your debt load.

Right now in California houses cost 2-4 times as much to own as to rent and generally mortgage payments are close to 10x income. These people have negative cash flow. As they default on their debts their cash flow increases therefore their ability to make small purchases increases. Their credit rating is toast and they can't buy cars or homes but they actually have much better cash flow. In the case of most Californians after the default on their mortgage and rent they massively increase their cash flow from negative to a decent fraction of their income. Since most people pulling this off also default on all credit card debt they go from being crushed in debt to having no credit but decent cash flow.

The point is that except for the increase in unemployment most Americans actually dramatically increase their cash flow even if they take lower paying jobs once they repudiate their longer term debts and often revolving credit.
They have plenty of income to pay rent, food, utilities etc if they default on their crushing debt load.

This is why we have every reason to believe that commodity demand will at least flatten at some level fairly quickly if not actually increase. In general VMT actually rebounds fairly quickly. Using the historical guide we can assume for the moment that the decline is very close to finished if not finished.

So the bottom line is you get a sort of Indian Summer economy esp in our case since housing prices became so distorted as consumers default on debt and have increasing cash flow for small purchases.

If supply does not meet this demand level then we will see high prices but I argue that at least initially the consumer can afford them and will pay.

This is one reason I hate that people are using debt deflation to predict effects similar to the monetary inflation of the 1930's its quite different.

As and example consider all the hedge funds that are unwinding because of redemptions. People are blaming this for low prices and the arguments are reasonable but they are not looking at the other side of the equation as hedge funds are liquidated the cash is now very very liquid most of it now landing in Treasuries but there is a ENORMOUS amount of cold hard cash thats now setting in Treasuries and unencumbered waiting for a deal. Remember cash is king.
Liquidity/ Cash flow is in better shape now than its probably been in decades. With cash sinks like Real Estate no longer viable investments you have a huge amount of money that will seek a return. I know I jumped between two different levels but overall as credit is pulled back people have no choice but to improve their cash flow situation.
This is done either via repudiating or paying off debt or probably most importantly not taking on new debt.

This cash is available for day to day expenses and small purchases i.e the daily economy is in pretty good shape.
The commodities are linked more with the daily economy then with the infrastructure investments thus demand generally flattens.

Price ??
Again I don't know nobody knows but overall historically production has been flat with exports declining that met demand has been declining. We can expect demand itself to remain fairly flat and met demand to continue to decline.
Therefore commodity prices should increase. Now exactly where we are on this curve is simply unknown since the markets are currently dysfunctional. I actually think that nothing has really changed on the supply/demand equation and we will quickly return to high prices. I don't see any problem with the consumer meeting these prices as debt deflation will continue to free up cash flow for some time to come.

In a year or two or maybe three then we can talk about the collapse of the economy because of high commodity prices but this only happens once its repudiated its long term debts and can no longer function with its cash flow. I.e not enough oil to run the day to day economy at effectively any prices. At this point we begin to see real and permanent demand destruction but it happens in a very high priced commodity regime not a low one.

The big difference is I know for a fact I'm guessing about the current situation for supply and demand. I've got historical evidence that demand flattens in a stagnant economy and I'm pretty sure supply is declining.
And I'm certain the current markets are dysfunctional. I'm quite willing to admit I'm guessing at where the supply and demand curve is simply because thats all you can do at the moment.

I am saying everyone drawing all these pretty supply and demand graphs and explaining how the current price is rational are full of sh%$^.

Just as a FYI memmel. I recently interviewed a former ag banker and asked him about this sort of stuff:


He's pretty concerned, but lays out the problem with such calm!

I shudder to think whats going to happen to agriculture over the next few years.

Yes, something weird is happening. This is also shown by the
Baltic Dry Index:
At present overseas trade of dry bulk matter (including grains) has virtually stopped:

James Howard Kunstler puts it another way:

My own starting point for this is the belief that in the years just ahead any sociopolitical entity organized at the giant scale will flounder -- this includes everything from the federal government to global corporations to factory farms to centralized high schools to national retail chains. So even expecting Mr. Obama's government to act effectively may be asking too much in a situation that will require mostly local action.

I think Kuntsler has a good point. With this breakdown in markets, the fixes are more likely than not local. That is why we may see local currencies pop up, or bilateral trade agreements (like barter). I think that there is at least some possibility that some of the larger countries will break into smaller units, as state and local governments take over more control of functions. Federal governments are likely to have so little money that they will not be able to do much.

I don't know how long all of the massive government borrowing will be able to continue. Eventually one would think that the amount being borrowed would exceed demand for investment. Also, buyers would start expecting inflation/default.

Ever since the severe 80's recession various forms of local barter have been about in the undergrowth in the UK, and will likely spring to life again in another recession.
You don't really need gold backing and so on, just a willingness of people to accept the medium, which if you are less likely to loose benefits on a pound for pound basis for doing a couple of hours of casual work is a big plus.
Here is Lewes's local currency:

While I am somewhat sympathetic of these local currency attempts, I am very doubtful that they will catch on as long as national currencies remain in widespread use. A national currency that is accepted in exchange everywhere is going to have higher utility than a local currency that is accepted in exchange only locally. The only way to change that is if local currencies offer something of powerful value that national currencies don't offer. The obvious thing they could offer would be near absolutely-reliable protection against inflation, probably in the form of 100% gold backing with no fractional reserve banking allowed. Were such local currencies available, they would be more attractive as a store of value (which is one of the other utilities of money). Furthermore, 100% gold backing would provide an objective basis for convertability between local currencies. This is probably the necessary precondition for their success.

Of course, there is also the problem that national governments don't like competition with their currencies, and usually have legal tender laws to discourage them. On the other hand, no government has ever been successful in completely discouraging barter, and precious metals have always been barterable goods. Negotiable depository certificates for precious metals are just one step beyond that, and then there you have your local currency, and maybe even able to make and end-run around legal tender laws.

One of the concerns is that the national currencies may no longer work, because of widespread bankruptcies. We haven't really been through this situation before.

Also, somehow we need to get away from fractional reserve banking. We have ended up with more debt than can possibly be paid back. It would theoretically be possible that national currencies could reform themselves, by gradually reducing the factor by which fractional reserve banking could be done. I find it difficult to imagine this happening in practice.

Gail - this seems too important a question to be left hanging on your difficulty of imagining it.
Perhaps we should just believe it on your authority! But is there any way you can expand on the question. Couldn't some government say from now on the nation's banks must reduce their fractions according to xyz progressive schedule? What would the consequences of such a rule be?

I guess the only other "happy transition" would be where a new financial system develops alongside the collapsing one.

The US appears to be peculiarly underdeveloped in respect of local networks trading, probably because there was a relatively high trust in Government- which was also true in the UK until the 80'd recession.

In countries like Italy, a substantial amount of their economic activity has always been 'off-books' in an adaption to inefficient and corrupt government.

The UK now has such a network, but partly latent.

In my local pubs I can buy my vegetables, meat and fish, and can certainly obtain all sorts of electronics, but mainly stolen at the moment.

You can't fiddle people or fail your debts - we all know each other.

Hard times will effectively establish informal 'currencies' in many places, which may become more formalised with more breakdown.

My introduction to online discussion was originally with Petr Beckmann's Access to Energy then to the once popular online service Prodigy, where I learned to type with 2 fingers. During the 80's there were discussions on Prodigy - aka *P - about inflation vs. deflation. Most posters including myself expected continued inflation or even hyperinflation. A few who had some understanding of fractional reserve banking and the velocity theory of money worried about possible deflation. These discussions continued on the USENET during the 90's with additional input from Jay Hanson and others on peak oil, population etc. Today I find differences of opinion between http://theautomaticearth.blogspot.com and those still expecting inflation or hyperinflation. I assume governments still prefer inflation since it can act as a hidden tax. Debtors may also prefer inflation unlike retirees living on savings. There is also the international problem and danger of competitive devaluations.
--Can governments re-inflate during the coming months. Are Ilargi and Stoneliegh at TAE missing anything? How should we prepare?

Robert Wilson asks how we should prepare?

Well it seems you are talking, still talking, about a techie fix?

There is none.

So. Go get some land. Start tilling up a garden. Dig a big hole and make it your home. It will suffice to keep you warm and also cool.
Take it from there......Oh..and on the south side of a hill/mound/slope.

There is lots more but garden produce and a hidey hole will make a good start. Forget the techie shit.

Airdale-its been a bad day and not much good on the horizon..out chere in the rural flyover...I did get some good oak split up today. Thats progress.

It's very simple.

We were in a prolonged global economic boom. We're now in deep global recession. The price charts are the same for all industrial commodities. http://www.lme.com/copper_graphs.asp

Credit was easy, people bought stuff. Credit is tight, people sell.

No one talks about Peak Copper.

Wikipedia article on Peak Copper projections:


In any case, the key difference between copper, which appears to have shown two years of increasing production in response to higher prices, and crude oil is that we have seen two years of slightly lower crude oil production rates, with an accelerating net export decline rate, in response to higher oil prices (with a slight increase in the average annual 2008 production rate, about one-half of one percent, through August, relative to 2005). This is quite similar to the initial declines in the North Sea and Texas, which corresponded to higher crude oil prices:

I realize that it is a difficult concept for some people to grasp, but most scientists now agree that we live in a finite world, with finite fossil fuel resources.

Much of the copper that has already been mined can be recycled many times. When you extract oil and burn it, you can't go back and recycle it (at least not in time periods measured in less than hundreds of millions of years). That is a basic difference.

But how much of the cost of copper is the cost of the energy input into mining/recycling?, in which case it may effectively be determined by supply or non-supply of oil. Without the energy for recycling the copper might as well be burnt up too.

The first time that I heard about peak copper was during the early 60's, well before the US Government ran out of silver and had to replace the vending machine friendly silver coins with clad coins and copper pennies with zinc alloys Copper prices were volatile and occasionally spiked up toward $1.00 per pound. Some pundits predicted that there would be peak copper by 1975 or so. That was long before the discovery of large copper deposits in Indonesia, South America and elsewhere..

Of course, I suppose there is always the off chance that the infinite resource model might be correct.

For example, at the 2007 rate of increase in production, the Barnett Shale gas play in North Texas would be producing about 7,000 TCF of gas per year in 2031, which would really help offset what some finite earth people think will be a rapid decline in worldwide net oil exports.

Alternatively, we could all get behind the following movement:

Laws of Nature to be Repealed
By Paul V. Cameron
Apr 16, 2007

As a result of recent disasters and extreme weather, in a move some say will only incite anger and retribution by none other than the Almighty, a UN-led group is planning to repeal most, if not all laws of nature.

"There are four laws we don't like," said UN spokesperson Liam Snugglam. "If it weren't for these laws, we could prevent the deaths of innumerable vulnerable citizens world wide."

Critique of Julian Simon and infinite copper

"The theoretical argument is that just as there are infinitely many points on a one-inch line segment, so too there are infinitely many lines of division separating copper from non-copper in the earth. Therefore, copper is not countable. Therefore, copper is infinite. Simon reasons from infinite divisibility to infinite amount. But the infinite divisibility of a line segment does not imply infinite length. Infinitely many possible boundaries separating copper from non-copper does not imply an infinite amount of copper. It is a replay of Zeno's paradox of Achilles never catching up with the tortoise that had a finite head start. Simon would clearly have bet on the tortoise. Understandably some readers will think it unlikely that anyone would make that mistake, and will therefore suspect me of setting up a straw man. I beg such readers to turn to pages 47-49 of The Ultimate Resource and read them carefully."

Thanks Robert for that one!

Brian Czech has an amazing chapter about Julian Simon in his book "Shoveling Fuel for a Runaway Train."

With that kind of argument, I would classify Julian Simon as clinically insane. Clinically he is actually dead, but according to Simon, he is probably only still nearing death and it will take him an infinite number of years to fully "die".

Sheeez. In Jon Lovitz' words impersonating Michael Dukakis standing in for Paul Erhlich "I can't believe I'm losing to this guy!"

According to Dr. Alan Bartlett, Simon once responded that we would never run out of copper because we would simply make it from "other metals."

Of course, Simon also thought the human population could continue to grow for (he claimed) 7 million years (the actual article that Simon submitted claimed 7 billion). But if you do the math (on 7 million), you find that the number of humans would exceed the number of atoms in the observable universe by more than 30,000 orders of magnitude.

Apparently as an economist, math was not Simon's strong suite.

double post deleted

Good article, Gail! (Saw the reference to economagic.com, too.)

I honestly can't make any head nor tail out of how this will play out. Being a controls engineer, I like to look at the gyrations of a system, try to divine its workings, and think about how it might be controlled.

• Oil is necessary and there should be little price elasticity of demand and little price volatility from the demand side. What volatility there is should be from changes in marginal cost on the supply side. This is probably a fair assessment of most of the last thirsty years or so.

• An increasingly large debt burden however has changed the situation. Low levels of debt are good – it temporarily keeps cash flowing even if prices go higher than I can bear in the long run. This liquidity provides time for price signals to create more supply (if possible). Too much debt service, however, makes it increasingly difficult to absorb price increases, increases price elasticity and price volatility. Debt also creates increased demand for oil (i.e. things to spend our borrowed money on). This pushes us to higher production, further increasing elasticity of demand and price volatility.

• We can summarize this as a liquidity induced demand constraint: above a certain price demand goes vertically to zero. In a liquidity crisis, finite cash supply alters demand curves.

• If supply is as constrained as we think it is, then we have a vertical tail on the supply curve. Too much demand and prices go vertically to infinity.

• If prices fall far enough to kill production, then the vertical tail moves to a lower and lower supply level over time. This will manifest severe price volatility at ever lower price levels until we have cooled demand to the point where it can be handled by “baseload” production capacity.

• In the case of natural gas, where there is no baseload production capacity, where constant reinvestment is required, the existence of a capacity constraint on either demand or supply may rapidly “volatilitize” the business, evaporate it into thin air.

The key insight here is the interaction “vertical” supply and/or demand curves and natural volatility in supply and demand. These tight systems oscillate themselves out of existence. The solution is to modify the supply or demand curves to take out the heavy non-linearity.

We can’t fix the supply side, except possibly by heavily subsidizing exploration and production. But this would also incent all sorts of counterproductive behavior that would only make the ultimate reckoning worse.

Removing the credit issues is possible, but there is a BIG problem to be fixed and we may not be able to do so in time. Simply adding more credit to the system will only make the ultimate reckoning worse.

Thanks for your insights!

We are dealing with complex systems, and it is hard to know which inputs will cause other changes. All of the derivatives add a whole new dimension. It makes for a scary situation.

Even if we do get past the current financial problems, I agree that natural gas is in a position where it could suddenly "volatilitize". Gas companies are mostly small. If the price is too low, they simply won't make new investments, and production will drop off rapidly.

Hi Shunyata,

re: "The solution is to modify the supply or demand curves to take out the heavy non-linearity."

Since the supply side can't be fixed, as you say, do you have any thoughts about constructive action on the demand side?

Great article Gail. Excellent thinking as usual. I just have one comment...

While you correctly write that getting rid of our debt-based monetary system and replacing it with one that more closely matches actual resources and the real economy (a steady-state system) will be necessary, you don't say anything about the enormous political challenges this change implies. The debt-based monetary system we have today has a long history of resistance. The vast majority of the people throughout the world in all times have fought against such a system, and for the most part, they have lost. This is true whether we are talking about usury in the classical era, or the "liberalization" of the global economy today (IMF, World Bank, etc.) Making money from doing nothing but loaning it to others who don't have it (at interest), has long been considered immoral. It is structured greed. Wars have been fought over it (the US civil war, for one).

Today the international banking industry (some call it a cartel) has accumulated more power than any other. They finance all other industries and all governments. Put this together with the age-old dictum that power has never conceded voluntarily, but has always used every weapon at its disposal to protect itself, how in the world are we going to change this system?

Please don't get me wrong here. I value and appreciate the importance of educating people on what has to happen. But we also need to figure out *how* we are going to make that happen. What politician or government is going to dismantle the very power (cartel?) that finances it in the first place?

Perhaps such "revolutionary" discussions are inappropriate for the oil drum, but still it's important that these conversations occur.



"Today the international banking industry (some call it a cartel) has accumulated more power than any other."

I wonder? I have seen posts at TAE and elsewhere that suggest that the international banks may be broke and powerless??

I agree with pretty much everything you are saying.

There are many reasons that we probably cannot voluntarily go ahead and fix the system, including the ones you listed. I don't see anyone calling for putting the big banks, insurance companies, and hedge funds out of business, even if that is a fair amount of what needs to happen. Pension plans would likely go up in smoke also.

We all know that something that can't go on forever won't. We also know that if we aren't going to fix the system, the system is likely to fix itself. The combination of those two statements is one reason I am concerned about the possibility of an unplanned financial collapse in the not too distant future, as the system fixes itself. Many governments are likely to be different after such a collapse, and even boundaries of countries may change.

Emanuel- good question but I think Gail is heading towards the answer.
The oppressed no longer need to win a revolution against the bankers. You have to understand that energy is real but wealth, money, and ownership are mere psychological constructs, figments of imagination. They only empower to the extent that enough people find it useful to believe in them.
And now an increasing number of people are finding them increasingly un-useful. These tokens of "wealth" will thereby end up in the trash-bin, along with the "universities" which are hauling themselves down the drain via their professors who mostly do anything but tell the truth (indeed deny there is truth to be told).
The people who are facing the bleakest future are likely to be the "wealthy" and "educated" because almost the only real wealth in the near future will be practical knowledge/talents such as the "wealthy" and "educated" largely lack.

Hi Gail,

I think that one of the major problems with what comes next is that the data policy makers use (GDP, Unemployment rate, poverty line, balance of payments, etc) do not really represent reality and cannot be used to guide policy.

· If I shoot someone, the cost of their medical bills and my trial adds to the GDP.
· The GDP also does not evaluate short-term gain vs. its long-term opportunity cost.
· Those who've given up looking for work aren't unemployed & statistically don't exist.
· Middle class wealth gain was based on leveraged real estate at inflated prices.
· The poverty line (created overnight for a slide presentation) is not analytical based
· The balance of payments does not take into account job exports, and so is its undervalued

And I'm sure those of you who Blog here can add many more to my feeble list. Whatever new economy replaces the current one, we need to develop different economic measurements that actually reflect reality, rather than politically expediencies. At least two major depressions (the Great Depression & the forthcoming one) and many more recessions should be more than enough to convince us we need far better coal mine canaries and yardsticks to manage the economy.

I would argue for one that the GDP is next to useless, and would be both logically and politically very difficult to fix. A ratio I like to use is real spending on infrastructure vs. minimum needed to keep it from degrading. It at least lets you know if you are treading water or sinking. The GDP gives the false sense of security that if its trending up, you must be doing something right, which clearly now is not the case.

The U.S.A. spends more on medical care in absolute terms and as a percentage of GDP (16%) than any country in the world. And yet we have millions without health insurance and many countries do better than we do in terms of longevity and infant mortality (not to mention many other measurements). Add in the massive amounts of money spent on defense and I'd say the U.S.A. is way behind in terms of real quality of life.

Way back when I was working on my degree, I had a law professor that suggested that "gross national product (or GNP)" was nearly correctly named. Grotesque was his view in the way it summed everything up. He suggested that the net (in 1973) might be significantly negative, even then.

A lot of the shortcomings you refer to derive from the fact that we are trying to run the economy by referring only to an income statement, and not also a balance sheet.

Anyone trying to run a business this way would soon go bankrupt. Is it any wonder that the USA is in the process of doing just that?


I would suggest you look into the Austrian Economic theory where they advocate that all money be backed by something tangible (ie gold) and in this way, once cannot spend what someone else has saved. The fractional reserve banking system and Keynesian ways have led to this debt binge. I am quite confident that what you are ultimately advocating is also a gold standard and the discipline of Austrian economics. A good place to start might be www.mises.org

Gold-backed currency is no more effective or efficient, simply changes the group of winners and loosers in an "event". Bottom line is, no government has ever proven itself capable of monetary discipline (eg. French and Spanish royalty fought many wars by devaluing gold currency by shaving coins), often to small fractions of original intended values.

The only value in ANY currency, including gold, is your counter-party's promise to deliver what you consider to be fair value in exchange. Try eating your gold some time. Or google "Bretton Woods History".

The following post is something I picked up from the comment section of Mish's blog. Courtesy of commentor moonbat1775 and it was he who has come up with this idea.

Dedicated to Ludvig Von Mises, Murray N. Rothbard, Frederik Von Hayek and lovers of liberty everywhere and throughout time

Money as Investment:
A proposed 100% reserve, equity backed money and banking system

0. Designed for maximum economic growth and general prosperity consistent with stability and saver time preference. The money supply shall only increase through purchases of money from the bank with equities at current backing levels. The money supply shall not ever decrease. The bank shall redeem money with either bank capital reserves or equity from the backing itself if the bank should liquidate. In the case of bank capital, open market purchases shall be made with the redeemed money to put the money in circulation. If the money is redeemed with backing, then pro rata distributions to all money holders shall occur. The right to suspend redemptions in order to raise additional bank capital shall be retained.

1. This model assumes that true savings + saver time preference -> business loans -> productivity increases -> increased aggregate output -> decreased price level -> additional true savings, etc

2. The bank's money will be preferred shares in the bank. The bank's money shall be backed by equity in companies the bank lends or expects to lend to. Thus, new money shall be purchased with common (or preferred?) stock in those companies. Capital appreciation in the equity backing shall be sought via loans to the companies whose common stock is contained therein. This is the key feature that joins all money holders in a mutually beneficial arrangement for maximum continuous economic growth and shared prosperity.

3. Savings, according to the time preference of individual savers shall be lent out to business for investment purposes. Savers and bank share in the interest proceeds. Collateral sufficient to cover the principle and interest for the entire term of the loan shall be required.

5. Redemptions will occur by the exchange of money for equity from the banks capital reserves. Suspension of redemption shall be allowed to allow the bank to raise more capital if necessary

6. This model should produce growth in aggregate output, causing drops in the price level. This in turn allows more consumption and/or saving. It is also a 100% reserve system, so it is stable.

7. The initial issue of money shall occur by issue of preferred stock in exchange for a single equity. This shall set the par value of the money. For example: 100,000 shares of preferred stock in exchange for 1000 shares of Toyata at $50 per share. The initial (par) backing value is thus $50,000. For purposes of illustration, each share of preferred stock issued as money shall be called the "Hayek". Par value shall therefore be $.50 per Hayek in this case. This is the initial current backing requirement per Hayek. Thereafter, new money shall be sold for other stocks in accordance with the current backing level. As a result of productivity growth in the money, the current backing should normally increase over time. Note that the initial issue of the money involves use of another money, the US dollar. After a market is established for common stocks in Hayeks, this requirement shall disappear. Until that happens, the US dollar shall be used to determine the value of stocks within the current backing and thus the current backing level. Additional issues of money may now occur in exchange for other common stocks. For example, 100 shares of Honda at $60 per share shall now purchase 12,000 Hayeks. Redemptions of Hayeks shall now be in a single stock or combination of stocks from capital reserves at the current backing level. The money is established. Now lets make it grow in value.

8. Bank lending shall occur by the strategy of exchanging non-appreciating stocks in the money backing for equity in companies the Bank lends to. Thus Bank lending, in addition to earning interest, should normally lead to appreciation in the backing and thus the money itself. Though the money should appreciate over time, repayment in it should not be a problem since the money supply shall never shrink. Interest rates are therefore set by supply and demand and the expected profitability of the loan.

Acknowledgments: Impossible to list all since this seems to be the solution to the free market's need for a money system that allows the most rapid growth without the boom bust cycle. But among them Ludvig Von Mises, Murray N. Rothbard, Frederik Von Hayek and the Austrian School of Economics
Please inform of any omissions. This was produced by standing on the shoulders of giants and the author is awed and humbled he should have a part with them, if this is original and worthy of the free market.

Lengould, I humbly disagree with the assumption that Any currency's value is based on some counter party. If I have gold, I dont need to worry about someone delivering anything. Moreover, the gold in my pocket has value atleast close to the marginal cost of production. So it has some intrinsic value and can be used as exchange with other goods and services that cost close to their marginal costs of production. Paper currency costs nothing to produce but if one puts a bunch of zeroes on it, it magically gets more value. So an exchange of anything with fiat currency is an unfair exchange. It only works as long as some other fool will accept the fiat currency from you.

You don't get his point do you? - that you can't eat gold.
In a (very conceivable) land of starving or freezing people no-one will give the slightest shyte about how many gold bars you can give them in exchange for food or heating. Your gold will be worthless for all practical purposes such as keeping alive to enjoy a luxurious later year. Sure it is sounder than paper money, big deal.

A question for the more data inclined, I posted this on today's Drumbeat as well.

Does oil consumption within a country follow the pareto distribution for eg the 80/20 rule? i.e. 80% of the oil consumed in the US is by 20% of the population?

I believe the Pareto rule usually applies to the primary variable, i.e. the primary is the random variable that shows the greatest amount of dispersion. In this case, income is the primary variable, and the dependent/secondary variable of income spent on oil is once removed from the dispersive effect.

Good question though.

There was a good post on Calculated Risk a few days ago:


and this graph by Krugman suggests several equilibrium points for oil supply&demand :

The fact that oil is an exhaustible resource means that not extracting it is a form of investment. And it is an investment that might look attractive to a national government when oil prices are high. If a country does not want to spend all of the massive flow of cash generated by a sudden price increase on consumption, it must do one of three things: engage in real investment at home, which is subject to diminishing returns; invest abroad; or "invest" by cutting oil extraction, and hence reducing supply... So there is a definite possibility that over some range higher oil prices will lead to lower output. And given highly inelastic demand, as Cremer et al showed, that means that you can have multiple equilibria. Figure 1 illustrates the point: given the backward-bending supply curve and a steep demand curve, there are stable equilibria at both the low price PL and the high price PH.

Good points! Thanks for your comment.

So, do we think that the multiple "equilibrium" points are what can give rise to oscillations in price as we hit a resource constraint? That is, prices fluctuate wildly between the two metastable points as suppliers and consumers decide on a true equilibrium?

fascinating, to say the least.

This fits with what I've noted that the market has two stable price points 50 and 200.

The reason it would flip between the two is simply because its doing its primary job i.e price discovery.

The fact they are widely split when a market becomes unstable is probably not that important.
The market has basically put its cards on the table either peak oil is real and now or its not and
we have plenty of oil and we should pay "fair market" price for it. That would be the lower equilibrium point.

But I'd also add that I think these are saddle points and incredibly unstable. It makes intuitive sense that they have to be saddle points since the two equilibrium points have to be connected. Thus this double price situation must be inherently unstable.

Other forces have to act to remove this oscillation's since volatility is itself a huge force in the markets.

This follows that my conclusion holds either the market breaks the double stable points and settles around a new equilibrium at 50 or it swings back and does the same at 200.

It also could have done what it was doing which was pass smoothly through the lower point to the higher then break without ever tracing back. 200 would have been a new floor price and probably will eventually be the post peak oil floor once it does pass 200 and consolidates for some time we will never see it trace back through that point.

I think the problem is we see it as "wild" movements simply because the two stable points are so spread out.

If a real stable point had formed at 100 then our price range would have been say 100-150 big but not as "wild".

So its our own viewpoint thats coloring the problem we see it as wild but thats not that important. Its normal for a market to test its highs and lows its just we don't often see them this so far spread out. But uncommon is not the same as abnormal.

There was a post some months ago making a similar point, that most commodity price curves really have two primary price drivers -- the marginal cost of supply and the marginal price of consumption. While most price/demand curves are shown as lines or gentle curves, nothing says they need to be this way. Discontinuous step functions could be perfectly reasonable, yet create drastic shifts in price with seemingly small changes in demand.

It is also possible that the price curves have different shapes when rising versus falling. A guy with an SUV will suck it up and drive as prices go from $2 to $3, but when it hits $4 (his marginal cost of consumption) he sells it and changes to riding the Metro or trades it in on a compact. Either way his demand destruction persists even if the $2 gas returns. Any "savings" he might have had may become negative (the compact car payment or bus pass may be more than his old gas bill) relative to the previous solution, permanently changing his cash-flow dynamic (which had previously shifted due to the gas price spike) for other purchases as well.

I think we are seeing this phenomena writ large, with corporations and individuals shifting to new "consumption states", hopefully stable.

On the earlier control theory post -- without a thorough understanding of the transfer functions, it is hard to argue that any system with feedback, such as the oil price market or economy over all, is stable. A minor shift in the control function could support oscillation. Another perspective would come from chaos theory, such as where a modest increase in velocity of a fluid changes flow from laminar (well behaved and nicely modeled) to turbulent flow (wasteful of energy and harder to model). Certainly margin ratios are a lot like gain in a feedback loop, and it's hard to see how relaxing rules or increasing input to the system (cash) will increase stability.

I suspect the truly intractable aspect of the broader economic model is that much of the transfer function is in people's heads, and thus the behavior can change literally at a whim.

Memm you appear to be ranting incoherently here. First you say two stable points then you say they must be incredibly unstable. And price has never gone above 150 let alone reached your upper stable/unstable 200.
Meanwhile, while a dual stable system would fit in with that squiggly graph above, the recent price moves have surely been quite in line with simply the "wall" of inflexible supply increase.

Peak Net Energy:

So what happened in 2000 - 2001?

EWG estimates that US coal peaked in energy content in 1998. And natural gas went on plateau in North America. That NG peak has since been slightly exceeded, but only by drilling so much as to cut the EROI in half. Only oil has grown as an energy source (and imported coal in the form of Chinese goods).

It is not surprising that economic growth has been flat.

At the Sacrament 08 Peak Oil conference Matt Simmons commented that when he asked a room full of Barnett gas shale managers to raise their hands if they thought the EROEI was positive, and not a single hand went up. It will be interesting to see how much of our current energy production is a net loss once oil prices go back up.

Those are good points, about coal and natural gas production, and natural gas price.

One person when looking at the trend in real GDP data commented that he thought it looked like it had been managed, by adjusting the easiness of the lending standards and interest rates. It is not clear that the adjustments really produced growth though.

Hi Jon,


re: "...only by drilling so much as to cut the EROI in half."

Do you by any chnce have a reference or link you could point me to for this?

Has someone written more in detail on this point?

From the original information, the debt adjusted GDP was also relatively flat from 1970 until 1985. Then it started growing again. So a period of flat debt adjusted GDP does not necessarily indicate a bad future.

The price of oil is based on worldwide demand and yet the GDP charts are US only.

An analysis of this type would need to look at worldwide and global debt.

Worldwide there clearly has been real GDP growth (even after debt adjustment). (Mainly in China and India). Probably a fair bit in Brazil, Spain. Ireland etc...

Plus the energy companies (as the banks) are consolidating. Stronger or bigger players are buying weaker ones. There were projects and activity when oil was $10-20/barrel. There were oilsands projects when oil was at those prices. As steel and other prices come down and as inflated labor prices for oil services and workers go down there will be projects that will carry on with the lower cost basis. There will be companies that scoop up opportunities where a company locked in a bad cost structure.

There is a financial cleansing going on but it does not have to mean doom.

I thought it was interesting in This Time is Different: A panoramic view of eight centuries of financial crises by two economists states:

It is notable that the non-defaulters, by and large, are all hugely successful growth stories.

Theory suggests that this is the way it should be, and this is what happens in practice when researchers look at the data. If you don't have growth, you don't get enough money to pay back debt with interest, unless you can generate inflation. If there is inflation, the lender will want a higher interest rate, so you are back where you started. I think we are kidding ourselves if we think we can have much debt in a declining economy.

So the paper seems to be indicating that financial crises and defaults are fairly regular throughout history and countries also regularly recover from them.

So the statement about this time is different goes not only to those who think there will not be any more crises and defaults but also to those who think that the next time we do fall [and whether this one is a really big one - ala a depression or not is still not clear, although the general updated assessments now are fairly long recession based on the official Dec 2007 start date and mid/late-2009 recovery] that we won't be able to get up unlike every other time.

Well I think right now we are like the standard subprime borrower. We have got a loan modification and will default again in short order. You notice a double crisis split by a few years is very common. I think thats exactly what we will see here. I'm confident that the Feds will pull off one last reinflation although I prefer to call it a flat bubble.
Not crashing is a bubble. I do believe that demand will remain fairly constant and this will result in high commodity prices resulting in a aborted bubble. At that point we have no choice but to default.

This will obviously crash production just as much as demand so I think once the oil industry is forced to pull back we will then have a long period of a crippled world. I say its obvious because a lot of our current extraction is done in either extreme environments our countries that would become politically chaotic in a financial crash ( US included ).

We don't have a lot of easily accessible oil left and rebuilding the oil industry to the level its at today is impossible with the remaining oil. Once it fails its gone.

A chance exists right now and will from here on out for us to enter crash conditions. The only reason I don't think we will have a single crash event is that the fiat currencies have yet to enter hyperinflation and full debasement.
Its very difficult to come up with a crash scenario with fiat currencies that does not include massive inflation right before the end.

This may spur some to go out and get into debt but I'd suggest that for the US at least given its current debt load I doubt we manage much more inflation before we crumble. Right now we are probably toast if long term interest rates even climb up to say 8-10% so I doubt we even make it through to the hyperinflation finale.

Given the amount of money thats been pumped into the economy and the amounts we can expect Obama to inject in and attempt to revive the economy and the fact that most of the bad debt is now being laundered by the Feds I think that the worst effects of debt deflation are probably behind us. I'm not saying that we won't continue to have debt deflation as current bad debts are slowly moved off of bank books and I don't expect our banking system to recover it will be replaced with the Fed acting effectively as the direct bank with a small number of "front" banks.

We will be back against the peak oil wall and to be honest despite the price drop its still not clear to me that we ever left it. People think we did but the real situation is still very hazy.

I pretty much agree with what you are saying. We are going to stumble along. The plan would be to try to re-inflate the economy, to try to continue a while longer.

It seems to me we are very vulnerable in the next few years. It is possible that there may be enough momentum to carry us through the current crisis, and as you say, one last attempted reinflation. It seems to me that we will start seeing more countries falling into bankruptcies in the next 12 months, and attempts by the IMF to bail countries out becoming more and more limited by available fund. Some countries may fall over the edge before others.

Great stuff here. I'm new so please be gentle. Those whom think oil can go up infinitely are wrong.

While oil might go up in the short term rather fast, if held at high levels, over $70/bbl in present dollars, it's rise will be stopped from RE like biomass, wind, tidal/river power, solar thermal generators and most importantly, conservation which caused the present downfall though the financial crisis made it worse.

Many doubt it I live that way already and many other live making their own power, fuels. And mostly with old tech!!

When you are paying $50-100 a car tank full and $1000/2000 for a tank of heating oil it doesn't take an engineer to figure out insulation, more fuel eff cars are a better idea!!

I build 2 seat EV sportwagons that get 200-600mpg fuel cost equivalent using 50+ yr old tech. These get 80-120 mile range on cheap lead batteries and 50-80 mph top speed though they can go faster. It's not hard if you design from scratch. The 100+ mile range, 80 mph one can be built at a profit for $15k, $10k in mass production.

Nor is it hard to make the power needed to charge them, power an eff home. A 10' dia windgen and a 200sq' solar collector/6hp steam engine supplying 3kw electric, 10kw heat could be built, sold for $6-8k at a profit in mass production. One can even make money with it!! I can do them for $2500 in parts in my small shop.

In fact if done right, building insulating/hurricane proof shells on present homes, business and adding RE where doable with large scale RE for those renting, ect could power help us lower costs with more jobs, energy savings.

If oil, coal had their true, full cost in them RE, conservation would already be the dominate energy source. And that doesn't include CO2 costs!!

As for the recovery building these RE, conservation will be the cornerstone of pulling out of this recession. And keep oil, coal, food prices down over time.

Now add GTL tech making stranded NG, biomass into syngas/H2-CO into gas, diesel, ect we become energy independent in 5-8 yrs
if we are smart. That means we have $800bllion/yr more money in our pockets that use to go to overseas oil, big coal now, making worthwhile jobs here.

Next point is why the crisis hit was we were in stagflation in real buying power. Inflation since 200-2008 was 100% average to most of us while wages went up only 20% which bled us dry till there was nothing left but debt, thank directly to Bush, repub energy, tax, debt, regulation policies.

Once the US pop runs out of money the world hurts. One benefit is our buying power is going up fast if we still have a job!!

The good point of this course keeping oil prices low is it starves terrorists, oil dictators, Russia, Venezuela from causing problems might bring us peace even!


Great stuff here. I'm new so please be gentle. Those whom think oil can go up infinitely are wrong.

While oil might go up in the short term rather fast, if held at high levels, over $70/bbl in present dollars, it's rise will be stopped from RE like biomass, wind, tidal/river power, solar thermal generators and most importantly, conservation which caused the present downfall though the financial crisis made it worse.

Many doubt it I live that way already and many other live making their own power, fuels. And mostly with old tech!!

When you are paying $50-100 a car tank full and $1000/2000 for a tank of heating oil it doesn't take an engineer to figure out insulation, more fuel eff cars are a better idea!!

I build 2 seat EV sportwagons that get 200-600mpg fuel cost equivalent using 50+ yr old tech. These get 80-120 mile range on cheap lead batteries and 50-80 mph top speed though they can go faster. It's not hard if you design from scratch. The 100+ mile range, 80 mph one can be built at a profit for $15k, $10k in mass production.

Nor is it hard to make the power needed to charge them, power an eff home. A 10' dia windgen and a 200sq' solar collector/6hp steam engine supplying 3kw electric, 10kw heat could be built, sold for $6-8k at a profit in mass production. One can even make money with it!! I can do them for $2500 in parts in my small shop.

In fact if done right, building insulating/hurricane proof shells on present homes, business and adding RE where doable with large scale RE for those renting, ect could power help us lower costs with more jobs, energy savings.

If oil, coal had their true, full cost in them RE, conservation would already be the dominate energy source. And that doesn't include CO2 costs!!

As for the recovery building these RE, conservation will be the cornerstone of pulling out of this recession. And keep oil, coal, food prices down over time.

Now add GTL tech making stranded NG, biomass into syngas/H2-CO into gas, diesel, ect we become energy independent in 5-8 yrs
if we are smart. That means we have $800bllion/yr more money in our pockets that use to go to overseas oil, big coal now, making worthwhile jobs here.

Next point is why the crisis hit was we were in stagflation in real buying power. Inflation since 200-2008 was 100% average to most of us while wages went up only 20% which bled us dry till there was nothing left but debt, thank directly to Bush, repub energy, tax, debt, regulation policies.

Once the US pop runs out of money the world hurts. One benefit is our buying power is going up fast if we still have a job!!

The good point of this course keeping oil prices low is it starves terrorists, oil dictators, Russia, Venezuela from causing problems might bring us peace even!


You just made the same error I made earlier today, a double post. I attempted deletion editing with partial success.

Hi jerryd,

Fellow newbie here!

I think it's awesome that you're making these super-efficient electric cars, but I'm afraid I don't share your optimism about our prospects in the face of an oil supply shortage.

Perhaps if oil prices could be held serenely fixed at, say, $120 per barrel, we could all 'sit back' and watch our civilisation gradually adapt and switch over to renewables under the assured guidance of the invisible hand.

However, the conclusion that commentators like Richard Heinberg and David Strahan have come to is that there simply isn't enough time - the crisis in oil supply is going to hit us in the 2010s, way before the transition phase is complete (as of right now, it's barely even begun!)

Moreover, as Kunstler (and Heinberg and Strahan) point out, the transition is more than just a question of where we get our energy and transport fuel. Our entire way of life - commuting miles each day in big cars from leafy suburbs into gigantic cities, having 2% of us grow vast amounts of food for everyone using gigantic oil-powered machines on oil-fed crops in overstrained topsoils - is completely unsustainable without fossil fuels.

The suggestions you make are sensible as far as they go, but in truth, the scale of the societal change that's going to be necessary to solve all these problems - just to avoid a Malthusian catastrophe - is almost beyond imagination.

I think the real cause of super-low oil prices is simply the crash itself. The entire world is much poorer than it was 6 months ago and producers are selling all their oil to give themselves spending money or at least a 'safety margin'. This applies to overspending oil exporters like OPEC, Russia, etc. Today they are a lot poorer then they ever thought they'd be.

Just 6 months ago there was nowhere but up and oil producers were on a spending spree. Now the money's gone and they are at the pawnbroker trying to raise cash.

Given the sharp drop of 50% in the world's stock markets, it will take a good while for oil exporters to make up even a portion of their money from equally broke consuming countries.
A ten million barrels per day at $50 per barrel is a paltry $180 billion dollars per year.
Russia has a $1.7 Trillion dollar economy and has $500 billion dollars of debt.
Sell energy! Sell it all!

Why is the price of gasoline so low? It is because Europe and Asia use so much diesel. The ratio of gasoline to diesel percentage from a given barrel of crude can vary only a small amount. To get enough diesel they create gasoline they can't sell over there so they have dumped it in the USA. They have dumped too much here so the price keeps falling.

This site has gotten to be too funny for words. The decline in oil prices is part of a natural economic cycle. As a result of the decline, in all sorts of commodity prices, including the price of money, a huge flow of funds is moving in the direction of consumers. The average family will see savings of more than $10,000 this year and they will spend it elsewhere. Just when everyone seems to think the wheels have fallen off the wagon, the cure is here.

jackafuss, you just don't understand the new logic...if oil prices are rising very fast that is a sign the end is near because the suburbanites can't survive it, food prices will rise and we will all starve, and we can't afford to haul Chinese underwear to Walmart so the gig is up...

But if oil prices are falling very fast, that is a sign that deflation has set in, the companies won't be able to make money on anything so they will fire all of their employees and shut down, the banks and investors will become terrified and hoard money, and we will be in an endless death spiral...

So if oil prices rise it's proof we're screwed, and if oil prices fall it's proof we're screwed...heads I win, tails you lose...

Of course there is a third alternative no one talks about...that being that any and everything about the modern American economy and lifestyle is so hated here that any scenario can be turned around to prove that it's over...that it will end in a horrific crash because it and those who support it deserve to end in a horrific crash...basically a theory of just punishment for the greedy aging boomers who had hoped to get to retire with enough money to bribe the healthcare industry into keeping them alive long enough to see their grandchildren for a few years (or as Gail says it "I think the problem is that everyone needs a devaluation",yeah right, most average working class folks have NEGATIVE net worth, what the hell are you going to devalue them out of...oh, that's right, take their house, their healthcare and their job, because they don't need crap like that, right?)..in the meantime the financial community vultures are in Europe having "conferences" at hotels that look like castles and riding around in huge limos talking about how badly thier "industry" has suffered in this "deleveraging". What an f-in joke.


I agree that is one of the issues as well. And then we have all of the mandated ethanol.

Gail, I can see a problem in your calculation of debt-adjusted GDP:

Suppose the nominal debt in year y is debt(y) and the nominal debt in year y+1 is debt(y+1).

Let r(y) be the ratio of prices in year y to prices in the year 2000.

Let r(y+1) be the ratio of prices in year y+1 to prices in 2000.

Then your calculation proceeds as follows:

First you calculate debt(y+1) - debt(y), the nominal debt increase during the year. Then you calculate the *real* debt increase as

(debt(y+1) - debt(y)) / r(y+1).

This is wrong, because you're ignoring the fact that last year's debt was in last year's prices. The correct formula, I think, is

debt(y+1)/r(y+1) - debt(y)/r(y), which is somewhat smaller.

The net effect, then, is that the debt adjustment is smaller than your numbers suggest.

Between 2000 and 2007, rather than falling from 8147 to 7954, debt-adjusted real GDP climbs from 8684 to 8937.

One could argue that this is a bit of a nit-pick, because the 'big picture' still shows the economy virtually flat between 2000 and 2007 (0.4% p.a. growth on average).

Still, I think it's an important correction to make.

As you say, though, the results come out fairly similar either way. I'll keep it in mind if I do a similar calculation later.

Gail, thanks for your story on oil prices!

You wrote:

The recent drop in oil prices has truly been extra-ordinary.

Inversely related to the drop in oil prices is the extra-ordinary rise in the USD currency in which most oil is priced. The value of the USD may have reached a top for both fundamental and possibly technical reasons. On December 8, Boris Sobolev said:

The problem for the Fed is that about $5 trillion of government debt (more than one third of the GDP) is held by foreigners. Most important US creditors are China, Japan and the Gulf States. For these creditors to continue to buy US debt while the interest rates are artificially deflated is not only unprofitable but also dangerous.

Japan has already hinted that it will only make further purchases of US debt only if such debt is denominated in yen. This means that the US trade partners see the threat of the US dollar decline, which could start as quickly and furiously as has been its recent rebound.

Conclusion: If the Fed continues, as declared, to support interest rates at artificially low levels by the way of debt monetization, a major down-leg in the US dollar is inevitable. What’s most difficult is to predict is timing. We believe that this process will occur in full swing in the first part of the next year.

Technical analysis might be indicating that the down-leg in the US dollar could be starting now. A technical pattern that can suggest a top is called "Head and Shoulders". Once the right shoulder has been formed, this represents a bearish signal for the chart.

This "Head and Shoulders" pattern has formed for the US dollar and is shown by the USD index in the chart below (LS=left shoulder, H=Head and RS=right shoulder).

source: http://quotes.ino.com/chart/?s=NYBOT_DX&v=d12

If the US dollar does start dropping then the oil price is likely to have reached a bottom this month. In July the USD Index was only about 72 when WTI oil prices were almost $150. Since July the USD Index has shown an extra-ordinary increase up to almost 88.5 last month. It is now under 86.

There is a possibility that oil prices could rally, measured in USD, starting very soon. The strength of this rally depends partly upon the size of oil production cuts that OPEC will announce next week.

Many of the previous oil price lows have occurred around December. Most notable was the low of about $10 in December 1998. The most recent low was in January 2007.

The dashed black line indicates that oil price might reach $150 by December 2009, if the historical logarithmic price channel is used as a guide.

click to enlarge

Hey I did not bring in the dollar :)

I think a good way to look at the value of the dollar is as follows. Many people make the claim that US debt is not like Argentina because its valued in dollars that we print. What they are missing is we are a debtor economy i.e people have to exchange other arguably better currencies for these dollars to buy our debt.

In many cases this means the return of US debt converted to another currency is important. As long as interest rates are adjusted in a way that our investors feel we are correctly taking into account inflation in our currency its not a big deal. However the current situation of low interest rates and the US obviously inflating while the currency remains strong is unstable long term. Or creditors will eventually force us to devalue our currency and increase interest rates.
I.e our bond market will collapse.

I don't think there is anything the Fed can do about it and right now its goal is to make as much use of the current imbalance to spend as much as it can saving the people it wishes to save. I'm sure you notice that the Fed did not step in and use the TARP money to directly bailout the Automakers instead it got routed to Congress as a different bailout.

I assure you this did not go unnoticed. Also you may have noticed that most of our creditors have their own ailing auto industries.

I agree that the gig is probably close to up with the strong dollar. I think that if the Fed does cut 50 basis points we will see a sharp drop in the dollar soon there after. Needless to say both the strong dollar and the bond market bubble are reaching the breaking point.

Now I think the plan of action is for the Fed to start buying up long dated treasury bonds to forestall a bond market dislocation thats too large. Its hard to say but with the dollar topping out it seems to me that some moves to monetize the debt with the current favorable conditions need to be made.

But the bottom line is we really are not all that different from Argentina since the buyers of our debt are foreigners its effectively the same as having the debt in external currencies. A bit more complexity but thats all in my opinion.

I think we will see the following.

1.) Dollar collapse
2.) Stock market skyrocket
3.) Bond market collapse
4.) Oil prices skyrocket

5.) Eventually lack of foreign capitol inflows forces us to increase interest rates.

Any one of the four will cause the other ones to move in the directions I'm indicating.
Number 5 is really the end game once we are forced to increase interest rates regardless of the state
of our economy we are toast.

Now I think the plan of action is for the Fed to start buying up long dated treasury bonds to forestall a bond market dislocation thats too large.

Long dated treasuries rose today on mortgage related buying and prospective Fed purchases.

The quote below is from http://www.financialmirror.com/News/Business_and_Finance/13001

Treasuries got a hefty boost on Monday after Fed Chairman Ben Bernanke said the U.S. central bank might buy long-dated Treasuries. Such a move would help lower mortgage rates and address one of the root causes of the global credit crisis.

The Fed is in a difficult position now. It's trying to keep long term interest rates down so that mortgage rates are low which should reduce the mortgage delinquency rate. However, buying treasuries means that more US dollars enter the market placing further downward pressure on the USD index.

In addition, the total US bailout must be close to $9 trillion now as it was $8.6 trillion as of Nov 19, shown below. This has to be placing more downward pressure on the US dollar. Holders of US treasuries and US dollars must be getting worried now. If the US dollar starts falling soon, then treasury holders will want higher interest rates as compensation for a lower dollar.

There is a chance that the following simultaneous events could be starting now: US dollar falls, US bond/treasuries fall, US interest rates rise, equity markets rise (in USD) and commodity prices rise including oil (in USD).

Item Issuer Amount of Outlay
Commercial Paper Funding Facility Federal Reserve $1.8 trillion
Temporary Liquidity Guarantee Program FDIC $1.4 trillion
Term Auction Facility (TAF) Federal Reserve $900 billion
Fannie Mae (NYSE: FNM), Freddie Mac (NYSE: FRE), and Ginnie Mae U.S. Treasury / Federal Reserve $800 billion
Treasury Asset Relief Program (TARP) U.S. Treasury $700 billion
Total USD International Currency Swap Lines Federal Reserve $688 billion
Money Market Investor Funding Facility Federal Reserve $540 billion
Other Loans: Primary Dealer Credit, etc. Federal Reserve $288.7 billion
Citigroup (NYSE: C) Guarantee U.S. Treasury / FDIC $306 billion
Hope for Homeowners Act of 2008 U.S. Treasury $304 billion
Term Securities Lending Facility (TSLF) Federal Reserve $225 billion
Term Asset-Backed Securities Loan Facility (TALF) U.S. Treasury $200 billion
Economic Stimulus Act of 2008 U.S. Treasury $168 billion
Paid to JPMorgan Chase (NYSE: JPM) to Settle Lehman Brothers Debt Federal Reserve $138 billion
AIG (NYSE: AIG) Bailout Federal Reserve $112.5 billion
Bear Stearns Brokered Sale Federal Reserve $26.9 billion
I'm afraid to look … Total: $8,597,100,000,000


I just started reading Gail's link.


I'm not all the way through but they show that treating domestic and external debt as different is a mistake.
Believing we are safe because its external buyers and dollar denominated is even more tenuous as I tried to point out.

And now the heated debate is whats the order that this will occur. observer1 ( Don Ross ) claims that the stock market rules all and will rise first. However he admits the dollar could decline leading to the rising stock market.
This leads to a bond sell off then rising long term rates and we are off to the end game.

This time around I really believe nothing is going to move i.e the bear market rallies will fizzle until either oil bottoms and starts rising strongly or the bond market collapses. Or I agree the dollar declines.

The reason is I think the selling sentiment is too high and the short squeezes will fail to turn into a real rally.

Regardless the macroeconomic situation will force us into a weak dollar high interest rate position. We really have no choice given the debt load. This is I think one place we have a enormous difference between Europe and the US. They don't have anywhere near the debt loads we do and can control their interest rates and to some extent currency strength much better than us.

And you can't pick simultaneous ! Thats cheating :)

We also want to consider that oil in this decade became a liquidity medium, as it provided channels for capital to fly around the world at a likely increasing velocity. Oil's fall like other asset declines was both a result of liquidation, but, has had its own deflationary effect.

Velocity and liquidity are really interesting phenomenon. They accelerate in each direction. That's part of the reason why monetary policy is so hard and rather doomed. Inflation(s) get really out of hand, and so do deflation(s).

Given the global money flood, as long as a number of key assets start moving in the right direction, then reflation which is its own self-reinforcing phenomenon, will start to take hold more quickly than people might presume. I would list those four key assets as the Yen, The Dollar, Global Equities, and Oil. You have to "reflate" to get those 4 moving. But once they start moving, then reflation starts feeding on itself.

I would argue that if equities simply stopped going down, and then the Yen and the US weakened and oil started firming up, then reflation would be on its way.

But until that starts to happen, then the accelerator will keep pulling things down in the deflationary direction.

I think Peter Thiel who is pretty good on the macro said today "It's deflation until it isn't. Could be this week, next month, or next year."

I think the turn is, in fact, going to be rather sharp.

Oh, Theil also thinks a re-test of the high in oil in 2009 is now very likely to happen.


Yep close enough. I generally don't split the Yen/Dollar and pound for that matter because the Yen/Dollar/Pound are in my opinion really variants of a single currency. The Euro is both a newcomer and constrained by its constituents to act more like a store of value. But the CB's of Japan,US and Britain can safely be considered a single unit.

The real monkey wrench in this grand plan is China. I think people will be surprised at how serious they are about building up there domestic market and how prescient they will be of the coming default of the US. Even as exports revive I think they can and will transition to a more balanced economy. This will put tremendous pressure on oil.
India will be forced to tag along out of fear of being overwhelmed.

Thats the real spanner in the future.

And yes we can do this until the fiat currencies are all defaulted on. As long as people are willing to accept them even as they devalue vs and good thats in short supply the game can continue.

It's interesting to note that the last two People's National Congresses in China
('07 & '08 ) had the development of domestic consumption as one of their central
themes for discussion. I think they could sense that the prevailing situation was

Gail, Memmel
I just read your linked Harvard paper on This Time Its Different
(really good - reminds me of The Great Wave)

one question on the chart on page 38 Figure 10 "The Runup in Domestic and External Debt on the Eve of Default.
Aren't US levels today much higher than that?

Certainly on the domestic side - the external side is more difficult to measure given the US reserve currency status


Geeze man our creditors might read that and start doing some critical thinking.

Also look at China's balance sheet they have decades to run up deficits to grow there economy.

I think Figure 10 is just an indexed amount. The base index=100 is debt at T-4. If we were to assume T for the US will be 2009, the index year would be 2005. If we assume T will be 2010, then the index =100 at 2006.

I would think the debt is just T-bills and such, split between internal and external holdings.

The point of the graph I believe is that internal and external debt seem to run up at about the same rate prior to default.

It is as if the FED and Treasury completely understand that heavy treasury issuance, combined with quantitative easing and now outright monetization, are unsustainable actions that will eventually need an escape valve. And so, they are accellerating the pace of each action, as though they hear the clock ticking, on the wall. And while this occurs, they get to sell into a raging bond bull market that is likely in its blow-off phase from whence it began in 1982, thus borrowing at historically low rates as global capital crushes through the doors of every Treasury Auction.

I can think of no more perfect end to this story, than to have the man who started the bond bull market, Paul Volker, in 1980-1982, return to Washington to preside over its crash.


In October, I wrote:

First, The FED could be getting close to more unconventional measures, like direct buying of long-dated Treasuries to bring long-rates down. Second, the quantity of new Treasury issuance, both in train and intended, is so gargantuan that it’s not clear how the world would be able to actually take up the supply. There may be structural limitations. Simply put, it’s not clear there’s enough available capital in the world to increase the US debt position further. After all, we have already been sucking up the world’s savings for most of this decade. It strikes me the only method to ensure this new supply is taken up would be that other central banks would eventually have to monetize the USA, in the same way the USA is monetizing its own banking system. So future Treasury issuance may depend either on our own central bank to monetize it, or for foreign central banks to do the same. When either happens, I’m of the opinion it’s Game Over.




I have a hard time seeing stock market skyrocket, unless you are looking at hyper inflation, if the bond market collapses.

Bond market collapse = high interest rates = many defaults on bonds

Stock markets do not do well in these conditions. There are likely to be many bankruptcies. The present value of future earnings is likely to be pretty poor, since the ability to invest for the future is pretty bad.

What am I not understanding?

Sorry do well is relative just a strong bear market rally. I believe the real value of the S&P 500 should be 500
or close to it when we crash. Basically anything over 500 is a bull rally anything over 800 is well over priced.

I'd say S&P 1000-1200 is easily possible. Its just if it starts to rise and it seems to want to and the bond market start crashing money will rush into stocks for lack of a better place to go creating a sort of artificial rally.

Companies are now pulling back and many will report profits or small losses over say the next several quarters for the most part this is acounting tricks and cutting back on expenditures.

Look at the Great Depression there where several large bear market rallies before the market finally crashed.
It does not go down all at once. I'd be surprised if the next one lasted more than 6-8 months at most.

Maybe one more and after that the insanity will be out. Also we are on the verge of inflation and a falling dollar this will cause a rally just by virtue of the currency being devalued.

The Great Depression took several year to sink in our inflationary collapse will take time.
With a number of head fakes along the way.

In general if you read by blasting us with bad news now any not bad news is going to look really good to a few folks soon.
Lots of psychosis in the stock market.

Thanks for your explanation. That makes sense.

Even if there is a need to cut way back on debt, I don't think that this lesson will sink in for a long time. People don't learn. And as you say, news that is not as bad looks good in comparison.

Thanks for all the information!

You are right--if the dollar starts dropping, the price of oil (in US dollars) will likely rise. It is hard to believe that other countries would be willing to buy dollar denominated debt, when interest rates are artificially low.

It seems strange to me that oil prices have fallen so far outside of the expected band, but we do have the credit crisis and the rising dollar involved.

Below is good example of using the "Head and Shoulders" pattern to show a top. Bear in mind that it's always easier to find a good example using hindsight.

The head and shoulders signaled a top to this rally. (The Japanese Yen had been in a downtrend for more than three years prior to this relatively short lived upmove.) As you can see, the head and shoulders pattern is easily recognizable on the price chart. While the volume chart is not as clear, closer scrutiny will reveal that indeed each topping day in the pattern was made on diminishing volume. The big jump in activity just prior to completing the 'head', was done on short covering, (shorts getting out of their positions rather than new longs coming in.) However, the familiar spike in volume is evident on the breaking of the neckline.

My opinion is these classic head and shoulder tops are a perfect example of the dual equilibrium points.

Shown in this thread.


For some markets volume can be substituted for supply. And the head and shoulder pattern forms when the market
mirrors itself on the way down.

The point is its a common situation and generally the distance between the head and shoulders is small.
However it is a fractal as you pull back on markets you see new "meta" head and shoulder forms forming.
This means its scale invariant.

If I'm right about oil we just passed the left shoulder which means the head is going to be a doozy.

I have my doubts we will last long enough to really form the right shoulder.

Back to what I said about this pattern being common and scale invariant whats happened I think is that a meta
pattern that should have formed over decades has in a sense been compressed in time. My best guess is that this pattern was probably starting to form in the 1980's but was disrupted by massive financial engineering.

If I'm right it would be interesting to look at markets that where disrupted that reformed a new peak.
And example for oil would be Russia I'd not be surprised to see a classic head and shoulder pattern now forming.

Even more fascinating would be KSA which also has repeatedly disrupted its oil exports. We would expect a similar
compressed head and shoulder pattern to form.

Its known from population studies that extreme oscillation can form right before the population enters final collapse.

It would be neat if people find examples of this since I surmise that head and shoulder patterns which are a very common topping signal did not form prior to collapse and the pattern became compressed.

Googled a bit and its way to common a term in the classic sense finding distorted ones would be difficult.
I'd not be surprised to see that some of the financial companies that recently collapsed did not form a partial
and fairly extreme pattern at the end. And I suspect the patient generally dies before the pattern fully forms.
The best bet may be other commodities which can actually survive a compressed head and shoulders event.

Memmel - some of your other posts look useful but here you are wading far out of your depth.
Head and shoulders is a part of technical analysis of price movements (as opposed to fundamental analysis). Technical patterns result primarily from behaviour of speculators (and market-manipulators) and where there is intrusion of changing fundamentals such as geo-constraints or KSA policy shifts, then that constitutes noise for the technical analyst, not part of a TA regular pattern.

In respect of HeadnShoulders, it does not have the same status as following of trends (by trendlines and moving averages). I have not seen any sound evidence that HeadnShoulders really have any predictive power, not even any attempt at demonstrating it, just anyone can "see" them in hindsight. And they most certainly don't work on the scale of decades as you suggested.

One used to hear that the US gov't debt didn't matter, "because we owed it to ourselves". One doesn't hear that anymore, because it can't be said.

Issuing US treasury obligations denominated in anything other than US dollars would be such a huge red flag that it would be a clear signal even to those with a lower IQ than the number of pennies in their pocket that it is time to bail out of just about everything, big time. It truly would mark the beginning of the end. Thus, I really doubt that it is going to happen.

I also doubt that the Japanese and Chinese are going to continue buying Treasuries no matter what. They need not implement the "massive dump" scenario that everyone is so afraid of, they can just quietly and politely decide to pass on the opportunity to make further purchases. It will still be bad news.

If we can't sell dollar denominated treasuries overseas, and if we can't sell foreign-currency denominated treasuries, then the only remaining options are either to: a) stop issuing treasuries (i.e., stop monetizing the debt and inflating the currency); or to b) find some way to sell them domestically.

Since option (a) would put the economy into free fall for certain, then option (b) is going to have to look like the most attractive available option to policy makers.

The problem is, there are not exactly a lot of potential buyers out there in the domestic economy right now. In fact, I can only see one possible stream of money that could potentially be tapped into: the continuing contributions of workers into their retirement funds. In other words, their only option is to "pull an Argentina", nationalize all retirement accounts, and require that all new investments be allocated to US Treasuries. They might even require a gradual liquidation of other investments in retirement funds in order to free up even more funds for purchase of US Treasuries.

Protecting workers from further losses will be the justification: Your retirement savings will be "safely" invested in US Treasuries.

Coming soon to a retirement account near you. . .

The fact that Treasuries are denominated in dollars is a red herring. All that matters is that the people who lend money expect to paid back without massive dilution of the currency or other shenanigans.

The paper that Gail posted makes a good case that it does not even matter who buys the treasuries.
If you think about it that makes a lot of sense. If I owned treasuries and the US gov inflated them away I'd not buy any more.

The point is once a government decides to inflate away its debt its effectively in default regardless of who it borrowed money from. None of its lenders will provide more money.

Being the reserve currency does allow us to inflate inline with worldwide growth not just growth in the US. Thus as long as the world economy is growing and using dollars we can expand the currency base.

A reserve currency is simply a substitute for gold. No one really cared if a country expanded the gold supply and injected it as currency outflows into the rest of the world. Until of course the world economy was contracting then the gold would be unwelcome monetary inflation.

I suspect that just like flooding the world with gold when the economy is contracting flooding the world with dollars will not be a welcome event. The rest of the world does not need our dollars and probably more important they don't need the US mucking up exchange rates with a massive dollar inflation campaign since they need to devalue their own currencies and inflate against the dollar.

My feeling about the banking situation is that you had a lot of phony assets being created for a number of years in the form of derivatives of all sorts, and every time one of these things got another slicing and dicing those creating it pocketed a few percent as a commission.

And I would imagine that there are a fair number of people in the banking business that made a small fortune that way.

And now the banks sit there with these "hollow assets" on their books, and due to the money that was sucked out of them from those various commissions and such, those show book valuations that are higher than the actual asset is worth.

Of course, I am neglecting the additional fact that the sliced and diced CDOs contain a lot of mortgages that are worth a lot less than is shown on the books because of the ones that have gone delinquent, etc.

So as I see it, the banks hold these mortgage-related assets that have been degraded in two ways- one from the actual degradation of the underlying mortgage, and the other from the fact that money has been bled out of them in fees for the service of creating a pyramid of derivative structures out of them, even though those structures have no actual value above and beyond the value of the mortgages that they were originally woven from, in fact the derivatives have probably actually created "value lost", because the mortgages have been turned into hairballs which will cost a lot of money to untangle.

Also, going forward, we really don't need any more of the sliced and diced CROs, so the work for a lot of people is disappearing. Rescuing the banks was needed to prevent the whole system from collapsing, but at the same time, we really don't need all of these services any more. It is hard to see a nice transition from our current system to a new one.

That is looking at it form a glass half empty POV.
From a glass half full POV, then vast numbers of some of the brightest people in the land will cease their entirely parasitic activities, which is a gain from the present time, and then you have the added benefit that they can actually start doing something worthwhile, so you gain again.

The same applies to many of the current structures. Malls, for instance, will no longer need heating, reducing power requirements and strain on on the grid.

Another big one is the collapse of the car industry, which will free vast numbers who are in engineering and are currently engaged in building cars no-one will have the fuel for.

It would also free material resources to dwarf any demands for building renewables or upgrading the grid, or upgrading railways.

Meanwhile, the collapse of the McMansion building industry frees both men and materials for insulating houses.

Even if the change is painful, it is better to have made a start than to continue with a bankrupt system.
We are better off i 2008 than we were in 2007.

Also, going forward, we really don't need any more of the sliced and diced CROs, so the work for a lot of people is disappearing. Rescuing the banks was needed to prevent the whole system from collapsing, but at the same time, we really don't need all of these services any more. It is hard to see a nice transition from our current system to a new one.

As to the oil supply/demand situation, it seems to me that "supply destruction" is liable to be a considerably more powerful force than demand destruction, although whether we will see prices start to rise very soon or if it may take a year or two.

We know that existing wells are depleting at 9% per year. We also know that the low oil price has drastically slowed down development work to bring new supplies online.

We also know that OPEC is aiming to reverse the collapse in prices by slowing down production. (although I acknowledge there is good reason for skepticism on to what extent the members actually abide by their production limits)

On the supply side, we no doubt have a few percent drop in demand in the developed world, and demand has probably flattened out in the developing world.

I do agree with those that think that US natural gas may still be quite vulnerable to further price drops, due to the supply increase associated with development of the Barnett, etc, etc shales.

As to oil, I do hope that it does recover soon. Certainly for the public good (low oil prices are disastrous for alternative energy development, and send everyone exactly the wrong message, namely, "we may have a lot of problems but running out of oil is not one of them" (aarg)

And, frankly, I want oil higher for my own self-interest, since I own some stock in Petro Canada, Talisman, and Apache.

Lance -- I agree that Ng prices may have continues downward pressure in the short term (6+ months). But the unconventional NG players are cutting back drilling budgets significant. I consult for one of the biggest players and they’ve cut the 2009 budget from over $1.4 million to less than $700 million. Over the next few months we’ll be releasing 405 of our drilling rigs. We have good credit lines but the decision was made to just drill from cash flow. Chesapeake also appears crippled to a large degree.

While the unconventional NG plays did provide a good up tick in production most understand their rapid decline rates. It was only the continued ramping up in the plays that kept rates up. We’ll likely see at least an 18+ months drop in drilling activity IMO. Perhaps a good bit longer. I can’t gauge how quickly this supply destruction will occur but I suspect many will be shocked. Even in the face of a continuing recession we could be hit with much higher NG prices by as early as next winter.

I can’t gauge how quickly this supply destruction will occur but I suspect many will be shocked.

Shocked :)

I'm actually very interested to see how this plays out for NG. Since its effectively the same
as the end of exploration for a fast declining resource. My opinion is it forms a cliff.
Bets guess is 20-30% decline in a year.

This is a prototype in fast motion for what I contend is happening to old fast oil.
As goes unconventional NG so goes about 15% of our oil supply.

Correction for above: 40% ...not 405

Can the released 40% of your (and others'?) NG drilling rigs be reallocated to relieve the shortage for oilfield drilling which Matt Simmons keeps alarming about?

Financial Markets are moved by contagion and hysteria. New communications technologies magnify suggestibility. Mesmer and Charcot are better guides to the new economy than Hayek or Keynes.

- John Gray in Straw Dogs

I did a similar debt adjusted GDP analysis with figures from Statistics Finland.
The resulting graph is much less alarming.
Finland doesn't have as nearly as much debt as US.
This current crisis will hit Finland hard. But not nearly as hard as US.
I'd post the graph but I don't have time to figure out how to get the graph out of openoffice.
The figures are publicly available from www.stat.fi.

All of this is being done specifically by design, to implode the energy sector and transfer all energy-related assets to Bilderberg members at fire sale prices. Once they have control of the vast majority of energy and raw materials production, they can do pretty much whatever they want. Including accelerating and upscaling their eugenics operations.

Consider figures 3 and 4 in light of the fact that the US population has continued to grow. The US population increased from 270,298,524 in 1998 to 301,139, 947 in 1997 - an 11.4% increase. Since aggregate real GDP has essentially remained flat in spite of that population growth, that means that over the past decade, US real per capita GDP has actually declined by that much. No wonder so many people have been feeling so poor in spite of supposedly prosperous times.

I assume that population was supposed to be 2007, not 1997, but a really good point.

I'd like to know more about Figure 4 and how it was put together, but on the face of it, this appears to be one of the roots of our current mess. The last 8 years of growth were like a big credit card binge when your salary has stayed the same. That can only go on so long.

Here is the question for the US, can we ever make the red line in Figure 4 go up again for any significant period of time? If we can, than the Obama stimulus might work if it is directed at things that will stimulate growth in the economy. If we can't, more government borrowing might make matters worse. Just sending people checks so they can run out and spend them at the mall might make the numbers look good for a quarter but it probably has a long term negative effect on the red line. Its like getting another credit card and blowing the money on stuff you don't need instead of investing it in things that will help dig out of the hole.

My gut is telling me that there is not much that can be done to make the debt adjusted real gdp (the red line) go up. This is what will happen when we bump up against natural limits to growth and I have to agree with Gail that we are probably at or near that place. We need to be thinking of a steady-state economy and abandon the growth at any cost model. Its going to be hard to give it up though. How many politicians want to say "I promise that things will be the same or a little bit worse in the future than they are today!"

I operate under the assumption that the days of sustained real economic growth are over, due to the resource constraints that we all know about here on TOD.

It appears to me that, at best, the US MIGHT just possibly be able operate an economy on a truly sustainable basis at something like maybe 25% of present real per capita GDP. This is by no means certain, we might actually have to level out at a much lower level. I have not personally seen any credible analyses that give me reason to believe that we can hope for anything better than that 25%, long-term. (By "long-term, I am thinking in terms of about a century or so.)

This in turn suggests to me that we have a long ways to decline. As has been discussed on previous threads, I tend to be sceptical about smooth projected economic trajectories; the typical patterns seem to always have a considerable amount of up and down noise around the long-term trends. In particular, I suspect that what we have to look forward to over the next several decades at least, and probably for the lifetimes of just about everyone reading this, is more of a "stairstep" trajectory downward. We are presently heading downward. I anticipate that we will level off within a year or few. Many people are likely to be misled with false signals of a recovery, for this leveling off will likely be followed a few years later by yet another step downward. This pattern will repeat for decades at least until we arrive at that 25% level.

(Note that I am only assuming a gradual peaking and decline of US population, not a crash die-off. I am doubtful that a catastrophic reduction in population would result in a higher per-capita GDP; more likely, the resulting chaos would so devastate the economic infrastructure as to result in the GDP numerator being reduced by proportionately as much or more than the population denominator. Thus, I find real per capita GDP to be a useful figure to focus upon when thinking about these things.)

Given a 75% decline in real per capita GDP over a time frame of several decades to a century, what does that imply about credit/debt?

An economy in long-term inexorable decline is in no position to take on any more debts, and will find it extremely difficult - impossible, really - to cover its existing debt service obligations. It is almost inevitable that declining economies must default on their debts, in one way or another, sooner or later. Default, of course, results in winners and losers. Political intervention (such as we are seeing now in Washington) can change none of this - except that it CAN change the set of winners and losers. Viewed in this light, the machinations now going on in Washington appear quite sinister rather than heroic.

We need to all lower our expectations and adjust to living within our continually declining means. That is not going to be easy or fun, but that is reality. A reality that cannot be found in Washington or Wall Street, apparently.

Per my above post, 1997 should be 2007.

You make a good point. Our recent college graduates have been having a really tough time finding jobs to match their degrees. There are also a lot of people working as contractors, when a few years ago they could have gotten a job as an employee with benefits. Those of us who have been in the workforce for a while aren't as badly hit as the younger generation. Now with the downturn, it will be even worse!

To make the long story short:
We've been living beyond our means for quite a while and now somehow lost our footing. And it may be a bit hard to come down to earth.

Our present location:



In order to ultimately get past this crisis, it may be necessary for governments to establish new currencies in which debt is severely limited, and at the same time unwind the debt in the existing currency.

Sadly, I suspect Gail is exactly right, that the creation of new currency will become the only way out of our having promised each other far more than we now believe we can ever deliver.

The implications are stunning: those who now possess any paper wealth will not, after currency exchange, ever have the purchasing power to which they earlier believed they were entitled. During the time period for currency conversion from Old Dollars to New Dollars, only (say) cash and treasury securities will be convertible into the new currency.

Once the time window shuts, Old Dollars, as well as any outstanding notes and securities denominated in Old Dollars, will become instantly worthless. By extension such securities will already have been rendered worthless even during the time window for currency exchange. By extension, such securities will even earlier... wait. Could that be just what we are already watching take place?

Somehow, there is some equity is this. The people at the top of corporations who thought they had hundred million dollar bonuses (while the workers got less and less) will find that all of the treasures they thought they stored up are worth not very much. If the sharing had been more equitable all along, the workers might have been able to use less debt, and we might have gotten ourselves into less of a mess.

According to the latest estimates from the EIA, consumption has been increasing, relative to production for the last 4 months and exceeded production for the last two. The oil price decreases make little market sense, if the estimates are anywhere near reality.

It is not clear to me which numbers are "real" and which ones are "guesstimates".

EIA just now came out with September production numbers, so I am guessing that October and November demand are "guesstimates". September was the hurricane month, and we had a lot of refineries off line so we couldn't use the oil that was available.

But you are right--the numbers don't look like the right kind of numbers to go with a huge price crash.


I'm too lazy to draw it, but the Wiki Supply (S) versus Demand (D) curves you show up top can be thought of as existing on one of many X-Y planes stacked in the Z direction and each representing a slightly different world.

(1) For example, the plane you show assumes a world where "producers" can produce ever increasing quantities (Q) in response to increasing prices (P). And the Wiki article at this spot explains that sometimes demand (or supply) curves can bend backwards. So one can therefore imagine a parallel P versus Q plane where supply shrinks as prices increase above a certain point --say $70/bbl for the case of oil (left click on image to the right to see SoupStone article re magic number).

(2) And of course, the X-Y plane (or assumed universe) you show up top assumes that there are substitutes. But as we know here at TOD, there are no known substitutes for oil (ones that are liquid phase, high energy density, cheaply extractable, etc.). One could imagine a competing substitute graph as appearing in the minus X, plus Y quadrant where Quantity of substitute (Qs) produced goes up when price of oil goes up and the quantity of substitute produced somehow dragging down quantity (Qo) of oil down as quantity of substitute goes up.

(3) And moreover, the X-Y plane (or assumed universe) you show up top assumes that consumers will have adequate income to be able to demand higher quantities of the product (i.e. oil). But if wages and productivity go precipitously down as price (P) of oil goes up, then in the alternate universe, the demand (D) curve collapses, thus drags price (P) down with it.

If we picture these parallel planes of alternate possibilities stacked one above the other, a 3D surface emerges where P versus Q behavior is not bound to just one plane, to the traditional P versus Q plane. What we are probably seeing is a slide into one of those alternate universe planes where the demand curve is collapsed worldwide close to the X axis and the supply curve bends down after some critical price point is crossed because producers simply cannot produce more Q in the face of growing demand.

Perhaps you have the answer. In any event, it is not as simple as one might expect.

I would argue that we need units for money. Rather than using dollars, euros, or even gold, I would argue that we need to denominate money in units of energy. The Ayres-Warr model of growth says that energy does essentially 70% of the work in a modern economy. Thus, the amount of money in circulation, including debt, should depend on the number of kwh, joules, or what ever, available in the country. In view of peak oil, or more generally peak fossil fuel production, the principle reasons to take on debt would be to invest in energy efficiency, or renewable energy production.

Food is also a unit of energy, so the local currency that Jason Bradford mentioned above might work in the direction you are talking about.

One of the issues is that people have come to think of money as a store of value (or perhaps it is defined this way). If we have less and less over time, it is difficult for anything to be a store of value. Once we finally return to a steady state economy (with essentially no fossil fuel use), it might be able to get back to money as store of value, but we would be living in a very different world--perhaps similar to the 1600s or 1700s.

Yes, I think that Jason Bradford's local currency is similar to the idea of money backed up by kwh. An energy based currency might be local if redeeming it was only possible at the energy source.

There are a few things I like about a kwh based money:

  1. Energy can be measured easily.
  2. Such a system makes it clear that peak fossil fuel production corresponds to peak economic output.
  3. Such a system forces us to look at the EROI of energy sources.

The second item thus puts things in perspective and, at least in my case, forces us to ask fundamental questions. Should the goal be peak economic output? If we do not optimize economic output what should we optimize? If economic output is finite and declining, how should wealth be distributed? Does being wealthy imply you are taking from others? Perhaps in the (near) future wealth will be defined as living in a very efficient house.

It also seems to me that your concerns about debt translates into the following: negative long term interest rates. If peak economic output was shared evenly by all people, which it won't, then peak economic output would translate into annual salary cuts. If people knew that in 15 years, their salary was going to be half of what it is today, naturally they would want to put money aside to be more comfortable later. This would lead to the opposite phenomena that we have today, a savings glut with no one willing to borrow long term. People would have to be paid to take on the risk of debt. 10 years ago I invested in stocks in the hopes of an early retirement. Today I am investing in insulation, a vegetable garden and chickens so that even if I can't afford to heat, we won't be too cold, nor will we be hungry. And I figure that I'm going to have to work till I drop.