Peak Oil Ass-Backwards (part 1): Peak

Oil, Meet Fractional-Reserve Banking

(image by Viktor Hertz)
(image by Viktor Hertz)

If the ongoing crash of oil prices over the past year – and now the stock market crashes of last week – have continuously taught me one thing, that would be that I've got very little clue regarding the economic implications of peak oil. To explain this I'll have to take a circuitous, roundabout route here, but if you've been as afflicted as I've been then you might find the following a bit illuminating.

For starters, even though I learned about peak oil in 2005, fractional-reserve banking in 2006, and pretty much instantly proceeded to put two and two together, I still ended up falling for what I might unfairly call the "peak oil orthodoxy." I'm not sure where I first came across this "orthodoxy" I speak of, but an example as good as any – and maybe even better than any – would be that of author and a former Chief Economist at CIBC (one of Canada's Big Five banks), Jeff Rubin.

As Rubin explained it in his first of two peak oil books, because peak oil implies a curtailment on the supply of oil, and since the demand end of a growing economy is by definition increasing, the notion of supply and demand imply that prices will head upwards if supply is limited. Because of this, upon oil's peak its price will eventually rise to such ungodly high levels that it'll become unaffordable by many. Following that, its demand will therefore peter out, and so thanks to the new glut in supply the price will crash to equally ungodly low levels. Once things settle down and the consumer can once again afford the now lower-priced oil, the process will repeat itself since the new (and increasing) demand will once again bump up against the limits imposed by peaking oil supplies. As a result, another crash will occur. On and on the process repeats itself, but with the higher price spikes followed by higher troughs.

Available on Amazon for the bargain price of $0.01
Available on Amazon for the bargain price of $0.01

For better or worse, that's what I now call the "peak oil orthodoxy," and is why I, for one, was waiting for the Second Coming of high oil prices after the spike of $147 in July of 2008. But after patiently waiting for six years, it never came. (At least those 2012 folk had a set date and could just re-apply for their jobs on the 22nd.) In fact, not only did oil's price spend a few years bouncing around the $100 level after rebounding from its low of $32.40 on Dec. 19, 2008, but beginning in June of 2014 it began to dive-bomb to its current level of about $40 (which has now jumped back up to $50 or so in the few days it's taken me to write this). Although the initial price-dive threw me off at first, a bit of reading near the end of 2014 (and I unfortunately can't remember the exact online sources) enlightened me in regards to the notion of demand destruction.

Although demand destruction made so much sense to me that I wrote my first oil piece on it – Peak Oil and the Fracking Bubble: Could this Mimic the 2004-2008 Housing Bubble? – I apparently hadn't properly comprehended the underlying factors and the ultimate implications of demand destruction as I was still expecting oil to eventually rise again, if not just hang out in some mushy middle-area of $70 or so. Although I knew enough that I could have known better, my background in economics – and especially my predisposition to even think in economic terms – is pretty much zilch, so I suppose I've got somewhat of an excuse for being a complete idiot here. In other words, although I'd at least managed to notice and call out the incongruences brought about by peak oil in a world of fractional-reserve banking, it took me until just recently to fully clue into the underlying and long-term implications of demand destruction. My apologies if you've already read me explain this a few times, but I'll repeat myself here for posterity's sake.

First off, the majority of "money" sloshing around out there – let's say 95% of it – is not created by governments but by private banks when they make loans. Secondly, the method by which this money is brought into existence, via fractional-reserve banking and double-entry bookkeeping, is upon the creation of new loans. In other words, money is created as debt. Furthermore, it is because banks create the principal and not the interest that there is never enough money in existence to pay off all the debts plus the interest. As a result, the debt bubble must be continually enlarged via ever-expanding credit so that previous loans can be serviced, lest the system implode in on itself. This is the debt treadmill, and is why economic growth must be maintained at all costs, even at the cost of utterly trashing the planet we live within.

So along with being gobsmacked when I learned about how most of our "money" is created, what pretty much instantly hit me was that since economic growth requires an increase in energy supplies to power that growth, and since peak oil implies an eventual maximum level of energy extraction, this limit to energy supplies is going to put us in a bit of a pickle.

I was thankfully proven to be only a partial crackhead
I was thankfully proven to be only a partial crackhead

In the meantime, seeing how the only friend I had amenable to chatting about these things lived half-way across the world in New Zealand, and seeing how I'd quit the Internet (which actually ended up being a five-year hiatus) and so didn't have an Oil Drum or whatever to bounce these thoughts and ideas off of, it was quite some time before I came across any written material putting the two issues I speak of together (the first time came in the book Fleeing Vesuvius I think).

So seeing how we both lived in Toronto at the time, I figured it might be worth stopping over at one of the talks that Jeff Rubin was giving for the release of his second book (The End of Growth), as here was not only some guy writing about peak oil, but an economist writing about peak oil! When the talk – with David Suzuki!? – was over and both authors got to the book signing part of the night, I slowly made my way to the front of the Rubin cue and asked him the following:

If peak oil means the end of growth, and if fractional-reserve banking requires perpetual growth to keep the system going, doesn't that mean we should be moving away from fractional-reserve banking?

"But that's not what I'm talking about."

Well, yeah. But still. Doesn't peak oil imply a serious problem to the way in which our banking and monetary systems currently operate, since they need ever more energy to keep growing?

"You're talking about the money-multiplier effect, right?"

Uhhh, yeah. [I'd only heard it referred to in this way once before.]

"Well that's not what I'm talking about."

He then proceeded to say something which I'd already read in his book (of which didn't address my question at all), and as I'd obviously come upon a brick wall, I didn't bother pressing any further and so made my way home.

My stone-walling with Rubin should have been expected though, for if you take a look at his first book, the summation of his peak oil prognostication is pretty much this: Californian's will be eating less Ontario maple syrup, Ontarians will be eating less California avocadoes, and we'll all be eating more locally grown carrots. In short, it's all about basic market mechanisms of supply and demand, which mean that we don't really need to do anything ourselves, nor change our ways, since markets will tidily work out this oil issue for us. But in the meantime, we should get cracking on creating locally-manufactured television sets (according to his second book)! In other words, if you're looking for a ho hum story of peak oil, look no further than Jeff Rubin.

A much better book than The End of Growth, also by a Canadian ex-banker
A much better book than The End of Growth, also by a Canadian ex-banker

Nonetheless, even though I'd clued into the banality of nearly everything Rubin had to say about peak oil, I unfortunately fell hook, line and sinker for his notion of escalating oil prices. So although I wasn't economically dogmatic and unwilling to question and factor in the method by which most of our money is created, I'd effectively handcuffed myself from being able to comprehend the economic ramifications of peak oil and fractional-reserve banking any further, even though, as mentioned, I'd already written a piece on demand destruction as being behind oil's recent dip in prices.

Nevertheless, for a while now I've had the hunch – based on nothing but a gut feeling – that oil was going to head on down to $20. I even got all techno-savvy and tweeted it, even before the recent stock market and oil price crashes (which, as already mentioned, have had a more recent upswing):

But then came the biggie. A few days after that I was reading the comments from an article on Resilience when it finally hit me: "Wait a second! Demand destruction doesn't imply a minor and/or temporary dip in prices to some mushy middle. It means the opposite of inflating prices – deflating prices! They're going to keep going downwards!"

In other words, not only have I somewhat been in the deflationary closet for nearly a decade now, but I didn't even realize there was a counter-argument, or even a counter-argument closet!

Having finally clued into all that, the implications that my willingness to put two and two together nearly a decade ago was finally leading somewhere. On top of that, that willingness of mine allowed me to take that further step that I'd been looking for, and so allowed me to put two and two and two together. That next "two" being money as a proxy for energy, as I'll get to in Part 2.

EDIT 06/09/2015: In the last sentence, the words "peak credit" have been changed to "money as a proxy for energy."

Ce post a était traduit en Français par online publication Le Saker Francophone. Il apparaît dans Le Saker Francophone ici ou dans From Filmers to Farmers ici (arrive bientôt). Pour d'autres traductions en Français, s'il vous plaît voir la page de traduction Française.

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Comments (12)

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peak.singularity
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Sep 2015
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Wouldn't the source about demand destruction you're taking about be this?
http://ourfiniteworld.com
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Johnny
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45
Mar 2015
<sigh>

Well, better late then never. The ability to learn has its own value, even if you haven't quite got all the pieces yet.

Are you familiar with the resource pyramid, and how long run prices tend to revolve around the marginal cost of production?
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Allan Stromfeldt Christensen
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Aug 2014
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peak.singularity: In a sense I'd guess that you're right, but I say "guess" since I never followed the Oil Drum and so am not aware of who was discussing this there and/or who it originated with. On top of that, although I did read a few articles by Gail a year or so ago, I haven't done so since. That being said, I did hear her speak twice at two Age of Limits conferences, but if she mentioned deflating prices (and I can only guess that she did), it must have gone right over my head. Not to any fault of hers, but due to my steadfast expectation for inflating prices.
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Allan Stromfeldt Christensen
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Aug 2014
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johnny: Thanks for keeping the faith! Believe it or not, when I was a kid I was actually tested (by the school board) and sent to another school for kids who learned faster. PACE it was called -- Program for the Academic Creative Extension. Shows how much they knew though. They should have instead stuck me on the small bus with all the "special" students!

Resource pyramid and marginal cost of production? I am familiar with EROEI.
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Johnny
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Mar 2015
EROEI is no more relevant to oil and gas professionals, or the oil industry in general, than the chemical composition of the dirt on the surface of Pluto is to you. No well, field, project, basin, play or offshore platform has ever been given the go/no go decision based on EROEI.

For some reason certain academics find it interesting, for example Charles Hall used net drilling yield and net energy circa 1981 to predict the end of drilling in the United States by the year 2000. The paper was probably actually written slightly earlier right about global peak oil production in 1979, resource scarcity was quite the rage back then as well. Charlie popped up again decades later when the next claimed global peak oil livened up the next generation of neo-malthusians.

In either case the resource pyramid concept is easy, as you move down within it, you open up more volume than the slice above. As technology improves, and economies of scale come your way, the price of that additional resource ends up being lower than it once was, pressuring the price on not only the marginal cost of production within a slice, but as we have seen with shale oil, it can even pressure the marginal cost of production in slices above, i.e. conventional oil produced by NOCs.
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Allan Stromfeldt Christensen
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Aug 2014
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johnny: That EROEI is of no relevance to oil and gas professionals nor the oil industry in general (as you say) comes as little surprise to me. What matters is meeting their debt obligations and servicing all those junk bonds at all costs. They don't want to pop the bubble and spoil the party after all, do they?

"More volume," "technology improving," "economies of scale"... are we close to reaching the creamy nougat of fossil fuels at Earth's core?
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Michael
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Sep 2015
"Furthermore, it is because banks create the principal and not the interest that there is never enough money in existence to pay off all the debts plus the interest."

This is pretending that the money paid in interest just disappears and is never used again. The interest is the banks profit. Why would they not use it? They wanted it to spend it in the first place. So when they spend it, and they will, it goes back into the economy where it can be used once more to pay interest on a loan or make other purchases.

This also ignores government debt which leaves (in the case of the US) trillions of dollars available for use.
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Allan Stromfeldt Christensen
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Michael: Well yeah, that interest (the banks' profit for doing nothing but conjure money out of thin air) will get used, but that's inconsequential as the dirty deed has already been done: the debt treadmill has been created, and must now perpetuate, requiring ever-expanding growth.

And about government debt, where do governments get that money from? Answer: the banks, and they must pay interest on it. Reason being, governments gave the money creation rights to banks centuries ago. The only money that governments do create is the physical bills and coins, but which is a very small portion of the money supply (the other end of the 95% I was talking about).
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Johnny
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Mar 2015
Companies exist to create value for shareholders. Some of them don't survive obviously. For those who don't invest in individual stocks, it shouldn't be of much concern to them at all. And any geoscientist can tell you that the earths core is hardly creamy nugget. Is that really the kind of nonsense they teach in the Canadian school systems nowadays? You need to find better teachers.

It is a problem for those who claim to know anything about resource scarcity of course, you are aware of the technically recoverable resource sizes of things like methane hydrates, aren't you?
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Allan Stromfeldt Christensen
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Johnny: No, as far as I know creamy nougat is not the kind of stuff Canadian teachers espouse, although like most other people in the world they do behave as if there aren't any limits. That being said, creamy nougat IS what you essentially proclaim. How come you avoided answering my question from my previous post questioning what year or decade or century or millennium you think oil levels will peak?

Methane hydrates, sure. But what's their EROEI going to be? And what energy source are we going to use to get at them? Creamy nougat?
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Nony
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Sep 2015
I don't think you need so many words nor terms like "demand destruction". Instead classical supply and demand analysis is the right framework. (I regularly get rebuttals from people on the Internet that supply and demand don't work, but they do...from porn to potatoes. And various complications such as cartels, imperfect cartels, future arbitrage, full cycle cost including capital, versus variable cost...all are covered.)
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Allan Stromfeldt Christensen
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Nony: No, I don't think that supply and demand analysis works here. To a certain degree it works on the upswing when resources are increasing, but now that they're decreasing things are going all wonky. Because of high extraction costs consumers are getting tapped out, and so business is going down for producers. With prices dropping, the mainstream media by default think that the problem is due to too much supply -- the supposed oil glut. This "supply and demand" thing should now be renamed to "high-priced oil and demand destruction."

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