E-Day! � The Final Chapter
By Eric J. Fry
"Dan, Peak Oil, as you've described it, will be wrong," Chris Mayer badgers Dan Denning, "because energy will not get more expensive - in the long-run, say, over the next decade or less. The long history of energy prices is that they go down - because of technological innovation, because of changes in consumption patterns, substitutes, etc. There are lots and lots and lots of examples of this. Many are already happening.
"So, the physical argument is not convincing to me at all."
"Hmmm. Good point," Dan replies. "But off the top of my head, Chris, I can't think of a lot of replacements for the energy density of a barrel of oil. And I have a hard time, the Saudis and ExxonMobil notwithstanding, believing that oil reserves are growing and that production is increasing.
"So the physical limitation of easy-to-find oil supplies is an inescapable reality. Even so, you could be right. Technology could somehow overcome this geological reality.
"But before trusting too smugly in the omnipotence of technology, I would suggest considering another reason why the inflation-adjusted cost of energy has tended to fall over the preceding decades: The availability of cheap and abundant energy may be related to the availability of cheap credit and liquidity to finance the exploration and discovery of new energy.
"It's true, of course, that the development of every industry requires some kind of investment, usually a combination of equity- and debt-financing. So credit and industrial development are inseparable. That said, I'm wondering if excessively easy credit, coupled with fiat currency, has accelerated the rate at which the world has developed and depleted its energy reserves.... Meaning that these influences revved the engine of growth for a good fifty years.... but may be redlining, as oil production declines.
"This I know: Printing dollar bills is easier than extracting barrels of oil. And yet, we have behaved as if the oil supply is as inexhaustible as the supply of dollars. Oil's $70 price tag suggests, belatedly, that oil is not inexhaustible. Easy credit, no matter how hard it tries, cannot extract/coax from Mother ! Nature what she no longer possesses.
"In summary, I suspect that easy credit and fiat money have been underwriting more of our energy costs than has technology. And I wonder how oil will get cheaper as the most abundant source of it (petroleum) reaches declining production."
To which Justice remarked:
"It seems to me, Dan, that the energy industry is subject to the same violent cyclical patterns that many industries, economies and nations face, with or without easy credit and fiat money.
"Think back to the Texas oil boom and bust of the 1980s...In a nutshell: Evil OPEC flexes its muscles in the 1970s, price controls lead to panic, oil industry profits go through the roof, E&P investment skyrockets. The ensuing production boom, coupled with OPEC quota-cheaters produced a supply that easily outstripped demand for the balance of the century. Enter $10 oil, the genesis of today's $70 oil.
"The oil bust of the 1990s put a stranglehold on exploration and instilled in every oil CEO a deep-seated fear of being suckered by high oil prices – a fear that endures to this very day. Meanwhile, the developing world ramped up oil demand and changed the big picture forever.
"I guess the key notion is that energy is still a commodity, perhaps the most important one, and is thus naturally prone to boom and bust cycles, with heavy infrastructure and production investment coming at the peak of the booms and thus sowing the seeds for following busts. I would argue that even more than easy credit, the rapid emergence of the developing world is what caught us asleep at the switch. Pre-China/India, the delivery system had ample slack. Post-China/India, no more slack.
"Cheap credit is like a performance-enhancing drug in that it can speed up the investment cycles (or kill the investor via overdose), but methinks the basic nature of the commodity cycle would be the same with or without it. The dynamics of progress are inherently violent and unstable.
"Now that we're awake, the key question is how fast a combination of innovation, investment, conservation and substitution can fix the problem. Unless technological progress is halted, energy will definitely get cheaper again--it's just a question of when, how, and how soon.
"While credit bubbles definitely create mismatches, commodities have their own natural boom and bust cycle independent of credit cycles. Hefty investment mismatches and forecast blunders are an inevitable part of the market landscape, especially with commodities. Credit bubbles just compound the error by adding leverage to the mistake.
"Cheap credit definitely drove excess energy consumption in the Western world while the getting was good, but today's problems have arisen primarily through a long-running neglect of infrastructure and a sharp spike in developing world demand. In fact it's interesting to wonder what the energy situation would be like today if China and India were still communist/socialist backwaters. We probably wouldn't be talking about oil at all right now. So far, the issue has only been one of capacity limits, not depleted reserves. If Asia weren't pushing demand at the margins, oil would probably still be in the $20s.
"So maybe credit hasn't played much of a direct role in this story after all... when you think about it, the effects of peak oil haven't really kicked in yet. Not saying that it isn't coming, just that our issue right now is capacity constraints – a lack of slack rather than lack of reserves.
"The free market can't act fast enough to implement a short or intermediate term fix at this point, even if the oil majors were committed to a massive outlays (which they aren't). We'll probably see a major recession and a coordinated government intervention in energy markets before our infrastructure is up to snuff again.
"Regarding oil and dollars, we are basically betting the ranch that the world has no practical means of abandoning or replacing the dollar as the world's reserve currency. Dollars grease the wheels of world trade; there's no easy way to get around that fact without bringing the entire engine of global commerce to a halt. That's basically what we're betting on: that America has carte blanche to enact banana republic fiscal policies with impunity. When our President says the rebuilding of New Orleans will cost "whatever it costs" in a conservative channeling of LBJ's ghost, he's smugly relying on that precedent. We will continue to stress-test the system until breaks. If and when our energy suppliers stop accepting greenbacks for whatever reason, shooting wars could start soon thereafter.
"More than likely though, we'll muddle through with some form of globally coordinated triage that keeps appearances intact. The dollar and the stock market get propped up from behind the scenes, gold and oil march resolutely higher, the CPI stays magically flat, and the disappearing middle class grows snarling and desperate as Republicans and Democrats unite to impose ever more stringent measures in the name of maintaining social order."
Thanks Justice, at least we have THAT to look forward to!