Finite Resources: One Possible Explanation for the Energy Crisis

This is a slide video of the presentation given by Gail Tverberg at the Oil Drum/ASPO Conference at Alcatraz, Italy in June 2009. Her talk is about Finite Resources: One Possible Explanation for the Energy Crisis ( Presentation PDF 1.3 MB).

Finite Resources: One Possible Explanation for the Financial Crisis from Rembrandt Koppelaar on Vimeo.

Has the credit unwind "seriously impacted" oil production? A few delays and minor cancellations in the oil sands, refinery builds, Saudi Aramco retendering various projects, stories about service companies being impacted to an extent. But no analysis suggesting that the overall fallout will amount to much, assuming the economy is back on track soon, of course, and that a serious retraction of credit doesn't occur. At least in the US the individual consumer is driving more than last year, judging from VMT data, suggesting to me that credit is still available enough for demand to remain high. Possibly this is exacerbated by the recession and the need for the unemployed to travel even more in search of work.

US the individual consumer is driving more than last year, judging from VMT data, suggesting to me that credit is still available enough for demand to remain high.

Hi KLR I think the penultimate item to go will be money (or credit) for the auto, lots of stuff not to buy before then, while the last to fade away will leave us sitting in the dark. Here is Denninger's awful post today on credit.

[edit] Ho ho, just watched a Christmas commercial for something called! Looks like Christmas will be on the cheap this year, but with still a ride in style to granny's house for the good old mass quantities of cut rate battery assembled Turkey dinner. Keep on trucking everyone and burn that gas, the next credit collapse may just save the planet if not our asses.

The credit unwind is on the demand side, more than the supply side. The number of cars being built is way down; the number of new houses being built is way down. As a result, the amount of oil needed in the production of cars and new houses and things to put in new houses is way down.

While the individual consumer is driving more miles this year than last, total petroleum consumption is still way down. The increase in gasoline use is more than offset by declines elsewhere. These are some graphs I put together:

Figure 1. US Gasoline Consumption. September 2008 was affected by two hurricanes

Figure 2. US Consumption of Products other than Gasoline

Figure 3. Total US Petroleum Product Consumption - (Total of Figures 1 and 2)

One can see from the graphs that total consumption (demand) is down, even though gasoline consumption (demand) is up somewhat from 2008. The September /October period last year is affected by two hurricanes, so will be a little tricky to compare to. Some people in Atlanta were staying home from work last year, because they couldn't find gasoline for driving--an unusual situation. Businesses drew down inventories, and refilled in October.

All those ten and twenty percent off coupons. I'm generating them for my clients and sending them out in bulk email. I'm buying stuff - hoarding - greenhouses, plastic, fertilizer - all with /at least/ 20% off prices.

Presumably the idea is to make up in volume the money lost on every sale. It's the deflation scenario Ilargi and Stoneleigh discuss on TAE. Cash is supposed to be king in deflation, but I'm worried that real assets won't exist at all - making cash useless.

Small businesses are going out on a limb to keep volume up. That's going to be painful. Bloody ripped out fingernails.

My query was about the supply side, and the words "seriously impacted" were taken from your presentation. I know about the demand retrenchment, which I expect to be temporary - if the 80s are any indication, lasting perhaps 3-4 years, if that, before achieving previous levels.

If the issue is international credit, there would be major players simply out of the running to purchase oil, because their credit is not good enough. Perhaps they would be able to purchase oil, if they could put together a bilateral trade agreement for some specific other product, but not otherwise.

With fewer paying buyers, price would likely drop, and those producing oil would find it unprofitable to do so, except in the areas of the world where it is very cheap to do so. So production would drop as well. With some big players out of the running as purchasers, prices could stay low for quite a while. Countries might just decide to produce what they need for their own use and the use of a few trusted partners, at agreed upon prices--more or less outside any functioning world oil market.

IMO, the three primary factors affecting oil prices are: The volume of net oil exports (long term decline accelerating with time, IMO); the rate of change in OECD demand (generally flat to declining) and the rate of change in non-OECD demand (generally up).

Unfortunately, our only good short term data applies to the one factor that is negative for oil prices, OECD, and especially, US demand. I have compared it to the old joke about a drunk looking for his keys under a streetlight late at night, because the light was better there, even though he lost his keys down the street.

I wish I could bet against the prediction from the last slide that global oil production will be 22 million BPD in 2012 (30% of the recent peak). What price would it take to make that happen? Something like $10 per barrel? Why do people combine interesting ideas with ludicrous guesses? It discredits the whole community.

The whole issue has to do with how the current international trade situation stays together. If everything continues to work well, and the United States can continue to buy oil on credit, without really having the ability to pay for it, then everything will be fine. I understand that this is the scenario you would like to bet on.

If instead the international credit situation starts falling apart, because there are many countries that would like to buy oil but really don't have the ability to pay for it, the situation could be very different. Countries with the ability to pay for the oil will be lacking, so the oil may stay in the ground for lack of financially solvent buyers. Why pump the oil, if the buyer can only pay in funny-money?

Another way the decline could occur (but probably not as steeply as shown in the graph) is if oil companies can no longer borrow the money they need for new investment, because of credit issues. This is already happening to some extent. The decline curve we usually see assumes new infill drilling and drilling of new small discoveries. If companies cannot get financing to do this, the decline curve will drop at a steeper rate than we are used to, but not as steeply as if the decline is "demand" induced by a cut-off of credit to certain non-credit worthy buyers.

Basically you are predicting a collapse of the finance system and the entire global economy while oil stays cheap. Other wise they would keep pumping the available reserves. As I see it, if oil stays cheap then the system will keep growing. There may be shocks along the way, but there is just no way that global demand for oil will decrease by a factor of 3 in the next 3 years. Many things are possible farther into the future, but the entire economic systems of transportation, petroleum and agriculture won't grind to a halt in 3 years. What model do you use to generate your charts?

Basically you are predicting a collapse of the finance system and the entire global economy while oil stays cheap....
As I see it, if oil stays cheap...

You call $80 oil cheap? Oil was, very briefly, cheap back in the Spring and that was has been cheap since 2005. I think the days of cheap oil are gone unless the financial system collapses. Oil is high enough right now to keep new projects going, though many were cancelled back in the Spring.

Gail's scenario is based upon the collapse of our financial system. If that happens all bets are off. I don't think there is any to predict oil prices under such a scenario.

Ron P.

It would take a global financial crash, which is exactly the scenario that Gail was presenting.

We had a wee taste of what that would look like last year, right up close and local, when Lehman Bros. went under. Lehman Bros. was handling something like 80% of the U.S. short term (days or weeks) commercial financing and a big chunk of the international letters of credit. When the letter of credit system seized up, grain piled up on the docks, apples rotted in warehouses, frozen fish sat sucking up expensive electricity and storage space while cargo ships waited at anchor out in the bay. Grain elevator owners sweated, as the grain could not be sold and could not be stored.

The seize up was brief, due to government intervention and various financial highjinks we may never hear the full story about. The ripples are still propagating outward a year later.

Gail was talking about a convulsion in international credit large enough to cause a phase change in the way the system operates. It could certainly happen, given enough systemic weakness in the underlying major economies. Then an event like the Lehman Bros. collapse could trigger a big change in the set point of the system, from about 80 mbpd to something else.

Someone here months ago pointed out that oil is not priced in dollars, dollars are priced in oil. For millennia, gold was priced in grain. Precious metals and objects of value were a way of time shifting the value of calories stored as grain and storing them in a non-perishable form. That too has its limits, as many have pointed out. Dollars are likely to become quite cheap in terms of oil in Gail's scenario.

Perhaps what you are getting at is that we in the west would be confronted with a very different reality if there was a 75% drop in the operating point of world energy consumption. Certainly. Previous "oil shocks" confronted us with a different world with a temporary decrease of less than 5%, and that was a bang on the head for a lot of people.

Problem is there just aren't any reasons presented as to why such a collapse would occur when there is still 70 million barrels per day of oil waiting to be pumped.

I think that we need to distinguish between the credit = "time to pay" necessary to oil the wheels of global commerce, and the credit which is invested medium and long term in productive assets, typically (at least in the private sector) secured by a legal claim such as a mortgage, or alternatively through the permanent ownership claim of equity typically consisting of shares in a Corporation.

The problem has been that credit institutions are now mostly 'dual purpose' and a credit problem caused by defaults in the investment area has the potential to freeze all new credit whatever the purpose, because the two activities are not distinguished.

In my view credit intermediaries aka banks are unnecessary in an age of direct instantaneous connections. As John Gilmore almost said (he was referring to censorship)..."the Internet interprets Banks as Damage and routes around them".

The Swiss WIR system of credit clearing demonstrates merely by existing (although all barter systems incorporating credit are similar) that an energy clearing union - where bilateral energy transactions take place on credit terms - is pretty straightforward to achieve.

The requirements are:

(a) Accounting system - ie a shared transaction and title repository;

(b) Value Standard - a unit of measure, by reference to which transactions would be priced, and here I advocate a Unit of energy rather than the literally valueless abstraction of a fiat currency like the dollar or the euro;

(c) Framework of Trust - where I suggest that both sellers and buyers would make a provision for the use of a mutual guarantee within what I call a 'Guarantee Society" agreement;

(d) Service Providers - formerly known as Banks - who would set guarantee limits, handle defaults and administer the system in return for a performance-based fee.

The beauty of this Peer to Peer Credit model for the banks is that it is the market participants' capital that backs the guarantee, not theirs, and the only capital they need is that required for operating costs.

One of the interesting aspects of this model is the similarity to the International Clearing Union proposed by Keynes at Bretton Woods, the principal difference being that here there is no central issuer of a fiat currency.

The 'default pool" funded by the guarantee charge/provisions made in respect of BOTH credit and debit balances is analogous to the Gesellian approach taken by Keynes with credit and debit balances of his Bancors. With the funds in the Pool it is possible to make investments in renewable energy and energy savings aimed at rectifying imbalances in energy flows.

The above model deals with a new risk sharing approach to credit - I also advocate a simple new approach to investment in energy assets, simply by enabling producers to issue Units redeemable in payment for energy supplied, and then selling these to the investors currently queuing up for just such an asset class eg Exchange Traded Funds, Sovereign Wealth Funds, and so on. Anyone who understands (say) Tesco Clubcard points, or Frequent Flyer Miles should understand Units redeemable against energy consumption.

It is also possible to apply a carbon levy on all carbon fuel transactions, and to then distribute Units in the pool to consumers. This is a simple but radical mechanism for the profligate energy producing and consuming nations to cut subsidies and consumption respectively. eg to gradually increase the global gasoline price level to around $5.00 per gallon initially, and to compensate consumers with Units. In the producing nations in particular, profligate consumption and sheer waste would be cut sharply as consumers saved their energy dividend so that they could exchange Units for accommodation, goods and services, or imports.

In this way we may 'monetise' the intrinsic energy value of carbon, (and energy generally) rather than attempting to monetise by government fiat something intrinsically worthless, like carbon emissions or carbon credits. It's no surprise to find that the system dreamt up by Enron is enthusiastically promoted by the same people who brought us the Credit Crunch by....errrr....monetising IOUs issued ex nihilo and with no intrinsic value.

The combination of risk sharing - through Peer to Peer Credit - and revenue/production sharing - through Peer to Peer investment - are capable of financing the necessary energy transition while in so doing providing new energy-based global reserve currency. Solving the credit crunch is another issue, of course, and there I advocate a new P2P approach to investment in land/location so that a debt/equity swap may prevent the global economy disappearing down a Black Hole.

Both Nasim Taleb and Willem Buiter have recently been saying that if debt is unsustainable - and it clearly is - then the only solution is equity. I concur, but I suggest that it will not be equity as we know it.

Framework of trust

Where greed is good, a framework of trust is difficult to maintain. In a decline scenario, even more difficult. Clearly, one cannot trust the current financial/tax/political context. Except to screw or get screwed. People are in that game now because they have to be, but the absence of trust, the guarantee that it's all a racket, that's all Endgame.

It is very difficult to step out of the system. The wealthier one is, the more difficult. That makes for a bloody interesting dynamic, I think. Those with nothing to lose will be the loosest.

cfm, the growlery, gray, ME

As far as the credit supply for building or drilling new projects is concerned, that doesn't seem to be the problem. Most of the oilsands projects are built with equity or cash flow. A lot of conventional-oil junior petes got silly during the boom and tried to become the next ExxonMobil on borrowed money, but a lot of them didn't. There are still private-equity offerings floating around Calgary for partnership units or preferred shares; I just wish I had enough cash to take advantage of them all.

What worries me is that there may be too much credit building up on the other side. The Wall Street banksters have their trillions in free money of course, but here in Canada a housing bubble is developing because of rock-bottom interest rates (see for the ugly details). I'm 10% in physical gold and have started building up towards 10% in palladium because I fear what is coming down the road.

late in the day...anyway:

It seems to me that the choice was, towards the end of Bush’s term, between, a) an economic crash, that is letting all lenders / stock holders / institutions holding dodgy or worthless paper eat the losses, following the ‘old model’ - bankruptcy, FDIC, defaulting on debt, etc. A kind of ‘creative’ destruction that wipes the slate clean. With, surely consequent Gvmt. intervention *after it*, in two ways: re-regulation; and massive disbursement, not in the form of bail-outs but in the form of re-investment and social relief. Because the financial world is so globally interconnected, and because the crisis ‘originated’ in the US, this avenue appeared disastrous, well nigh impossible to grasp in its dire consequences, and choice b) propping up the current system, was adopted. There were surely many other factors leading up to choice b - the stranglehold of certain sections of ‘finance’ on ‘government’, an inherent belief in future growth lifting all boats, fear of the dissolution of the present world order, which de facto favors those in power who take the decisions, etc.

Choice b necessitated a free-wheeling approach, breaking the old model, rendering it defunct, but without an explicitly laid out new model taking its place. The new model can’t be made public because it is fascistic - a melding of gvmt., corporations, the finance sector and, in the US, to some degree, the military - it is deeply ‘anti-democratic’ or contra-republican. It is an aberration, or an extremism of the center (not left or right in its essence, compare Pinochet, Mao..) and arises, as we know, when great leaps forward need to be made, and the populace controlled, or possibly just ignored, left to shift for themselves in disorganised, unfavorable conditions. Of course change is insidious and not abrupt (except in war time, and the US fights wars while pretending not to at home) and the whole situation had a long build-up.

But what is the role played by ‘oil’, or more generally, energy / vital resources extraction from the natural world?

Oil prices spiked and played a major role? Maybe... I still don’t see it... Price of health care rose too; mortgages, etc. Some - some! - consumers were strapped out and spent less, however the sub-prime, housing bubble, unwinding was a given, independently of prices at the pump. It was fraud on a major scale, with many parties participating, most for short term financial benefits. It worked, it was a hype, then it crashed...the clever players made exceptional money, or were ‘bailed out’, the chumps were left in the street. Then as Gail describes a downspin begins, credit is tightened, positive feedback kicks in, etc. (Subprime was the canary in the mine only; not a major or principal cause; it exposed the rot in the finance industry, an outcome of an erroneous comprehension / modeling of risk on the intellectual side, and greed on the emotional end.)

Energy, however, is still flowing to the ‘west‘ as well as to/in BRIC and many other places. Its price is not of first importance, as has been argued on TOD. While world leaders, and many movers and shakers are well aware of PO, it is not really on the agenda because of a need, desire to continue BAU, so it is relevance right now is not high. I find the arguments that underground, beyond all the player’s perceptions, it is playing a major but more or less invisible, or hard to tease out role, in the economic meltdown, difficult to integrate. Certainly the ‘A ha!‘ moment is lacking, meaning only I might be short-sighted or wrong. A longer time view and more in depth discussion - short book length vs. a lecture - might illuminate. Yet, I found myself musing, what would be in that book?

Malfeasance, fraud, malinvesment, hopeless and corrupt Gvmt., all tolerated and unpunished, are not central topics for TOD, although they impact the overall functioning of society, and the ‘energy‘ industry, including the large, foreign, ‘nationalised‘ parts (Venezuela, Saudi Arabia, etc.) With a better, sounder, more reasonable method of exchange PO would not be such a looming horror (I agree it is and am not diminishing its importance) investment of a semi-rational type might have a chance... Truism, sure.

There are a lot of things that are a little hard to understand. The oil price rise started way back in 2003 -2004. Then the Federal Reserve started raising interest rates, with the reason given in their minutes being to hold back the inflation caused by the higher oil prices. There was a long-squeeze, started by the run-up in oil prices.

Economic growth is normally fueled by growth in low priced oil supplies, but about 2004, that started to stall out, because oil supply stopped growing. But the economy needed growth to keep our debt based system going, and TPTB knew that growth was essential. Since "real" growth coming from an increasing supply of low priced oil wasn't forthcoming, they contrived "fake" growth, based on greatly relaxed lending standards. That required a lot of malfeasance, fraud, and other tricks, to keep the appearance of growth up--regulators looked the other way, as banks found risks that would never have qualified for loans in the past. If the economy had been able to rely on normal growth in oil supplies at low prices, there would not have been the need for this phony growth to cover up the lack of real growth.

Eventually it all started to fall apart--the phony appearance of growth, to cover up the lack of real oil-based growth was part of the problem. But the other problem was that oil prices continued to rise even further, squeezing the most vulnerable. People stopped buying houses in the distant suburbs, prices of houses started dropping there particularly. Debt defaults started rising first among the most vulnerable--sub-prime risks. Gradually the debt defaults spread further, and banks found themselves in poor financial condition, so they could not lend as much. Eventually, the lack of credit started affecting those buying products using oil, and eventually oil prices, so the break came in oil prices.

US consumer credit outstanding peaked in the same month as world oil prices--July 2008.

There is one distortion in Gail's insightful presentation - the energy associated with production of biofuels is counted twice, once as the fuel leaving the processing plant and again as the oil required to produce it. In the case of corn ethanol (the major biofuel in the U. S.), the oil consumed in planting, harvesting, transporting and distilling corn is not available to the economy. As long as oil production is measured at the wellhead, and biofuel at the distillery, this double counting will continue. Oil and other fossil fuels (natural gas to produce fertilizer and coal to produce electricity) about equal in energy value the ethanol that is produced, so a more accurate measure would be not to count the ethanol as a net contribution to energy supplies. Future improvements in production methods may yield a modest energy return on energy invested, but the fossil fuel used in production should be subtracted from the biofuel produced to give an accurate measure of available energy.
Of course some of the oil produced is used in refining and transport of oil products, but the distortion is minor compared to the energy required to produce biofuels.

Glad my plot was of use.

When I use that plot (with the bridges in the background) I tell people that the reason I include the bridges is the inherent assumption that there is someplace to go on the other side of the bridge.

The curve and the data suggest something else.

Thanks for the plot and the explanation. I don't remember if I gave you proper credit in this presentation. It seems like I have used it more than once.