Blogs & Comment

The energy issue at the heart of our crisis

It was interesting to hear the always-estimable Rick MacInnes-Rae interview Robert Hirsch on CBC national this past Sunday. Rick is a steady and reassuring voice on foreign policy and big issues, and so the fact he was interviewing Hirsch, the author of the key reporton Peak Oil, the aptly-named Hirsch report, was interesting. Is the CBC getting onside with Peak Oil? Looks like it. And thats a good thing.
Yes, the price of our most precious commodity, the source of 32% of our total energy consumption, has plunged. And that has caused mainstream opinion makers to assume that Peak Oil was just a flash in the pan as a concept. But many in the oil industry are actually moving to a new and higher level of concern around the issue of peaking oil through this period, especially now that we’re seeing a slowdown in investment in new oil projects as a result of lower prices.
Ongoing depletion in current oil production projects continues to take production off line. But this is happening at the same time were failing to replace that production, and thats going to lead to a plunge in total production in the years ahead. This past Friday Cambridge Energy Research Associates (CERA), the energy stats organization that most mainstream fund managers follow, suggestedthe world might be facing a sharp decline in daily global production of seven million barrels a day over the next five years as a result of the current low prices. That is, according to many in the industry we’re winding the system up for a huge price spike as soon as the economy recovers, or tries to.
Think about that for a moment. Seven million barrels a day in production coming out of a our current daily production of 86 mbpd? That will be a severe shock to the system and will virtually ensure a price spike if the economy recovers. Remember, it was only a slowing of the rate of growth that caused the Great Energy Spike of 2008. Real declines (which some suggest could begin next year) will take prices to a new level. For those who are assuming we’ll see a quick recovery from this recession, you might want to rethink those assumptions. Look at the price of oil right now. With every bit of good news the price trebles, seemingly ready to break out into a new oil bull market. That will be good for the speculators buying into the spike. But it also means that whatever recovery we get is going to run right into a huge wall of high oil prices, and thats going to kill any recovery.
No doubt well see another huge round of shoot the speculator if we see oil prices rise. But sit back for a moment and think about the bigger picture here and what this all means. What is really happening is that free markets are working just as they are supposed to. Markets are registering the new ceiling on oil production (and the specter of possible declines). And in that they are sending the right message to us: There is no more room for growth in the total supply of oil. It will be constrained. After 150 years of constant expansion were near the upper limit of that expansion, and there is nothing we can do about. Heed the signal people, we need to change.
Hopefully higher prices will arrive soon enough to get enough new (and more expensive) unconventional oil supply online to avoid real chaos in oil supply. But what we should also take from this is the idea that the only way out of this mess is to move to alternative energies and nuclear. These other sources of energy are all far less efficient than hydrocarbons (oil and natural gas). Hydrocarbons provide by far the highest energy return on energy invested and so any move away from them will require more of out total societal capital to be put toward energy production, which will take growth from every other sector of the economy. But we no longer have a choice. The path to growth can no longer go through oil. America is going to be in a permanent recession until it begins to grow (albeit more slowly) through other energy means.
This is all old hat to the peakists, of course. But it seems to be slowly dawning across the rest of the society. The CBC is interviewing Hirsch. That long-time cheerleader of Chimerica (read: more American consumption) Thomas Friedman is changing his tune(shamelessly so). And in Alberta and Texas theyre just watching everyone else catch up to this kind of thinking. (How many people know that the Greater Houston Partnership, and the Houston Chamber of Commerce has already put this stuff togetherand is now engaged in an effort to develop the city along more alternative energy lines? Its true.)
Im headed to Alberta this evening to attend a CFA-sponsored Investing in Energy conference, which will feature both the CEO of Suncor, Rick George, but also Kenneth Deffeyes, an emeritus professor of geology at Princeton University, and someone who worked with M. King Hubbert, the patron Saint of Peak Oil. Im very interested in hearing what he has to say. His take is that were at peak, basically. Our current low prices will lock in this level of production since so much new production is going to be delayed. Once prices pick up again and flood oil companies with enough money to get the projects back online, depletion will have already moved ahead far enough to ensure that we never increase out total daily production that far above 90 or 100 mbpd. We’re there.
It is telling that Deffeyes has been invited to this conference. He has been warning about the dangers of peak for years, and hes finally getting some attention. Tune in here over the next couple of days for some live blogging from the conference.
Also at the conference will be an analyst from Simmons & Co., the energy investment bank run by Mathew Simmons, another well-known voice among the peakists. Through this period of low oil prices he has also been busy. In a recent speech he gave in Australia, Simmons suggested that free markets in oil may really be, basically, screwing us over right now. What we need is a guaranteed price for oil (a carbon tax!) to guarantee the money in the energy sector necessary to get us through this period. That is an astonishing comment from someone who made a life out of working in free markets, and its a warning not to be taken lightly.
Free markets are great when the underlying commodity is expanding in its supply. But now that this is no longer the case for the most important base input into the economy, the volatility that is going to result from a shift from expansion to contraction of oil supply could crash our economies more seriously than we’ve experienced to this point. If we get a massive oil price spikeif we lose, say, 7 mbpd in total production in the next five years as CERA maintainsyou will know exactly what Im talking about.
The world is at a weird place right now. When America peaked in production of domestic oil production in 1970, the U.S., which in the early parts of last century had been the biggest net exporter of oil (and therefore the biggest recipient of the worlds energy dollars), had to rely more and more on foreign imports of oil. And that reversed a basic flow. No longer was America selling oil to the rest of the world and collecting huge sums of private and tax money on that. It was now sending money offshore. And so now other countries are now collecting the rents on energy provision, not America.
Nevertheless, America went ahead consuming energy at the level it always had. To cover the gap that began to widen between the money coming in and that going out we saw the personal savings rate decline, and we saw a large bubble in paper assets created by over-leveraged banks. This worked through the late ’80s and ’90s when the price of oil was low. The country was able to literally paper over this financial hollowing out by de-regulating lending to increase the amount of debt outstanding. But the Day of Reckoning has arrived. The supply of oil stopped growing back in 2005 and that caused the price of this base commodity to rise to the point it pushed the banking industry over the edge.
Germany and Japan were already in recession as a result of the rise in the price of oil through this decade even before we heard of sub-prime mortgages (which are a symptom, not the cause of our current crisis). But the price spike in 2008 knocked the by then fragile U.S. banking system into the ditch as people put more money into their gas tank and less toward their mortgages. The banking industry fell over. The easy credit dried up and the auto industry went shortly after. And that gets us to where we are today.
Now America is printing money to keep it all going. But that can only work for so long. America can no longer pay for its energy consumption and its economy has hit the wall. Lets hope the centre holds (the U.S. dollar doesn’t crash) before Obamas new energy initiative works. Because that is the only way out of this thing. And while the shift away from oil to a more sustainable future will mean permanently lower growth and checked markets for years to come, we no longer have a choice. This is where we are.