Oil Prices Below $40 per Barrel

Oil prices under forty dollars per barrel? It can't be true.

Yes it is true, oil prices are back to where they were more than four years ago. Time for a few thoughts on these past years and what led to apparently dissonant energy prices.

This is a crosspost from the European Tribune.

Back in July, no one that I am aware of was forecasting a 100$ drop in oil prices during the following six months. Even Daniel Yergin, the Nemesis of modern day Peak Oil study, was at the time predicting higher prices. Back then a friend told me to go short on oil, because all price forecasts by CERA are wrong. If I were a trader, I would have probably followed that advice, but could never imagine what was to come.

One of my first dives into the Peak Oil world was with Kenneth Deffeyes' book Beyond Oil. In it, the Princeton Professor explains how resources' prices go through chaotic periods in face of scarce supply. Without knowing it, he derived an expression to explain movements like spot Natural Gas prices in the US after 2002, that was equivalent to Queueing Theory. This made immediate sense to me, after studying this theory in my formative years at the University.

Let me try to explain briefly what this theory is. Imagine a supermarket with a certain number of points-of-sale (POS), to which a certain number of costumers arrive per hour. Queueing Theory allows one to derive information like the average queue length at each POS and the average waiting time each costumer spends in the queue. This information is not only useful for supermarket managers but also in other fields like transport and tele-communications.

Queueing Theory shows also provides another important result: if the load on the system goes above a certain threshold, it becomes impossible to predict queue lengths or waiting times, and the system goes into chaos. Going back to the supermarket, imagine that for some reason the flow of costumers increases several-fold over its normal rhythm (e.g. Black Friday in the US). At first, lengthy queues form at each POS, waiting periods then go beyond costumers' patience, and they simply start quitting the queue and leaving the supermarket without shopping. The dissatisfaction is such that costumers quit entering the supermarket altogether and the manager is eventually forced to close down some POS. But this is Black Friday, the avalanche of costumers eventually returns and it starts all over again. During this chaotic period a random sample of queue length at any given POS can result in any possible number and becomes effectively impossible to predict.

Substituting costumers by oil importers, POS by oil exporters and queue length by oil prices we have the international oil market.

This chaotic outcome with respect to commodities prices in face of scarce supply was studied by Ugo Bardi, who found interesting examples of it in the past. I first got to know his work soon after I read Kenneth Deffeyes' book and was especially impressed with the pattern Ugo identified in whale oil prices after the peak in sperm whale catches in 1850. The Whaling Industry was possibly the largest of its time, on a global scale that in many ways can be compared with the modern day Oil Industry. To me a most fascinating aspect about Peak Whale Oil is that in the book Moby Dick, published right about that time, Herman Melville lays down quite clearly the reasons for a coming decline of the Industry: in his view Easy Sperm Whale was over.

With all this information I became convinced an increased volatility in oil prices would unfold, eventually leading to a series of "boom and bust" cycles, just like whale oil prices in the XIX century. Predictions of oil prices would become impossible, and I never attempted to forecast them.
Another important aspect to my understanding of this issue was presented by Carlos Cramez and Jean Laherrère in 2006 at the seminar that kicked off ASPO-Portugal. They showed a chart with oil prices in terms of the number of working hours required to buy the oil in the US and France, and concluded that to return to 1980's levels, the last oil crisis, prices would have to reach something like 125$ per barrel (in 2006 dollars). This number stuck to my mind, and I assumed this would be about the level at which the "boom" would turn around into "bust".

Oil prices as a function of working hours by the French minimum wage. For 2008 the oil price is taken as the July peak.

Jean updated this graph recently and was kind enough to mail it to me, showing that by July, prices were very close to the level that had caused pain previously. When oil prices fell after that, they did so in dollar terms, but not so much against the euro, thus the 2008 barrel price in working hours will be below the 1979 - 1985 period but will likely surpass the 1974 - 1978 period.

My mental model of oil prices evolving with scarce supply and expanding monetary mass.

Finally there was another piece to add to this puzzle: paper currency supply has been growing by two digit percentages every year. So these fluctuations would possibly occur within a band of ever higher numbers but without never surpassing the 1980s record oil price in terms of working hours. The following is a graphic rendition of this mental model for the long term evolution of oil prices.

Back in July with prices nighing on 150$, I was getting concerned that either my mental model was rubbish or that the fist turn was now overdue. I had the opportunity to write at that time that oil prices had become unbearable to many people in developed countries, protesters were dying in picket lines and less scrupulous people started stealing diesel from their neighbours. Something had to break and something broke.

But I would expect something more in the line with the price turn that took place in the second half of 2006 and could never imagine so much in such a short time: more than 100$ in six months.

As anyone knows, oil prices are in fact being pulled down by the Credit Freeze. It is perhaps worth to take a look back to the events that lead to to this point, and oil's important role in these events:

  • 1999: Glass-Steagall Act is fully repealed;

  • 2001: September the 11th, NATO goes to war;

  • 2002: Interest rates are now at historic lows, monetary mass starts expanding fast to finance the war (eventually reaching as low as 1% in the US);

  • 2003: Half of NATO invades Iraq;

  • 2004: OPEC's spare capacity dries up;

  • 2005: Oil prices go above 60$, interest rates are inverted towards ascent;

  • 2006: US interest rates reach 5.25%; households are confronted with increasing daily prices and increasing mortgages simultaneously;

  • 2007: The US housing market bubble pops;

  • 2008: Bear Stearns and the Lehman Brothers collapse, panic leads to a halt of the fractional reserve system, Central Banks are effectively unable to put their monetary policy at work;

Interest rates set by the European Central Bank, the US Federal Reserve and the Bank of England.

The most important thing to take home here is that the Fed started the rate hike in 2004/2005 because it misunderstood the oil price rise as a consequence of its poor monetary policy. But instead crude oil production had reached a plateau that remained up to the second half of 2008. In fact, the underlying physical economy stopped growing soon after the invasion of Iraq.

With this interest rate hike, millions of American families slowly became unable to honour their debt compromises, squeezed between mortgages and consumer prices, both rising. This lead to a sharp decline in home prices (demand collapsed, supply sky-rocketed) that were the physical collateral for much of the paper currency created during the low interest rates years. Losing this collateral, banks had to devalue or even write off asset after asset on their balance sheets. These problems started to affect an increasing number of banks and financial institutions to the point of breaking trust among them. The rest is history.

In Europe, events unfolded in similar ways, although the interest rate swings were of smaller magnitude. Here the rate set by the ECB never dipped below 2% and never went above 4.25%. The problem was that many European banks had acquired financial instruments backed by assets in the US housing market; within days of the spectacular collapse of Lehman Brothers, several institutions here started showing serious difficulties. In spite of the reversal in monetary policy by the ECB, the inter-banking lending rate, Euribor, was perilously going up, menacing to squeeze households.

Governments are scrambling to invert the Credit Freeze and get their economies back on track. Luckily the ease seems to be coming first to Europe: the action by the ECB rapidly reducing interest rates and by state governments in providing credit and guarantees to ailing banks (or in some cases simply nationalizing them) has apparently restored confidence, as the collapsing Euribor rates show. Households in Europe are now facing declining consumer prices, with the fall in commodities' prices, and declining mortgages. This will bring some ease to European families and eventually pave the way for a turn around in Demand and avoid a serious expansion of unemployment. A major difficulty remaining is that an economic turn in Europe also depends on a turn in aggregate Demand of its main trading partners - especially the US.

In the US, things are not as simple. Not only were the interest rates swings much wider, but more importantly, the crisis is coinciding with the beginning of the transition between two governments (from two different parties). Interest rates have been brought down to the floor again and consumer prices are falling (also a consequence of a turn of the dollar exchange rates with other major paper currencies), but it came too late to avoid unemployment expanding. Restoring the confidence in the banking market seems a harder task, and similar to Europe, easing households from their obligations doesn't guarantee an immediate pick up in aggregate Demand.

All these actions by Governments and Central Banks, that translate into a rapid expansion of money supply, don't go without consequences. But that will be an issue for another time.


The Credit Freeze impacted the oil market in two different ways:

a) It decreased Demand, by crippling industrial activity--this is especially the case in the US where unemployment is already reaching significant numbers; in Europe several states entered Recession in the third quarter. At this moment there isn't enough data yet to evaluate how much Demand contracted; only in following months, as institutions like the IEA or the EIA produce their regular reports, it will be known.

b) Companies hedging their business in the futures market were forced to liquidate their positions in order to meet near term obligations, leading to a collapse of the number of transactions in the market.

Now that oil Demand has retracted, bringing prices down with it, the opposite phenomenon occurs: Supply destruction. Current prices are too low for the development of many oil reserves, especially those on the fringe of technology. The perfect example is the sub-salt layer reservoirs identified in the Santos Basin off Brasil. A recent study by Deloitte pointed 90 $/barrel as the break even for production from these fields. An optimistic figure possibly, given that as indicated by Brazilian scientists last year, the technology for doing is so is yet to be developed.

With time, new projects needed to offset aging fields won't be there, either because of lack of exploratory activity or lack of financing. Even healthy fields can become unprofitable and be mothballed or abandoned. Supply will go down to the point it can't fulfill Demand any more at low prices, the cycle will be closed and a new "boom" phase will unfold.

It would be interesting to know when this new cycle will start. That's all but easy, made even more difficult by unpredictable monetary policy shifts. Looking at the present futures market, presenting a heavy contango pattern, it doesn't seem like an oil price rise is imminent. Likely, only when the futures market moves toward backwardation will the environment be propitious for a new price rally.

The impossibility of predicting long/mid term oil prices is a serious problem for governments and businesses planing ahead. But this is all part of the game: the destructive process of dependence on scarce resources. If a steady increase in prices was the outcome (as some believed), business would be able to plan ahead, for instance hedging on the futures market. Instead, these unpredictable price swings are very disruptive. Taking the example of an airline company, if it plans for a high oil price and prices go down, it will likely loose competitiveness. On the other hand, if it plans for a low price and it happens to go higher, the company will lose profits and eventually have financial difficulties. If Queueing Theory applies fully to the oil market, prices are effectively impossible to predict in the long term, guaranteeing losses to all airline companies.

Probably these "boom-and-bust" cycles will henceforth perpetuate until at least one of two things happens:

a) A "bust" phase permanently erases an important part of Demand;

b) A "boom" phase eventually takes place supported mainly by alternative energies;

I'm hoping for b).

It's really hard to see where oil will go from here. I have no idea how bad the economic situation is going to get. It could be a severe recession, a depression, or a return to the Dark Ages. Nobody really knows. The fractional reserve banking system is 500 years old and it's at risk. This is the engine of the Western/growth/industrial system. Without it, sure there are still advanced technologies and medicine, but it's hard to imagine us returning to anywhere near the same level of activity. If that's the case, it'll be many decades before we again reach the limits of the oil supply.

On the other hand, if the recession is just severe enough to dry up funding for new production, when the economy comes back, oil would be set for an even bigger run-up.

Who knows?

Yes, exactly, who knows? And this is pricisely the question, we don't have a clue. This unknowness is what's causing so much instability, the doubt, the fear, the horror, of where we might be heading, into a world we don't know, a world we don't understand or recognise.

I think, if we are ulucky, we could well see a slump on a scale that we haven't seen since the 1930's. In many ways it could be worse, as this is developing into a truly global crisis as the economies of the world are so interconected. What's happening? The world's economy is slowly grinding to a halt. Many sectors of the real economy are now, in reality, collapsing, on scale and at a speed not seen since the Great Depression.

How one get's the world's economy going again is a really hard question to answer. It may be a question with no real answer. I'm not sure Keynesian remedies will work this time. I'm not even sure they worked last time! If it was the second world war that really and finally ending the Great Depression, the creation of form of centrally controlled, state, command economy, preparing for war, then we have a lot of hard thinking to do.

I think "old-school" capitalism, the dogma of the "free market" is pretty much dead and buried. What we are seeing is the evolution, at speed, of new type of economy, a merging of state and market on an almost unprecedented scale. How this will influence the rest of society is too big a question to get into right now, though I do think it will have a profound affect.

"I'm not sure Keynesian remedies will work this time. I'm not even sure they worked last time! If it was the second world war that really and finally ending the Great Depression..."

I see this idea that WW2 ended the Great Depression repeated a lot. It depends on your definitions. If you look at unemployment and consumer spending, they still had not recovered in 1941. So in social terms, the Depression continued up until WW2 in the USA.
However, the stockmarket bottomed in 1932. GDP bottomed in 1933. It took a long time for the USA to climb out of that hole, but GDP grew in 1934,1935,1936 (recession in 1937),1938,1939 etc

Once FDR devalued the dollar against gold and started the big public spending programs, the economy moved to inflation and strong GDP growth (20-30% per anum) off a very low base.

I'm not saying this as a defence of Keynsianism. I'm just saying that in 1933 they conceived and executed a policy of engineering inflation, and they got inflation.

As for a "new type of economy, a merging of state and market" - it's all be done before, largely in the 30's. Public Works Administration, TVA,Civilian Conservation Corp, Resolution Trust Corporation after S&L. Recall the UK nationalisation of car makers, utility companies etc. There's nothing new under the sun.

Excellent post, Luis. The history of whale oil, indeed, has been a useful guide for me. On the basis of whale oil data, at the beginning of 2008, I predicted on my Italian blog that oil prices would stop their rising trend and collapse before the end of the year. It was a good prediction, especially considering that almost everyone was projecting oil at 200 $/barrel by the end of the year. I also made some calculations based on the whale oil price trends that told me that the "equilibrium" oil price should be now around 60-70 $/barrel. This value turns out to be similar to the cost of extraction of the "marginal barrel" as given by IEA. It seems that, indeed, we are going to fluctuate around that value.

The bottom line is that if one understands the mechanism of the market, it is possible to figure out where the market is going. Unfortunately, as you correctly point out, the vagaries of the market are chaotic and - as such - unpredictable. Too bad, but if it were possible to make correct quantitative predictions of oil prices we wouldn't be here chatting. Eh, well....

Pre-salt fields have been drilled in offshore Angola: Seeking Operatorship in Angola : Geoexpro

StatoilHydro has participated in 104 wells off Angola on a number of licenses in the offshore Lower Congo and Kwanza basins. At present, the Norwegian major has a strong position in the prolific deep-water Lower Congo Basin (StatoilHydro licenses in blue colour) with production from deep-water turbidite sands and access to potential pre-salt plays, similar to those recently proven offshore Brazil (GEO ExPro no. 3/2005). The company is also ready to bid for more acreage in the next licensing round, due early next year (open blocks in brown colour) and this time the company is hoping to get status as operator.

I had posted a comment on similar lines a couple of weeks back


Nice to know that I was not totally off the mark with my line of thinking.

My own mental model matches yours - except that I see higher amplitudes as we go into the future and the boom and bust cycles happen more frequently taking into account declining net exports.

Does this not have implications for the oil futures market itself?

Global supply chains will be hit very hard as well because sourcing plans, manufacturing were built on the assumption of cheap freight costs. I personally think that the future (after a rough transition) will be more local production and consumption of mostly necessities.


Thank you for this posting that I enjoyed very much. I would like to add another factor that is increasing boom and bust cycles here. All new fields and alternative energy sources - even measures taken to increase energy efficiency need energy themselves. But not only is the EROI lower than for the easy oil, but in most cases the energy needs to be invested first while the resulting energy will be received later. Take a wind turbine for example. Lets assume the wind turbine has an EROI of 5 that is yielded within 20 years. But the invested energy is needed upfront for construction. So it will take 4 years until the initial enery invested is returned.
With rising oil prices governments and investors try to switch to alternative energy solutions. If this would be done within 4 years for 10% of the oil consumption this would mean an additional oil consumption of 10% during this time. Without spare capacity it is clear that this heavily expands the boom cycle. On the other hand with energy investments cancelled or delayed, it works the other way round as well.

regarding your comment about wind turbines: You are aware of the fact that oil is only a very minor part of the energy expenditure for constructing a windmill? Without knowing precise numbers, I would say the highest energy investment is in making the steel, which is done exclusively by burning coal. So installing infrastructure made of steel should lead to an increase in use of coal more than oil, which is indeed what has been happening in China on a tremendous scale.
We really have to let go of this simplistic view often prevalent here on the oil drum that oil equals all energy use. It really does not! Currently in Europe oil is only the basis for all road transportation fuel, but even freight and people can also be moved by electrified rail.
I agree with you that you are right at least in principle regarding the reinforcing of the boom and bust cycles, but this can and should (!) be smoothed out by state investment programs in renewable energy production and infrastructure that is long term and predictable. Indeed this can help too in smoothing out the economic boom bust cycles as well. If on the other hand we leave the private sector to its own devices here, it will indeed become ever more chaotic.

Thank you for clearifying that the real world is always more complex than simplistic examples.
Governments should spend money on energy efficiency and alternative energies. However the administrations are continuing the same unchanged politics. Building even more highways and subsidies for new cars are shortsighted programs that cost a lot of money. The population is more aware of the change needed and buys less cars. We should support that change and not try to reverse it.

The link below could be a useful real world comparison for wind turbine EROEI and lifecycle assessment.
I would like someone to check my calculations but in the above example, in the best case scenario, this looks like about one year's output equivalent in embodied energy (>3,700,000kWh annual output for an embodied energy of 12,000GJ x 277.8). Worst case scenario could be 4 or 5 years worth of output?
PS I posted a bad link to this here before. Hope this one works OK.

The paper he links to compares different scenarios for building and placing wind turbines, looking at actual turbines built in Germany and Brazil. For example, building in the region the turbine's to be set up with recycled steel melted in a furnace powered by hydroelectricity is different to building with new steel in a furnace powered by coal and then shipping it across the world.

Thus old_europe's comment above,

I would say the highest energy investment is in making the steel, which is done exclusively by burning coal.

is true, but not precisely true; steel is almost always made originally with coal, but you can use mostly recycled steel to make things, and for that you need great heat - which doesn't have to come from coal. (For interest, it seems that the rotors cost about as much energy to make as the tower, but the nacelle is most of all.)

And then where you place the thing makes a big difference, if one place gets twice the wind of another, it has half the energy payback period.

My check:-

Worst annual output = 881,972kWh = 3,175 GJ
Best annual output = 3,558,926kWh = 12,812 GJ

Highest embedded energy = 13,797 GJ
Lowest embedded energy = 6,289 GJ

Highest embedded energy / worst annual output = 13,797 / 3,175 = 4.35 years energy payback time
Lowest embedded energy / best annual output = 6,289 / 12,812 = 0.49 years energy payback time, or about 6 months.

The best payback time is for turbines constructed largely of recycled materials in Brazil and used there; the worst for those constructed of new materials in Germany and shipped to Brazil.

The German-Brazil report phil harris linked to complicates matters somewhat by not reporting turbine weight, and by discussing different models without specifying all the differences. We get heights of 45-65m, and foundation masses of 132.7-185.8t.

There was a Danish study of turbines constructed and used in Denmark, which gives figures of
- 3,169 GJ for construction and maintenance over 20 years
- 522 GJ for scrapping after 20 years
+ 733 GJ recovered from materials
or 2,958 GJ net.

Note that these figures are about half the German and Brazilian ones.

This all leads to an energy payback period of 3-4 months.

The Danish report notes,

During the past ten years the weight of Danish wind turbines per kW nameplate electrical power has been halved. That obviously contributes significantly to energy balance improvement.
Danish 600 kW wind turbines on average weigh approximately 60 metric tonnes plus 4.5 tonnes weight for the rotor blades.

A comparable German 600 kW Tacke turbine weighs some 90 tonnes plus 4.5 tonnes of rotor blades. If we account for differences in tower height, and look at turbines with 50 metre tower height only, it would appear that Danish turbines weigh one third less than the German turbine.

So while phill harris' calculations were good, what must be borne in mind is that apparently the Germans, despite their reputation, are not terribly efficient - at least not with wind turbines :) Go with the Danes!

Lastly, given that a barrel of oil is about 6GJ, if we used nothing else to produce the energy required to make one of 500-600kW wind turbines above, that would be about 500bbl for the Danes, and 1,000-2,000 for the Germans. So we can say 1,000-4,000bbl oil per MW, if no other energy inputs were used. Or 3,000-12,000bbl/MW if we assume all the energy comes from burning oil in some furnace for electricity or just the heat (don't know why you'd do that when you can get electricity and heat from more efficient sources, but still).

But of course, at present oil is only required for the machinery to mine the ores, and that to transport, erect and maintain the turbines. So the actual oil use would be fairly trivial, I'd say.

Bear in mind that over the past quarter-century total electricity generation has risen IIRC some 3% annually. So already we're spending a lot of money, time and effort building new power plants.

I'm confused as to why building (say) a coal-fired plant, nobody worries about the costs or resources or energy required, but building (say) a wind turbine, suddenly doom is upon us, we'll all go broke, think of all the steel you need, etc. If we can build terawatts of coal or gas each year, I don't see why we can't build terawatts of wind or solar or whatever.

Thanks for an excellent post.

The Danish study is the best that I have seen for wind turbines because it includes the energy calculations for decomissioning and recovery of recycled materials.

Within its 20-year design lifetime a wind turbine will supply at least 80 times the energy spent in its manufacture, installation, operation, maintenance and scrapping.

IIRC, that would compare favorably to the most productive oil fields.

Well, I am bit uncomfortable with citing recycling as a gain in energy. This is a bit like the "emissions saved" nonsense that lets us pay for someone else to reduce emissions and claim it against our own.

Yes, energy or emissions were avoided, but others still happened. I think it's better not to talk of energy gain from recycling, but to think of it all as an ongoing process - the old turbines are scrapped and recycled into new turbines, so that over time the material required per kWh declines, and the EROEI improves.

Still, they give all their figures and you can make of them what you will. It seems that like anything else, different countries have very different efficiencies in things.


My history of posts on TOD US will demonstrate that I had repeatedly warned people against falling into the trap of believing that oil and other commodities were going nowhere but up in price. I say this not as a way of saying “I told you so” but as a way of reminding people to be very, VERY cautious about believing current projections.

The price of commodities shot up very quickly across the board, and then declined just as fast. Are we to believe that supply dropped that fast in EVERY AREA of commodities, and then recovered just as quickly? That does not seem likely. On the demand side, yes, demand has declined, but has it declined in EVERY AREA to the extent that price declines would indicate.

The fact that these price moves have been so fast, across the board and in both directions indicate that we are seeing a speculative bubble inflate and then pop, pure and simple, and price moves have little to do with supply and demand changes in the short term.

Logically we must ask, “What has caused such an acceleration in price changes over the last few years?” I think it is extremely informative that you mentioned first on your list of events “1999: Glass-Steagall Act is fully repealed”. Very perceptive observation to put this event right at the front of what would become the beginning of an accelerated increase in house prices, commodity prices and speculative investment. We must recall that another source of capital was the flood out of the already overextended tech sector.

With the repeal of Glass-Steagall and the flood of cash from the tech sector, we had a situation of huge amounts of money looking for a place to go. The banks could now jump in and play the speculative game just like the hedge funds and venture funds. Everybody, whether they knew it or not, was now playing in the casino and had money on the table, through hedge funds, banker’s investing in hedging, funds of funds, pensions, and homes, which would soon be subject to the same accelerated price swings that oil and other commodities were already subject to.

Needless to say, the new flood of free flowing money brought out the “adventurer” in bankers (now freed up by the repeal of Glass Steagall), hedge fund managers, market advisors and gurus and even mutual fund and pension fund managers. The “Lords of the Universe” now had the chance to show what they could really do, and investment vehicles tied to underlying commodities, interest rates, and collateralized debt obligations could become ever more complex, multi layered and “hedged” six ways from hell.

The main point of all this is that price swings which would have in past years happened much more slowly now happen with whiplash inducing speed. The flood of money, the complexity, the speed of the internet has accelerated the “Queuing Theory” past a point that allows for comprehension by most humans. If you add in the pure irresponsibility and outright fraud of managers and financial firms who purposely complicate things for the purpose of obfuscation, you have a recipe for disaster.

Oil, like real estate and houses and other commodities are simply the vehicles to which the financial manipulators tied their wagons. The real value of the commodity simply does not matter to the speculators and financial managers at banks and hedge funds. What matters is that people can be convinced to pour money into the investment firms on the belief that the price will change, hopefully to the investors advantage.

When the economy is growing and things are going up, the tool used to recruit investors is greed, i.e., “look at the return you can get on this, you don’t want to be left out”, and when they are going down the tool used to recruit is fear, as in “we have a hedge against losses that can protect you”.

Finally, there were too many people playing the same game. Everyone wanted double digit returns, and everybody was pouring money in, and there was plenty of money to go around at first, with the money that had fled the tech boom available, the massive returns made by the banks on the prior rises in real estate available, and the depositors money now available if it were need since the repeal of Glass-Steagall, and a new fast moving almost completely unregulated group of funds, the Hedge Fund, and then the “fund of funds”, which could pretty much do anything they wished without oversight, but, and this turned out to be very important, without insurance or government protection.

So when the U.S. invaded Iraq in 2003 oil prices were already rising after the price decline caused by the 9-11 terror attack, and the war further accelerated the price gains. Production was starting to flatten because in the 1990’s investment had slowed to a crawl because oil had been so cheap as to be beyond belief (we’re talking about prices below $20.00 per barrel) and the OPEC nations and others had simply stalled on investment in E&P. The rumbles of “peak oil” were just beginning to get into the media. This was a DREAM RECIPE for those who wanted to suck investors into investing in oil, gas and commodities. As you say, “The Rest Is History”, as money flooded into the commodities markets. When the housing market started to show signs of weakness, investors began to get scared, and the ones that were able to bailed out, selling houses. More sold, the market was getting full of houses, but now there were fewer buyers. A few foreclosures became a few more as some of the “house flippers” could not unload at a profit. Again the rest is history, and the money from the real estate boom needed somewhere to go. Commodities, yes, said the investment gurus, commodities were safe!

Brokerage firms who know almost nothing about oil production, consumption and pricing began to talk about $200 per barrel oil (the disgrace that was Goldman Sachs), and retired geologists were on every channel telling the public that the end was near, we would be lucky to get through the next summer (whichever of the last three or four summers they were referring to) without a catastrophe. And the money just kept pouring in, and the commodities skyrocketed.

And then, like all bubbles, the bubble popped. The financial gurus were in trouble and they knew it because frankly they had not gotten it right for their investors for too long. From the collapse of the S&L’s they had herded the investor from one short lived bubble to another, from Asian bonds to the tech bubble, to the real estate bubble, to the Euro bubble, to the commodities bubble. But the acceleration of the cycle of promotion, inflation, extreme high prices and then bursting of these bubbles had become too fast. Even the banks and hedge funds could not stay up, and the investors themselves were either become scared or had been so cleaned out by the gurus they couldn’t keep adding money. Again, the rest is history…

A story of a friend of mine who is in the business, by which I mean the financial sector: She had her clients in the stock market, well diversified, funds, ETF’s, mutual funds, and Index funds. She saw the bad news getting worse, so she persuaded them to move to something “safer”, a mix of REIT’s and, yep, you guessed it, commodities funds. She had become persuaded that oil and gas were only going to get more and more expensive. Do I have to tell you the results of what happened? Her investors are now down by more than 55%. Some of them are getting rather close to planned retirement, and are horrified. Even if the market returns to 10% annual returns, it will take years for these aging boomers to regain what has been lost, post taxes and fees it may take even longer than they may live, and how likely do you think it is that the market will soon deliver double digit returns?

Many in the Peak Oil community have embarrassed themselves badly by making wild claims about short term prices. The same thing has happened in the climate change community, where people have made wild predictions about short term weather changes. The Oil Drum has been unfortunate, in that it is a very open forum, and has posts from both of these movements, peak oil and climate change. This means that people come to TOD and see streams of posts which are based on the two most unreliable and unpredictable patterns in the world, weather patterns and market patterns. This is not TOD’s fault, and long time visitors to the site know that these projections/predictions must be taken with a HUGE grain of salt, but newcomers to the site do not grant this license and the whole cause of peak oil and climate change thus lose credibility in the larger public because a few posters have essentially decided they are prophets.

As for the future, I agree with you Luis, I would not dare to predict future prices. I will say this however: I would be happy to live the rest of my natural life with oil and gasoline prices as much as twice what they currently are., inflation adjusted, meaning I will accept gasoline prices of $4.00 to $5.00 per gallon U.S. (I have survived worse than $4.00 and I was poorer then) So obviously I could hedge by buying oil and gasoline futures at ANY PRICE CURRENTLY AVAILABLE and still be happy! I am not seeking massive returns, just a stable price for my lifestyle. I would be amazed if the very wealthy are not hedging their oil price futures just this way, but I could be wrong.

On the other hand, I have been astounded by how many wealthy people and families have pissed away their money with this Ponzi hedge fund scheme run by Bernie Madoff, and wonder how many more of these type of funds are out there. With apologies to De Niro, “Ah markets, I love the smell of default in the morning!”

Roger Conner Jr.

Roger, I cannot tell you "how many more of these type of funds are out there" but know there will be many more. part of a bubble is the greed and lack of caution that is so beloved by scammers and con artists.

At the moment i am in Africa typing on a dusty Arabic keyboard with missing letters, i.e. remember which letter goes with which key:) i have spent a very entertaining 30 minutes being conned out of USD 20 and it was a delight to see how hard he worked and the tales he invented to obtain his money. i knew all along i was being conned but wanted to see how he would do it.


Well said. Long winded, but well said.

Just let me add that "price" is just another noise we chattering monkeys make. Mother Nature is both mute and deaf. She doesn't tell us what her laws are and she doesn't listen to our monkey noises.

So we can chatter the "price" of oil way up, way down and way up again; and it won't change the realities: Our populations keep growing, the environment keeps being depleted (non-renewably), and we keep chattering, making more babies, and making more "price" noises. What a joke! (On us.)

p.s. I didn't know that in UK a "customer" (American spelling) is a costume-r. All dressed up and ready to spend, eh?

So, there was a speculative bubble on used cardboard?

Let's ask the question another way...Was there a shortage of used cardboard? If so was it caused by geological peaking? Or perhaps failure to invest in cardboard exploration and development? :-)

I have known financial people to speculate in products and commodities both new and used that I didn't even know a market could exist in. I also know personally a man who has spent his adult life making a living hauling and selling used cardboard to the recyclers.


Thanks for the post. I would like to defend TOD, not because I have anything personally invested in it, but because it is, in fact, the most intelligent and open forum out there discussing "Peak Oil" and "Climate Change", their inter-relationships and their grounding in physical reality.

If "short term" or "new" readers come here for a quick fix, and if they are disappointed by the result, well so be it. TOD is a sort of blurry mirror of nature, and although we are all looking through that glass darkly, we all discern different things. For me, the beauty of this site its its essential honesty-- no idea or model has yet, and hopefully never will, reached the status of "orthodoxy." Even the founding principle "peak oil" has been subjected to intense scrutiny and redefinition and recalculation.

Practically all other vaguely similar sites are organized around some favored notion, which is not permitted to be challenged, and so rapidly becomes irrelevant.
So I keep reading TOD. I read it like I read modern fiction -- I think we are looking at multiple parallel and intersecting stories-- each has a personality behind it, and a set of assumptions about how the world works. They can be read individually, but taken together, they form a complex and far more interesting tale.

Roger, yes the greatest of energy experts along with mere myself were taken in by this false call of the market. But the real one is surely not far behind. The demise of those auto makers and airlines doesn't come a day too soon.

Thanks Roger. Your post here feels very true to me. I am a lower-middle class single adult concerned about the future (for myself and for everyone). I don't pretend to understand the complexities of markets and financial trends, yet I try my best to use my reason to make the best decisions I can. Nonetheless a lot of what I have to go on is trust; trust in the opinions of other people, like yourself, who I find reasonable and more informed than myself. So I have a question for you...

I have recently moved more than half of my savings out of my credit union savings account and into gold (precisely, this would be seven Maple Leafs). What I want to know is if gold is also a bubble or if it reasonable to guess that gold will rise relative to the dollar over the next, say, 3-5 years. What are your thoughts on this?

Thank you,

I've also been buying maple leafs. I read somewhere that throughout history, an ounce of gold has always been able to buy about an acre of land. I can't answer your question, but a few weeks ago, I read that if the Chinese economy really starts to tank, they will start selling off all their gold reserves and so serve to greatly depress the price. However, I'll keep my maple leafs whatever happens.

What I heard is that an ounce of gold buys a fancy suit, and an ounce of silver buys a fancy meal. This is true for the years 1800, 1900, and 2000.

Since the Federal Reserve was established in 1913, the US dollar lost 96% of its value.


First, I have a bit of natural caution concerning precious metals due to my own history...In the 1970's I poured money into silver which at that time was going "nowhere but up", and quickly lost about two thirds of my investment :-(

Gold is a currency substitute (or it is really more correct to say that currency is a gold, silver, platinum, etc., substitute but that is a theoretical argument), so how you feel about hold depends on how you feel about the longer term stability of world currency. Someone down below in this string makes the humorous case that "while the oil consumers try to use gold to buy oil, the oil sheiks use oil to buy gold" :-)

The problem with gold is that you can't get paid while you wait. You have to sell it to collect your moeny. Did you feel your credit union accounts were in any danger? Did they have national government protection? Because to go to gold, you would have to believe that not only the credit union would collapse but that the protecting authority (usually the national government) would also collapse and fail to pay.

If that were to actually happen, then gold would not be a bad bet, you just have to figure the odds. By the time I am down to buying gold, I would feel even better about buying canned food, guns and ammo. Oh, and don't forget the all important can openers. :-)

Then when you sell the gold, it will be to buy back the dollar that you had lost faith in...as you ask "gold relative to dollar". It's a speculative route, and in a deflationary environment, which we now seem to be in, we will have to many goods chasing too few dollars...until the flood of paper from the worldwide bailouts hit the market place at least. It could be all over the place for quite awhile, meaning that you better not need the money soon.

So short term gain possible on the panic, long term, sell on gains and take the money UNLESS you are convinced of the collapse of worldwide currencies, something every national government will fight to the death. Gold is a bit against the world economy, so by nature it's a long shot.

That's my thinking as of now anyway, and you can't eat gold or burn it for heat, so you are still invested in an "exchange" market either way...but as a speculative investment, good for panic runups, yeah, I would take gold if anybody out there loses faith in it and wants to give some away...:-)



I liked your original posts and following comments but it was easy to predict years ago that we would be where we are today.

People need to read and understand their history. More people need to read about the Great Depression particularly with an eye to the events that led up to it rather than the misery after 1929. The similarities between 2008 and 1929 are great if you substitute oil for land and hedge funds for private bank stocks.

The pattern is the same and was fostered in both cases by a total belief in FREE MARKETS enabled in the U.S. by an Executive and Legislative government that had an active dislike of and worked to prevent OVERSIGHT of financial institutions. I stress financial institutions not business in general.

Those two things are all you need to repeat 1929 and 2008. The details will always be a bit different but the pattern and the outcome will be the same each time around. Engines without governors go to runaway mode and break. Now the TIMING of when things break, that's unpredictable.

With apologies to De Niro, “Ah markets, I love the smell of default in the morning!”

Great post, but that was Duvall:

"I love the smell of napalm in the morning. You know, one time we had a hill bombed, for 12 hours. When it was all over, I walked up. We didn't find one of 'em, not one stinkin' dink body. The smell, you know that gasoline smell, the whole hill. Smelled like... victory. Someday this war's gonna end..."

Seems a fitting quote for TOD...

your right, it was Duvall! I thought about double checking it, but I was overdue for some sleep and my old guy memory failed me...good catch jimbo...my error.


' ... and “hedged” six ways from hell.'

Isn't it really ' ... and “hedged” six ways TO hell. '? ;-)

Hey, what is this, a literary magazine? :-) But your right, "six ways to hell" would be the more correct usage...as we say in the south, I got it "bass ackwards". :-)


Very nice story.

And I even believe in most of it (no sarcasm intended).

However, the scientist within me wants to ask:

Where is the proof for all this?

To this this day no credible source that I have been able to find, has produced watertight evidence as to who, why, where and how manipulated oil prices or how speculation more than doubled the price of oil spot?

I can't say it didn't happen, but I don't yet see the proof anywhere. To me correlation just isn't sufficient.

Because, if we lack the proof we will NOT be able to stop it the next time around: the same people ('us' or 'them', doesn't matter), using same mechanisms will be able to do the same thing all over again.

That's why I'd really like to see some hard facts on the table.

As for the production and price linkage, I think you might be making a serious error of judgment.

Just as high price doesn't directly prove tight supply/demand situation or production problems, NEITHER does low price disprove any problems either.

One can't have it just one way, the correlation must work both ways.

To me the basic rule of thumb is still this:

High prices are a required, but not sufficient signal of tightness/problems in production (cf. demand). But, and this is a big but, this doesn't always pan out in the short term. Markets can stay irrational longer than one can stay solvent, Keynes used to say.

BTW, thanks for taking the time to write that lengthy post. I really appreciate it. It's much nicer to read long and well well thought out posts, which are not the norm here - or elsewhere for that matter.

Hi Luis

Thx for an interesting post. I've been thinking about this years volatility for some time and this thread seems a good one to post my tuppence-worth;

Is the main reason inelastic supply? On the upside we got to the position of almost zero spare capacity and we know creation of new supply takes time - far more time than the rate at which demand was growing. So once demand hit capacity the price shot up to the point at which demand was reduced. We get a brief glimpse of how much consumers are prepared to pay for oil, at least short-term.

The dramatic fall in price is just as easy to understand if you assume that supply holds up in the face of reduced demand. And I think it does unless OPEC manage to reduce it - history suggests they struggle thanks to the prisoners dilemma;


For oil producers it pays to keep pumping for all they are worth because, even at lower prices, they are better off covering part of their OPEX even if they can't cover all of it. The price point at which pumping is no longer cost effective is far lower than the point at which total costs are not covered (better to have some income to offset costs rather than none!).

Reduction in longer-term supply will happen as projects get delayed. But, as for the argument on the way up, this effect is on a different time-scale than the current rate of demand destruction. So a temporary gap opens up under the supply ceiling and prices head south rapidly.

So we have the possibility for fluctuations in demand that are not time-matched with fluctuations in supply. Maybe just a re-wording of others thoughts on here but sometimes it helps me to get my thoughts down even if just to clarify them for myself!

If this argument is correct then as soon as demand recovers to meet capacity, presumably with global recovery, then prices will once more shoot up. The only question (admittedly it's a big one) is when this recovery will happen.


Reply to thewatcher,

"Is the main reason inelastic supply?"

I think you are right that inelastic supply is a major factor. But there are many commodities that exist on the edge of demand matching supply at any given moment. This was the whole idea behind "Just In Time" inventory and planning.

This would seem to mean that any speculative activity could be greatly magnified in their impact on price, which is what seems to have happened. JIT inventory keeps the market jumpy, and the internet/hedge fund/short sale/long sale speed of the markets means that even short term jumpiness can be converted to big and fast price moves.

Energy markets are even more subject to nervousness due to the crucial role that energy plays in modern economies.

Years ago, I once heard an oil executive say in an interview, "with energy, the difference is at the margins, but the margins make all the difference." He went on to point out that if there was a 1% or 2% surplus in energy, no one noticed, but if there was a 1% or 2% shortage, it was a catastrophe that could derail the economy.

Energy, oil and gas in particular (although electric power is not immune as the Enron "emergency" power shortages showed us)are perfect for those who want to make money on hyper volatility and instability.

By the way, let's think of all those "investors" who bought oil at $70 to $80 per barrel and then innocently watched it go to $148 per barrel. They must have started selling up near the top or the price would not have dropped so far so fast...where did the profit from that doubling go? How many of them went one better and shorted on the downside, and made a second fortune on the way down..."anyone, anyone?"

I wonder how the market is holding up for "discreet" Chateaus in Switzerland, France or Malta or maybe luxury hunting lodges with private lakes in Canada are holding up these days? A fellow has to rest after all of that "hard work". :-)


Great Post, Luis!

Your timeline is the best explanation of the relationship between monetary policy, war in Iraq, rising oil prices and the financial crisis today I have read so far.

Yergin was right, although his timing was off.:

So was Mike Lynch:

Instead, we appear to be experiencing a financially-driven oil price bubble, which will eventually burst and leave oil prices much lower than the current $110/barrel. (Prices might not go below $80 this year, but longer term, $45 is more likely the norm.) The industry will once again lament that they “screwed up the boom,” companies with deep pockets will buy up those who are cash short, resource nationalism will recede as will upstream costs, while investors in alternative energies flock to Washington in search of ever more government support.Source

So was David O'Reilly:

"We're a cyclical business," David J. O'Reilly, chief executive of ChevronTexaco, the second-largest American oil company, said in a telephone interview, "and at the high end of the cycle it makes sense to get the company in good shape and strengthen our balance sheet. "History tells us that what goes up also goes down."Source

Jerome "Countdown to $200 Oil" Paris was wrong.

Westexas (Jeffrey Brown) was mega-wrong:

From this point out I think we'll see a geometric progression in prices… you know, $50, $100, $200, $400, whatever. The only question now is how short the periods will be between prices doubling again”. -- Jeffrey Brown, June 5, 2008Source

Notice that the Cornucopian crowd continues to use price as a proxy for production?

Published Jan 7 2008 by GraphOilogy / Energy Bulletin
Archived Jan 8 2008
A quantitative assessment of future net oil exports by the top five net oil exporters
by Jeffrey J. Brown and Samuel Foucher

Our middle case forecast is that the top five net oil exporting countries, accounting for about half of world net oil exports, will approach zero net oil exports around 2031—going from peak net exports to zero in about 26 years, versus seven years and eight years respectively for the UK and Indonesia. In our opinion, the only real difference between the top five and the UK and Indonesia is that the top five net exporters in 2005 had a lower rate of consumption relative to production.

Extrapolating from year to date 2007 data, it appears likely that the top five will show an average aggregate net export decline of about one mbpd per year in both 2006 and 2007, putting them on track to go from about 23 mbpd in net exports in 2005 to close to zero in the 2030 time frame.

Smaller oil exporters like Angola can and will increase their net exports, but smaller exporters, just like smaller oil fields, tend to have sharper production peaks and more rapid net export declines than do the larger net exporters. And offsetting many of the gains by some smaller exporters will be sharp declines in net exports from other smaller exporters like Mexico, the #2 source of imported crude oil into the US, which will probably approach zero net oil exports by 2014.

Declining net oil exports will inevitably result, absent a severe decline in demand in importing countries in continued rapid increases in oil prices, as oil importing countries furiously bid against each other for declining oil exports.

In most of my presentations and comments, I also noted that the price of oil represents a horserace between declining demand and a long term decline in net oil exports.

Yergin’s point was that rising oil production would drive prices up. In reality, declining net exports, flat crude oil production and a slight rise in total liquids production—probably augmented by NGL’s from the dying gasps of large oil fields with gas caps, as they are blown down--caused prices to go up, through this summer. What is primarily driving prices down now is a decline in demand.

Here are the recent EIA numbers for annual net exports from the Top Five, along with annual US oil prices, including my estimate for 2008, through 9/08. While the top five are showing a year over year increase, primarily because of Saudi Arabia’s increase in production to a level below their 2005 annual rate, their 2008 rate, through 9/08, was substantially below their 2005 rate. And BTW, both the UK and Indonesia showed year over year net export increases, in their terminal decline phases. As you know, in the above paper we were building on work that I first did in January, 2006--warning of a near term decline in net oil exports by the top three net oil exporters.

EIA Top Five Net Exports & Annual Oil Prices:

2005: 23.9 mbpd & $57

2006: 23.2 & $66

2007: 22.0 & $72

2008: 22.5* & $100**

*Estimated net exports through 9/08
**Oil Prices through year end

EIA Top Five Net Exports & Annual Oil Prices:

2005: 23.9 mbpd & $57

2006: 23.2 & $66

2007: 22.0 & $72

2008: 22.5* & $100**

*Estimated net exports through 9/08
**Oil Prices through year end

I'm predicting right now, that if the avg price of oil in 2009 is below 100$ it will no longer be the avg annual price that really matters or people care about, but the "average decade price".

Notice that the Cornucopian crowd continues to use price as a proxy for production?

I think that we have a new syndrome. CPDBS--Cornucopian Production Decline Blindness Syndrome. If the top five had maintained their 2005 net export rate, their cumulative (post-2005) net exports through 2008 would have been on the order of 26.2 Gb. Through 2008, they probably will have (net) exported less than 24.7 Gb. This is the elephant in the room that the Cornucopian Crowd refuses to see.

In any case, I think that the real damage to the economy as we know it is still ahead of us. When demand recovers, I don't think that the net export capacity will be there to power the recovery.

I have often argued we have another syndrome, IGAS - Independent Geologist Assumption Syndrome. It assumes that if a model works for a couple of cherry picked countries it must work for all countries.

ELM has always and will always remain a worst case scenario that may or may not arise, depending on intranation demand. The case may be made that ELM likely will not arise due to other interdependencies on domestic and world economies for some nations (China can only ramp up domestic demand as long as US/world demand for goods maintains a certain level), however regardless of whether ELM proves to be a big decider (which depends on world economic growth), declining production is still the elephant standing in the room, waiting to crush any recovery effort. If geologists are correct about the basics of where oil and gas is to be found with good EROI, then we're in trouble. ELM just gives us a worst case timeline on how soon we'll feel the pinch.

It's always interesting when people accuse me of misusing the Export Land Model (ELM)--a term for a simple little mathematical model which I developed--citing the example of the UK, which had very little increase in consumption. The key point about the ELM is that production declines in exporting countries magnify the net export decline, and tend to result in accelerating net export decline rates. The rate of change in consumption usually just changes the slope of the net export decline.

In the top five paper (linked above), we noted that Export Land fell between the UK and Indonesia in terms of both production and consumption rates of change (Export Land had a faster rate of increase in consumption than the UK, less than Indonesia, while Export Land had a faster production decline rate than Indonesia, but less than the UK). The key similarity between the three was that all of them were consuming about half of production at their final peaks. See a similarity here in the year over year change in net exports for Export Land, the UK and Indonesia?

(Note that the graphs shows year over year changes, not exponential decline rates. The overall exponential net export decline rates are highlighted on the graph.)

BTW, anyone else find it bizarre that the Cornucopian Crowd is using the UK--a country that went from peak net exports to zero in seven years--in an attempt to rebut the Export Land Model? Especially when we cited the UK twice in our top five paper.

That graph is extremely misleading, and a form of statistical chicanery. The actual data for your ELM looks like this:

The column labeled "Decrement" shows the difference between the current and previous year's net exports. As you can see, the decline is sub-linear (i.e. the decrement decreases with each year), and there is no increase at all in the amount of exports lost each year.

Any ordinary linear decline can be painted as an "accelerating decline rate" using your gimmick. Suppose, for example, you have a gas tank filled with 10 gallons, and you use one gallon per hour. Then the hour-on-hour decline rates are: 1/10, 1/9, 1/8, 1/7, 1/6, 1/5, 1/4, 1/3, 1/2, 1 (= 10%, 11%, 13%,14%, 17%, 20%, 25%, 33%, 50%, 100%). Voila: an ordinary linear decline can now be misrepresented as "decline at an accelerating decline rate".

Here's the actual stats for the UK from the BP Stat. Rev. 2008:

As you can see from the Decrement column, the decline is basically linear. BTW, nobody knows where you got your data for Indonesia or the UK, because you didn't bother to cite it.

. . . and there is no increase at all in the amount of exports lost each year.

Well, that would be the definition of a linear or "sub-linear" decline, now wouldn't? Let's see. You are showing a net export decline rate of -89%/year for year eight versus -12.5%/year for year one.

Would that be:

(A) A falling decline rate:

(B) A stable decline rate or

(C) An accelerating decline rate?

Your analogy of a gas tank is somewhat apt, in that unlike exponential production decline rates, net exports actually go to zero in a fairly short time period, versus a long "tail" of production. The flaw in the analogy is that the volume of net exports tend to decline at a linear or sub-linear fashion, what some would call an accelerating decline rate.

BTW, if we assign some reserve numbers to Export Land, only 10% of post-peak production would be exported, with 90% being consumed locally. That is similar to the problem that we are currently facing with the top five, which have--from 2006 to 2008, inclusive--probably already (net) exported something like one-fifth of their remaining cumulative net exports. Two key caveats: we are looking at conventional oil and mature basins, especially for Russia, but I suspect that frontier basins in Russia are to Russia as Alaska is to the US.

In any case, I have asked Khebab to double check my numbers, but if memory serves, our middle case is that only about 25% of post-2005 cumulative production from the top five (combined) will be (net) exported, with 75% being consumed locally.

The data in the above graph of UK and Indonesian net exports came from the EIA, as noted in the top five paper linked above:

Figure 3 shows the year-over-year changes in net exports, from the start of the most recent production declines to the (apparent) final year of net exports (EIA, Total Liquids) for the ELM, the UK and Indonesia.


while your mathematics may be correct, your "export land model" only works for countries whose economy doesnt depends in a significant way on exporting oil. The export of the UK fell to zero very quick precisely because its economy doesnt depend on exporting oil in a major way. If Saudi Arabia would stop exporting oil, they'd probably implode, as almost all their income comes from exporting oil. If that income fell away, how would they buy the cars to burn the gas they dont export anymore?
So, I think it is fair to consider that oil exports slow down when oil becomes more expensive, but your simplistic export decline model will get significantly slowed by the fact that most major exporters (i.e. Arabia,Venezuela,Russia) cannot economically survive without exporting oil, so they will always want to export a significant amount, even if that would mean to slash internal gas subsidies. For instance Iran has done this last year and they also build nuclear power plants to conserve their oil exports.

Old Europe

I think the model does work for your so called 'oil export defendant countries' because it ignores assumptions such as this. Take Saudi for example, they are building a Large Chemical plant and an Aluminium Smelter, ie their consumption internally increases without effecting their export earnings in fact it can increase it. The scary thing with the Aluminium smelter is that KSA doesn't have a lot of gas (yet) and generates its electricity from oil, but it still makes sense for them to export electricity (which essentially what the smelting of Aluminium is) produced from oil.


KSA's oil is exportable worldwide; Iceland's hydropower is not.  We can hope that Iceland will undercut KSA in the aluminum market (perhaps magnesium also?) and keep oil for transport fuel.

I thought that the UK and Indonesian examples were interesting. The UK has a high per capita income and energy consumption taxes--and had a low rate of increase in consumption. Indonesia has a low per capita income and energy subsidies--and had a fast rate of increase in consumption. Indonesia was also a founding member of OPEC. Indonesia went from final production peak to zero net oil exports in 8 years.

I guess the challenge would be to find a major net oil exporter that cut their consumption approximately in tandem with production, as their production declined, in order to maximize net exports. I really haven't seen any examples, but I suppose there may be some, although the EIA shows that Iran has been able to slow their rate of increase in consumption, through their rationing program. In any case, the primary problem, even with stable consumption, is that net exports declines tend to be magnified, because they "come off the top" after consumption is satisfied.

Also, assuming that a combination of voluntary + involuntary export restrictions drive oil prices back up, the cash flow from export sales will tend to increase, even as net export volumes decline, at least in what I call Phase One net export declines.

You and Pitt use the term sublinear to describe stuff. That is pretty odd, cuz I don't run across that term too often. You two might actually be the same guy, but Pitt seems much smarter. So you must have kiped it from him, as he associates with the academics.

Instead of sublinear, you should use the term decelerating or perhaps damping, which is a very real physical effect. As in a damped exponential, which you would see in a proportionality law. :)

I thought that the following comment was typical of JD's work, and as noted above, his allegation was completely false:

BTW, nobody knows where you got your data for Indonesia or the UK, because you didn't bother to cite it.

WT, yes, it is the typical hit-and-run work on JD's part.

This kind of stuff really annoys me, and perhaps my comeback had a condescending tone but I don't mind stooping to his level on occasion :)


In the past, the boom and bust cycles were caused by demand hitting the roof and then the roof getting higher. Now I think we're on the otherside and its the roof thats coming down and hitting demand.

Looks the same from a price side, but economically more disasterous.

Of all of the explanations for the bubble we just had, one that seems more convincing to me is that it was just human nature, feeding off the increase in prices.

There is an article in the December Atlantic magazine by Virginia Postrel, reporting on some research done on financial markets in a lab:
Short version: bubbles are part of human nature; when prices start to rise, humans get caught up in momentum trading, until there is no one left to push the bubble higher; then the crash. I think that what we had this past year was momentum trading, which crashed after the ability of the market participants to buy more paper barrels evaporated in the credit crisis.

But, longer term, no one should dispute this: we are constantly printing more dollars, while the amount of oil remaining in the world is declining (that’s what it means to be a fossil fuel). Even worse than that, the world is producing less oil every year. The second half of 2008 was the first time in many, many years when the amount of dollars in circulation decreased, even though the printing presses were running full tilt: the credit crunch was destroying money faster than the central banks of the world could produce it.

If we keep producing more and more dollars, and we keep producing fewer and fewer barrels, what else could result but a price increase? The only question is when the next rise in prices begins.

Short run, commodity markets may be voting booths; long term, they are weighing machines. Once this bubble passes, the next one, according to the research on human instinct, will be longer and bigger—driven at first by supply and demand, and then by greed. Natural oscillations, each ramping up higher.

I agree with GregTX. Reading Luis' post you might think this is all just business as usual, and there will be many more cycles of boom and bust as our grandchildren grow old. A friend of mine says "perception is reality". Do most people think that way? If you're conned into a belief, does that make it real. Is it all really just a confidence game? How long before confidence is restored and business as usual can proceed?

Should read: "Yergin’s point was that rising oil production would drive prices down."

Just to put that Mike Lynch quote into context, here's what precedes it in the linked article (emphasis added):

(Although I have certainly not predicted oil price behavior correctly in the past few years --to put it mildly--I would argue that this is not relevant to the issue of supply forecasting, and hope my views on that subject will be considered in that light.) The prospect of an oil production peak at 100 mb/d, as some in industry now believe, appears unlikely in my opinion, as most of the above-ground constraints should be overcome. Unless there are serious demand side pressures (which I don’t expect), oil production will probably pass 100 mb/d within 12-15 years. Certainly, given that we’ve produced only 10-15% of conventional oil resources and unconventional resources are larger than that, there seems no reason to consider petroleum to be a scarce resource.

And while non-OPEC supply has underperformed, it seems likely to recover soon, as it has done the past two times it plateaued. Indeed, having spent two decades writing about the Malthusian bias to oil supply forecasts, I cannot find any differences with the current set of arguments, whether from resource pessimists, those concerned about flow rates, or senior industry officials, and the predictions of a quarter-century ago.

He was correct on the direction of the price movement but for the wrong reasons (or so it would seem, judging from the above quote). It may be too early to tell, but is non-OPEC production 'recovering' in the manner Lynch predicted? Thus far, judging by the current economic turmoil, it's 'demand side pressures' not increased production, which are helping to fuel the fall in oil prices.

I have no doubt many of the concepts raised above play a role in the psychology of oil pricing; however, I am left feeling a much simpler explanation is being given short shrift. Oil is prototypical product with an inelastic demand curve. When demand exceeds supply it takes a large increase to reduce that demand back to the level of supply. When demand falls below supply a market glut develops and the increasing stocks of oil drive price down. This behavior is based on very short term responses to the problem.

Luis de Sousa, very good points. JD....you also bring up some good points, but to say West Texas was MEGA WRONG, might be somewhat premature in your assessment. There is a GEOPOLITICAL FACTOR that many are not factoring in. Basically it is between the Great American Bull (along with England) and the Huge Russian Bear (including Iran and Venezeula). The Orchestrated Collapse of LTCM (Long Term Capital Management) back in 1998-99 helped collapse the price of oil which destroyed the Russian Economy. We have to remember, because of the collapse in the price of oil, Russia Devalued their currency overnight and Russian Citizens got wiped out overnight.

The Russian Govt would start to get in trouble at $80 a barrel oil. At $60, the Russian Ruble comes under severe pressure and the govt starts to prop up its currency. At $40...GAME OVER for Russia, as Russian Ruble is now in Danger.....Govt spends a great portion of its currency reserves to hold off a collapse of its currency. When Russia went into Georgia, it proved to the powerful entities that they did not learn their lesson from the 1998-1999 LTCM takedown. Thus, to keep the Russian Bear in check, the price of oil was taken down by the very institutions that held the opposite trades from their own customers. JP Morgan, Goldman Sachs to name the larger players, took down the very hedge funds they represented who were long commodities....while JP Morgan and Sachs were short.

People need to remember, the Russian Bear is not just fighting against the American Bull, but entities within it. JP Morgan, Goldman Sachs, the Fed, The Treasury are just as powerful in destroying a country as is its military. After the United States won the war in Iraq, JP Morgan was given the task of putting together the new National Bank of Irag in 2003. After the new National Bank was put in place, JP Morgan was able to start trading medium term Oil Contractsin Dec 2003 through the National Bank of Iraq along with the new control of 2 million barrels a day oil.

Many in this blog do not realize that JP Morgan is the FED. JP Morgan has the largest Derivatives exposure of any Bank in the United States. Furthermore, the way to control the price of oil, is to control the price of Gold. Ever since the United States withdrew its policy of backing the US Dollar with Gold, a new regime of World Fiat began. For the US Dollar to survive with out any backing, manipulation of commodities had to take place.

Lately, Antal Fekete, Professor Emeritus of Mathematics has been writing for years about how GOLD is MONEY. According to Fekete, Paper gold contracts started to trade in 1975 after Nixon unpegged the Dollar to gold in 1971. Ever since 1975, Gold has been trading in Contango. Contango means the futures price is higher than the present cash spot price. For the first time in history, Gold went into Backwardation on Dec 2, and continued to do so, and even got worse. Fekete has been writing about Gold going into Backwardation when the world starts to lose faith in FIAT PAPER MONEY. Instead of investors trading paper contracts, making risk free profits, they rather pay a premium for spot cash gold and take delivery. Fekete states that when gold goes into permanent backwardation, there will be no one willing to sell gold at any paper price. This means the end of Fiat Money....also the destruction of world trade.

There is a historic example of this. Back when the Roman Empire was starting to collapse, Gold went into hiding in Private hands. Basically Gold left the public arena and was bought up and taken into private hands. Thus after the Roman Empire Collapsed, the Dark Ages enused for over 1,000 years. On the other hand, the eastern Roman Empire, Constantinople allowed to keep their MINT open to gold and their Civilization remained vibrant for another 1,000 years.

The United States took Gold from its public back in 1933 by order of FDR...and only allowed trade through Foreign govts. US public citizens were not allowed to own gold until 1973. This was the beginning of the end of the US EMPIRE. Even though American citizens were allowed to own gold....this was the start of funneling gold from the public sector to private hands. Thus we had the beginning of the same situation that ended the Roman Empire. Today, with the Bailouts and the huge inflationary policies of the FED and US GOVT, gold is being taken off the shelves with alarming speed. Small denomination gold like small bars and coins are hard to find and if so may take months to receive. The only gold still easy to get are the 100 oz bars on the COMEX. And that is exactly what the smart investors and wise public are doing. They are buying contracts of Gold on the Comex and taking delivery. This is putting pressure on the shorts, thus backwardation is threatening the Gold Window. There is a great deal of talk about a Gold Default either in Dec or Feb 2009.

If the Gold window closes and defaults, this will end the Hedgemony of the US DOLLAR. Without the trust in the world Paper currency, world trade will plumment as foreigners will no longer take US PAPER MONEY for goods and oil. The United States has a Leech and Spend Economy...which can only survive on imports of oil. According to Antal Fekete, if Gold goes into Permanent Backwardation....there will be no trust in PAPER MONEY, even though there might be an attempt to reissue a new world currency or regional currencies. The only money that would put trust back in the market are gold and silver. If the world govt's backed their currencies with gold or at least a part of it, trust could have been put back in the markets, but when gold went into backwardation on Dec 2, all bets are off. It is too late for this to be an option. It is just a matter of time before Gold goes into permanent backwardation and the gold window closes. Thus the end of the Great United States Empire will take place.

When the US Dollar loses its place as the world currency.....imports will dry up into this country as the facade of paper money is destroyed. The lack of imports will put immediate shortages in this country. Their will be delfation of worthless assets such as real estate, most stocks, and paper assets as US Treasuries, Bonds and Retirement accounts...but inflation and hyperinflation of real goods that citizens will need to survive: Food, energy and clothing.

This is the end of the United States as we know it. Unfortunately....the public has no clue that the rug has been pulled out from underneath them. But...it time, they will

Very impressive summary of the current situation.

I love it - Hedgemony of the US dollar; should have gone for Hedgemoney. Well it used to be hedgemoney mostly due to being backed by guns and butter but the glory days of that seem behind us.

The fascination of so many armchair economic theorists with gold is amusing. The object of any currency is that it should be accepted in trade as having value in future trades. Who the hell wants gold? Why? That said, may I point out that the general price of oil since 1972 has been about ten barrels an ounce. Judging by the gold displays in Dubai, etc., the Gulf States seem to have far more fixation with gold acquisition than some poor sod in Minnesota whose concern is keeping his ass warm. When you have gold you trade for oil, when you have oil....

Gold made a big runup along with oil and the US debt/money creation inflation denial mess. My guess is that the relationship will continue, thus either the oil price will rise or gold will fall way down. Once you get the dollar out of the way the export price from the Gulf has been reasonably steady or self correcting.

SRSrocco, you write:

Gold went into Backwardation on Dec 2, and continued to do so, and even got worse. Fekete has been writing about Gold going into Backwardation when the world starts to lose faith in FIAT PAPER MONEY. Instead of investors trading paper contracts, making risk free profits, they rather pay a premium for spot cash gold and take delivery. Fekete states that when gold goes into permanent backwardation, there will be no one willing to sell gold at any paper price. This means the end of Fiat Money....also the destruction of world trade.

The 'backwardation' or 'bird in the hand' theory of Professor Feteke is as fascinating as it is controversial. So it's only fair to draw readers' attention to the other side of the debate. The articles can be consulted at



John Needham, writing on the backwardation controversy on 16 December:

There is an entire industry, presumably of bullion holders, dedicated to the bullish case for Gold. Articles espousing the supposed benefits of owning physical Gold or at least being perpetually long Gold are pumped out with rare dedication and single mindedness.

Indeed there is an unhealthy PC element to this ongoing campaign to lure you into the perma bull camp, but a fool and their money are soon parted and what we can say about the perma bulls of Gold campaign is that they have been consistently wrong since 17th March 2008. Since the Danielcode warned that “markets fluctuate, sometimes violently” in late February in these pages and forecast at least an interim top in Gold at 1034.10 (I know, I missed it by 2 ticks. Shucks), we have consistently kept our clients on the right side of the gold trade with both long and short term signals. ...

Needham is clearly referring to Fekete, the chief of the permabull camp.

I'm not taking a stand on this myself, just like to point out that it's deep water for non-experts.

Carolus Obscurus,

You bring up a good point. Needham is not the only one offering opposing views. Mish Shedlock and Tom Szabo have offered different opinions. As for Fekete being a PERMA BULL, I might disagree. Fekete is not your typical GOLD BUG, who is full of $$$ in their eyes. Fekete could care less about the price of gold, but rather its use as money.

Fekete speaks about Gold in a classic sense and not in terms of Short term profits as many of the GOLD BULLS today. When Needham spoke about parting dollars for gold on March 17, stated that Gold Bugs keep getting it wrong, misses Fekete's point all together. Needham has no understanding of the Clandestine actions of both Goldman Sachs and JP Morgan in their smashing of the paper price of Gold.

As I stated in a Previous Post, the only way the US GOVT can control the price of Oil is to control the price of Gold. Gold Futures trading on the COMEX allows the REGIME of the FIAT DOLLAR to exist. When the Gold Window closes, so does the world of FIAT MONEY...and people rather own Real Money than Paper. This was true when the Soviet Union collapsed in 1989. Dimtry Orlov, commented that citizens in Russia rather have real goods, gold and silver than the Russian ruble to use for trade. When Orlov and some family members wanted to go into a distant town by way of car, to obtain gasoline they had to trade anything but Russian money.

People in this Blog are reacting to my post in a very shallow and ignorant way. That is to be expected. Most people have no clue that those little Federal Reserve Notes are not money but debts. If anyone held a NOTE on their House, it would be a Liablity, not an asset. A Federal Reserve note is a form of Debt that is backed by the US GOVT. With the bailouts and Quantitative Easing, the US DOLLAR is worth less than Toilet paper...as was witnessed today when the Dollar last 200 points.

Fekete's forcast for gold to go into Permanent Backwardation is not a HAPPY ONE. 2009 will be the DEATH BLOW to the US DOLLAR and the World Financial System. As the Roman Empire Fell when gold went into private hands...so will the United States.


Thanks for your highly informative reply, am currently digesting it.

All currencies are fiat, including gold. The benefit of gold, when it was chosen, is that it:
1. Doesn't corrode.
2. Is dense and therefore doesn't take up a lot of space.
3. Had no value.
Read #3 again. Gold was too soft to be useful for anything. Now we use it as a conductor, but for the most part it is still useless. That is why it makes a good medium of exchange. No one is going to melt it down to make a coffee pot out of it.

Another way of looking at this is to consider the copper penny. It isn't used any more because copper gained value beyond it's use as money. Once that happened it became worthless as money because people would rather melt it down and use for other things than keep it as money. If that doesn't occur with Gold it is because gold isn't valuable beyond its use as a fiat currency.

deleted repeated comment

deleted repeated comment

Certainly, a few questionable assertions:

1) The United States took Gold from its public back in 1933 by order of FDR...and only allowed trade through Foreign govts. US public citizens were not allowed to own gold until 1973. This was the beginning of the end of the US EMPIRE.

1933 started END of empire? It didn't even START until mid-WWII, about 1944. Prior was British empire, but USA carefully stayed out of that one until British Empire was broken.

2) When the US Dollar loses its place as the world currency.....

It may happen, in fact I consider it likely, but will have NOTHING to do at all with gold. That's just a gold bug's wet dream.

Some interesting points, not sure whether this is the first time Gold has gone into Backwardation see
These are interesting times :0

interesting analysis
but you have left out panic hoarding
i think in the next round the psychological & emotional factor will be different

that is, if export capacity declines rapidly, there is a shock to the system. people react irrationally (or more irrationally than usual)

i believe that a 5% decline rate on total 86 MBD, when applied to export capacity of 47 MBD, results in a 12 MBD loss of exports in 3 years, or 25%
the question is, when does this start. i think 2010 is the first year

the pessimistic view is 9% decline as mentioned by IEA, which results in 21 MBD over three years, or 45% of export capacity by 2012

then the system siezes up

It was and is a misreading of peak oil theory to conclude that prices only go up from here.

Instead, the plateauing of production (where we seem to be now) implies extreme price volatility.

Volatility means going up AND coming down.

My price prediction for oil?

Extreme price volatility.

Which is still a very good reason for reducing one's exposure to petroleum -- households, companies and countries.

on February 21, 2008 - 1:03 am I wrote one of my first comments ever on the Oil Drum. It addressed oil pricing, but wandered over into finance as a corollary issue that seems equally appropriate today. Here it is, with a few updated phrases marked in square brackets like these: [ ] .

Given the choice, would people rather start starving to death immediately, or quite a bit later?

That’s really what is at issue here, isn’t it?

Back when most folks were subsistence farmers (and the world’s population was a tenth what it is now) day to day living was a practical and direct activity. You grew food, or hunted it, provided your own transportation and shelter, and really understood the importance of staying on good terms with [your neighbors and] the tribe or land lord.

The means of survival were not abstract, and they were seldom distant.

Now they are both.

For most of the six billion souls currently on earth survival requires money and the overwhelmingly complex systems that money runs. The ‘stuff’ we live on [including the ultra necessity, oil] comes from the other side of the planet, as often as not, and the various elements that comprise the system of creation, control and delivery are as distant as you can get on a spherical rock such as ours. That these systems are completely dependent upon shrinking supplies of fossil energy [and availability of credit] is somewhat hidden from those who don’t make a deliberate effort to figure it out, and it’s daunting even for those who do.

When Peak Energy arrives, death cannot be far behind, but for those who just hate to wait, there is a faster way to the same end. Break one [of the other two or three] other life support systems and the dying can start immediately.

[Climate is the biggest, of course, but it moves so slowly! Let's go for the fast ball]

The hands down easiest and most quickly devastating one to break is money. Not only is it both the craziest and the most abstract, it’s also the one we use to regulate and control all of the other things that we are capable of regulating or controlling.

[I would stress that we now use money as the primary control system for all of our other systems... all of which are now driving above redline on the 'engine of civilization' tachometer]

How crazy is the modern way of making money? Barking mad. Suicidal.

Just look at the mainstream way of making money. Borrow too much money to acquire an overpriced thing no matter how ultimately destructive it might be (macmansions where farms used to be, new weapons systems, packaged subprime mortgages, whatever) on the assumption that in the near future that overpriced thing can be re-sold at an even higher price. The players know that the biggest fastest bucks happen when the deal is signed. Once they’ve got the money the question of fair value is someone else’s problem. [they are willfully oblivious to the damage they cause in this manner, just as they were willfully oblivious to the murder and mayhem financed by their investments.]

Ever larger loans mean ever larger profits (and net worth) so Banks are eager to drive the process. It is a world-wide Ponzi scheme gone haywire, and like all such scams (pyramid sales, multi-level marketing, chain letters) it hits the wall when there are not enough fresh suckers to go another round. Suckers are a renewable resource, [of course] but when that next ridiculously huge loan can not possibly be repaid, Lenders turn off the money spigot and pray for a government bailout… because they know that what happens next is really going to hurt. But turn it off they do anyway, because lending every penny they’re worth on a dead certain loser would hurt even worse. They know a thing is a dead certain loser when they are dead certain they won’t lend anyone that much money to buy it.

That brings us back, remarkably enough, to the problem of getting our leaders to do something about the impending peak energy disaster [or financial disaster, or Climate disaster, or any other disaster for that matter.]

Any energy [or financial] policy capable of adjusting consumption [or lending against asset value] downward to bring it in line with projected supply, will have the immediate effect of destroying the world’s economic system because that system, lamentably, is utterly dependent upon growth. Less energy consumption [or less lending] means less everything… and especially less credit based ‘growth.’ Such a move would end the Ponzi scam. It would cause world wide economic recession on a scale to make the Great Depression an insignificant blip.

Without ever-expanding credit to regulate and control production, distribution and security, the nearly instantaneous consequence would be chaos, starvation and violence. Train wreck on a global scale.

Actually, since the poorest are the most vulnerable it would be a ‘caboose first” sort of wreck.

[The caboose end of the train is currently being evicted in America, throwing molotov cocktails in Athens, and planning the next suicide attack in India. I don't think anyone low enough on the socio-economic ladder to be caught dead reading the Oil Drum is far enough forward on the train to escape. Just keep a close eye on your personal balance sheet. When net worth hits a year-on-year decline of greater than 50% then it's time to cash out and buy farming supplies... if they're still available.]

To carry the train analogy one more step. It’s a little late to be flagging down the engine to warn that the bridge is out. The 'engine' is doing exactly what it was designed to do: [trying desperately to] make more profit for its owners next quarter than it did last quarter. Feeding them facts and expecting sensible results is working about as well as talking to a train.

In other words, we can (and shall) slam into the wall when declining energy supplies trigger collapse, [which will propagate so chaotically that the precise chain of well understood causes and effects will only become completely clear in retrospect] but just forget about any leaders slamming their nations into the wall voluntarily prior to that event. No leader ever achieved power by promising unbearable hardship and death, nor lasted for long by delivering it. [They will pull any trick, tell any lie, perpetrate any violence rather than surrender their privileged positions. That is their nature. That is both how and why the achieved power in the first place.]

This is all ‘In Plain Sight’ sort of stuff. World events and the otherwise inexplicable obliviousness of our government to Peak Oil, [and their professed shock and amazement at the 'unforeseen economic meltdown] makes sense,in a criminally negligent sort of way, when viewed from this perspective.

The world’s leaders [and our new president must be included] aren’t ignoring the problem. They see the situation clearly, have carefully estimated consequences and they are vigorously responding … by getting as far away from that caboose as they can possibly get.

DBS, sorry to be picky but I've got nothing better to do!

is somewhat hidden from those who don’t make a deliberate effort to figure it out, and it’s daunting even for those who do.

should this read

is somewhat hidden from those who don’t make a deliberate effort to figure it out, and it’s very daunting for those who do.

Very deep, but probably close to the truth.

Hi Partypooper,

Well, it reads either way, but I must admit that your version improves the rhythm and beat, and makes better sense... so we'll go with that.

Ya know, I had a neighbor lady at one time who used to read my rural community newsletter and send a copy back with the spelling and punctuation corrections marked. You wouldn't be any relation of hers, would you?

Not that I'm complaining. It really kept me on my toes, grammar-wise.

You took my comment in the light hearted way that was intended, though the correction was my intepretation of what I thought you were trying to say. It is difficult to write a fault free post and also dangerous correcting people! You make be looking for revenge now. It's a disease I caught from my father, trouble is he's much smarter than me and less susceptable to fall foul.

Being serious now, I do think ignorance is bliss where this subject is concerned and I try and isolate my children from the situation, though that gets more difficult now they are in their teens. My wife remains in denial.

The traders would take the prices up but there was no real opposite forces that would take it down. The Chinese were using more oil every quarter, 20-30-40% more, till the end of Olympics which was this summer. Everything and anything can go up/down by manipulation but they can also reverse if there is a meaningful feedback and that wasn't such a feedback in works and the oil consumption was not going down as prices were going up. The consumption of oil did not really drop till the markets crashed. The prices are going down now which is due to the crash and they will flip again as soon as consumption is up. I doubt that even this crash can sustain low oil prices for long because the emerging market consumers can not be manipulated by the western media to consume less than them.

the Queueing Theory may explain the "speculative" and "nervous" a part of the strong oscillations. But I think here the major fundamental mechanism is due to the good old Cobweb Model (or pork cycle):
For the producing industry, the consumers and the policymakers the time lags to react to the changing reality are too long, which regularly leads to overreactions.
This might be avoided by a policy that is targeted to balance these oscillations, e. g. by energ taxes or supports for alternatives. But for this the policymakers need to know the future development to be balanced - which, as you wrote, is now very hard to predict - let alone to communicate.

BTW: Our current location:

The mathematics behind queuing theory helps explain the long term lag in price. The same thing that explains the production lag and smoothing from 2 separated oil discovery deltas, also will partially explain long-term "out-of-sync" oscillations of supply at the pump.

I don't normally use the abstraction of queues in the Oil Shock model since straightforward probability flows work perfectly well.

Coincidentally, Satyajit Das published a long examination of global capital flows and their current state of decline. This is another one of Das's articles that everyone here should read carefully;


There are several highlights, one focuses on the difficulty of large holders of US assets such as Treasury securities to access the cash money value these represent:

It is also not easy to tap this liquidity pool. Given the size of the portfolios, it is difficult for large investors such as China to rapidly mobilize a large portion of these funds by liquidating their investments and converting them into the home currency without substantial losses. This means that this money may not, in reality, be available, at least at short notice. If the dollar assets lose value or cannot be accessed, then China must still service its liabilities. It can print money but will suffer the economic consequences including inflation and higher funding costs.

This reduces that amount of reserves available to restart the credit machine both here as well as in the 'reserve countries' such as China, Japan and Saudi Arabia. Additionally, large sales if US securities by these countries would certainly put downward pressure on the dollar.

The substantial buildup of foreign reserves in central banks of emerging markets and developing countries, as identified by David Roche (see David Roche and Bob McKee, 2007, "New Monetarism," Independent Strategy Publications), is really a liquidity creation scheme that relies on the dollar’s favored position in trade and as a reserve currency.

Many global currencies are pegged to the dollar at an artificially low rate, like the Chinese Renminbi, to maintain export competitiveness. This creates an outflow of dollars (via the trade deficit that is driven by excess U.S. demand for imports based on an overvalued dollar). Foreign central bankers are forced to purchase U.S. debt with dollars to mitigate upward pressure on their domestic currency.

The large buildup in reserves in oil exporters from higher oil prices and higher demand from strong world growth was also recycled into U.S. dollar debt. The entire process was reminiscent of the "petrodollar" recycling of the 1970s.

This is certainly happening with the local currencies in the oil producing countries, the unwinding of this "liquidity creation scheme" is having an effect on crude prices. The currency pricing mechanism is stronger in its unwinding than the crude pricing mechanism at this point as it amplifies other deflationary forces that exist within the consuming countries such as the 'New Frugality'. The bustup of capital flows and the flight to 'safety' in US treasuries further amplifies the effects. The idea is there will be severe deflation so all non- treasury assets are questionable with the treasuries being less so. So all funds flow toward treasuries causing asset prices to fall which validates the deflation mindset causing further flight out of assets and into treasuries.

With the Fed setting a high floor for treasury prices it is a hard paradigm to overcome; the creation of a credit bubble in credit itself.

For the short term oil prices will decline; you can't fight the Fed.

Markets placed great faith in the volume of money available to support asset prices and assist in alleviating shortages of liquidity. The perceived abundance of liquidity was, in reality, merely an illusion created by high levels of debt and leverage as well as the structure of global capital flows. As the financial system deleverages, it is becoming clear, unsurprisingly, that available capital is more limited than previously estimated.

None of us were as rich as we wanted ourselves to believe.

I have repeatedly been reminding people here on TOD that oil is a commodity, and like all commodities its price will fluctuate in the short term. Long-term, as we move unambiguously past peak and start the long trip downslope, scarcity will become the rule, and supply will continually fall behind demand. Thus, the long term trend will be that prices will rise. Be careful, though: it is quite possible to be perfectly right in the long term, but to still lose your shirt on the short term movements.

Long term, oil will still have its ups and downs, but there will be more ups than downs and the ups will be up more than the downs will be down. That is about all that one can predict with any reasonable degree of confidence, and I'm not sure if that is enough of a basis for an successful investment strategy.

Can anyone tell me the actual value of a dollar? For that matter can anyone say with certainty that ten dollars are actually valued at 10 X $1?

In fact there is no inherent value in currencies. There is no inherent value for fiat currency. There is no inherent value for gold or any precious metal.

There is inherent value in foodstuff. There is inherent value in any form of energy that keeps us moving. In short, the only real currency we should attend to is the net energy at high potential that is available to do useful (economic) work. Paying attention to prices in dollars will never tell us what something is worth.

The only numbers that really matter are these: fuel production, fuel quality, and EROEI (as compared to energy consumption rates). It takes energy at high potential, produced in a sufficient flow rate, to drive our industrial economy, including our production of food. To haggle over the dollar value of oil as if it were a meaningful number is not productive, nor does it tell us anything meaningful in its volatility other than that our control systems for managing the flow of energy have gotten out of order. Price is not a meaningful parameter any more. It is just the convenient one we've gotten into the habit of paying attention to. Like magicians distracting our attention the bankers and politicians can use the dollar prices to fool us into thinking they are in control. They are not. No one is.

Our economy is a physical process. It requires an influx of high potential energy and a dissipation of low potential heat to keep the engines running. Money is an invention of convenience to help regulate the flow of energy through that system and nothing more. But since it is now completely divorced in value from the energy it was meant to regulate it can no longer be used for that purpose.

I urge TOD writers to focus on the meaningful numbers since that is what will tell us what is happening. The mess in the financial markets, the markets in general, are all due, I suspect, to a reduction in influx due to the peaking of oil production (or at least its entering into a plateau phase) and the decreasing EROEI, which means net energy flow is declining at an accelerating rate. We have been building more useless junk with what we have (letting infrastructure and investment in new energy technology go to hell). We were borrowing against a presumed future where we could always have an increasing energy influx to pay it back. We always have had one, haven't we?! Only the peak of oil production, followed shortly by the peak of energy production in general and the energy cost of having what flux we can get, means we have no future to recoup. I suspect that if we do a good job of tracking the real numbers we're going to find that the future is contraction.

Of course if we were wise we would value money on net exergy (energy available to do useful work).

Question Everything


I have always been able to get 100 pennies at any bank for $1, no more and no less. The true value of any currency is what it will buy. This is opposite of what my parents always told me which is the value of a dollar depends on how hard you work for it. I soon discovered that the jobs which pay the least required more physical labor than higher paying jobs like the boss had.

I soon discovered that the jobs which pay the least required more physical labor than higher paying jobs like the boss had.

It has (unfortunately) always been true throughout history in every nation-state that the most productive workers also tend to be the worst compensated. However, what is unusual is that the extremes in income disparity we are experiencing in the U.S. today dwarfs anything in our nation's history (we've already surpassed our previous record set in the 1920s). The insane levels of compensation for people who routinely perpetrate and abet systemic, massive fraud leads me to believe we are headed for a nasty day of reckoning.

Conventional wisdom is always the easiest to quote.

I have always been able to get 100 pennies at any bank for $1, no more and no less. The true value of any currency is what it will buy.

You actually have no idea what you are buying. You look at functionality perhaps but you really don't have much information on which to base comparisons of features with costs (see "The Paradox of Choice" by Barry Schwartz). The rational agent is a myth. But don't let that stop you from believing the conventional wisdom.

I soon discovered that the jobs which pay the least required more physical labor than higher paying jobs like the boss had.

I assume you are meaning that low-paying physical labor uses more energy, hence there can be no correlation between energy flow and value. The key is in the phrase 'useful work'. The greater the apparent usefulness of the work, the more value it imparts to the whole system. But this is a difficult concept to grasp, I will admit. Try hard.

Probably these "boom-and-bust" cycles will henceforth perpetuate until at least one of two things happens:

a) A "bust" phase permanently erases an important part of Demand;

b) A "boom" phase eventually takes place supported mainly by alternative energies;

I'm hoping for b).

Why are you hoping for b)? If human beings are going to be around for the long term we are going to have to get over boom phase of economic development. The OECD nations do not need X decades more of economic boom times. We should hope that alternative energy will expensive enough to put and end to boom economics for the richest nations, but cheap enough to support a comfortable but modest style of living.

If two hundred years after the start of the industrial revolution the richest nations on earth are unwilling to consider the end of growth based economics, what makes you think that X decades more of growth will do anything to change this attitude? Grow until you collapse is the strategy of yeast.

I am a simple minded kind of person. My attitude is that if you want to make infrastructure investments that are conducive to the long term health of the human community (which coincidendtally implies the long term health of biosphere) then this goal has to be part of the job description of people with responsibility for making such investments:

If you make investment decisions which benefit the long term health of society you will be well rewarded and honored. If you make investment decsions which are detrimental to the long term health of society then you will be out on the street looking for a new job.

This kind of economic focus will never take place in boom phase of private finance capitalism.

Well, my hats off to all of you who saw a collapse coming. I for one felt that while the prices might decline to $100, I did not see under $80 as a possibility. However, as we discuss the magnitude of the oil price collapse, years of bad U.S. fiscal policy outside of the oil industry seem more to be the culprit. Yes, $140/BBL prices were causing a global slow down, but it took the U.S. housing bubble create a global collapse that’s now threatening to become a global depression. (BTW, does anyone have detailed knowledge of the dynamics and policies in place during the previous oil price spikes? Obviously, the ‘67 and ‘73 oil embargos were not driven by market forces, and I would argue, neither was the magnitude of this one. I’ve read about supply and price spikes before Rockefeller took over, but I don’t have detailed knowledge about them. Another market to look at would be timber. It’s more of a pure supply and demand driven system. One of the sayings in the industry is that it can rapidly kill any good market (higher prices) in short order, because demand over stimulates supply, leading to a supply overshoot and then a price collapse.)

In any case, I think that if in June 08 you had asked Yergin, Westexas, Louis, Khebab, DBS, JD or anyone else who has discussed price models & projections what would happen given the unfolding events, you would have found unanimous agreement that the price would fall dramatically. The only disagreement would have been just of low it would have gone and how long it would stay there. While queuing theory provides a model that has similar reactions, I don't think its a good physical match for what's actually going on other that it says when things get tight, any small perturbation can create chaotic reactions. I'm not familiar enough with it, but cellular automata mixed with Chaos theory would be my next step for trying to model the petroleum industry (SimOil?). Neither logistic depletion curves nor market-driven models can account for oil platform attacks, resource wars, a once per century financial meltdown, unknown oil reserves, hidden futures contracts, and resource nationalism.

I think the worry now is what the long-term impact of low oil prices will be on all of those expensive natural gas and oil megaprojects. The ever-optimistic IEA (08 report) basically depended on them to make up for the impending shortfall from established fields that they predict will start this year.


Many of the projects depended on $60/BBL and above oil and will probably get shelved. Meanwhile, the past peak fields will continue to decline, leading to potential short falls when the world economy rebounds. For example, if we have 20% lower production for 5 years, you’ve essentially pushed the peak off by one year (I know its not strictly linear but bare with me). However, if the existing fields decline at 4.5% per year (as CERA has acknowledge), then after 5 years, you’re down 16% to 20% in production. As demand increases, there won’t be the capacity to support it and it will take 3 to 5 years to spool up the mega-projects, resulting in another 12% to 20% reduction in capacity. Depending on how things play out, and what policy governments follow, the oil price collapse could create a much worse situation in terms of future oil supply than we have been anticipating.

Something few seem to understand or appreciate:

Sure: $150 bbl was absurd. The economy tanked and now we're down to $40 a barrel.

After $150 we think it's a bargain, but let's be clear:

Oil was $10 bbl in 1998. So, in 10 years it has gone up 400%.

I don't consider that a "bargain".

Assuming $40 bbl is the "new" bottom, then we're looking at $160 bbl as the "new" bottom in 2018, if it follows the pattern. That still sounds like a lot of wreckage to me. I don't know if it will follow the curve, but I thought $150 bbl was about where it belonged today, so I would think $160 bbl in 2018 would be a bargain...

A couple of comments.

Excess of light sweet crude should result in oil prices returning to 30 dollars a barrel or below. I.e if oil really is in excess supply we should see prices continue to drop 40 is not a bottom. Next the decline should result in the collapse of expensive oil production projects this should even impact current projects i.e some may be left unfinished as they simply don't cash flow. The is effectively a repeat of the collapse of Texas in the 1980's.

Given the recent market moves the chances of us hitting 30 esp for any length of time seem improbable.

Next the oil market has remain in contango if we have excess oil sufficient for a real glut then the market will go out of contango and into backwardation esp as we leave the high demand winter months and look into the spring.

Right now April 2009 futures are at 52.14 this is some serious contango and makes storing oil for future delivery profitable.

Next if you look you will see that as each new front moth roles in we have seen the front month fall pulling down futures prices but not removing contango this is in my opinion probably the best evidence that the futures market is really telling us that it is looking short term. Its acting like a spot market with a short term glut. Coupled with the contango its still not telling us we have a long term glut.

Bottom line is the market is not pricing in any long term glut of oil it is telling us that its finding plenty of buyers every month but generally to date at a lower price point. There are no shortage of buyers for 40 dollar oil thus oil but we have enough of a excess right now to keep prices from rising strongly in the front month.

So either the market must go into backwardation across the futures curve or we will see the front month price begin to rise the current situation indicates to me at least that the market is still in a temporary short term glut mode.

Its not something you can make any long term conclusions from. If oil becomes constrained I suspect the market will discover plenty of willing borrowers up the price curve. How it moves will then depend on supply and demand.

So we need one of two scenarios to happen before I believe the market is back looking longer term ie its a real futures market it has to go into clear backwardation.

This is either via a increase in the front month price or steep decline in the long term futures prices esp in the Spring.

I think to force the long dated futures market down we would need to see the front moth price dive to 30 or below then rebound a bit it needs to send a very strong signal that honestly we don't need more oil. Then it should rebound a bit and put the market in backwardation representing the expectation of excess oil. The oil market may become slightly in contango but it should then be moving back and forth between contango and backwardation at the very least.

Or it goes into backwardation because of a strong price increase in the front month. Given the current steep contango my opinion is we may well see the steepness expand not decrease i.e as the front month rises the outer contracts rise even more putting us on a vicious price spiral.

The other possibility is the one I think the Saudi's have guessed which is a strong rise in the front month contract putting the market into backwardation will move up the future months but with contango lessing fairly quickly they are guessing that it ends at about 75 a barrel and thats their stable price point they have quoted.

I don't agree with there result but regardless until the market finally shows clear backwardation I don't believe you can use the current price of oil as any sort of economic indicator outside of a short term supply glut and the condition of the glut is determined on a month by month basis.

As usual an interesting, if not mindboggling, analysis memmel. If OPEC members actually honor the just proposed production cuts how would that effect your analysis?

I've been thinking about that. One thing I think happened this year was KSA was a bit high in their production numbers. My guess is at least 1mbpd. By this I mean I think they are overstating internal demand growth for oil.
7+% is really hard to actually achieve. The highest I think demand can grow in a economy is probably at best 5%.
China for example has had a what a 15% growth rate and like a 5% demand increase. And of course KSA does not let women drive. Next its primarily desert with the population fairly densely settled. Bottom line where are you going to drive in the country ?

This is not and attack on export land instead I'm simply saying that high internal growth rates makes it difficult to determine real overall production numbers. We don't know for sure what the drivers are for falling exports.
It simply adds more uncertainty. Same for Venezuela for that matter its tough to gauge real production rates.

One reason to question these consumption rates is simply looking at all the products from refining and the refining capacity I can't find any indication that refining in KSA changed in a manner I'd say matched the high increase in internal consumption. And just to be clear I'm saying I cannot find anything thats supportive of such a high internal consumption rate. I'd expect to see excess refinery products of some sort exported in larger volumes.
It could be simply because they are burning unrefined lower grade crude in their electric plants. It would be nice to see if some sort of measurable change in oil products in these exporting countries could be used to justify reported production rates. Right now we simply have to take their word for it.

So I think some of this decline could well be paper barrels that never existed in the first place. Say about 1mbpd.
Next I think that they won't actually reduce exports by 4mbd my guess is that 4mbd means 2mbd.

Now this should be enough to begin draining down OECD inventories I think and thus it will put pressure on prices.
On the inventory side we also seem to be accumulating some paper barrels. I.e its tough to justify the current supply levels from export reports such as you get from Oil Movements. This happened last winter in 2007. I could not figure out the source for at least 30 million barrels. Basically at the end of the day the US seems to be able to at times to capture and extra 1mbd of oil that I can't square away with what I know about exports.

So we have 1mbd at least of questionable Saudi production and 1mbd of excess imports of questionable sources.

I'm giving the 4mbd supposed cut a real export cut of 2mbd. Next I'll assume that this will dry up the excess oil we seem to be able to get i.e for the US it should send us down on imports about 1mbd.

Now to price this should put a strong floor under prices as winter demand should finally start drawing the resistant US storage.

However the market is in strong contango right now as its a bit of a race between people storing oil for later delivery and dropping exports from OPEC. The point is we don't know how much of this mysterious boost is actually oil that won't be put on the market until later in the year. A lot of it may be for delivery later.

So back to price if this is sufficient to start a price spiral then the spiral should take off the conditions for a price spike continue to get more and more favorable. As far as timing goes :) I'll have to wait till we see US oil storage start to decline I'm a bit tired of trying to predict it. It should by all right been lower this week. Maybe next week.

Then I expect yet another OPEC cut to be announced in Jan as prices don't "respond" this should be 2mbd and it should probably bring the real cut to 3mbd. From here they may have to really cut with Russia and additional 1mbd
to force prices up again I'm not sure. Once they ignite the price spiral then they will slowly increase production in my opinion.

But again understand that I think I price spike can happen at anytime nobody knows when I give it like I say from the end of the year say on the outside March. Given the US inventory report it looks later. But if the US is getting extra oil that means of course someone else is not getting oil so it depends on inventories we don't know about.
My hunch has been that the price spike would start to happen before US inventories actually declined significantly.
Initiating out in the world in the dark inventories we know nothing about. This hunch could prove wrong I dunno.

And finally sorry for this wishy washy answer I don't see that the real situation is clear yet its clearing but not yet obvious if OPEC can control prices. They are going to give it a serious try but it takes time for OPEC to get serious.

And last but not least as another factor the key point is light sweet crude if KSA cuts primarly its lightest crudes then looking at barrels of oil is not the right way to do it. The impact could be larger esp if I was right that the surge this summer was stored Arab Light. My hunch is that this will be the case and the crude cuts will have a bigger impact then volume alone would suggest. It makes sense to me at least that KSA would use this as a chance to rest production in Ghawar saving it for later.

Edited to add some pictures.

US production


Total Supply:

Gasoline Stocks from


Given the imports US production and gasoline stock levels I don't end up with as
large a build as reported in crude stocks are reported. This is of course the supposed
demand decline I guess. But its not obvious.

Looking at days of supply of gasoline and previous stock levels:

I would not be able to predict the same stock build esp considering gasoline imports are down.

Basically if you take all the graphs the EIA gives and remove the one for total oil stocks then
I at least would not predict the reported level of oil stocks.

Just got a look at Oil Movements report.

True production cuts from sustainable production would have to happen from our current level so if KSA is seriously going to cut production we should find out over the next several weeks. The surges of what I consider unsustainable production are finally out of the system although some may still be showing up onshore.

Real honest to god true believable what ever you want to call it production cuts would should begin to become to show lets say withing 2 maybe 3 weeks.

Your mental model of oil prices struck me as almost identical to a drawing I did the other day based on a different idea. In the 30 year update of Limits to Growth, Randers & Meadows note that stock brokers call overshoot "bubbles". So I looked at oil prices as having gone into overshoot, followed by collapse, overcorrection, to be followed by the usual oscillating wave, as the price finds its way back to the "k" line, what might be called the natural, or logical price.

But k is only flat for a sustainable resource like wind (assuming the sun doesn't go out, on top of our other problems); for oil, k must be rising as oil depletes. So you get an oscillating series of overshoots and undershoots around a rising line, exacerbated by the usual psychological, physical and military factors. Just thought the tie-in to overshoot is interesting, as a way of looking at this - I suspect the mechanism of overshoot is at work around us all the time, in ways we don't think about.