Peak Oil Ass-Backwards (part 2): Crashing Oil

Prices Aren't Due to an Oil Glut But to Demand

Destruction and Peaking Credit

Confusion dawns upon the smartest men in the room
(photo by Rafael Matsunaga)
Confusion dawns upon the smartest men in the room (photo by Rafael Matsunaga)

As I began to mention at the end of the first part of this three-parter, I've only just recently come to the conclusion that oil prices aren't going to have a tendency to rise due to the tightening of supply imposed by peak oil, but to depreciate. This of course flies in the face of the common logic of supply and demand, but when factoring in the method by which the majority of our money is created, a deflationary effect can be seen to come into play. This has taken me an absurdly long time to clue into, for although I'd steadfastly amassed a bunch of pieces (various information), I hadn't realized they were actually all part of the same puzzle.

With peak oil and fractional-reserve banking being the first two pieces of this puzzle, the third piece that I needed to factor in (which oddly enough I'd already written about) is the fact that money is a proxy for energy. As I wrote in a previous post, Money: The People's Proxy,

Simply put,... the core function of money is that it enables us to command energy – the energy used to move our bodies with, to power our machines, to feed to domesticated animals whose energy we then use to do work (which nowadays generally means entertaining us), etc. In other words, it might be tough and/or inconvenient, but one can get by without money. You can't get by without energy.

In other words, at their core, our economies don't run on money, they run on energy. Moreover, it doesn't even really matter what you use as your form of currency – coins, pieces of paper, gold, zero and one digibits, conch shells, whatever – because if you don't have the energy to perform the work and/or create the products your society expects, the money is virtually useless and worthless.

Although it would be far too extreme to say that all our economic problems have always had energy issues as their core problem, peak oil (and peaking fossil fuels in general) combined with the fact that money is a proxy for energy, imply, in reverse, a kind of peak to money. In other words, this therefore implies a limit to credit creation. As a result, since private banks create money as debt via the fractional-reserve system and must continually create new loans so that the interest can be created to service previous loans (so that the system doesn't implode in on itself), well, the system is in a bit of a pickle. Furthermore, with oil prices and worldwide stock markets taking a recent hammering, and the situation in Greece and similar countries still a thorny issue, this fermented cucumber seems to be taking shape.

Regardless, none of these core issues and problems are readily recognized (or at least mentioned) by the mainstream media. As Business Insider aptly, yet perhaps a bit daftly, put it (in regards to the current market confusion),

And this is really the crux of the current confusion in markets right now: there is nothing to point a finger at. There is no tech bubble bursting or subprime mortgage market imploding... And so what the media — like, for example, Business Insider — and actual market participants have to go on is to simply say what has happened without being able to say why.

What was once the seemingly endless supply of Chinese plastic toys and electronic gizmos (photo by David Grant)

So far, all that's really been stated by mainstream media sources is that we're in the middle of an oil glut, the reasoning ranging from the US's massive increase of fracked oil production the past few years, OPEC's increased output over the past year, and more, to go along with Iran's possible addition to oil markets upon lifting of sanctions. However, this notion of an oil glut is rather dubious for a variety of reasons. First off, global coal consumption is growing at its slowest rate since the Asian crisis of 1998. On top of that, earlier this year the Baltic Dry Index (an index which measures the price of shipping freight rates) hit a 28-year low. Meanwhile, export orders from Chinese factories just fell for an eleventh straight month, with August's activity shrinking at its fastest rate in three years, and which in turn has led to an increased rate of layoffs.

What was once the seemingly endless supply of Chinese plastic toys and electronic gizmos (photo by David Grant)

Those kinds of things don't occur because there's too much oil — the supposed glut — they happen because people are buying less. It is those and other factors then that have some people thinking that perhaps the problem isn't so much an oil glut as much as a lack of demand — otherwise known as demand destruction.

In the past, dips in the price of oil eventually led to their own recovery since demand became enlivened by the new-found cheap prices. However, those were often after geopolitically induced oil-price shocks, while the current situation is more of a geologically induced oil-price shock. That is, for several years now oil has been selling in the rather high-priced $100 range, due to most of the easier-to-access and so cheaper oil having been extracted and produced first. This has therefore left us with the pricier to get at and produce tar sands, deep sea oil, and fracked oil, all requiring higher prices in order for oil extractors to turn a profit. In effect, while oil at $100 enabled drillers and such to turn a profit, it was costly enough for a long enough period of time to price a significant amount of people out of the market, or at least out of a substantial enough part of the market. In fact, it was just announced a couple of weeks ago by the National Employment Labor Project that "average pay in real terms slumped 4 percent from 2009-14."

In turn, the curtailment on demand has contributed to a depression on oil prices, which has then led to massive layoffs of high paying ("It's easy to earn at least $100,000 a year") oil patch jobs – a loss of 100,000 in the US so far, another 900 more in Canada just last week, and so forth.

What looks like an oil glut, acts like an oil glut, but isn't an oil glut? (photo by Joris Louwes)
What looks like an oil glut, acts like an oil glut, but isn't an oil glut? (photo by Joris Louwes)

As a result, this increasing number of consumers on the margins has ended up with less money to spend via loss of access to the more conventional form of credit – jobs – while others are no longer seeking out and/or accepting as much of the credit that banks are desperately trying to dish out — either because people are trying to pay off the debts they've already got, or are waking up to the risks of taking on even more. As the Toronto Star conveys (italics mine),

economic troubles could start to weigh on their [the big Canadian banks] results — if not directly, through higher loan losses, then indirectly, by hurting loan growth and other sources of revenue.

If you're anything like me, then you've probably been receiving boatloads of 0% interest rate credit card offers (with an initial fee of 1% or so on said transfers) from all sorts of banks. In other words, banks are increasingly desperate to get consumers to spend credit so that the debt-spiral doesn't come to a halt and the system ultimately seizes up. Similarly, this is why governments are practicing quantitative easing (QE), to increase "liquidity."

In the meantime, while credit problems on the consumer end of things are posing a problem, the credit situation for the energy extraction and production industries isn't doing all that great either. The Canadian tar sands provides as good of a stand-in for explaining this as any.

Never minding the massive ecological destruction left in the wake of tar sands projects, but because of the massive industrial operation entailed, to earn back enough funds so as to turn a profit they require a relatively high oil price (that is, the high prices that contributed to the insolvency of many of their customers in the first place). With oil prices currently so low, only 450,000 of the 2.2 million barrels of synthetic crude currently being produced are in the black. This has then placed many tar sands companies between a rock and a hard place. For as the Toronto Star also quotes,

The problem is these companies just can’t stop producing. They still need to produce, they need to pay their bills, and they need to ensure their bond covenants are not breached.

One doesn't stop a juggernaut on a dime (photos by Shell)
One doesn't stop a juggernaut on a dime (photos by Shell)

In other words, with so much money having been sunk in their operations, and with so many bonds having been sold (to go along with all the junk bonds sold by fracking operations, especially in the US), money-losing oil projects must continue extracting to get their bare minimum daily revenues, lest they renege on their payments and go bankrupt.

That being said, some oil producers have hedged their bets through 2015 with a median price of $87.51, and so are making do for now. Nonetheless, with these hedges expiring and debt repayments coming due, producers need to come up with more than half a trillion dollars within the next five years. What happens between then and now is anybody's guess. Are oil drillers and other companies going to be able to restructure their loans and/or access fresh credit if they're bleeding money? Are they going to go bankrupt en masse and get sold off for pennies on the dollar, quite possibly throwing the world economy into yet another bubble-induced recession? Are derivative-exposed banks going to get bailed out yet again after inflating and seeing their second bubble burst in less than a decade?

On the other hand, with low prices being such a problem, it is not possible that some kind of government intervention and/or policies can somehow induce an oil price recovery and save the markets (and, uh, industrial civilization)? Well, as it happens to be, governments did actually do two things last week that made the price of oil increase by 27% in three days. First off, Saudi Arabia announced that it was willing to talk about oil prices. This got the market happy, and so helped prices increase. However, this was essentially just talking up the market since Saudi Arabia was actually saying nothing new, as it had long ago stated that it was willing to engage in a dialogue (for the purpose of curtailing production in line with others, not unilaterally). Secondly, New York's branch president of the Federal Reserve came out hinting that the upcoming interest rate hike that many had expected was likely to be delayed. In effect, the stock markets got another dopamine rush and regained most of their losses, while oil's price concurrently rebounded. However, you can only talk up the markets so much, and for so long.

Similarly, any number of circumstances could cause oil's price to rise, from a well-placed hurricane to an outbreak of war in some relevant part of the world. In reality, guessing oil's prices and movements is ultimately a fool's game, the fools nonetheless getting paid rather handsomely.

Regardless of how this all turns out though, all things being equal, the tendency is now for oil prices to continue decreasing. No longer are we in a cycle of higher highs and higher troughs followed by ever higher highs and troughs, but one of lower highs and lower troughs, bouncing their way down in the opposite direction from the simpleton economics that papers like the New York Times profess: "it boils down to the simple economics of supply and demand."

It's pickling time! (photo by Jacki Gallagher)

To close this all off, and to point out a fair enough — and quite relevant — question, does this mean that oil will crash all the way down to $0 and be free? In short, no, and present circumstances can explain. Sure, if governments and bankers decided to just Let The System Be, then yes, the Ponzi scheme would likely go kablooie and implode in on itself, and oil would be $0 — or rather, $N/A. That of course won't be allowed to happen. For as it is, since the credit system is a proxy for the energetic system that industrial civilization maintains, this means that triaging people and nations from the industrial credit machine effectively triages them from the supply of fossil fuels. Supposing that "we" can even afford it, that means that there is less fossil fuels for "them" and more left over for "us" to maintain the operation of our industrial economies and continue living the 21st century fossil-fuelled lives we've become accustomed to (until the triaging hits closer to home, which it already has for some). And the methodology by which all that triaging is enacted is via what we all now know as austerity on the micro scale and Grexits and such on the macro scale.

It's pickling time! (photo by Jacki Gallagher)

As ambiguous as it/they may be, there is however a third option that can be strived for, which I'll get to in part 3.

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 (16)

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Nathan
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Sep 2015
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Current "low" oil prices are not a problem. They are very much in line with long term trends. The question that should really be asked is why oil was so expensive for the 6 or 7 years it was. Also, the whole boom and bust cycle of the orthodox peak oil explanation is nonsense for a much simpler reason: markets are forward looking. They will smooth the prices and investment rates based on predictions about the future. For the price to wildly swing up and down like that would imply that they regress 100+ years in their ability to accurately predict future production and demand. It's highly doubtful that would ever happen. So while peak oil will likely cause prices to rise, it will do so in a managed manner until the market adjusts to a new more sustainable equilibrium. It will also spur a lot more investment in other technologies like biodiesel, hyrdogen fuel cells, etc. to meet our transportation needs. Homes will start to be powered with solar, wind, geothermal, and light water or molten salt nuclear reactors. There is very little reason to panic about the collapse of society because of no more oil.
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Irv Mills
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3
May 2015
I've been following the Peak Oil scene for about 15 years now and it always seems easier to explain what has already happened than predict what's going to happen next.
I like what you are doing here though and can't wait for Part 3.
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Allan Stromfeldt Christensen
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Aug 2014
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Nathan: Very true, these are "low" prices in comparison to... to what? Two years ago? Ten years ago? What's the normal here? That being said, and as I mentioned, the high prices of the past six of seven years has been due to extractors having to tap into more expensive sources of oil that require higher prices to pay for themselves.

I'm not so sure about the market smoothing things out though. One reason for this, and perhaps what is throwing you off a bit, is the notion that other forms of energy are going to step in for oil (and that peak oil will spur investment in them). A proper response would require a whole post (which I haven't done yet and so can't link for you), but suffice to say, hydrogen is not a source of energy, but more like a battery. You need a prior form of energy, like natural gas, to split the hydrogen off of a water molecule via electrolysis. That's an energy intensive venture, and, in fact, an energy losing one due to the four laws of thermodynamics. Similarly, biofuels are pretty much a write-off. They require a massive amount of energy to produce, and their net energy result is close to zilch, if not less. I recommend looking up EROEI, Energy Return On Energy Input. I hope to me writing an EROEI primer in the next month or so. Cheers.
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Allan Stromfeldt Christensen
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Aug 2014
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Irv: Well, I suppose that rather than predicting I'm taking the easier path you mention of explaining what's happened, but it seems to make sense to me, based on what I'd already known. That being said, going by comments on other sites, it seems that some think that I'm reaching for straws by trying to mold peak oil into current events. Fair enough, but it seems to me that what's going on fits the "money as proxy for energy" thing I've explained.

Question for you Irv: As a fellow Age of Limits attendee, was I the only one that had the deflationary argument go over their head, or had you clued into it all (regardless of whether or not you agreed with it)?
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Nony
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3
Sep 2015
1. If low prices are from demand dropping off, then why is total volume of crude consumed/produced increasing?

2. I demand is down, why are US road miles going up?

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You know, it's OK to be wrong. It's not OK to not face facts. Peakers have a really bad tendency to not face their mistakes. It shows non objectivity. Shows social behavior rather than scientific.
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Allan Stromfeldt Christensen
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Aug 2014
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Nony: Good questions.

1. According to this post (which I overall disagree with), although worldwide "demand" (as the graphs put it) has been on the increase, it's been on the decrease for non-OECD countries for a few years now. Those are the countries I'm talking about. Then again, is that largely a result of offshoring production of iGizmos and such to our vassal states (and China)? Possibly. With so many variables going on it can be hard to nail these things down as I'm sure you understand. At the same time, with EROEIs dropping, and so much more energy needed to get at all that energy, I wonder how much of that oil is getting consumed not via general consumption, but by drillers and such. That is, oil is being consumed to get at oil, yet it's being recorded in consumption numbers. How much is that skewing the numbers?

2. Again, just looking at one aspect of the economy can be misleading, and could rightfully be deemed as cherry-picking. Nonetheless, the increase in US road miles is worthwhile looking at, and this random page I came along, if its numbers can be trusted, points out that the US road miles have just barely passed the previous peak achieved in November of 2007. (That being said, a worthwhile site checking out on the topic is Mark Robinowitz's Peak Traffic.) Why is that? Well, as pointed out in the article, average pay of American's was down 4% between 2009 and 2014. With fewer funds, could that mean that American's are choosing to fly less and drive more? I don't know really.

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Thanks for confirming that it's okay to be wrong. As this and the previous article readily point out, was I ever wrong when it came to thinking that oil prices were going to inflate to the moon, eh? Geez! Fortunately I was willing to face my mistake! But your mentioning of "peakers" is throwing me off a bit. Are you implying that there's such a thing out there as "non-peakers," people that think oil and other energy supplies will never peak because... because oil supplies are infinite?
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Nony
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Sep 2015
Great answers. I will go check earlier post.

I don't think that oil will last forever, but I think it is kind of scarecrow to make that argument about the terminology. Clearly there was something different with those who were into the rampant mid 2000s peak oil scare and those who thought it would be another one of the several times over last 150 years that we get this scare in error. Whatever you label the two camps.
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Allan Stromfeldt Christensen
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Aug 2014
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Nony: Well I do think that we're at the cusp of hitting the peak in both conventional and unconventionals. Just the other day the EIA pointed out that it estimates 2016 oil crude production for the US will be a million barrels less than its peak in April of this year. So if we're not there already, we're pretty damn close.
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Irv Mills
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May 2015
Allan: sorry, I didn't mean to accuse you of explaining rather than predicting. Other do lots of that. I assume you will have a prediction to make in part 3, after getting us set up for it in parts 1 and 2.
The deflationary idea didn't go over my head at Age of Limits, but that would be mainly because I had already encountered it from Nicole Fosse at The Automatic Earth. She actually did predict a few years ago that the price of oil would eventually take a big drop because of demand destruction. But if I understand her correctly, she thinks the price of oil will recover and there will be hyperinflation.
I'll go out on a limb here and predict that this is it--we are in a deflationary spiral from which we won't recover until energy consumption matches what is available from renewables, 10 to 20% of current levels.
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Allan Stromfeldt Christensen
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Irv: Hehe, no worries. About that prediction though... ah, well... if I gave the impression that I was about to make one in part 3, whoops. But you can certainly count on some fancy foot-work and pretty pictures. I hope you like pretty pictures.
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Johnny
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Mar 2015
"geologically induced price shock".

No Allan. It isn't. And those prior, so called geopolitically induced price shocks? Jimmy Carter wasn't whining in 1977 about ONLY the geopolitics, he was proclaiming RUNNING OUT (a geologic concept because that is where the oil starts out, and he said we weren't finding any more). Hindsight is 20/20, but it also allows for a perspective that has nothing to do with what was being said at the time. At the time, running out was all about lack of, not some Arab countries deciding to horde the stuff.

In other words people back then are saying the same thing you are NOW, and you don't even understand the past well enough to know you are recycling a failed idea, and therefore have no hope of even understanding why yours is no different.

And I promise that oil prices won't continue decreasing. They may get lower, find a floor, and then, just as had happened during the 1979 peak oil, demand and supply will equilibrate at a new price and as one or the other changes, so too will price.
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Allan Stromfeldt Christensen
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Aug 2014
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Johnny: I'm "recycling a failed idea"? Well that's pretty rich coming from the guy who has twice now avoided answering the question: what year or decade or century or millennium do you see oil supplies peaking? Are you going to continue to cower from answering that?

"'geologically induced price shock'

No Allan. It isn't."

Actually, yes it is. And I'll repeat it for you. To maintain and increase production levels, we're now forced to extract more expensive oil. This has resulted in higher prices. They proved to be rather unaffordable for consumers and businesses, and so resulted in less demand. Prices then dropped.

Furthermore, all I see is that you want prices to go up. I see no economic rationale or argument to back up anything that you're saying. Just "promises" and normalcy bias and ad hominem attacks. Got anything else?

p.s. You said "And I promise that oil prices won't continue decreasing." Then your next four words were "They may get lower..." Nice job of covering all your bases.
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Johnny
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Mar 2015
The real price of oil began increasing around 1970 Allan. So what more expensive oil are you talking about? Prudhoe Bay? The North Sea? And this resulted in higher real prices ever since, effectively your entire life has been under the auspices of higher oil prices. This was uncomfortable to consumers who then bought Japanese cars and used less, launching Toyota and Honda to their current stardom. And then in 1986 when it became obvious that new sources, like Prudhoe Bay and the North Sea had created yet more decades of abundance, the price crashed.

You were implying that today is somehow different? Why whatever could you mean, other than pointing out how little you know about this topic, it apparently not being required reading for either filters or farmers.
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Allan Stromfeldt Christensen
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Aug 2014
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Johnny: Awesome! So it's a one-way conversation we're having here, eh? I'm willing to answer your questions, yet you seem to shy away from answering mine, particularly my question of what year or decade or century or millennium you think oil supplies will peak. As you like to say, "interesting." Don't worry, I'll keep trying though.

Anyway, on to your question(s).

Yes, oil's price increased in the 70's. Did you forget about the oil embargoes?

North Sea oil? You mean the North Sea that peaked a decade and a half ago?

Of course I'm implying that today is different! We're tapping into energy sources with lower EROEI's, heading on down towards a 1:1 ratio! Muy differente, although it's admittedly a tough pill to swallow for some.
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basil
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Sep 2015
great post, mr christensen. i was 19 during the arab oil embargo of 1973. the world changed very abruptly. gasoline was just something you tried not to run out of before then, and suddenly it was a budget-buster for everyone. society has become accustomed to the large fluctuations in fuel prices, and it doesn't seem like such a big deal now. i remember paying under $.30 per gallon before the embargo, and now the price can fluctuate that much in a couple of days. i really think that point in time was a sea change in the way oil was marketed, in response to the industry's knowledge that oil would no longer see substantial growth in supply/availability. i also think that supposed game changers like deep-sea drilling and other massive technology/ limited return projects have been used as marketing tools to reassure the public that there will always be plenty of oil. the result has been, predictably, consumers purchasing trucks and suv's and generally using their personal "abundance" of petroleum products at will. the oil-induced predicaments we currently find ourselves immersed in are severely damaging to everyone, everywhere.
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Allan Stromfeldt Christensen
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Aug 2014
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basil: I heartily agree with everything you say. I think you're right regarding the unconventional oils being used as marketing tools to assure the public about limitless energy supplies, but possibly even worse, I think the marketers believe their schtick as well. How high up the totem pole that belief goes is something I often wonder.

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