Wednesday, November 20, 2013

Key Concept 3: The Peaks

In key concept 2 we looked at how diminishing energy returns are effecting the economy and the steps the elite are taking to mitigate that issue (for themselves). In key concept 3 we'll be looking at the other side of this equation, how oil enables the foundation of the current control system and what peak oil means for that situation.

Betting on 'more'

The infinite growth economy operates on the principal that the future will always be larger than the present. When we talk about risk in loans that risk derives from the likelihood that the loan can be repaid. The likelihood that the loan can be repaid is based on the odds that there is enough productive capacity that can be utilized by the loan to generate enough real wealth to cover the bet plus incurring interest.

"Growth" is extremely important within the current control system as to keep the hamster wheel spinning there must always be more debt to pay than actual currency to pay it. The result of this is that all debt is actually paid by other debt. Every dollar you own is someone else's debt and if all debts were somehow able to be repaid there would be no currency in circulation.

Let me give you a practical example:

Person 'A' takes out a mortgage to afford a house, this mortgage has compound interest attached to it. to pay off this mortgage person 'A' gets a job with company 'B'. Company 'B' to pay their employees and expand takes out a loan which likewise has compound interest attached to it. For company 'B' to pay off their loan they must sell products, which are likely being paid for by people or companies who themselves are utilizing loans for capital or are employed by companies using loans for capital, and so on and so on. Consumer banks themselves also borrow from the central bank at interest.

Each loan is a bet on future production, that there will be more future production, or in other words that the future will be larger than the present. This isn't a big problem so long as the underlying energy supply continues expanding relative to the rate of growth. With conventional oil it was quite easy to expand the underlying energy supply, with extreme energy like shale or oilsands this has become a major challenge.

Expansion is much more than just production numbers, production numbers don't clearly show how much of past production or the wealth generated by past production is being utilized for current production. sure the U.S. production numbers are climbing to levels not seen since their initial decline from peak production but they are also using a lot more than they had to historically to accomplish that. Despite a glut in supplies, prices remain high because high prices are required to produce these numbers in the first place.

Viewing peak oil through an economic lens

What's commonly misunderstood about peak oil is that not only is it not describing 'oil depletion', if peak oil theory is accurate then oil depletion is actually impossible. The reason it is impossible is that economically it is both natural and logical to go after the easiest or cheapest to produce oil first. So oil companies initially sought after conventional oil deeming the other oil to be "nonviable". Now we've moved on to extreme energy which is a lot harder, and more resource intensive (expensive) to produce. We produce oil discoveries in the order of the easiest to produce to the hardest to produce. The harder the discovery is to produce, the less energy returned on energy invested you get from it.

It is inevitable that we will hit discoveries that have an energy return ratio of 1:1 which to produce would have no net benefit at all. There is no reason to produce a barrel of oil if it took roughly as much energy to produce as you get in return. To actually deplete the world supply of oil would require more energy than there is oil to accomplish it. Depletion in a practical sense simply means that we've hit that 1:1 ratio.

The reality though is that oil production is unlikely to even reach that point as oil production itself relies on a healthy and functioning supply chain which is operated by the economy. When oil becomes too expensive the supply chain seizes up, consumers have to direct more of their spending towards gas and to absorb other increased cost, and ultimately demand is destroyed before we even test the limits of production.

We witnessed this in 2008, in fact it can be argued that it was the price of oil and not the ponzi scheme in housing which actually triggered the collapse of 2008. Yes the ponzi would have eventually collapsed regardless but the reason it collapsed when it did was likely due to the price of oil which hit a record $147 / barrel. This price caused consumers to drastically alter their spending habits, eat significantly into their credit and ultimately default on their loans. The expansion required of cheap energy to meet the existing debt obligations was not possible to achieve. The bubble popped, and the rest is history.

Demand for oil after this event almost completely dropped off entirely, temporarily bringing the price down into the $40 range which then began causing problems for extreme energy projects like the oilsands. What's important to note though is that despite $147 representing incredible demand and diminishing supply the economy itself became unstable long before oil supply would have become unstable. Oil shortages won't be happening because demand exceeds supply as the economy itself can not support that situation, oil shortages will be coming when the economy can no longer remain stable for periods long enough to maintain oil production.

As we covered in key concept 2, expanding the currency supply without being able to expand the underlying energy to support an expansion in the means of production and new wealth simply means that the currency is devaluing. The efforts to print currency to kick start growth are all in vein as the moment that growth places demand on energy that is unaffordable to your average consumer, or business, demand drops off.

You can see this effect playing out right now. When oil price is relatively low (80-90) money printing kicks off a new run at growth and the "recovery" resumes. By the time the recovery has truly taken hold though the price of oil has risen to upwards of $100, which I have determined to be the current ceiling of affordability. Shortly after we hit this ceiling the recovery "stalls", demand for oil is destroyed and the price returns to an affordable amount and we start all over again.

The amount of capacity built up in the credit markets before 2008 allowed the oil price then to overshoot the ceiling as to continue affording oil people dipped into their credit to get by. However, now that this credit has been used up the market is reacting almost directly to the affordability of oil within very short time frames. The window of opportunity for growth is very small, between 80-100 / barrel, which has resulted in a growth economy that's not provided enough room to build up the momentum to carry growth on it's own. By the time growth starts heating up we hit our $100 ceiling and within a few short months demand is destroyed and oil price drops again.

It's not just oil

Peak oil is the most prominent of the 'peaks' but is certainly not the only one. Peak oil is incredibly important because oil is perhaps the most ubiquitous resource we have with so many uses that you can pretty well declare that the modern industrial economy is founded on it. It is the basis of our technological prowess; without oil we couldn't mine the lithium or materials needed for more advanced forms of technology.

Major advances in our technological ability have always rode on the back of major energy finds. It's always been a move to energy of a better quality, not worse. The world's population never surpassed 1 billion people until oil provided the capability to sustain more than that through industrial agriculture. A transition to a lesser form of energy has never happened, and all other forms of energy available to us do not match oil's density, mobility and versatility combined.

Oils combined energy density and mobility is unmatched by any other source. Its important to understand that the cost of all other forms of technology is subsidized by oil. When you see reports that solar, for example, has improved its energy return and therefore it's cost, these reports often exclude the resources required in the first place to construct them. They probably ignore the oil powered supply chain which moved these materials around the world. Oil is so embedded in our society and economy that it is almost impossible to fully quantify the size of the subsidy it provides as each stage in the supply chain is also subsidized by oil as they are dependant on other parts of the supply chain, subsidized by oil. Alternative energy should rather be called derivative energy, as it is technology that is made possible by oil either directly or indirectly. This introduces additional problems to using the market as a solution for climate change or peak oil, for example in the form of carbon trading, as I've written about previously.

Because of oil's core position in economic growth peak oil is able to act as a reasonable template with which to explain the increases in the cost of living and guess where approximately we are on the path of decline but we're reaching peak in many other resources too and as extreme energy exploration requires more of these resources than conventional energy to produce there is now additional strain being placed on these resources as well.

Living like kings

Oil drives our standard of living and how affordable it is. If you look back to the time of monarchy and what made a king a king, it was the amount of raw energy they had at their disposal (mostly in the terms of 'human resources', horses, etc). A king may have had a castle because slaves built it, today we have homes built by machines that run on oil. Oil is the common man's slave. Today even the poorest of us are living like the kings of the past when you look at the amount of cheap energy available to them even at more recent inflated prices.

Our drive to be a functioning member of society comes on the back of a promise made by elected officials and the financial system in general that the future will be greater than the past. It's the unspoken social contract that policy and public relations revolves around. No politician is promising a 'contracted future', it's always a grander future. Our expectation is that at a minimum there is a fair opportunity to improve your standard of living, if not an outright entitlement to it. It is this promise made by the control system that is the reason the elite are preparing for civil unrest as we discussed in key concept 2.

The world's peasants today are enjoying more wealth and mobility then has ever been available to them before and this is largely because of oil. Peak oil theory dictates however that this trend is now reversing and we're now at the point where this reversal is becoming plainly visible. Political theatre and economic stimulus are efforts by the elite to hide this reality from the peasants while they prepare a new neo-feudalist system in the background and emergency measures to deal with the coming infrastructure failures as affordability and maintenance declines.
CERDAFIED-The United States, Canada and Mexico has just finished simulating an electrical grid failure as part of a joint drill conducted by thousands of utility workers as well as FBI agents, governmental agencies, anti-terrorism experts, and private businesses in the power grid drill held on Wednesday and Thursday (Nov 13 & 14).

The American Society of Civil Engineers (ASCE) issued their
power grid grade card of our antiquated electrical system as it approaches the end of its service life. Barely passing with a D+ means there is strong likelihood that the system will fail. Major power outages have increased from 76 in 2007 to 307 in 2011. These figures do not include storm related outages.
For further exploration of the relationship between the economy and energy see this article (with video).

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Richard Fantin is a self-taught software developer who has mostly throughout his career focused on financial applications and high frequency trading. He currently works for eQube gaming systems.

Nazayh Zanidean is a Project Coordinator for a mid-sized construction contractor in Calgary, Alberta. He enjoys writing as a hobby on topics that include foreign policy, international human rights, security and systemic media bias.

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