Monday, October 13, 2008

The Timing of the Financial Crisis & Peak Oil

Here is the big topic that needs to be developed over the next several weeks and months: the interrelationship between peak oil/peak energy and the financial crisis/global economy.

In my opinion, it's necessary to take a deeper look at the impact of the financial crisis on our economy--because it is not clear at this point that "financial crisis" is the same as "general economic crisis." The financial crisis is like a falling soufle--you pump enough air into something by way of what I've called "financial wizardry," and eventually it will pop and deflate. But it isn't like a balloon--when the derivative-driven froth is blown off the pint of beer, there's still beer underneath. It's a question of how much...

I'll stop with the metaphors (for now). It's undeniable that the implosion of global credit and derivatives markets has very real effects--both on the global demand for oil and for general economic activity.  However, the recent tumble in oil prices is, in my opinion, more due to the aggressive pricing into the market of a long global recession than it is of an actual change in the supply and demand situation.  It's worth noting that the IEA just revised their projection for the next year's oil demand growth from 0.8% to 0.5%.  Note that is still growth, a very real 350,000 barrels per day or so.   What is also undeniable is that, even if global credit locks down permanently, there are very real prospects for economic activity and growth. At one extreme, if the credit markets lock down, you can't buy a $800,000 house with nothing down, no credit, and no verification of income. That hurts the housing price bubble. On the other hand, even with no credit market at all, the Adam Smith-style economic opportunities still exist: you can still grow vegetables and sell them, you can still assemble raw materials into a value-added product you can still provide services for money or barter, you can still build furniture, buy houses, etc. Every "real" economic activity that can be done with credit can be done without. There is, of course, a huge catch here: you can't do it the same WAY.

You can buy a house with a frozen credit market--you just have to save up the cash purchase price first. Novel approach, I realize, but there you have it. Believe it or not, people used to do this fairly frequently.

You can still manufacture complex products. But, rather than getting a loan to buy the capital equipement, materials, and pay the labor, then give it to the customer, get them to pay you, and repay the loan, now you need to 1) get the customer to pay you, or 2) maintain enough cash reserves to carry this cost until payment. This means that either the customer or the producer  needs to save up the money for the end product first, rather than pay later. This also has a dramatic impact on business models--the 'get big first, then figure out how to profit' model advanced by and others simply doesn't work. All these changes really shake up the rate of throughput while System B reverts back to System A.

Of course, it's also worth pointing out that our credit markets are nowhere near frozen. They just aren't quite as artificially lubricated as they recently were. As with most things in life, when it comes to credit today you can get anything you want, but most likely not everything you want.

So back to the froth on the beer. Most of that froth is going away. The question is how much beer is left underneath. When the economic fantasy land of recent credit-driven excess falls back down to earth, there will still be a very vibrant agricultural sector, a vibrant market for cheap, energy efficient transport, a vibrant market for clothes, homes, etc. just as there always has been. It might be more potatoes and less Cabernet. It might be more renting and less owning a 4,000 square foot home on a $50k/year salary. It might be more buses and light rail and fewer Escalades. And make no mistake--there will still be plenty of excess, plenty of luxury, plenty of waste. But, to the degree that things change, this is opportunity for economic activity and profit. The economies of specialization and centralization haven't gone away (though the energy cost of distribution from a centralized facility must be considered).  But the traditional economies of scale and place will be in increasing competition with what I've termed the "anti-economies."  Whether you're a farmer, an accountant, a furniture maker, or a nurse, you still perform an important economic function.

And that's the point: When the froth is gone, there is still a very vibrant economy hiding underneath. In fact, and this is where I start to get concerned, to the degree that we refocus our efforts away from keeping the froth full of air, we'll start to focus more of our effort to revving up the fundamental economic engine that sits beneath it. And so will the rest of the world, which brings me to the other half of the equation: Peak Oil.

It seems likely that it takes a few years to fully sort out the frothy mess we're currently in. But when this is sorted out, we'll still have 5 billion people in the developing world who want home heating and air conditioning, want to drive a car, want to eat more meat, want hot water on demand, etc. And there's no fundamental problem with our underlying economics that will prevent them from demanding these things. Except Peak Oil. The next two or three years of focus, budget, and effort fixing the financial crisis are two or three years where we aren't using oru rapidly dwindling supply of high net-energy surplus oil and gas to invest in a renewble energy infrastructure or to restructure our economy away from the demand for continual growth. In fact, the short-term drop (or at least fear thereof) in commodity consumption is likely to depress prices enough that there's no financial incentive to even invest in keeping production steady.

We're setting ourselves up for the perfect storm. Resurgent global demand for energy will hit just about the time that our energy supplies (especially our net energy supplies) begin to rapidly decline. As I've said in jest many times on this blog, the Mayan prophecies about 2012 may not be that far off the mark--at least as far as timing is concerned. This topic--the interrelationship (and political disconnect) between finance and energy, and what we can do about it--will be a frequent topic going forward...

See a few older posts on this topic:


bryant said...

Analogy may be the weakest form of argument...but it is so fun!

Sticking with your foam/beer analogy; you imagine the foamy head of a well-drawn beer. I wonder if this is more akin to popping the top on a new keg...that foam carries all your beer away and after the foam settles there is just a skosh of beer in the bottom.

While switching from a credit-driven economy back to a capital-driven economy much lasting damage could occur. Companies which might otherwise succeed could be destroyed by the transition, thus eliminating the productivity and concomitant capital needed by the larger economy. This process could cascade as interrelated business suffer from each others' demise.

I am trying to imagine the changes which would have to be weathered in my business; metal mining. Because they are resource-extraction companies they essentially create wealth, but their operating costs would need to be funded out of current production; I can imagine this. My problem is understanding how they can fund the expansion necessary to off-set depletion at the same time. Right now, everyone has debt and no capital.

carstars said...

I think the pay as you go and equity capital only model is on the upswing. Really has little direct effect on my as I have for the last 25 years only lived this way. Could the no interest based society be more sustainable? Possible due to the fact that only the most productive stuff will be funded? Capital flowing into consumption will be greatly reduced.

Jeff Vail said...

Well, at a minimum, a capital-driven (as opposed to credit-driven) economy is more sustainable because there is a reduced (though not eliminated) structural demand for growth. While I don't (ever) see a total elimination of credit markets (I have money to loan right now at terms very favorable to me!), I do think that a credit market more grounded in reality is more compatible with a sustainable society over the long-haul.

Chris said...


The near future of America's economy could be a lot like Mexico's right now. The timing of peak oil in Mexico is also a good model for us in the US to watch as their oil reserves dry up first.

Kate said...

For more 'analysis' on the energy, economic and political climate, check out this youtube video...

Joe said...

"We're setting ourselves up for the perfect storm. Resurgent global demand for energy will hit just about the time that our energy supplies (especially our net energy supplies) begin to rapidly decline."

Superbly summarized. I don't know which way the economy is going; I think at this point it hinges on whether or not the dollar can retain value in the face of this new bailout debt. If the dollar can hold I suspect we may have bought another 5-10 years of market fantasy-land like we did at the end of the collapse.

I think we're between a rock and a hard place concerning financial collapse vs. increased consumption. Perhaps if we manage to avoid total meltdown all that newly injected capital can be redirected towards addressing the energy crisis through research in clean and renewable tech, rather than CEO country club memberships. Unfortunately, I think the memberships are here to stay....

Tom said...

Recently read that both Iran and Venezuela need a price of $95 per barrel to cover costs and make enough profit to support the current governments in the two countries. If that is the case and we now have $70 oil, will this contribute to the perfect storm to which you allude? I can see civil unrest, not unlike the MEND/Nigerian Delta problems causing supply interruptions in both Venezuela and Iran. Could this, too, occur about the time the world's economies get back to full production/consumption? Just a thought to ponder.

Tom (

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Villette said...

This is already outdated, the crisis has become worse.

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