Gail Tverberg – Economy Watch

Are Economic Growth Models Inherently Flawed?

Gail Tverberg — Fri, 27 Sep 2013 06:14:31 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

Most economists today seem to think we can rely heavily on past patterns to forecast future growth. We however live in a finite world, so that even if growth can go on for a while, there are likely to be barriers at some point. Energy limits for instance could screw up all our growth models.

What will the world economy be like ten years from now? Or fifty years from now? Is it something that we can forecast by looking at the past, assuming that past trends will continue?

Most economists today seem to think we can rely heavily on past patterns. If we can really assume that the economy will grow at 3 percent per year (over and above inflationary increases), then in 50 years, GDP (Gross Domestic Product) will be 4.38 times as high as it is today. Economists might assume a 3.0 percent growth rate in a developed country, like the US, and a higher annual growth rate in a country like China, India or Brazil.

It seems to me that this standard view is incorrect. There is a substantial chance of a sudden shift toward a less favorable growth pattern (which I refer to as a “discontinuity”). This possibility is not obvious though, if a person bases his models on the growth that took place between 1940 and 2000, as economists today often seem to. In this post, I describe an alternate view showing how such discontinuities can occur.

The Current (or Recent Past) “Standard” View of the Economy

Most economists today seem to believe a whole collection of theories and models that basically support the view that humans (and in particular, politicians and Federal Reserve Officials) are in charge of the economy. With this view, natural resources are not very important. If there is a shortage, either (a) alternatives will take over quickly or (b) prices will rise for a short time, leading to more extraction, thereby eliminating the shortage.

Productivity is expected generally to trend upward. In other words, the expectation is that there will be increasing output per unit of input. Part of this increase in output comes from improvement in technology. This improvement in productivity is expected to lead to increased profits for companies and higher wages for workers.

If the economy is not performing optimally, demand (that is, the ability and willingness to buy more “stuff”) can be increased through deficit spending or by very low interest rates, or both. For example, deficit spending might be used to give a worker who has been laid off unemployment benefits, so he can buy food, clothing, and other goods and services. (Without money, the laid-off worker has no demand, according to the standard economic definition.) Very low interest rates tend to make a new car or new home more affordable, or might allow an oil and gas producer to drill more wells inexpensively.

Debt, or “leverage” as it is often called, seems to be seen as beneficial. Debt is seen to being able to increase indefinitely. The primary measure of how the economy is functioning, GDP, completely ignores debt. For example, if a person goes to college for a year, tuition will be part of GDP, whether or not the individual takes out a loan to pay tuition, room, and board. If the college builds a football stadium, the amount paid to the contractors for building the stadium is part of GDP, but the loan the college takes out to finance the stadium is not considered in the calculation.

Needless to say, if politicians want to increase GDP, the easiest way to do so is to encourage everyone to “max out all their credit cards,” or do the equivalent with other types of loans. Of course, doing this in the early 2000s helped lead to the subprime debt bubble – not exactly the effect one wants.

With the foregoing view of the economy, economists can talk about substituting one energy source for another over a very long time frame. The reason economists can think in these very long time frames is because the economy is seen to always be growing, thanks to productivity growth, more human laborers, technology growth, and occasional stimulus, if needed. In this model, there is nothing to challenge the growth of the economy, so no turning points are anticipated. Thus, we can undertake very long projects, such as trying to swap low-carbon energy sources for other energy sources.

Discontinuity: Why Might Economic Growth “Misbehave” Going Forward?

We are aware of many situations in the physical world where there is a sudden change of behavior. We pull on a rubber band for a while. At first it stretches; then it breaks. We skate on thin ice for a while. At first the skating goes fine; then we fall through the ice, into the water. We throw a ball up in the air. It rises for a while; then it stops and falls back to the ground.

Another example is a little closer to the economic growth model we are looking at here. Yeast transforms sugars in grape juice into alcohol. Alcohol is in fact a waste product, made by the yeast, as it metabolizes the sugar. At some point, the concentration of alcohol in the wine becomes too high for the yeast to survive, and the yeast die off. Growth of yeast population, instead of continuing to rise rapidly, suddenly turns negative and the population falls to zero.

In a model such as the wine and yeast model, it is not until the pollution level becomes too high that the adverse effects are seen. We can encounter somewhat of a similar problem with our economy, with pollution of various kinds.

A similar turning point can appear with resource extraction of various kinds, such as oil. When we begin extracting resources, the cost of extracting those resources is not very high. In fact, the cost of extracting the resource may even fall, with greater use of fossil fuels and improved technology. This growing productivity enables a rising standard of living.

At some point, however, the cost of extraction begins to rise, because the easy-to-extract resource (such as oil) has already been extracted. This higher cost of extraction may set up negative feedback loops, throughout the economy. This occurs partly because resources must be diverted toward oil extraction, rather than being used for other productive purposes. From the point of view of the worker, he finds it necessary to lower his standard of living, because he spends more of his total income on the same (or a lesser amount) of oil, leaving less income for other purchases.

The original factors of production were land, labor and capital. This simplified model did not consider natural resources, or pollution caused in extracting and using the natural resources, or the role of debt. It also did not consider the fact that we live in a finite world, so that even if growth can go on for a while, there are likely to be barriers at some point. If the economic model economists are using misses important variables, it is easy for the model to miss problems that haven’t come up to date, but can be expected to come up in the future. The model may have, in fact, worked well in the 1940 to 2000 period, because resource limits did not start raising resource prices significantly until after the year 2000.

A related issue is that if economists are overly convinced that their models are correct, they may miss seeing important trends that suggest their models are incomplete.

Figure 1. US Ten Year Average Real GDP growth, based on BEA data.

If we look at the trend line related to US GDP growth (Figure 1), we see that there is a decided downward trend to it. While an estimate of 3 percent per year going forward might have made sense based on the experience through 2000, this estimate seems increasingly less likely, based on recent experience. In fact, if experience since 2010 were included, it would further emphasize the downward trend. The IMF projects that US economic growth in 2013 will amount to 1.7 percent, and for advanced economies together will amount to 1.2 percent.

Besides slower than expected economic growth, there are many other parts of the theory that are not holding up very well now, either. Wages of the common worker have not been rising as planned. Oil prices have not come down, even with considerable success in US oil production. The Federal Reserve has needed to keep interest rates very low, and even with that, the economy is limping along. The Federal Reserve keeps printing money. In fact, it announced today that it is continuing its Quantitative Easing at $85 billion a month, because the economy is not yet doing well enough to get along without it.

What is Missing in Economic Models

What is missing is a broader view of how the economy really works. The economy is far more than land, labor, and capital. The economy includes a huge number of players–governments, businesses, and individuals, each deciding what action to take based on how the system behaves at a given time–for example, what products and services are available at a given time, at what prices. Resources of many different types play a role in this system, as does pollution, and the cost of mitigating this pollution. This complex economy has been built up over the years, by the gradual addition of new layers of businesses, governments, government rules, and consumers. Unneeded older parts drop out, as new parts are added. A system such as this is sometimes referred to as a Complex Adaptive System.

There are two parts of this system that play a special role. One part is energy products that are needed to make anything “happen.” These energy products are of many different types, including oil, natural gas, coal, geothermal energy, captured wind energy, even food. For example, if goods are to be transported, some sort of energy product is needed. It might be oil used to fuel a car or truck. Or it might be food fed to a horse pulling a cart. It might even be food fed to a human being, who is then able to carry the goods as he walks.

As another example, if heat is to used for some process such as baking, some energy product is required. It might be heat from burning oil or coal, or it might be heat from the sun captured by a solar cooker. Energy for heat might even come from food. For example, a chicken, after eating appropriate food, is able to sit on an egg and provide heat to incubate it.

Another critical part of the system, besides energy resources, is the financial system. The financial system ties everything else together through its pricing mechanism. By knowing prices, we can tell how society values many very different types of resources and products (such as a bushel of wheat, a barrel of oil, and an hour of a common laborer’s time). Because of its tie to all of the other resources, the financial system is likely to be one of the systems that is stressed earliest, if there is a major change to the system.

Besides tying the system together, money produced by the financial system also acts a “pseudo resource”. It is not the money itself that has value–it is the fact that it can be exchanged for a resource of real value, such as a bushel of wheat, a barrel of oil, or an hour of a common laborer’s time. When the amount of resources is not expanding rapidly, printing money can temporarily inject pseudo resources into the system, making things temporarily look better than they are. Of course, when this money printing stops, the temporary improvement is likely to disappear.

Oil Has Caused Recent Stresses to the Financial System

When recession hits, the financial system gives a hint that this networked system of businesses, governments, consumers, and resources is being stressed. What causes this stress on the financial system? Recently, evidence seems to suggest that rising oil prices are a major contributor. For one thing, economist James Hamilton has shown that 10 out of the last 11 US recessions were associated with oil price spikes. He has also directly shown that the oil price in the run-up in the 2005-2008 period was sufficient to explain the Great Recession. I have also written an academic article called, Oil Supply Limits and the Continuing Financial Crisis.

Oil is part of the constellation of energy resources that allows things to happen within this complex networked system. It is not easy to substitute away from oil in the short term, because the cost of the vehicles and other equipment that we have today is extremely high. If we were to transition to other types of vehicles (say natural gas operated or electric), the cost of building new fueling stations and vehicles would be very high, and take many years. Customers would also find the new vehicles unaffordable, unless the old ones could be phased out as they wore out.

What Can Go Wrong In This More Complex System?

The problem with this more complex system is that everything depends on everything else. Things that seem obvious, such as how much oil reserves a company can expect to extract in the future, no longer are obvious, because the prices of resources can go down as well as up. This happens because prices of resources depend upon (a) the amount buyers can afford to pay for these resources, as well as (b) how much it costs to extract the resources. If the cost of extracting resources increases, the question is whether workers will really be able to afford the cost of higher-priced resources.

There can also be conflict between the amount of debt outstanding and the amount of products (made from resources) available to repay that debt. There is no limit on debt issued, but the amount of resources extracted in a given year eventually slows down, as the inexpensive to extract resources are depleted.

Interest rates on debt are important as well. If interest rates remain very low, interest payments do not “squeeze” prospective buyers of goods too much, so they can afford additional goods. But if interest rates rise, then the financial situation changes at many points in the system. The cost of buying homes and cars increases. The resale value of homes likely drops.

Another issue with the networked system that we are operating in is that shortages in one area tend to get transferred to other parts of the system, stressing the system as a whole. For example, when we discovered a few years ago that oil supply could not grow as rapidly as desired, we started using food crops (primarily corn and sugar) to produce ethanol, as a substitute for oil. When we did that, the additional demand for food tended to raise food prices. Thus the stresses from one part of the system were spread more broadly. This can be a temporary help to oil prices, but it can eventually lead to widespread system failure.

Because of the interlinkages in the system, we should not be surprised if what looks like a problem in one part of the system–high oil prices–has an adverse impact on other parts of the system. The financial system, since it connects everything else together, would be especially likely to be stressed. Governments, because they act as a safety system for unemployed workers, would also seem to be at risk.

We have many real-life examples of civilizations that grew for a time, then reached limits and collapsed. These civilizations were agricultural civilizations, so admittedly not exactly like ours. But the symptoms prior to collapse were disturbingly similar to the symptoms we are seeing today. As I have discussed previously, there was a growing disparity of wages between the common workers and the elite, and increasing use of debt. Food prices often spiked. Eventually, it was the inability of governments to collect enough taxes from increasingly impoverished workers that brought the system down. Workers also became more subject to disease, because low pay and high taxes did not allow for adequate nutrition. The collapse came over a period of years–typically 20 to 50 years.

We don’t know exactly what kind of discontinuity we are headed for, but we have some clues, based on the risks we are facing and on what happened in the past. The discontinuity will likely play out over a period of years. Financial systems and political systems are likely to be involved. Because of the networked nature of the system, it will not be just one type of energy that will be in short supply–more likely, there will be problems affecting nearly all types of energy.

By Gail Tverberg

Gail Tverberg is a trained casualty actuary who writes about the impact of the limited supply of oil. She speaks internationally about oil issues, and writes frequently about the issue on her blog, Our Finite World and on The Oil Drum (where she is an editor). Tverberg is also a Fellow of the Casualty Actuarial Society and a Member of the American Academy of Actuaries. She has a Masters Degree in Mathematics from the University of Illinois, Chicago.

Discontinuity Ahead – Oil Limits will Adversely Affect the Economy is republished with permission from Our Finite World.

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The post Are Economic Growth Models Inherently Flawed? appeared first on Economy Watch.

Behind Syria’s Crisis: How Oil & Gas Limits Contributed To The Civil Unrest

Gail Tverberg — Wed, 11 Sep 2013 07:59:55 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

The Syrian civil war has been ongoing since 15 March 2011. Though the roots of the conflict are political by nature, Syria’s depleting oil and gas reserves also played a major role in sparking the unrest: When oil exports dropped, the government suddenly found itself unable able to pay for programs that had been placating its citizens to some degree.

In my view, oil and gas resource limits are major contributors to the conflict in Syria. This is happening in several ways:

1. Syria is an oil exporter that is in increasingly perilous financial condition because of depleting oil resources.

When oil production is increasing, it can help an oil exporter in two ways: (a) part of the of the oil supply can be used internally, to grow more food and to support increased industry, and (b) exports of oil can be used to provide revenue for governmental programs such as food subsidies, education, and building highways. Syria’s population grew from 8.8 million in 1980 to 22.8 million in 2012, at least in part because of the wealth available from oil extraction.

Figure 1. Syria’s oil production and consumption, based on data of the US Energy Information Administration.

Now Syria’s oil production is dropping. The drop between 1996 and 2010 reflects primarily the effect of depletion. The especially steep drop in the last two years reflects the disruption of civil war and international sanctions, in addition to the effect of depletion.

When oil exports drop, the government finds itself suddenly less able to pay for programs that people have been expecting, such as food subsidies and new irrigation programs to support agriculture. If revenue from oil exports is sufficient, desalination of sea water is even a possibility. In Syria, wheat prices doubled between 2010 and 2011, for a combination of reasons, including drought and a cutback in subsidies. When basic commodities become too high priced, citizens tend to become very unhappy with the status quo. Civil war is not unlikely. Thus, oil depletion is likely a significant contributor to the current unrest.

Egypt has many Similarities to Syria

Egypt is another example of an oil exporter whose oil production has dropped because of geological decline. Its chart of oil production and consumption (Figure 2) looks very much like Syria’s (Figure 1).

Figure 2. Egypt’s oil production and consumption, based on BP’s 2013 Statistical Review of World Energy data.

Egypt is actually doing a little better than Syria. One of the things that has helped Egypt is its natural gas production, because it has been another source of export revenue. Unfortunately, Egypt’s natural gas production suddenly flattened starting in 2009, again because of depletion (Figure 3).

Figure 3. Egypt natural gas production and consumption based on BP 2013 Statistical Review of World Energy.

As Egypt started losing oil supplies, it was able to keep its own energy consumption growing (to keep up with growing population) by rapidly cutting back on exported natural gas (even though it had contracts in place to sell some of the this natural gas).Part of this cutback was to its pipeline customers, namely Israel, Lebanon, and Syria. Of course, this left Egypt with less foreign revenue to fund subsidies, education, and many other programs, but Egypt’s own energy consumption (Figure 4) was able to keep growing, helping agriculture and industry to function as normal.

Figure 4. Egypt’s energy consumption by source, based on BP 2013 Statistical Review of World Energy.

Syria, on the other hand, was consuming all of the natural gas it produced. In fact, is was importing a little gas from Egypt, so it had no exports it could cut back on. In fact, Egypt’s cutback worked the wrong way from Syria’s perspective–it lost a small amount of natural gas imports from Egypt.

Figure 5. Syria Natural Gas production and consumption, based on data of the US Energy Information Administration.

As a result, Syria found its energy consumption decreasing (Figure 6), even as population continued to rise.

Figure 6. Syria Energy Consumption by Source, based on EIA data.

At least part of the decline in Syria’s energy consumption occurred because of damage to oil and gas pipelines and to electrical transmission equipment. According to the CIA Fact Book, Syria’s industrial production shrank by 36% in 2012. Thus, geological depletion and the civil war that grew out of inadequate resources both contributed to the drop in energy consumption.

Going forward, this tendency toward civil disorder is likely to get worse, whether or not the US decides to attack. The underlying issue in Figure 1 is depletion. Population remains high. Even if damage to pipelines and transmission lines get fixed, the depletion issue will continue, and the population will need to be fed.

2. Economic sanctions, to the extent they have an affect, can be expected to act similarly to resource depletion and increase the tendency toward civil disorder.

Syria has been operating under economic sanctions from the US since 2004. To the extent that these had an effect, one would expect that they would reduce economic activity, and thus energy consumption. It is hard to see a significant change in energy use patterns in the years immediately after 2004, from the charts provided.

Many other countries have added sanctions since hostilities broke out in 2011. It is difficult to tell how much effect the 2011 sanctions have actually had. It is possible that they contributed to Syria’s drop in energy consumption. It is also possible the civil disorder together with depletion explain the recent drop in oil production and consumption.

Even with sanctions, Syria continues to participate in international trade. According to the EIA, Syria continues to trade with Russia, Iran, Iraq, Malaysia, and Venezuela. Other sources mention China (here and here) as a trading partner with Syria. North Korea is also mentioned as being a trading partner, especially in the area of chemical weapons.

3. Oil pipelines from Iraq through Syria would be helpful if Iraq is to greatly ramp up its oil output in the next few years.

The United States has an interest in getting oil production from Iraq ramped up, in the hope that world oil production can continue to rise. World oil production has been increasingly flat, even taking into account liquid substitutes and new sources, such as biofuel and new US tight oil production.

Figure 7. Growth in world oil supply, with fitted trend lines, based on BP 2013 Statistical Review of World Energy.

One of the limits in ramping up Iraqi oil extraction is the limited amount of infrastructure available for exporting oil from Iraq. If pipelines through Syria could be added, this might alleviate part of the problem in getting oil to international markets.According to the EIA,

One particular project proposes to build two oil pipelines (and one for natural gas) that would send Iraqi crude to the Mediterranean coast in Syria, and from there to international markets. The first of the proposed pipelines would send heavier crudes from northern Iraq and have a capacity of 1.5 million bbl/d. The second pipeline would send lighter grades from southern Iraqi fields, and would follow the same route as the former Haditha-Banias pipeline; the second section is scheduled to have a 1.25 million bbl/d capacity.

4. The possibility of natural gas pipelines through Syria to alleviate potential shortages in Europe and elsewhere is contentious.

Russia currently is a major exporter of natural gas to Europe. It would like to keep natural gas prices as high as possible because of the high cost of its natural gas extraction, and because of the high cost of building new pipelines. Russia does not necessarily welcome new natural gas production from, for example, Qatar or Israel, carried by pipeline through Syria. Such new supply might reduce natural gas prices in Europe, either because of oversupply or because the other natural gas sources have a lower cost of extraction and transport.

If new pipelines are built through Syria, there are several countries that might theoretically ship natural gas through such pipelines, and there is considerable rivalry among these countries. For example, Israel and Iran are rivals as to which country might export natural gas to Europe. Also, as noted above, there is a possibility that natural gas from Iraq could be exported through Syria to the international market, if suitable pipelines were built. There is even theoretically a possibility that natural gas from Turkmenistan could be exported by pipeline through Iran, Iraq and Syria, cutting out Russia (and the profits it receives in buying, transporting and selling this gas).

It should be noted that even though many countries have their sights set on exporting natural gas to Europe and other parts of the world that need natural gas, it is not at all clear that this additional transport of natural gas will work out as planned. We have known for a long time about a large amount of “stranded” natural gas–gas that is theoretically available, but it simply too expensive to extract and ship to locations where it might be purchased. The limits on how much natural gas will be consumed are financial–how much can consumers really afford.

The affordability issue is clear if we think about a family in India, living on $2 a day, deciding whether to burn animal dung or compressed natural gas for cooking. If the price of natural gas is high, the family in India will choose to burn dung. A similar issue arises for a pensioner in the UK, deciding to what temperature to heat his home. It also arises for an electric power plant in Germany, deciding whether to burn natural gas or coal. If the cost of natural gas is too high, demand is likely to shift to cheaper fuels, or to disappear through alternative behavior–for example, wearing long underwear to keep warm in winter, instead of heating homes as warmly as today.

5. Need for America to prove its might, to maintain the US dollar’s reserve currency status.

Without the reserve currency status of the US dollar, America cannot continue to run a big balance of payment deficit importing large quantities of oil. This is important, because the world’s total oil supply is not growing much (Figure 7), regardless of price. If America is forced to consume less, more oil will be available for the rest of the world.

Conclusion

Because of its oil depletion, Syria will remain a problem country, regardless of whether the US decides to intervene militarily. Removing Assad as leader of Syria cannot be expected to solve Syria’s problems. Even if oil deletion were not the major issue, US’s recent experience in Libya suggests that removing a leader does not guarantee future stability. Associated Press reports this week, Libya’s oil exports plunge as problems escalate.

Some may argue that Syria has other gas and oil that it can exploit, and because of this, its depletion problems are only temporary. In particular, the EIA report on Syria notes that there are both shale oil resources in Syria and natural gas resources offshore that Syria might develop. In my view, there are several reasons that this optimism is unwarranted. As a practical matter, even if there were peace and plenty of investment capital, developing these resources would take several years. During this period, other countries would need to donate enough resources to keep the population pacified. Can this really be done, especially if other countries are reaching limits themselves?

Furthermore, it is not at all clear that extraction of oil from shale can really be developed profitably. No one outside North America has yet figured out how to do so. The US has laws and pipeline infrastructure that are different from elsewhere that help make shale development possible at reasonable cost. Available credit and low interest rates are also helpful. The US also has abundant water resources, and population that is not too dense, so that fracking is less of an issue than it would be elsewhere. A recent Wall Street Journal article talks about the difficulty China is having trying to extract hydrocarbons from shale.

There is also the question I mentioned above with respect to the economic feasibility of new natural gas resources. If the cost is too high, the cost may simply be too high for buyers. Furthermore, if buyers find a need to cut back on other expenditures to purchase gas products (or for that matter, high-priced oil products), they are likely to cut back in the purchase of other discretionary items. Layoffs are likely to occur in discretionary sectors, leading to recession and reduced demand through fewer jobs. Thus, one way or another, a reduction in demand is likely to occur.

Egypt and Syria are not the only countries in the area with oil depletion problems. Yemen’s oil chart of oil production and exports (Figure 8) looks very much like that of Syria and Egypt.

Figure 8. Yemen oil production and consumption, based on US Energy Information Administration data.

Saudi Arabia may even be reaching limits on its extraction capability. It recently is reporting refocusing on unconventional resources, something it would not do if conventional oil were performing well. Saudi Arabia is also using a greater number of drilling rigs, reported to be necessary because of the increasing difficulty of extracting oil from mature fields.

If oil depletion is becoming an increasing problem, I am afraid we can expect increasing conflict in the Middle East, regardless of whether the US chooses to intervene in Syria because of increased oil depletion. A shortfall in one country can ripple to the next country, and on to the next country, as exports are reduced, and as civil unrest spreads.

It is easy to blame bad leaders for the problem, or a bad form of government. Much of the problem, however, is simply not having enough oil resources to go around for the size of population the world has today. We can kid ourselves about additional oil and natural gas resources being available, but these very much depend on the ability of buyers to pay higher prices, without excessive recessionary impacts.

By Gail Tverberg

Oil and Gas Limits Underlie Syria’s Conflict is republished with permission from Our Finite World.

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The post Behind Syria’s Crisis: How Oil & Gas Limits Contributed To The Civil Unrest appeared first on Economy Watch.

What Happens To Government and Business Promises When The Economy Tanks?

Gail Tverberg — Tue, 16 Jul 2013 09:24:25 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

For a long time, the US economy had been on an upward escalator, fueled by the growth of cheap energy and loans. Continued growth in debt made sense, because growth seemed likely for as far in the future as anyone could see. Governments and businesses made promises such as pensions, social security, bonds and so on. But what happens to these promises as we step off the up-escalator and on to the downward escalator?

A question that seems to come up quite often is, “Are we going to have inflation or deflation?” People want to figure out how to invest. Because of this, they want to know whether to expect a rise in prices, or a fall in prices, either in general, or in commodities, in the future.

The traditional “peak oil” response to this question has been that oil prices will tend to rise over time. There will not be enough oil available, so demand will outstrip supply. As a result, prices will rise both for oil and for food which depends on oil.

I see things differently. I think the issue ahead is deflation for commodities as well as for other types of assets. At some point, deflation may “morph” into discontinuity. It is the fact that price falls too low that will ultimately cut off oil production, not the lack of oil in the ground.

Even with little oil, there will still be some goods and services produced. These goods and services will not necessarily be available to holders of assets of the kind we have today. Instead, they will tend to go to those who produced them, and to those who win them by fighting over them.

Up and Down Escalator Economies

It seems to me that economies operate on two kinds of escalators–an up escalator, and a down escalator. The up escalator is driven by a favorable feedback cycle; the down escalator is driven by an unfavorable feedback cycle.

For a long time, the US economy had been on an up escalator, fueled by growth in the use of cheap energy. This growth in cheap energy led to rising wages, as humans learned to use external energy to leverage their own meager ability to “perform work”–dig ditches, transport goods, perform computations, and do many other tasks that machines (powered by electricity or oil) could do much better, and more cheaply, than humans.

Debt helped lever this growth up even faster than it would otherwise ramp up. Continued growth in debt made sense, because growth seemed likely for as far in the future as anyone could see. We could borrow from the future, and have more now.

[quote] Unfortunately, there is also a down escalator for economies, and we seem to be headed in that direction now. Such down escalators have hit local economies before, but never a networked global economy. From this point of view, we are in uncharted territory. [/quote]

Many economies have grown for many years, hit a period of stagflation, and ultimately collapsed. According to research of Turchin and Mefedov documented in the book Secular Cycles, such economies have typically gotten their start by learning to exploit a new resource, such as using land cleared for farming, or learning to use irrigation, or in our case more recently, learning to use fossil fuels. These economies typically start out by growing for many years, thanks to the opportunity for more population and more goods and services from the new resource.

After a while, a period of stagflation is reached. Population catches up to the new resource, and job opportunities for young people become less plentiful. Wage disparity grows, with wages of the common worker lagging behind. The cost of government rises. Because of the low wages of workers, it becomes increasingly difficult to collect enough taxes from workers to pay for rising government costs. To work around these problems, use of debt grows. Needless to say, this scenario tends to end very badly.

Our situation today sounds a great deal like the down escalator situation. As I have discussed previously, wages stagnate as oil prices rise. In fact, most increases in wages have taken place when the real price of oil was less than $30 barrel, in today’s dollars.

Figure 1. High oil prices are associated with depressed wages. Oil price through 2011 from BP’s 2012 Statistical Review of World Energy, updated to 2012 using EIA data and CPI-Urban from BLS. Average wages calculated by dividing Private Industry wages from US BEA Table 2.1 by US population, and bringing to 2012 cost level using CPI-Urban.

As oil prices rise, wage-earners hit a second problem–higher outgo for fuel and food, since fuel is used in growing and transporting food. Thus, wage-earners are hit on two sides–flat income and higher outgo for necessities, leading to less discretionary income. Governments find that they need more taxes to pay for increased benefits for the many who no longer have jobs. These higher taxes place another burden on those who are still working. Businesses find their profits pinched by higher oil prices, and respond by outsourcing to a low wage country, or automating processes to cut costs, lowering the amount local citizens earn in wages further. Furthermore, even apart from oil issues, globalization tends to pull US wages down. All of these issues tend to add to the down-escalator phenomenon for the US economy.

[quote] In past years, governments and businesses have made promises of many types, such as bank account balances, pensions, Social Security, Medicare, insurance policies, stock certificates, and bonds. The question becomes: what happens to these promises, as we step off the up escalator, and onto the down escalator? All of these promises could be paid when we were on the up escalator. The amount that gets paid is much less clear, if we are on the down escalator. In this post, I would like to examine what happens. [/quote]

The General Price Trend: Downward, with Discontinuities

Each year, an economy produces various kinds of goods and services. It grows crops, and extracts minerals. It uses energy products to process the crops and minerals into finished goods, and to transport them to their final destination. The amount produced depends on the amount of goods and services potential buyers can afford. If wages are stagnant, and the government’s share keeps rising, the amount wage-earners can afford (in inflation adjusted dollars) keeps falling.

Since the early 2000s, the cost of extracting oil products has been rising, because the oil that was cheapest to extract was extracted first, and the “easy oil” is now gone. There tends to be a relatively small amount of a resource available cheaply, and increasing amounts available at higher and higher prices (Figure 2, below).

Figure 2. Resource triangle, with dotted line indicating uncertain financial cut-off.

In fact, minerals of all types tend to follow the same pattern as oil for two reasons: (1) Mineral extraction follows the same pattern–cheapest to extract first, moving to the more expensive to extract, and (2) Oil is generally used in extraction. If the cost of oil is rising, its cost tends to get passed on. Of course, in some instances, technological improvements can offset rising prices, but for most of the time since the year 2000, cost of commodity extraction has tended to rise.

There has been a lot of publicity recently about more oil being available, and more natural gas being available. This additional availability is because of high price. It doesn’t bring the cost of extraction down. In fact, if price drops, extraction is likely to drop. This drop will not occur immediately, because much of the cost has already been paid on wells that have already been drilled, so extraction from these wells tends to continue. But future investment is likely to drop off quickly if prices drop, bringing supply down, with a lag.

Because of the downward escalator the economy is on, wage-earners don’t really have enough money to pay the higher prices that are needed for increasingly costly extraction of oil and other minerals. Instead, prices tend to be volatile. The general trend can be expected to be downward, because even if oil prices rise when the economy is functioning fairly well, at some point, the higher price leads to adverse feedbacks, such as consumers defaulting on debt and cutting back on discretionary purchases. The result can be expected to be recession, and again lower oil prices.

The big danger is that lower oil prices will lead to lower oil production, and this lower oil production will become a problem for business and commerce around the world. The United States is likely to be one of the countries whose oil production will be affected most by lower oil prices, for three reasons:

We tend to have most tight oil production, and tight oil production tends to be high-priced production. It also drops off quite quickly, if drilling stops.
Shale gas drillers tend to use a lot of debt. Shale drillers will especially be hit if interest rates rise because of debt problems.
Taxes and fees related to oil production in the US (unlike many countries) do not vary with the price of oil. The US government will continue to get most of its revenue (estimated to average $33.29 per barrel on a $80 barrel of US tight oil by Barry Rogers, Oil & Gas Journal, May 2013), even as companies find themselves short of funds for new drilling.

If oil production is down, US oilconsumptionto be lower as well. The reason for low oil price is likely to be recession and greater job loss. With fewer jobs, less oil is needed for making and shipping goods. Furthermore, the many unemployed cannot afford cars. The pattern of declining demand in the European Union, and Japan is likely to continue, and get worse.

Figure 3. Oil consumption based on BP’s 2013 Statistical Review of World Energy.

In 2008-2009, the economy was able to somewhat recover, so commodity prices increased again. This recovery was not based on US economy fundamentals–a large part of it seems to be related to artificially low interest rates and deficit spending. As interest rates rise, and as deficit spending is eliminated through higher taxes/lower benefits, the US economy seems likely to head back into recession, with more job loss, probably worse than last time.

Countries with low wages to begin with may be spared of some of the down-escalator economy dynamics for a few years, because their low wage levels will continue to make them competitive in a world economy. These countries will attract a disproportionate share of new jobs, allowing them to continue grow for a time, even as the US, the European Union, and Japan continue to lose jobs. Thus, world oil prices may be able to bounce back, but probably not to as high a level as in the recent past. Eventually, these countries will tend to follow the rest of the world into stagflation and collapse, because of the interconnectedness of the global economy, and the similar dynamics that all countries are subject to.

Chance of Discontinuity

In order for the models to work in the expected way, business as usual must continue. A few obvious problems come into play:

“Demand,” as defined by economists, is what consumers can afford to pay. Therefore, a jobless individual without any type of government compensation, would have no demand for food, clothing or shelter–at least using the term in the way economists use the word. All of us know that in the real world, lack of a job and lack of government benefits causes problems. At some point, marginalized people will riot and overthrow governments. Civil war may take place, or war against another country.
Part of Business as usual is continuing availability of debt. At some point, it will start to become clear that the economy has gotten off the up escalator, and moved to the down escalator. On the down escalator, much less debt makes sense. It probably still makes sense to use debt on a short-term basis to cover goods in transit, and it may make sense to use debt to finance investments with a high expected rate of return. But in general, debt is likely to become much less common, greatly worsening the down escalator problem.
As long as the economy was on an up escalator, increasing economies of scale were part of what caused a positive feedbacks. When the economy is on a down elevator, we have the reverse effect–higher fixed costs relative to production. This is even an issue when reduction in sales are intentional–for example, increased water conservation tends to lead to higher fixed costs, per unit of water sold, and greater use of high-efficiency light bulbs leads to greater electricity fixed costs (such as grid costs) per kWh sold. These higher fixed costs tend to push up prices for services further, increasing the down escalator effect.
Investment in a capitalistic system does not work on a down economic escalator. Who wants to invest, if it is probable that the economy will shrink, leading to increasing diseconomies of scale?

What Happens to Government and Business Promises?

There are many kinds of promises currently outstanding:

Government promises: Social Security, medicare, unemployment insurance, continued maintenance of roads, free education for all through high school, government debt (federal, state, and local), financial help after hurricane damage, guarantees of bank accounts and pension plans
Insurance and bank promises: Life insurance policies, annuities, long term care policies, pension plans, auto and homeowners policies, bank account balances
Promises by companies of all types: Stock – implied promise it will be worth more in the future, loans borrowed will be paid back (to banks or on bonds), pension plans, implied guarantee of future 24/7 electricity availability; grid maintenance

What happens to these promises? Over time, it is clear that pretty much all of them will disappear. They are up-escalator benefits that work when there are plenty of fossil fuels and the economy is expanding. They don’t work for very long on a down escalator.

Promises to Individuals

At the level of the individual, one of the implied promises has been is that an individual who gets a good education will be able to get a good paying job. This is one of the promises that is already disappearing.

There is also a second implied promise–people who actually perform the work, will be compensated for it. This promise is falling by the wayside, as wages fall (partly due to globalization, and partly due to other down escalator effects). At the same time, governments need higher tax rates, to pay for all the promises made to those who are retired, unemployed, or have wages that are too low to support a family.

Goods and Services Produced in a Given Year

In any year, there will be a mixture of people buying goods and services: people who are currently in the work force, retirees, people who own assets and want to sell them.

One thing that may not be obvious without thinking about it, is that all of the people wanting goods and services have to compete for the same set of goods and services that are available at that time.

For example, we grow a certain amount of corn and rice, and we extract a certain amount of oil and coal and copper, and we make a certain amount of electricity in electric power plants. Because of inventories, there is a little flexibility in these amounts, but basically, the amount that is available is determined by market prices and availability of supply lines. If the amount of goods and services produced is decreasing, because we are on a down escalator economy, this smaller quantity of goods and services needs to be shared by the entire population.

If there is relatively little available in total, and those who produced it don’t want to part with it, a person trying to trade accumulated “assets” for current production will not receive very much scarce production in return for his accumulated wealth, no matter what form it may take. In the case of most assets (stocks, bond, gold, silver, etc,) this means that the value of the asset tends toward $0. If currency is viewed as another asset, its value may go to close to zero as well. In fact, if there has been a government change, its value of the currency may be exactly zero.

How about Quantitative Easing?

Quantitative Easing (QE) represents an attempt to reinflate the economy by making more credit available to the economy, at lower interest rates. It also has the effect of reducing the interest rate the government pays on its own long-term debt, thus holding down that taxes the government needs to collect.

In terms of inflation/deflation effects QE has, its primary effect seems to be to artificially inflate asset prices–stocks, bonds, home prices, and agricultural land prices. The announced goal of the Japanese QE attempt was to try to raise the inflation rate (generally) in Japan to 2%, but it has not had that effect. In fact, the same link shows that in general, QE has not led to inflation.

In my view, the primary effect of QE is to create asset price bubbles. The price of bonds is raised, because of the artificially low interest rates. The price of stocks is raised, because people switch from bonds to stocks, to try to get yield (or capital gains). To get better yield, businesses find it worthwhile investing in homes, with the idea of renting then out on a long-term basis. Very little of QE actually gets through to wages, which is where the major shortfall is.

QE will at some point stop, and the asset price bubble will deflate. (Crunch Time: Fiscal Crises and the Role of Monetary Policy by David Greenlaw, James Hamilton, Peter Hooper, and Frederic Mishkin points out that QE is not viable as a long-term strategy.) This is likely to add to deflation woes. The higher interest rates and the need for higher taxes to cover the higher interest the government needs to pay will add to the down escalator effects, making the trends noted previously even worse.

By Gail Tverberg

Inflation, Deflation, or Discontinuity? is republished with permission from Our Finite World.

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Are International Sanctions Against Iran Counterproductive?: Gail Tverberg

Gail Tverberg — Thu, 27 Jun 2013 08:17:15 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

The Obama administration in June introduced its ninth set of international sanctions aimed at driving Iran’s oil sales to a halt. If we are very lucky, the United States’ stepped up financial pressure could get Iran to back down on its nuclear weapons programme. But if we are less lucky, we may find ourselves with spiking oil prices.

A June 6, 2013, article from Reuters is titled, “Lawmakers in new drive to slash Iran’s oil sales to a trickle.” According to it,

U.S. lawmakers are embarking this summer on a campaign to deal a deeper blow to Iran’s diminishing oil exports, and while they are still working out the details, analysts say the ultimate goal could be a near total cut-off.

My concern is that the new sanctions, if they work, will put the United States and Europe in a worse financial position than they were before the sanctions, mostly because of a spike in oil prices.

How much reduction in oil exports are we talking about? According to both the EIA and BP, Iranian oil exports were in the 2.5 million barrels a day range, for most years in the 1992 to 2011 period. In 2012, Iran’s oil exports dropped to 1.7 or 1.8 million barrels a day. Recent data from OPEC suggests Iranian oil exports (crude + products) have recently dropped to about 1.5 million barrels a day in May 2013.

Figure 1. Iranian oil exports, based on BP and on EIA data.

If the ultimate goal is “close to total cut-off,” an obvious question we should be asking ourselves is whether it makes sense to handicap world oil production by close to 2.5 million barrels relative to 2011, or close to 1.5 million barrels relative to May 2013. Oil prices have spiked in the past when there has been an interruption in world oil supply. Why wouldn’t they this time? Furthermore, who are really handicapping: Ourselves or Iran?

Possible Alternative Sources of Oil Supply

I would argue that we do not have adequate sources of backup oil supply. We are operating too “close to the edge” when it comes to world oil capacity.

Saudi Arabia likely has some spare capacity. If we go by how much Saudi Arabia in the recent past has been able to increase its production, its short-term spare capacity would appear to be about 600,000 barrels a day–not nearly enough to offset the decline in Iran’s oil exports. The 600,000 barrels a day is calculated by comparing Saudi Arabia’s highest production for individual months of 2012 of 10.0 million barrels of oil a day with its actual production in May 2013 of 9.4 million barrels a day, according to the OPEC’s Monthly Oil Market Report (MOMR). Saudi Arabia claims to have capacity of 12.5 million barrels a day, but its production in recent years has never been anywhere near its claimed capacity, raising questions about the truthfulness of the claim.

How about exports from Iraq? This is a graph of oil exports from Iraq, based on EIA data.

Figure 2. Iraq oil exports, based on EIA production and consumption data.

Iraq is indeed adding a little bit to world oil exports–about 326,000 barrels a day in oil exports were added in 2012. But the wild fluctuations don’t provide confidence the trend will continue. It is possible to get a rough idea of what future increases in oil exports might amount to. The International Energy Agency (IEA) is targeting 6 million barrels a day of oil extraction for Iraq by 2020. (Dave Summers–also known as Heading Out–isn’t confident even this can be achieved.) Extraction at this level would mean oil exports of about 4.5 million barrels a day in 2020. The expected annual growth in exports from today’s 2.2 million barrels a day of oil exports would be about 283,000 barrels a year, between now and 2020. Even if this rate of increase in oil exports is achieved, it won’t handle the immediate need for close to 1.5 million barrels a day of oil exports if Iranian exports are taken out of the world supply.

How about the supposedly miraculous growth in US oil supplies? If we look at the actual data, we see that the United States is still a major oil importer, even when such sources as “biofuels” are included in the total. (Imports are the gap between the”consumption” and “production” lines.)

Figure 3: US Liquids (oil including natural gas liquids, “refinery expansion” and biofuels) production and consumption, based on data of the EIA.

At the same time, Europe keeps falling behind farther, so it needs increasing amounts of imports.

Figure 4: European Liquids (oil including natural gas liquids, “refinery expansion” and biofuels) production and consumption, based on data of the EIA.

[quote] Thus, even if the US’ need for imports is declining, Europe’s need for imports is increasing, as is the need for imports to Asia, including China and India. Losing part of the world’s oil supply makes it harder to get enough imports, without oil prices spiking again. [/quote]

If Oil Supply Cushion is Less

Suppose that we somehow, miraculously, take Iranian oil exports off-line and find enough substitute supply without oil prices spiking too badly. We know too well from experience that there is the distinct possibility that part of current oil supply will later be taken off-line, for some unplanned reason. This might be another Arab Spring revolution, or perhaps fighting may break out between two oil producers. Or the United States may have a bad hurricane season. So even if oil prices don’t spike immediately, removing what little spare capacity there is, increases the likelihood that oil prices will spike in the future, from some unrelated cause.

Who Gets Hurt With An Oil Price Spike?

The countries that are most hurt by high oil prices are the big oil importers–the United States, the European Union, and Japan. We can see this with recent experience, shown in Figure 6 below. Oil prices have been high since 2005. These high oil prices have led to a cutback in consumption by oil importers, even as other countries more-or-less sailed along. The countries with lower oil consumption since 2005 are precisely the ones that have had problem with recession.

Figure 5. Oil consumption based on BP’s 2013 Statistical Review of World Energy.

If oil prices rise, more money will be transferred from oil importers to oil exporters. Oil exporters, such as the members of OPEC, will benefit. Of course, Iran itself will not benefit. Oil importing countries that have been having trouble with their debt loads are likely to have even more difficulty, because their citizens are made poorer by high oil prices.

How Badly Do Sanctions Really Hurt Iran?

[quote] The sanctions cause Iran to leave its oil in the ground until later. While this hurts the Iranian economy now, the oil will still be there for extraction later. With the fields “rested,” Iran may even be able to increase the amount that can be extracted later. If oil prices are higher later, Iran will get the benefit of the higher prices. The oil supplies of other countries will also be more depleted then, so it will have more of an advantage than it does now. [/quote]

With all of the sanctions against Iran, the country has been encouraged to ramp up its natural gas production. It has also increased its fleet of natural gas-powered cars, so that it has more such cars than any other country in the world. Iran is also refining more of its oil, making itself less dependent on gasoline imports. Making these changes now makes Iran more self-reliant in the long-run.

A person might think that all of the sanctions to date have significantly reduced the standard of living of a typical Iranian. If this is true, it is not showing up much in the data. Prior to 2012, the economy had grown consistently for two decades. The sanctions led to an estimated decline in real GDP of -1.9% in 2012, according to the CIA World Fact Book. Iran’s per capita use of energy has been rising, and continues to do so, even in 2012. Its per capita energy use is now higher than Italy’s.

Figure 6. Per capita energy consumption for Italy and Iran, based on BP total primary energy consumption from 2013 Statistical Review of World Energy, and EIA population data.

There are obviously any number of other countries that Iran’s energy consumption could be compared to. If we compare Iran’s energy consumption to Israel, Iran’s per capita energy consumption is a little lower.

Figure 7. Per capita energy consumption for Israel and Iran, based on BP total primary energy consumption from 2013 Statistical Review of World Energy, and EIA population data.

Messing with Iran’s Currency

According to Bloomberg:

“The idea is to cause depreciation of the rial and make it unusable in international commerce,” he said. “On July 1 we will have the ability to impose sanctions on any foreign bank that exchanges rial to any other currency or that holds rial-denominated accounts.”

The move is intended to toughen sanctions that so far failed to press the Islamic republic to halt its nuclear program. According to the Treasury, the rial has lost more than two-thirds of its value in the past two years, trading at 36,000 per U.S. dollar as of April 30, compared with 16,000 at the start of 2012.

Interesting! Isn’t devaluing the currency exactly what Japan and all of the countries doing Quantitative Easing have been trying to do, perhaps to a lesser degree? As a result, Iran’s stock market has been soaring. Iran is a country that has two export products that other countries want to buy: oil and natural gas. It has little debt, and in the past has been running a budget surplus. Making more rial to the dollar makes imports to Iran more expensive, but exports more competitive in the world marketplace. This is precisely what other countries have been trying to accomplish.

I am skeptical this rial marginalization will work. Will these changes make any difference, in terms of trade with China and Russia? For that matter, will countries that want to buy natural gas from Iran stop trading with Iran? There are ways around any barriers we put up. The US dollar is the world’s reserve currency, but it is already under pressure in that role. Doesn’t all of this messing with the rial lead to more pressure to move away from the US dollar in its role as a reserve currency? Countries that have products to sell that are in short supply globally can usually find a way to sell them. The countries that seem to have much worse problems are those with nothing that the rest of the world wants to buy–Greece, Spain, etc.

Conclusion

All of this posturing looks like a power struggle between the East and the West. The techniques the West has been using so far haven’t been working all that well. The plan is to step up the same techniques, in the hope they will work better. It is not all that clear that they will–if they work, they may quite possibly backfire, because we are working with world oil supply, in a world where oil supply is still constrained. Reducing world oil supply by the amount of Iran’s oil exports doesn’t help the West at all.

There have been a lot of exaggerated reports, seeming to suggest all is right now with world oil supply. The danger is that US leaders are now starting to believe what they read. Supply is now available, because of high price. Price is high because of the problem of diminishing returns leading to ever higher prices required to make oil extraction profitable for exporters. Demand is now down in the West, because high prices are leading to job loss and recessionary forces there. Pushing the world further in this direction is hardly helpful.

If we are very lucky, the United States’ stepped up sanctions could get Iran to back down on its nuclear weapons program (assuming it has one). But if we are less lucky, we may find ourselves with spiking oil prices. To make things worse, we may see the role of the United States dollar as the world’s reserve currency destabilized. It seems to me that we are playing with fire.

By Gail Tverberg

Additional Iranian Oil Sanctions May Be Counterproductive is republished with permission from Our Finite World.

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Are Current Oil Prices Crippling Growth?: Gail Tverberg

Gail Tverberg — Tue, 11 Jun 2013 06:49:13 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

For those who are wondering how high oil prices need to be to be considered “too high”, the answer is: We are already there. In fact, continued high oil prices may be the key reason behind the recessionary forces we are seeing around the world now, troubling developed countries like the United States and most of Europe, as well as the main drivers of global growth China and India.

The US Energy Information Administration recently released its report showing oil consumption by country updated through 2012. Based on this report, it appears that at current high oil prices, demand in both China and India is being reduced. Thus, for those who are wondering how high oil prices need to be, to be “too high,” the answer is, “We are already there. In fact, continued high oil prices are a big reason behind the recessionary forces we are now seeing around the world.”

A big part of China and India’s problems is that they, like the United States and most of Europe, are oil importers. In this post, I also explain why there is a big difference in the impact of high oil prices on oil importing countries compared to oil exporting countries.

Figure 1. Liquids (including biofuel, etc) consumption for China, based on data of US EIA, together with Brent oil price in 2012 dollars, based on BP Statistical Review of World Energy updated with EIA data.

Figure 2. Liquids (including biofuel, etc) consumption for India, based on data of US EIA, together with Brent oil price in 2012 dollars, based on BP Statistical Review of World Energy updated with EIA data.

We can see from Figures 1 and 2 that at $100 per barrel prices, there is a definite flattening in per capita consumption for both India and China. Per capita consumption is used in this analysis, because if total oil consumption is rising, but by less than population is increasing, consumption on average is falling.

Some Other Countries with Declining Consumption

There are many other importing countries with even sharper drops in consumption than China and India. These declines started in the 2005 to 2007 period, as oil prices rose, and continued as oil prices have remained high. One example is Greece:

Figure 3. Liquids (including biofuel, etc) consumption of Greece, based on data of US EIA, together with Brent oil price in 2012 dollars, based on BP Statistical Review of World Energy updated with EIA data.

In fact, all of the PIIGS (Portugal, Ireland, Italy, Greece, and Spain, known for their problems with recession) have shown steep drops in oil consumption:

Figure 4. Per capita oil (“liquids”) consumption for countries known as PIIGS, based on EIA data.

Europe in total shows a somewhat less steep drop in oil consumption than the PIIGS:

Figure 5. Liquids (oil including biofuel, etc) consumption for Europe, based on data of US EIA, together with Brent oil price in 2012 dollars, based on BP Statistical Review of World Energy updated with EIA data.

The US shows a similar drop in consumption to Europe:

Figure 6. Liquids (oil including biofuel, etc) consumption for United States, based on data of US EIA, together with Brent oil price in 2012 dollars, based on BP Statistical Review of World Energy updated with EIA data.

Where is per capita oil consumption rising?

Oil consumption is rising faster than population in many oil exporting countries. If we look at OPEC in total, we see a big upward jump in per capita oil consumption in 2011 and 2012.

Figure 7. Liquids (oil including biofuel, etc) consumption for OPEC, based on data of US EIA, together with Brent oil price in 2012 dollars, based on BP Statistical Review of World Energy updated with EIA data.

In fact, this pattern occurs both in Saudi Arabia, and for OPEC outside Saudi Arabia:

Figure 8 Liquids (oil including biofuel, etc) consumption for Saudi Arabia, based on data of US EIA, together with Brent oil price in 2012 dollars, based on BP Statistical Review of World Energy updated with EIA data.

For Saudi Arabia, 2012 oil consumption per capita is more than five times as much as that of Europe. Outside Saudi Arabia, there is a definite upward bump in consumption, both during the 2008 price run-up and corresponding to the higher price in 2011 and 2012.

Figure 9 Liquids (oil including biofuel, etc) consumption for OPEC ex Saudi Arabia, based on data of US EIA, together with Brent oil price in 2012 dollars, based on BP Statistical Review of World Energy updated with EIA data.

One reason why oil exporters show higher growth in oil consumption than other countries is because oil is becoming more difficult to extract, and because the easiest to extract oil was extracted first. There are often indirect needs for oil as well, such as desalinization to have sufficient water for a growing population, or a new refinery for difficult-to-refine oil. I talk about these issues in my post, Our Investment Sinkhole Problem.

A second reason why oil exporters often show higher growth in oil consumption is because exporters often provide subsidized prices on oil products, so their citizens do not have to pay the full cost of the product. Thus, their citizens do not really experience the high oil prices that most importers do.

A third reason why oil exporters show higher growth when oil high prices are high has to do with all of the money these exporters receive when they sell high-priced oil. The Economist this week has an article “Saudi Arabia risk: Alert – The next property bubble?” It talks about the huge number of office buildings, schools, low-priced homes, and other building projects underway, thanks to a combination of easy credit availability and lots of oil money. The article indicates that citizens rarely put their new-found wealth into paper investments. Instead, a significant part of their wealth ends up in building projects that require oil use.

Norway is an exporter that does not subsidize oil prices (in fact, it has quite a high tax on oil use in private vehicles). It shows higher per capita oil consumption in the past two years, despite higher world oil prices.

Figure 10. Liquids (oil including biofuel, etc) consumption for Norway, based on data of US EIA, together with Brent oil price in 2012 dollars, based on BP Statistical Review of World Energy updated with EIA data.

Brazil is not an oil exporter, but it has been trying to ramp up its production. Its per capita consumption has been rising recently as well.

Figure 11. Liquids (oil including biofuel, etc) consumption for Brazil, based on data of US EIA, together with Brent oil price in 2012 dollars, based on BP Statistical Review of World Energy updated with EIA data.

In fact, Africa in total, Central and South America in total, and the Middle East in total, all show oil consumption rising faster than population, in 2011 and 2012. These are areas that, in total, are oil exporters.

Some very low oil-use countries, such as Bangladesh, are showing rising per capita oil consumption in 2011 and 2012, even with higher oil prices. This could indicate that some manufacturing is shifting to even lower cost areas than China and India.

Australia is showing growing per capita oil consumption, perhaps because of oil’s use in resource extraction and transport.

Why would a drop in per capita oil consumption for oil importers matter?

A drop in per capita oil consumption is a likely sign that oil is becoming increasingly unaffordable. We know that oil is used to make and transport goods. If less oil is used, or if oil use is growing less rapidly than in the past, there is a real chance that an economy is slowing.

Figure 12. World growth in energy use, oil use, and GDP (three-year averages). Oil and energy use based on BP’s 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.

There are a number of reasons oil consumption may be down. Fewer goods for sale may be being transported, perhaps because European demand is down. Citizens may be driving less in their free time. Or many young people may be unemployed, and be unable to afford to buy a car or motor scooter. Any of these changes could mean a slowing economy.

[quote] Obviously, there are situations in which reduced oil consumption doesn’t mean a slowing economy. A shift from manufacturing to a service economy could lead to lower oil consumption; a shift toward more fuel-efficient cars and trucks could lead to lower oil consumption. But these changes tend to take place slowly over time, not all at once, when oil prices rise. [/quote]

Another way oil consumption can be reduced is if a country has in the past generated electricity using oil, and such generation is shifted to another fuel, such as natural gas. This type of change is being made in Greece, but seems unlikely in China and India. Similarly, if homes are heated with oil, sometimes an alternate fuel can be used, reducing oil consumption. China and India aren’t areas where oil has traditionally been used to heat homes, though.

In general, though, sharp reductions in oil consumption in a growing economies, such as China and India, are cause for concern, if one was expecting growth. Are high oil prices stressing the economy?

United States and European Oil Imports

The US oil consumption pattern looks very much like that of an oil importing nation, under stress from high oil prices. Recently, there has been a lot of publicity about higher US oil production, but this does not really change the situation. If we look at US oil consumption and production (actually “liquids” production and consumption since all kinds of stuff including biofuels are included), we see that the US remains an oil importer. In fact, it is still a long way from becoming an oil exporter. (And, importantly, oil prices aren’t down by much, and high oil prices are our real problem.)

Figure 13: US Liquids (oil including natural gas liquids, “refinery expansion” and biofuels) production and consumption, based on data of the EIA.

The European oil import situation is worse than the United States liquids situation, and no doubt part of its current economic problems. A graph of its recent production and consumption is as follows:

Figure 14: European Liquids (oil including natural gas liquids, “refinery expansion” and biofuels) production and consumption, based on data of the EIA.

Difference Between Oil Importers and Exporters – Additional thoughts

The cost of extraction varies widely by country and by field within country. In order to provide a large enough quantity of oil in total, the world price of oil has to be high enough to provide an adequate profit for the highest cost producer. Clearly, if every oil company charged the price needed for the highest cost producer, many would be collecting far more than they need for future oil extraction and payment of dividends. Where does all of this extra money go?

To a significant extent, this money is “latched onto” by governments. In the case of oil exporting countries, governments often own oil companies directly. But even if they don’t, governments tax oil extraction at very high rates, to make certain that the government gets the benefit of any extra revenue available. Sometimes Production Sharing Agreements are used. A chart by Barry Rodgers Oil and Gas consulting (Figure 15 below) shows that for many oil exporting countries, the government “take” is 70% to 90% of operating income (that is, net of direct expenses of extraction).

Figure 15. Chart showing “government take” as a percentage of operating income by Barry Rodgers Oil and Gas Consulting.

Even in the case of the United States, the government take is significant. Barry Rodgers, in an article in the May issue of Oil & Gas Journal, calculates that for tight oil (such as oil from the Bakken), the average government take is $33.29 per barrel. This compares to $19.50 per barrel, for tight oil extracted in Canada. These amounts include payments to state governments as well as the federal government. If extraction costs are low, as in the case of Alaska, the state adjusts its tax accordingly.

Oil importing countries would like the world to have a level playing field with respect to the price of oil. In the real world, this doesn’t happen. Oil exporting countries get huge benefits in the form of the tax they collect from the oil they sell abroad. Often, this tax revenue amounts to 70% or more of a country’s tax budget from all sources. If oil exporters have small populations, they can afford to offer oil at subsidized rates to their own populations. (If they have large populations relative to exports, offering a subsidized price would soon eliminate all exports!)

Economists would like us to believe that many of the differences between oil exporters and oil importers will even out because money spent by oil exporters to purchase goods and services together with purchases of government bonds from oil importers should mostly make their way back to oil importing countries. There are several differences though:

Oil exporting countries can choose to charge their citizens a lower price oil, thus insulating them from the high world oil price, and raising their demand for oil (that is, the amount of oil they can afford). This higher demand allows these countries to increase their oil consumption, even as other countries, subject to higher prices, reduce theirs. Evidence presented in this article suggests that this, in fact, is happening at high prices.
Oil exporting countries need not tax the income of individuals and businesses, or institute value added taxes, because their tax needs are mostly met by the taxes they collect on oil that is exported. This gives them a competitive advantage in making goods from oil or natural gas for international trade.
Since world oil supply is limited, the oil that the oil exporting countries are able to purchase at subsidized prices (even if to build unneeded office buildings in Saudi Arabia) is removed from the world market, further driving up oil prices, and leaving less for other countries to consume.
The money that is spent by oil exporters rarely makes it back to the salaries of individuals in oil importing nations who are faced with buying high-priced oil products. In fact, I have shown that in times of oil prices, Unites States salaries tend to stagnate:

Figure 16. High oil prices are associated with depressed wages. Oil price through 2011 from BP’s 2012 Statistical Review of World Energy, updated to 2012 using EIA data and CPI-Urban from BLS. Average wages calculated by dividing Private Industry wages from US BEA Table 2.1 by US population, and bringing to 2012 cost level using CPI-Urban.

At best, the money makes it back to financial institutions and corporations selling products such as exported grain. The higher demand for grain tends to raise food prices, putting another stress on the economy.

By Gail Tverberg

Gail Tverberg is a trained casualty actuary who writes about the impact of the limited supply of oil. She speaks internationally about oil issues, and writes frequently about the issue on her blog, Our Finite World and on The Oil Drum (where she is an editor). Tverberg is also a Fellow of the Casualty Actuarial Society and a Member of the American Academy of Actuaries. She has a Masters Degree in Mathematics from the University of Illinois, Chicago.

High Oil Prices are Starting to Affect China and India is republished with permission from Our Finite World.

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The post Are Current Oil Prices Crippling Growth?: Gail Tverberg appeared first on Economy Watch.

Is A Steady State Economy Possible?: Gail Tverberg

Gail Tverberg — Wed, 22 May 2013 07:40:32 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

A Steady State Economy is one that seeks to balance growth with environmental integrity by maintaining stable or mildly fluctuating levels in population and consumption of energy and materials. In our current global scenario – with population and demand for resources rising – what would it take to achieve a steady state economy?

Humans live in equilibrium with other species in a finite world. In such a world, there is never really a Steady State. Instead, there is a constant ebb and flow. For a while, one species may be dominant in an area, and then another. If populations are closely matched in “ability,” then the ups and downs aren’t too severe. If a predator depends on a particular type of prey for its dinner, it can’t eat all of the prey, or it will go hungry.

When the populations of various species are graphed, they rise and fall. We usually think of a close match, such as depicted in this graph:

Figure 1. Volterra_Lotka equations used to illustrate situation where population of predators and prey do not vary over too wide a range. Source: Wikipedia.

In fact, the variability of the many species over time tends to be greater than this, as illustrated by the following model that started with 80 baboons and 40 cheetahs:

Figure 2. Lotka-Volterra equations used to illustrate situation that begins with 80 baboons and 40 cheetahs. Source: Wikipedia

If species evolve together, a natural balance tends to remain in place. If a species suddenly finds a new, better source of nourishment (really, energy supply, since food supplies energy), its population may increase greatly. For example, yeast may metabolize the sugar in grape juice, converting it to alcohol. The yeast population temporarily rises and then declines, as the food source disappears and alcohol pollution poisons the yeast. Or bacteria may multiply rapidly inside the human body under certain circumstances (including adequate nutrients and a compromised immune system).

An example is sometimes given of reindeer introduced to St. Matthews Island near Alaska, where there was considerable lichen on the rock. The reindeer ate the lichen at a speed faster than the lichen could reproduce. Soon the lichen was gone, and the reindeer population crashed.

Figure 3. Assumed population of St. Matthew Reindeer herd, with actual counts given. Based on research of David R. Klein of University of Alaska.

The reindeer example is similar to a very severe predator-prey curve. The reindeer ate a renewable resource faster than it could reproduce. There were a few other food sources a reindeer could eat, so a few reindeer remained, but there was a very sharp drop in the number of reindeer.

The population of humans has ramped up greatly in recent times:

Figure 4. World population based on data from “Atlas of World History,” McEvedy and Jones, Penguin Reference Books, 1978 and Wikipedia-World Population.

The most recent growth coincides with the addition of fossil fuels to the energy supplies used by humans, starting about 1800. If we look back, we see though that human population has been ramping up for a very long period. Humans discovered how to control fire over 1,000,000 years ago. Since 75,000 BCE, there has been fairly consistent population growth, if we look at the data on a log/log graph.

Figure 5. Log/log graph of human population growth, with energy sources giving rise to this growth.

The initial growth of human population occurred with the discovery of how to burn biomass, and how to use it for such purposes as cooking, keeping warm, honing stone tools to a sharper edge, and scaring predator animals away. All of these uses allowed ancestors of modern man to spread over a wider area of the globe, while at the same time wiping out many species of animals, as humans spread to new areas. Biologist and paleontologist Niles Eldridge says that Phase One of the Sixth Mass Extinction began when the first modern humans began to disperse to different parts of the world about 100,000 years ago. Phase Two began about 10,000 years ago when humans turned to agriculture. Even at these early stages, energy use by humans allowed human population to grow at the expense of the population of predator species.

There was a lull in human world population growth between 1 CE and 800 CE (Figure 5). In this period, there were many local collapses, so growth in one area tended to offset collapse in another area. When these collapses happened, they generally looked financial in nature, according to the research of Peter Turchin and Surgey Nefedov in Secular Cycles. Populations had found a new resource that allowed them to have more food supply–for example, they cleared land of trees so that it could be farmed or learned to use irrigation.

But over time, population grew and caught up with available resources. At the same time, the resources started degrading. The soil started eroding, or became less fertile, and or salt built up from irrigation. Wages of the common worker dropped, and it was hard for them to get adequate nourishment. Epidemics became common. The general shape of these collapses was approximately as follows:

Figure 6. Shape of typical Secular Cycle, based on work of Peter Turkin and Sergey Nefedov.

So even in the Year 1 CE to Year 800 CE period, there was not a Steady State. Instead, there was a combination of overshoot and collapse type waves of the types seen with other species in different parts of the globe, which together averaged out to relatively flat world population growth.

Angus Maddison analyzed GDP growth in the 1 CE to 1000CE period. He concluded that the per capita GDP was slightly lower at the end of the period (453) than at the beginning of the period (476). He doesn’t give amounts at the Year 800. But assuming that the change was fairly representative, the period 1CE to 800CE or 1 CE to 1000CE was close to a Steady State economy (with lots of collapses), considering the lack of both population growth and GDP growth per capita.

In more recent times, humans were able to add more energy sources (including peat moss, windmills, and water mills). They also developed better ocean-going ships that allowed them to make colonies, and spread agriculture further, and demand that these colonies extract resources to support the home country. Also, with a more globalized world, agriculture could be improved through a wider choice of domesticated plants and animals, by introducing species from other parts of the world.

Since 1800, the growth in fossil fuels has helped ramp up both population and standards of living.

Figure 7. Per capita world energy consumption, calculated by dividing world energy consumption (based on Vaclav Smil estimates from Energy Transitions: History, Requirements and Prospects together with BP Statistical Data for 1965 and subsequent) by population estimates, based on Angus Maddison data.

What Are Humans’ Options for Living in a Steady State Economy?

I am not sure there are many good choices:

1. If we went back to the period before the ancestors of humans discovered fire, about 100,000 to 200,000 of us could live in the warm areas of the world, eating raw food, and living much as chimpanzees and baboons do today, based on populations of those primates today. The population of humans under such a scenario would fluctuate upward and downward, perhaps as in Figure 1.

Because of the availability of cooked foods for many years, the bodies of humans haveadapted to the improvement in diet. It is not clear that our teeth and internal organs could handle a purely raw-food diet, unless we happened to live in a part of the world where a soft diet (berries, fish and worms) was available. The areas where humans could live would also need to be warm, so our lack of fur would not be a problem. To meet these criteria, the population might need to be even lower than 100,000 to 200,000.

2. Having no humans at all is by definition a Steady State. I am doubtful that most people would consider this an acceptable Steady State, however.

3. If we did not have globalization and stopped adding energy supplies, we might continue to have local collapses, as in the 1CE to 800CE or 1000CE period. In this way, we could approximate a Steady State. Of course, now with globalization, a problem in one part of the world quickly spreads to other parts of the world.

4. If we want 7 billion people to be able to continue to live, we will need some basic level of energy supplies for these 7 billion people. If we assume that as a minimum, people today will need at least the 1820 level of energy consumption (based on Figure 7), we will need total energy consumption of at least 22 gigajoules per capita. This would amount to about 7% of the current energy consumption of the United States. It would not be enough to perform what we now consider basic functions such as maintaining roads, electrical systems, water systems, and sewer systems, so would be a major step down for US residents.

At the 1820 level of energy consumption, we would still need to continue a portion of fossil fuel consumption, since there are now so many of us that biofuels would no longer suffice (Figure 7–read across at 1820 level). Also, renewables, including today’s modern hydroelectric and solar panels are made and transported with fossil fuels, so in order to have what we now consider renewables, we would need to continue to have some fossil fuel use. Also, electricity from wind and solar PV needs to be backed up with natural gas electricity generation.

In addition to needing energy to maintain a population of 7 billion people, we would also need a way to:

(a) keep population down, and

(b) keep people from using available energy supplies (beyond the 22 gigajoules per capita allotted), to improve their lifestyles.

The way we often hear proposed for keeping population down is more education of women together with availability of birth control measures. Unfortunately, this approach is energy dependent. Unless considerable external energy is available, women will have to work in the fields to produce food. This will give them little time for education or the jobs that education would provide.

There are some cultures that have been able to keep population down by less energy-dependent means. For example, China uses strict governmental controls. Cultural and religious practices may also be used, such as delayed marriage and long breastfeeding. In some cases, abortion or infanticide may be used.

Keeping people from using available energy supplies to improve their lifestyles is even trickier. Some central authority can dictate that the US will use only 7% of the energy the population used in the past, meaning that everyone has to give up nearly everything. But enforcing this will be a real trick, unless energy supplies really are constrained.

There seems to be a common belief that cutting down on personal transportation fuel would have a big impact on total energy consumption. In the US, gasoline amounts to about 44% of US oil consumption. If we eliminated all gasoline consumption (even that by police, ambulances, and sales people), it would only reduce US energy consumption (all types, not just oil) by 16%. On a worldwide basis, much less oil is used for personal transportation, so eliminating all oil for personal transportation would likely reduce world energy consumption by something like 10% to 12%.

Is There a Reason for Aiming for a Steady State Economy?

At this point, we seem to be headed for collapse, because the number of humans is so far out of line with the population of other species. There are many other limits we are reaching as well, including the cost of oil extraction, the availability of fresh water, and the amount of pollution (including CO2 pollution). Also, governments are in increasingly poor financial condition, because when there are not enough resources to go around, governments tend to “come up short”. They can’t collect enough taxes relative to the benefits they pay out and all of the government programs they administer.

The only way a Steady State would make sense would be if there were some level of Steady State that humans could fall back to, instead of collapse. Unfortunately, it is hard to see a good place to fall back to. The only period during which human population was relatively constant was the period 1 CE to 800 CE, when frequent collapses kept population down. It is difficult to see any point at which humans have not increased population, or increased resource use, if resources were available, except when frequent civilization collapses overwhelmed the system.

If our civilization does collapse to a lower level, but not all the way back to zero, it seems likely that humans will again repeat the pattern they have experienced, over and over. They will again increase population and resource use, if resources are available. This pattern seems to be an instinct for all species, which is why it is virtually impossible to eliminate. Humans will then again collapse back to a more sustainable level.

By Gail Tverberg

What Would it Take to Get to a Steady State Economy? is republished with permission from Our Finite World.

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Curse Of The Black Gold – How Oil Exporters Reach Financial Collapse: Gail Tverberg

Gail Tverberg — Wed, 17 Apr 2013 07:56:03 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

Although oil often provides an abundance of riches to producing nations, declining production capabilities, coupled with the volatility of oil prices, can lead some exporters down a road to financial collapse. Egypt, Syria, Yemen and the former Soviet Union have – at one point or another – struggled to re-adjust their economies at times of lower production, while Venezuela now appears set to fall under the same trap.

Recently, I explained how high oil prices can bring on financial collapse for oil importers. In this post, I’ll discuss the flip side of the situation: how oil exporters reach financial collapse.

Unfortunately, we have many examples of countries that were oil exporters, but are dealing with collapse situations. Egypt, Syria, and Yemen all have had political disruptions since 2011. These may not be called financial collapse, but they all took place as the country’s oil exports decreased and as the price of imported food rose. Another example is the Former Soviet Union (FSU). It collapsed in 1991, after a period of low oil prices, in what looks very much like a financial collapse.

There are several dynamics at work in the financial collapse of oil exporters:

1. Oil exporters are often dependent on oil export revenue to fund government programs.

2. The need for government programs grows as population grows and as the price of food rises.

3. The amount of oil that can be extracted in a given year often declines over time, as initial stores are depleted.

4. Exports often decline even more rapidly than oil supply, because of rising oil consumption as population grows.

In general, high oil prices are good for oil exporters (except the effect on food prices). At the same time, oil importers strongly prefer low oil prices. As a result, we end up with a price tug of war between oil importers and oil exporters.

One additional issue is declining Energy Return on Energy Invested. Countries often have the option of reducing their rate of decline by adding production in areas which are more expensive to drill (say deeper, smaller locations offshore Norway) or by using enhanced oil recovery methods. Such approaches add costs (and energy use), and further add to the price that oil exporters need for their product.

Egypt, Syria, and Yemen

Egypt, Syria, and Yemen are three countries that the press would say are suffering from the continuing impact of the Arab Spring revolutions, which began in 2011, or of civil war. The similarity of the oil production and consumption charts for the three countries (shown below) suggests that declining oil exports likely played a major role as well.

In all three countries, oil production rose and then began to fall (Figures 1, 2, and 3). At the same time, oil consumption rose. The two lines – production and consumption – come very close to meeting in 2011, indicating that oil exports are at that point dropping to 0.

Figure 1. Oil production and consumption for Syria, based on EIA data. (Both are on an “all liquids” basis.)

FIgure 2. Oil production and consumption for Egypt, based on BP’s 2012 Statistical Review of World Energy.

Figure 3. Oil production and consumption for Yemen, based on EIA data. (Both are on an “all liquids” basis.)

To make matters worse, the three countries are in an arid part of the world, where a large share of food must be imported. Oil prices and food prices tend to rise at the same time (Figure 4, below). By 2011, both food and oil prices were high. In fact, both prices have tended to stay high. Now, these countries find themselves with the unpleasant problem of paying for the higher cost of imported food (grown and transported with oil), so indirectly they are becoming an oil importer instead of an oil exporter.

Figure 4. Food and oil prices tend to rise at the same time. Based on data of the FAO and the EIA.

Faced with less revenue from oil exports, and higher prices of food imports, these countries find themselves with a permanent mismatch between revenue and expenses. Part of the revenue mismatch relates to subsidies offered to poor residents. With higher food and oil prices, the funding needed for subsidies rises rapidly, even as oil exports drop to close to zero.

One issue that makes the situation worse is the huge rise in population that came with increased prosperity. Population has nearly doubled since 1980 in Egypt, and has more than doubled in both Syria and Yemen (Figure 5, below).

Figure 5. Ratio of population in later years to population in 1980, based on EIA data.

All in all, the situation is very bad. These countries admittedly do have other resources, such as grazing land for animals, food crop production, and in some cases natural gas exports, but the loss of oil exports puts a hole in their budgets. If oil production continues to drop in the future, both jobs and local oil consumption are likely to be affected as well. (This is a link to a post I wrote about the Egyptian situation two years ago.)

I tried to put together an index of the relative dependence of various countries on oil exports, by comparing the value of oil exports to Gross National Income. Based on exports before the recent drop-off, Yemen’s index is around 30 percent; Syria and Egypt are a little under 10 percent. The index no doubt understates the role of oil, because it does not include the oil the country uses itself, or the impact of any natural gas industry. It also excludes indirect jobs, like that of grocery store owner or taxi driver.

If Egypt and Syria are indeed collapsing with what seems like low dependence on oil exports, it makes one wonder about the impact if Saudi Arabia’s (index over 70 percent) or Libya’s (index about 60 percent) oil extraction would drop.

The Collapse of the Former Soviet Union

The Soviet Union was an oil exporter and a major world power, prior to its collapse in 1991. While there are many views as to what led to this collapse, one issue seems to be a drop in oil price in the early 1980s.

Figure 6. Former Soviet Union oil production and price in 2011$, based on data from BP’s 2012 Statistical Review of World Energy.

The drop in oil prices did not lead to an immediate decline in oil production (Figure 6), most likely because the cost of maintaining production on a field that has recently developed, is low for a few years. What is expensive is the up-front cost of bringing new fields on line. These were not added, causing a decline in production, after a few years.

Russia’s energy data shows the marks of the financial collapse building, prior to 1991. Revenue from oil exports dropped in the mid 1980s, because of the lower oil price. Oil production started declining in 1987, four years before the collapse. Other types of energy production started declining as well, as if a recession were underway, pulling the economy down in all areas.

Figure 7. Former Soviet Union Energy production by type (hydroelectric omitted), based on BP’s 2012 Statistical Review of World Energy.

Every type of energy production (except hydropower, not shown) dropped back during this period, even coal and nuclear, with decreases beginning prior to 1991. Population growth started slowing prior to 1991 as well. Eventually, the government collapsed, after continuing recession.

Figure 8. Former Soviet Union energy production and consumption, based on BP’s 2012 Statistical Review of World Energy.

The FSU never regained its former stature as a manufacturing country, even when oil production rose, after oil prices rebounded. With little manufacturing, energy consumption has remained far below its pre-1991 levels (Figure 8).

I visited Russia in 2012, and saw for myself a little of the current situation. One problem is that its cost structure (based primarily on oil and gas which is now high-priced, and workers who need wages to pay for these fuels) is not competitive with the low-cost structure of the Chinese and Indians. Another issue is the poor condition of Russia’s infrastructure (roads, bridges, water pipelines, etc.) due to neglect during the time of its collapse. With the high cost of oil, it is expensive to make repairs and add new infrastructure.

In terms of my index, Russia’s oil exports now amount to a little less than 20 percent of Gross National Income.

Collapse in Countries with Declining Exports

Egypt, Syria, and Yemen are examples of countries whose exports have pretty much disappeared, causing great crisis. But how about countries with earlier declines in production? To some extent, there were not many problems in the 2003 to 2008 period, because declines in oil exports could often be offset by increases in oil prices.

One country that stands out, though, is Argentina, with problems both before and after the 2003-2008 period.

Figure 9. Oil and Gas Production of Argentina, based on EIA data (total liquids).

Argentina’s oil production hit a peak in 1998, and began dropping in 1999. Oil prices were at an unusually low level in the 1998 to 2002 period. This timing coincided precisely with it first economic crisis, which came in 1999 to 2002. Oil prices rose in the 2003 to 2008 period, and Argentina’s problems seemed to disappear.

Now Argentina’s oil exports are very low, and in 2012 and 2013, the country is again having financial problems. Argentina’s economy is well diversified, so a person wouldn’t think that oil would play a big role. (My index of the role of oil exports was only about 2 percent, as of 2008.) But oil problems overlay any other problems a country may have. If a country has a tendency to overspend its income, or over-promise subsidies, any reduction in oil income will tend to magnify this effect. When making plans, it is easy to overlook the fact that the benefit from oil income is temporary.

Target Break-Even Brent Oil Prices

Many large oil exporters include revenue from oil exports in a country’s annual budget. This is quite different from the cost of pulling the oil out of the ground. It is the money governments collect, as taxes or revenue sharing agreements or leases, to support their programs. With rising population, and often with declining exports, oil exporters find that they need higher prices each year, just to make their budgets balance.

Figure 10 provides some Deutche Bank estimates of budget break-even oil prices.

FIgure 10. Budget breakeven oil prices, based on a Deutche Bank analysis provided in a presentation by Mark Lewis.

Note that the indicated break-even prices for Nigeria and Russia are above current Brent price levels. (The current Brent Crude oil price is $106.) An estimate from Energy Policy Information Center (EPIC) shows Venezuela’s break-even price to be a little higher than Russia’s, and Iran’s between that of Nigeria and Russia. According to EPIC, Iraq’s break-even is in the $80 to $100 barrel range. The Saudi Arabian oil minister was quoted on January 16, 2013 as saying that the country needs oil prices averaging $100 barrel.

One concern is that these break-even prices will keep rising. Another concern is that countries “at the margin” will find it difficult to reach their price targets.

One country of concern is Venezuela. It has a very high break-even price, and recently underwent a leadership change. It also has a tendency to spend oil revenue, even before the oil is pulled from the ground, through loan programs from the Chinese.

Figure 11. Oil production and consumption of Venezuela, based on data of the EIA.

Venezuela’s exports are lower than in some previous years (Figure 11, above), but with the rise in the price per barrel, the dollar value has perhaps risen–this really depends on the price negotiated by China. With funds spent before the oil is produced, Venezuela can easily get itself into a trap, if “regular” oil production drops, or if it is difficult to ramp up new planned production.

Venezuela’s oil export index is about 20 percent, which is similar to Russia’s and Norway’s.

In general, oil exporters with declining oil production face worrisome situations. Reduced oil exports present a drag on the economy unless oil prices are rising rapidly. If oil prices do not keep rising rapidly, oil exporters will need to cut back on social programs–something that will not be well-accepted by citizens. Furthermore, adding new industries to take the place of missing oil supply may be difficult. There may even be a reduction in oil supply available to world market, if civil disorder causes a loss of production which would otherwise reach the export market.

By Gail Tverberg

How Oil Exporters Reach Financial Collapse is republished with permission from Our Finite World.

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The post Curse Of The Black Gold – How Oil Exporters Reach Financial Collapse: Gail Tverberg appeared first on Economy Watch.

Why Renewables Can’t Fix Our Energy Problem: Gail Tverberg

Gail Tverberg — Thu, 21 Mar 2013 08:16:41 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

Despite its merits, the cost of renewable energy, in its current state, means that it is unlikely to become a viable primary energy source anytime in the near future. At best, renewable energy will serve only as a “fossil fuel extender”; though even then, renewables could eventually reach a limit.

Based on the sound of the name renewable, a person might think that using only “renewable” energy is ideal–something we should all strive to use exclusively. But there are lots of energy sources that might be called “renewable,” and lots applications for renewable energy. Clearly not all are equally good. Perhaps we should examine the “Renewables are our savior,” belief a little more closely.

1. Renewables that we have today won’t replace the quantity of today’s fossil fuels, in any reasonable timeframe.

Figure 1. World fuel consumption based on BP’s 2012 Statistical Review of World Energy data.

Figure 1, above shows the distribution of fuels used since 1965.

Other renewables, which includes wind, solar, geothermal and other categories of new renewables, in total amounts to 1.6% of world energy supply in 2011, according to BP. The light blue line is not very visible on Figure 1. (The blue line that is visible at the top is “Nuclear.”)

Biofuels, which would include ethanol and other types of biofuels, such as palm oil, amounts to 0.5% of world energy supply. Its orange line is not very visible on the chart either.

Hydroelectric, shown in purple, has been around a long time – since 1880 in the United States. It amounts to 6.4% of world energy supply. Its quantity is not growing very much, because most of the good locations have already been dammed.

In total, the three categories amount to 8.5% of world energy supply. If growth continues at today’s rate, it will be a very long time before renewable energy supply can be expected to amount to more than 10% or 15% of world energy supply. We very clearly cannot operate all the equipment we have today on this quantity of energy. In fact, it is doubtful that we can even cover the basics (food, water, and heat to keep from freezing) for 7 billion people, with this quantity of energy.

2. If there is a huge collapse scenario, there is a possibility that those who are in possession of renewable energy technologies will be able to use these technologies to their own benefit, when others do not have such options.

There are many ways that today’s technologies may benefit a few hundred thousand or a few million people who happen to have use of them, for perhaps a few decades. A person who has a solar panel and backup battery may be able to operate an electric light, when no one else has one. A person living near a large hydroelectric plant may expect to have electricity, when other parts of the country do not. A person with a solar thermal hot water heater may be able to have hot water, when others do not.

There are of course limits to this. If the solar panel depends on battery backup, the battery may wear out pretty quickly. We know from the Second Law of Thermodynamics that everything degrades over time. This includes solar panels, hydroelectric plants, transmission wires, and even the solar thermal hot water heater. So at most, the benefit of today’s technology is only likely to last for a few generations, unless we are able to repeat making new units.

There is considerable misunderstanding regarding the availability of electricity from solar PV panels on roofs of houses. Usually, these are operated with an inverter (to produce alternating current) and connected to the electric grid. These units cannot be used if there is an electrical outage in the area. With some rewiring, the panels might be used on a stand-alone basis. On such a basis, their use would be much more limited. They could only be used for devices taking direct current, and only when the sun is shining (unless backup batteries are available).

3. Renewables can’t be expected to operate on a “stand-alone” basis, in any reasonable timeframe.

Each energy source is quite specialized. In the past, human and animal labor played an important role in growing crops. Charcoal made from wood was used in making a very limited amount of metals and glass. It was possible to use traditional sources of “renewable energy” to power society, in large part because only a small amount of non-human and non-animal energy was used in total. World population was 1 billion or less, not 7 billion. The standard of living was quite low.

In India today, the crops are grown primarily with human and animal labor, two sources which could be considered “renewable”.

Even with this low standard of living, there is a substantial fossil fuel contribution that would be difficult to eliminate. The hand tools that workers use are sickles, which are made using coal. India uses nitrogen fertilizer made using fossil fuel (natural gas or coal) as well as irrigation pumps (manufactured using fossil fuel, and fueled by diesel or electricity). Only the electricity component would be fairly easy to eliminate with today’s renewable energy (if scaled up sufficiently).

Some seem to believe that renewables can power the world on a stand-alone basis. The tiny quantity of renewable energy currently available is, in and of itself, a huge limitation in making this happen. Furthermore, today’s solar PV panels and wind turbines are made and transported using fossil fuels, and most of our transportation industry uses petroleum. In theory, we could develop new devices that use only electricity, or create enough biofuels to make a complete closed loop (devices made and transported only with renewables). In practice, we have trillions of dollars of cars, trucks, airplanes, and construction machinery built to use oil. Because of this, a complete changeover to renewables is at best decades away.

[quote]At this point, renewables are only “fossil fuel extenders.” They operate within our current fossil fuel system. They cannot be expected to reproduce themselves without the benefit of fossil fuels.[/quote]

4. Some renewables are economic in today’s world, while others require subsidies.

There are clearly many types of renewable energy that are economic in today’s world. Geothermal is economic in some locations, because there is underground heat that can be used to boil water to create electricity, or to heat homes directly. Solar PV panels, together with back-up batteries, are often the lowest-cost electricity source in remote locations. This is why energy companies use them to provide power in remote locations. Solar thermal energy is inexpensive for heating swimming pools and for heating hot water in warmer climates.

Other renewables require subsidies. We usually think of intermittent renewables, such as wind and solar PV panels, as requiring subsidies. In fact, it is often difficult to tell how much subsidy is truly required. Part of the subsidy comes in the need for upgraded grid transmission; part of the subsidy comes from the need to run fossil fuel back-up stations fewer hours and ramp them up and down more often, making them wear out more quickly; part of the subsidy comes in the form of increased complexity, that makes it more difficult to maintain electricity supply for the long run. There is no obvious reason to believe that intermittent electricity will make the electric grid last longer–if we are increasing the complexity of grid regulation at the same time we are reaching limits of many types, adding more intermittent renewables would seem to increase the likelihood of early failure.

As long as there are renewable energy mandates for renewables, and costs divided among many different payers (most of whom are not reimbursed for their payments), it is hard to tell how much today’s subsidy actually is. Energy return on energy invested (EROEI) calculations of intermittent renewables do not look at the whole system cost, including impacts on other players, so overstate economic benefits and understate energy costs. In the end, we do not have a good measure of how much mandated renewable energy supplies cost us. Also, as we add more intermittent renewables to the electric grid, the cost to other players can be expected to escalate, making the understatement of costs (and overstatement of EROEI) greater over time.

5. High-priced renewables help some of our problems, but make others worse.

Inexpensive renewables–ones that require no subsidy or mandate–are not a problem from a financial point of view. Many of these can help the environment without providing economic challenges.

The ones that tend to be problematic are ones that require subsidies, especially when we have no idea how much the subsidy really is. Figure 2, below, gives my view of how some of the various limits we are reaching act together.

Figure 2. Author’s view of how various limits might work together to produce different symptoms.

In my view, the limits we hit first are the limits on the outside of the chart on Figure 2: financial issues and political issues. (I introduce this chart in my post Our Energy Predicament in Charts.) Disease susceptibility enters in, as there are more unemployed and as the government finds it necessary to cut back in financial programs for the poor and unemployed.

If the price of renewable energy is high, it tends to exacerbate the problems on the outside of this chart, even as it reduces CO₂ contributions within the country, and reduces local pollution as electricity is made. There may still be pollution issues associated with making the rare earth metals that go into the wind turbines or the solar panels, but these are conveniently in China or another remote location. Making devices themselves also requires fossil fuels–usually coal if the devices are imported from China.

The way our current financial woes work out can be represented by Figure 3, below:

Figure 3. Author’s representation of how government financially caught in the middle. Photo credits: Texaspolicy.com, Thetaxhaven.com.au, Usahitman.com, politic365.com, autoevolution.com.

High priced renewables tend to exacerbate the poor financial situation of governments represented in Figure 3 in several ways:

Wage earners are even more penniless, thanks to the higher cost of these renewables,
Companies tend to move their manufacturing to cheaper locations (often using coal). This both reduces (a) taxes paid by the company to the US government, and (b) wages paid to US workers,
The government pays out more benefits to the unemployed workers, and
The government pays out more in funds for subsidies.

In the end, when we look at world CO₂ emissions, we discover that they have in fact risen relative what would have been expected prior to the Kyoto protocol (signed in 1997), rather than fallen, as the emphasis on renewables grew (Figure 4).

Figure 4. Actual world carbon dioxide emissions from fossil fuels, as shown in BP’s 2012 Statistical Review of World Energy. Fitted line is expected trend in emissions, based on actual trend in emissions from 1987-1997, equal to about 1.0% per year.

A major reason for emissions growth shown in Figure 4 seems to be globalization. I wonder, though, if globalization was pushed forward by the practice of looking at emissions within a country’s own boundaries, while excluding emissions associated with imported manufactured goods. The pushed developed countries toward renewables, at the same time Asia increased market share greatly through its use of coal.

Germany is now the leader in the use of renewable energy. Recent reports say that there are 800,000 German households that cannot pay their electricity bills, because of the high cost renewables add. There are also reports that German natural gas producers want to close back-up plants for wind/solar, unless they too receive subsidies.

6. Even if renewables look to be cheap and non-intermittent, there still can be problems with their use.

Unfortunately, nature doesn’t really provide us with a free lunch. If we use growing plants–such as trees, corn, palm oil trees, or other biomass, we start reaching limits as well. It is very easy to cut down trees more quickly than they regrow. We know from research by Sing Chew that deforestation was already a problem 6,000 years ago, when there were only 20 million humans on earth. Deforestation also leads to soil loss and erosion, which is also a huge problem. Plowing of fields for crops of any kind in fact tends to lead to soil loss.

Hydroelectric, as good an energy source as it is, has its downsides as well. In the early years after its construction, it tends to increase CO2 production in the flooded areas. It tends to interfere with fish migration, and with the normal balance of species. Building large hydroelectric plants can take huge amounts of arable land out of cultivation and displace large populations. It can lead to earthquakes and landslides. One country can sometimes “steal” the water of another, by building a hydroelectric facility.

Our whole ecological system, including animals and our climate system, requires a balance among the various species. We are being warned by scientist today that humans cannot simply commandeer all of the natural resources for our own use. Renewables often use natural resources that other species also have a need for-especially biofuels, wood and biomass. Biologists tell us we are in danger of reaching a tipping point due to overly high use of “net primary productivity” (Barnosky and Haberi).

Conclusion

It truly would be convenient if nature had provided us with a free lunch, in the form of renewables. At best, we were given something that if we use wisely, can add a little to what we have today. Renewables may, in fact, “save” some remnant of humanity, if limits truly become a problem in the near future.

If renewables are truly to provide widespread benefit for the world population as a whole (going beyond the measly 2% for non-hydroelectric renewables), we need to develop renewable energy supplies which are much lower in resource use than the renewables we have today.¹ Such lower resource use would have several benefits:

1. It would reduce the pollution impacts of making the renewable generating devices.
2. It would reduce the cost of making alternative energy.
3. It would improve the scalability of such renewables.
4. It would improve the EROEI of such renewables.

There seems to be widespread belief that an EROEI of 3 or 4 or 5 is “good enough” for renewables. The economy is showing signs that our current cost of fuels is already way too high. What we really need to do is bring our energy cost level down. Thus, what we really need is renewable energy sources that will reduce our average energy cost andraise our average EROEI of fuels.

Note:

[1] The name renewable unfortunately doesn’t equate to low resource use. In some cases, such as solar and wind, it means “front-ended fossil fuel resource” use. In other cases, such as biofuels, it means “using soil, fresh water, and fossil fuels to provide an oil substitute.”

By Gail Tverberg

Renewables – Good for some things; not so good for others is republished with permission from Our Finite World.

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The post Why Renewables Can’t Fix Our Energy Problem: Gail Tverberg appeared first on Economy Watch.

High Oil Price’s Heavy Burden On Government Debt: Gail Tverberg

Gail Tverberg — Wed, 13 Mar 2013 07:40:01 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

Recently, the growth of most types of US debt has stalled. The major exception however is governmental debt, which is still growing rapidly. In our current circumstances, the US is reaching its debt limit mainly because of a specific resource limit — lack of inexpensive oil.

If an economy is growing, it is easy to add debt. The additional growth in future years provides money both to pay back the debt and to cover the additional interest. Promotions are common and layoffs are few, so a debt such as a mortgage can easily be repaid.

The situation is fairly different if the economy is contracting. It is hard to find sufficient money for repaying the debt itself, not to mention the additional interest. Layoffs and business closings make repaying loans much more difficult.

If an economy is in a steady state, with no growth, debt still causes a problem. While there is theoretically enough money to repay the debt, interest costs are a drag on the economy. Interest payments tend to move money from debtors (who tend to be less wealthy) to creditors (who tend to be more wealthy). If the economy is growing, growth provides at least some additional funds offset to this loss of funds to debtors. Without growth, interest payments (or fees instead of interest) are a drain on debtors. Changing from interest payments to fees does not materially affect the outcome.

Recently, the growth of most types of US debt has stalled (Figure 1, below). The major exception is governmental debt, which is still growing rapidly. The purpose of sequestration is to slightly slow this growth in US debt.

Figure 1. US debt, based on Federal Reserve Z1 data

The growth in government debt occurs because of a mismatch between income and expenditures. There is a cutback in government revenue because high oil prices make some goods using oil unaffordable, causing a cutback in production, and hence employment. The government is affected because unemployed workers don’t pay much in taxes. Government expenditures are still high because many unemployed workers are still collecting benefits.

What can we expect going forward? Will the debt situation get even worse?

I think we can expect that from here, the debt situation will deteriorate. One issue is rising oil prices. While there seems to be a large supply of oil available, it is at ever-higher cost of extraction, because of diminishing returns. (This is even true of tight oil, such as from the Bakken.) Furthermore, I recently showed that not only do high oil prices adversely affect government finances, they also adversely affect wages.

Figure 2. US per capita non-governmental wages, in 2012 dollars. Non-governmental wages and population from Bureau of Economic Analysis; Adjusted to 2012 cost level using CPI-Urban from Bureau of Labor Statistics

If wages are low, the temptation is for governments to try to create more “spendable income” by increasing debt. This can’t really fix the situation, however. The real issue is increasingly high oil prices, which adversely affect both government finances and wages. Adding debt adds yet more interest payments, adding a further burden to wage earners, and creating a need for payback in the future, when wages are even lower.

Ultimately (which may not be very long from now), the debt system appears likely to collapse. The Quantitative Easing (QE) which a number of governments are now using to hold down interest rates and make more funds available to lend cannot continue forever. While there are claims that QE is a bridge to “when growth returns,” it is seriously doubtful that economic growth will ever return. Inexpensive oil is simply too essential to today’s economy. As oil prices rise, wages fall, and demand for oil is further constrained. Falling wages also reduce demand for debt, as payback becomes more difficult.

How Household Debt Adds to Spendable Income

One thing readers may have not thought about is that it is the increase in debt that adds to a person’s (or company’s) spendable income. For example, taking out a car loan allows a person to buy a car. Paying back the loan over a period of years tends to reduce spendable income. If, in the aggregate, the amount of debt outstanding starts decreasing each year, spendable income is actually reduced below the level of wages, because in total, the balance is being reduced.

If we add the increase in household debt (mortgages, credit cards, student loans, car loans, etc.) to wages, this is the pattern we see historically. (The increase has been adjusted for inflation using CPI-Urban):

Figure 3. Per capita wages (excluding government wages). Also, the sum of per capita wages and the increase in household debt, also on a per-capita basis, and also increased to 2012$ level using the CPI-Urban. Amounts from US BEA Table 2.1 and Federal Reserve Z1 Report. *2012 estimated based on partial year data.

The pattern is very much what we would expect, given what we know about recent debt patterns. The amount of debt rose rapidly in the early 2000s, when interest rates were lowered and lending standards relaxed. Some people bought new homes. Home prices escalated, with the higher demand. Many homeowners were able to refinance at lower interest rates. In the process, homeowners were able to “pull out” funds that they could use for any purpose they liked–fixing up the house, buying a new car, or going on a vacation.

By 2008, the party was over. In fact, the amount that was added through debt started decreasing in 2006 and 2007, after the Fed Reserve raised interest rates, in an attempt to choke back inflation caused by high oil prices. I talk about this in Oil Supply Limits and the Continuing Financial Crisis, available here or here.

Increased Government Debt Can Also Add to Spendable Income

In Figure 3, we added the increase in household debt to wages, to get an estimate of spendable income, adjusted for debt. Theoretically, at least part of the increase in government debt might also be added to spendable income, since it is often used (in leu of increased taxes) for programs that benefit citizens. (Some of the increased debt is used for things like bailing out banks, which is of questionable value in raising the spendable income of individuals, so perhaps not all of the increase in government debt should be added in estimating spendable income. Also, increased interest costs related to higher debt amounts would tend to have a dampening effect on spending, if interest rates are not continually dropping, as they have been under QE.)

If we add the increase in government debt (all kinds, including state and local) to the amounts shown in Figure 3, this is what we get:

Figure 4. Amounts shown in Figure 3, plus change in government debt added to the sum of (wages plus increase in household debt). Non-Government debt from Federal Reserve Z1 report, with changes adjusted to 2012 cost levels using CPI Urban. *2012 amounts estimated based on partial year values.

How much did citizens really spend? The Bureau of Economic Analysis tells us that as well, as an item called Personal Consumption Expenditures. We sometimes hear that in the United States, personal consumption of goods and services makes up more than 70 percent of GDP. In fact, this percentage has been growing since about 1950.

Figure 5. Wages (excluding government wages) as a percentage of GDP and personal consumption as a percentage of GDP, both based on data of the US Bureau of Economic Analysis. *2012 estimated based on partial year data.

Strangely enough, wages excluding governmental wages have been falling as a percentage of GDP during the same period. How can wages be falling at the same time personal consumption is rising? I think that a large part of the answer may very well be “increasing debt.”

If we compare wages to personal consumption expenditures, we find that wages were about 2/3 of personal consumption expenditures at the beginning of the period graphed, but gradually fell to a lower and lower share of Personal Consumption Expenditures. If we add a line to Figure 6 showing 2/3 of personal consumption expenditures, the line comes out very close to where we might guess it would, if all of household debt increases, and part of government debt increases were acting to increase personal spending (Figure 6).

Figure 6. Same data shown on Figure 6, plus a line equal to 2/3 of Personal Consumption as shown on BEA Report 2.4.5. also adjusted to a per capita and 2012 cost basis using CPI-Urban.

While there are too many variables to make this comparison exact, it does indicate that the increases in debt levels are of the right order of magnitude to explain what would otherwise be a very strange anomaly.

I might mention, too, that part of the reason that Personal Consumption Expenditures can be rising as a percentage of GDP is the fact that investment has been falling, as businesses move their manufacturing offshore, and as other changes take place. According to the American Society of Civil Engineers, we are allowing bridges, roads, and dams to deteriorate, and not adequately maintaining electrical transmission infrastructure. We are reaching limits on how far we can allow investment to drop, however. In fact, the time is coming when we will need to increase investment, or face loss of some of the infrastructure we take for granted.

Figure 7. United States domestic investment compared to consumption of assets, as percentage of National Income. Based on US Bureau of Economic Analysis Table 5.1.

Where Do Debt Limits Put Us

Even if all debt limits were to do is erase the beneficial impact of debt increases, based on Figure 6, it appears that spendable income (or Personal Consumption Expenditures) would decrease by about 23 percent, to bring it back to might be expected based on wages.

In fact, reaching debt limits is likely be a messy affair, with some type of change (such as increasing rising interest rates as QE fails, or the US dollar losing its reserve currency status, or huge changes in the Eurozone) leading to changes that affect governments and currencies around the world.

[quote]It seems likely that trade might be disrupted. Some governments might be replaced, and the debt of prior governments repudiated by the new governments. It is not clear what would happen to personal and corporate debt. In many countries, reform governments have redistributed land and other property. In such a circumstance, neither prior land ownership nor prior debt would have much meaning.[/quote]

In our current circumstances, we are reaching debt limits because of a specific resource limit — lack of inexpensive oil. Oil is used almost exclusively as a transportation fuel and in many other applications as well (such as construction, farming, pharmaceutical manufacturing, and synthetic fabrics). Expensive oil is not really a substitute, and neither is intermittent electricity. We are reaching other limits as well. Perhaps the most pressing of these is availability of fresh water. Fresh water can be obtained by desalination, but expensive water is not really a substitute for cheap water, for the same reason that expensive oil is not really a substitute for cheap oil.

The situation of reaching debt limits because of resource limits is a worrisome one, because it is hard to see a way to fix the situation. People often say that our debt problem arises because we have a financial system in which money is loaned into existence, and as a result, requires growth to pay back debt with interest. I am not sure that this is really the problem.

We have been used to a financial system that “works” in a growing economy. In such a system, it makes sense to take out loans on new business ventures. In such a system, money is also a store of value. In a shrinking economy, relationships change. Some loans will still “make sense,” but such loans will be a shrinking proportion of current loans, with long-term loans being especially vulnerable. Money will either need to “expire,” or a high rate of inflation will need to be expected, making interest rates on loans very high. In a shrinking economy, businesses will fail much more often, and workers will more often lose their (fossil fuel supported) jobs.

Some have suggested that new local currencies will fix our problems. I am doubtful this will be the case. The problem may well be that all currencies start being more local in nature.

By Gail Tverberg

Reaching Debt Limits is republished with permission from Our Finite World.

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12 Reasons Why Globalisation Is A Major Problem: Gail Tverberg

Gail Tverberg — Tue, 26 Feb 2013 08:12:41 +0000

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

Globalization seems to be looked on as an unmitigated “good” by economists. Unfortunately, economists seem to be guided by their badly flawed models; they miss real-world problems. In particular, they miss the point that the world is finite. We don’t have infinite resources, or unlimited ability to handle excess pollution. So we are setting up a “solution” that is at best temporary.

Economists also tend to look at results too narrowly – from the point of view of a business that can expand, or a worker who has plenty of money, even though these users are not typical. In real life, businesses are facing increased competition, and the worker may be laid off because of greater competition.

The following is a list of reasons why globalization is not living up to what was promised, and is, in fact, a very major problem.

1. Globalization uses up finite resources more quickly.

As an example, China joined the world trade organization in December 2001. In 2002, its coal use began rising rapidly (Figure 1, below).

Figure 1. China’s energy consumption by source, based on BP’s Statistical Review of World Energy data.

In fact, there is also a huge increase in world coal consumption (Figure 2, below). India’s consumption is increasing as well, but from a smaller base.

Figure 2. World coal consumption based on BP’s 2012 Statistical Review of World Energy

2. Globalization increases world carbon dioxide emissions.

If the world burns its coal more quickly, and does not cut back on other fossil fuel use, carbon dioxide emissions increase. Figure 3 shows how carbon dioxide emissions have increased, relative to what might have been expected, based on the trend line for the years prior to when the Kyoto protocol was adopted in 1997.

Figure 3. Actual world carbon dioxide emissions from fossil fuels, as shown in BP’s 2012 Statistical Review of World Energy. Fitted line is expected trend in emissions, based on actual trend in emissions from 1987-1997, equal to about 1.0% per year.

3. Globalization makes it virtually impossible for regulators in one country to foresee the worldwide implications of their actions.

Actions which would seem to reduce emissions for an individual country may indirectly encourage world trade, ramp up manufacturing in coal-producing areas, and increase emissions over all. See my post: Climate Change: Why Standard Fixes Don’t Work.

4. Globalization acts to increase world oil prices.

Figure 4. World oil supply and price, both based on BP’s 2012 Statistical Review of World Energy data. Updates to 2012$ added based on EIA price and supply data and BLS CPI urban.

The world has undergone two sets of oil price spikes. The first one, in the 1973 to 1983 period, occurred after US oil supply began to decline in 1970 (Figure 4, above and Figure 5 below).

Figure 5. US crude oil production, based on EIA data. 2012 data estimated based on partial year data. Tight oil split is author’s estimate based on state distribution of oil supply increases.

After 1983, it was possible to bring oil prices back to the $30 to $40 barrel range (in 2012$), compared to the $20 barrel price (in 2012$) available prior to 1970. This was partly done partly by ramping up oil production in the North Sea, Alaska and Mexico (sources which were already known), and partly by reducing consumption. The reduction in consumption was accomplished by cutting back oil use for electricity, and by encouraging the use of more fuel-efficient cars.

Now, since 2005, we have high oil prices back, but we have a much worse problem. The reason the problem is worse now is partly because oil supply is not growing very much, due to limits we are reaching, and partly because demand is exploding due to globalization.

If we look at world oil supply, it is virtually flat. The United States and Canada together provide the slight increase in world oil supply that has occurred since 2005. Otherwise, supply has been flat since 2005 (Figure 6, below). What looks like a huge increase in US oil production in 2012 in Figure 5 looks much less impressive, when viewed in the context of world oil production in Figure 6.

Figure 6. World crude oil production based on EIA data. *2012 estimated based on data through October.

Part of our problem now is that with globalization, world oil demand is rising very rapidly. Chinese buyers purchased more cars in 2012 than did European buyers. Rapidly rising world demand, together with oil supply which is barely rising, pushes world prices upward. This time, there also is no possibility of a dip in world oil demand of the type that occurred in the early 1980s. Even if the West drops its oil consumption greatly, the East has sufficient pent-up demand that it will make use of any oil that is made available to the market.

Adding to our problem is the fact that we have already extracted most of the inexpensive to extract oil because the “easy” (and cheap) to extract oil was extracted first. Because of this, oil prices cannot decrease very much, without world supply dropping off. Instead, because of diminishing returns, needed price keeps ratcheting upward. The new “tight” oil that is acting to increase US supply is an example of expensive to produce oil–it can’t bring needed price relief.

Related: Effects of Globalization

Related: Process of Globalization

5. Globalization transfers consumption of limited oil supply from developed countries to developing countries.

If world oil supply isn’t growing by very much, and demand is growing rapidly in developing countries, oil to meet this rising demand must come from somewhere. The way this transfer takes place is through the mechanism of high oil prices. High oil prices are particularly a problem for major oil importing countries, such as the United States, many European countries, and Japan. Because oil is used in growing food and for commuting, a rise in oil price tends to lead to a cutback in discretionary spending, recession, and lower oil use in these countries. See my academic article, “Oil Supply Limits and the Continuing Financial Crisis,” available here or here.

Figure 7. World oil consumption in million metric tons, divided among three areas of the world. (FSU is Former Soviet Union.)

Developing countries are better able to use higher-priced oil than developed countries. In some cases (particularly in oil-producing countries) subsidies play a role. In addition, the shift of manufacturing to less developed countries increases the number of workers who can afford a motorcycle or car. Job loss plays a role in the loss of oil consumption from developed countries–see my post, Why is US Oil Consumption Lower? Better Gasoline Mileage? The real issue isn’t better mileage; one major issue is loss of jobs.

6. Globalization transfers jobs from developed countries to less developed countries.

Globalization levels the playing field, in a way that makes it hard for developed countries to compete. A country with a lower cost structure (lower wages and benefits for workers, more inexpensive coal in its energy mix, and more lenient rules on pollution) is able to out-compete a typical OECD country. In the United States, the percentage of US citizen with jobs started dropping about the time China joined the World Trade Organization in 2001.

Figure 8. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. 2012 is partial year estimate.

7. Globalization transfers investment spending from developed countries to less developed countries.

If an investor has a chance to choose between a country with a competitive advantage and a country with a competitive disadvantage, which will the investor choose? A shift in investment shouldn’t be too surprising.

In the US, domestic investment was fairly steady as a percentage of National Income until the mid-1980s (Figure 9). In recent years, it has dropped off and is now close to consumption of assets (similar to depreciation, but includes other removal from service). The assets in question include all types of capital assets, including government-owned assets (schools, roads), business owned assets (factories, stores), and individual homes. A similar pattern applies to business investment viewed separately.

Figure 9. United States domestic investment compared to consumption of assets, as percentage of National Income. Based on US Bureau of Economic Analysis data from Table 5.1, Savings and Investment by Sector

Part of the shift in the balance between investment and consumption of assets is rising consumption of assets. This would include early retirement of factories, among other things.

Even very low interest rates in recent years have not brought US investment back to earlier levels.

8. With the dollar as the world’s reserve currency, globalization leads to huge US balance of trade deficits and other imbalances.

Figure 10. US Balance on Current Account, based on data of US Bureau of Economic Analysis. Amounts in 2012$ calculated based on US CPI-Urban of the Bureau of Labor Statistics.

With increased globalization and the rising price of oil since 2002, the US trade deficit has soared (Figure 10). Adding together amounts from Figure 10, the cumulative US deficit for the period 1980 through 2011 is $8.6 trillion. By the end of 2012, the cumulative deficit since 1980 is probably a little over 9 trillion.

A major reason for the large US trade deficit is the fact that the US dollar is the world’s “reserve currency.” While the mechanism is too complicated to explain here, the result is that the US can run deficits year after year, and the rest of the world will take their surpluses, and use it to buy US debt. With this arrangement, the rest of the world funds the United States’ continued overspending. It is fairly clear the system was not put together with the thought that it would work in a fully globalized world–it simply leads to too great an advantage for the United States relative to other countries. Erik Townsend recently wrote an article called Why Peak Oil Threatens the International Monetary System, in which he talks about the possibility of high oil prices bringing an end to the current arrangement.

At this point, high oil prices together with globalization have led to huge US deficit spending since 2008. This has occurred partly because a smaller portion of the population is working (and thus paying taxes), and partly because US spending for unemployment benefits and stimulus has risen. The result is a mismatch between government income and spending (Figure 11, below).

Figure 11. Receipts and Expenditures for all US government entities combined (including state and local) based on BEA data. 2012 estimated based on partial year data.

Thanks to the mismatch described in the last paragraph, the federal deficit in recent years has been far greater than the balance of payment deficit. As a result, some other source of funding for the additional US debt has been needed, in addition to what is provided by the reserve currency arrangement. The Federal Reserve has been using Quantitative Easing to buy up federal debt since late 2008. This has provided a buyer for additional debt and also keeps US interest rates low (hoping to attract some investment back to the US, and keeping US debt payments affordable). The current situation is unsustainable, however. Continued overspending and printing money to pay debt is not a long-term solution to huge imbalances among countries and lack of cheap oil–situations that do not “go away” by themselves.

9. Globalization tends to move taxation away from corporations, and onto individual citizens.

Corporations have the ability to move to locations where the tax rate is lowest. Individual citizens have much less ability to make such a change. Also, with today’s lack of jobs, each community competes with other communities with respect to how many tax breaks it can give to prospective employers. When we look at the breakdown of US tax receipts (federal, state, and local combined) this is what we find:

Figure 12. Source of US Government revenue, by year, based on US Bureau of Economic Analysis Data.

The only portion that is entirely from corporations is corporate income taxes, shown in red. This has clearly shrunk by more than half. Part of the green layer (excise, sales, and property tax) is also from corporations, since truckers also pay excise tax on fuel they purchase, and businesses usually pay property taxes. It is clear, though, that the portion of revenue coming from personal income taxes and Social Security and Medicare funding (blue) has been rising.

I showed that high oil prices seem to lead to depressed US wages in my post, The Connection of Depressed Wages to High Oil Prices and Limits to Growth. If wages are low at the same time that wage-earners are being asked to shoulder an increasing share of rising government costs, this creates a mismatch that wage-earners are not really able to handle.

10. Globalization sets up a currency “race to the bottom,” with each country trying to get an export advantage by dropping the value of its currency.

Because of the competitive nature of the world economy, each country needs to sell its goods and services at as low a price as possible. This can be done in various ways–pay its workers lower wages; allow more pollution; use cheaper more polluting fuels; or debase the currency by Quantitative Easing (also known as “printing money,”) in the hope that this will produce inflation and lower the value of the currency relative to other currencies.

There is no way this race to the bottom can end well. Prices of imports become very high in a debased currency–this becomes a problem. In addition, the supply of money is increasingly out of balance with real goods and services. This produces asset bubbles, such as artificially high stock market prices, and artificially high bond prices (because the interest rates on bonds are so low). These assets bubbles lead to investment crashes. Also, if the printing ever stops (and perhaps even if it doesn’t), interest rates will rise, greatly raising cost to governments, corporations, and individual citizens.

11. Globalization encourages dependence on other countries for essential goods and services.

With globalization, goods can often be obtained cheaply from elsewhere. A country may come to believe that there is no point in producing its own food or clothing. It becomes easy to depend on imports and specialize in something like financial services or high-priced medical care–services that are not as oil-dependent.

As long as the system stays together, this arrangement works, more or less. However, if the built-in instabilities in the system become too great, and the system stops working, there is suddenly a very large problem. Even if the dependence is not on food, but is instead on computers and replacement parts for machinery, there can still be a big problem if imports are interrupted.

12. Globalization ties countries together, so that if one country collapses, the collapse is likely to ripple through the system, pulling many other countries with it.

History includes many examples of civilizations that started from a small base, gradually grew to over-utilize their resource base, and then collapsed. We are now dealing with a world situation which is not too different. The big difference this time is that a large number of countries is involved, and these countries are increasingly interdependent. In my post 2013: Beginning of Long-Term Recession, I showed that there are significant parallels between financial dislocations now happening in the United States and the types of changes which happened in other societies, prior to collapse. My analysis was based on the model of collapse developed in the book Secular Cycles by Peter Turchin and Sergey Nefedov.

It is not just the United States that is in perilous financial condition. Many European countries and Japan are in similarly poor condition. The failure of one country has the potential to pull many others down, and with it much of the system. The only countries that remain safe are the ones that have not grown to depend on globalization–which is probably not many today–perhaps landlocked countries of Africa.

In the past, when one area collapsed, there was less interdependence. When one area collapsed, it was possible to let cropland “rest” and deforested areas regrow. With regeneration, and perhaps new technology, it was possible for a new civilization to grow in the same area later. If we are dealing with a world-wide collapse, it will be much more difficult to follow this model.

By Gail Tverberg

Twelve Reasons Why Globalization is a Huge Problem is republished with permission from Our Finite World.

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The post 12 Reasons Why Globalisation Is A Major Problem: Gail Tverberg appeared first on Economy Watch.