Oily Origins of the Economic Crisis

In an article some months ago I suggested that “perhaps this crisis is simply an unconscious recognition of this inconvenient truth?” – namely, the peaking of oil extraction and all that it implies for the continued survival of a financial system built on assumptions of continuous economic growth. In other words, the fashionable approach of focusing on exotic financial instruments, regulatory failures, etc, if a case of mistaking the forest for the trees.

The Oil Drum had a nice graphical summary. According to the author, Gail the Actuary, the chain of causation runs thus: rising oil prices -> inflated asset values -> booming phantom wealth -> high energy costs undermine real economy -> more and more bubbles pricked -> banking crisis -> credit crisis -> cascaded economic failure -> oil demand destruction -> oil prices plummet -> so do ever costlier long-term investments in oil extraction -> economic recovery at lower level -> rising oil prices. Cycle repeats itself to oblivion.

This explains the extreme severity of the crash – record GDP growth at a time of plateaued oil extraction in the 2005-2008 period was patently unsustainable, so a very big “correction could not have been unexpected.

And it is quite a correction.

As of the September-November average, global industrial production was plummeting at an annualized rate of -13% and merchandise trade by a truly remarkable -43%. And it is obvious the collapse accelerated since then…

Already far worse than during even the worst month of 2000-2001, the last and only global slowdown for which the IMF has data.

Already far worse than during even the worst month of 2000-2001, the last and only global slowdown for which the IMF has data.

But this is not a strictly economic post, or meant to be long / detailed (I’ll post that kind of thing within the next few weeks). So on to the next point about the oil connection…

Another Oil Drum blogger, Phil Hart, wrote about the dramatic rise and fall in oil prices in terms of simple supply and demand curves. I’ve had the same thoughts tumbling about in my head but unfortunately didn’t come to writing about them in such detail…

Oil demand and supply.

Oil demand and supply.

His thesis is that because of the geological limits to oil supply, the marginal cost of providing ever more oil is generally low until it reaches some point – say, 85mn barrels a day – and then veers off into the sky (i.e. becomes very inelastic). Demand is also inelastic, since modern society basically runs on oil. Hence there comes a time when the demand curve reaches a point when its intersection with the supply curve – i.e., the market price – starts rising exponentially.

Exponential rise in oil prices; all exponents in a finite environment will eventually overshoot and collapse.

Exponential rise in oil prices; all exponents in a finite environment will eventually overshoot and collapse.

Supply can no longer be expanded to any significant extent, despite the market signals. All we managed was a precarious plateau, the big rate of natural decline of existing oilfields being compensated for by remoter and lower-EROEI sources. The strain got too big, we slipped up and are now falling to a lower plateau – at an annualized rate of at least negative 13% of global industrial production…

PS. Is it also a coincidence that possible the hardest hit major industry was the automobile sector, with production plummeting by up to 50% in most countries? Particularly when you consider that they are the sector that is most tightly linked to cheap supplies of oil products?

Calculated Risk compiled a graph of the fleet turnover (total vehicles divided by annual sales) to give a historical value for the number of years required to totally refurbish America’s car fleet – from hovering at 13-15 years, it soared to an historically unprecedented 27 years. Projecting this forward, the size of the fleet will decline AND age simultaneously since most vehicles don’t last anywhere near 27 years on the road.

Since most vehicles won’t last this long, unless situation turns around the size of the fleet will decline AND age simultaneously. (But of course it won’t, because of impending energy shortages).

This is a completely rational development from a peakist perspective, of course. Even though generally more fuel efficient on paper, a lot of energy needs to be spent manufacturing them; since these initial energy costs have already been spent in old vehicles, it makes sense to prolong their lifespans instead of trying to increase the turnover of the fleet. So unless oil magically remains cheap and plentiful in the years ahead, or hybrids / battery-powered vehicles become far more successful than they are currently, expect the cars on our roads to gradually get older, creakier and dirtier like in Third World places – albeit with much better, cheaper and more intelligent electronics (due to Moore’s Law and its siblings).

Comments

  1. hi AK,

    thank you for compiling these graphs!

    i’ve reposted a lot of this great article on my blog, http://endofcapitalism.com

    please let me know if you want to be credited differently.

    you can reach me at [email protected]

    thank you!
    alex
    philadelphia students for a democratic society

    p.s. let me know when you’ve written a more in-depth analysis of how peak oil and oil prices are at the core of the economic collapse.

  2. How can it be said that high energy prices undermined the real economy if IP had been growing together with energy prices all around the world?

    No, I think the causes of the current recession are more prosaic — it’s a classical case of overinvestment and subsequent contraction. I thought the next crisis would be ’70s style, but it turned out to be back to the ’30s. Don’t see any evidence for peak oil being responsible.

  3. @alex,
    Thanks. However, that last bit will take a lot of time and thinking. :)

    @fedia,

    I’m not denying that this could be the case, but I think one should ask why the greatest and widest economic crisis since the Great Depression exactly coincided with record-high oil prices.

    True, the apparent cause is indeed irrational over-investment. But why was it possible? Cheap credit from the US, which they apparently issued because it was the only way to keep the economy growing at its supposed “long-term trend” rate.

    There’s the car industry which was hit extremely hard. Other devastated sectors include a) the subprime / suburban housing market in the US, which takes a great deal of energy to upkeep, b) the energy inefficient states of the former Soviet Union, c) merchandise exporters and shipping. Seems like the global market is trying to send a certain warning signal, which is being ignored by policymakers everywhere.

    I admit that this theory is of now tentative and has no real analytical backing, but I find the circumstantial evidence to be compelling and it just feels right.

  4. antoine liagre says:

    bonjour,

    je pense que la crise à plus de raison que celle-ci, pour moi la hausse exponentiel du cour du pétrol est une conséquence plus qu’un déclencheur.

    Il faut concidéré plusieurs choses :

    d’abort la geurre en Irack a été financé par des emprunts qui ne se justifient que par la création obligatoire, même fictive d’une valeure équivalente à la somme engagé. Faute de pouvoir le faire rationnellement la société américaine a du utilisé des substitue pour se financer : les subprimes. Ce substitut a permi au classe moyenne faible de s’endéter et d’acquérir des biens à la limite de leur moyen. Il est à noté que la crise de 29 fut à l’origine un problème d’endettement.

    Cependant il faut considérer les moyens du rembourssement de la dette. En effet la richesse produite par les subprime justifie l’endétement, mais n’offre pas à l’Etat les moyens d’un remboursement. Pour ce faire l’Etat américain fait tourner la planche à billet entarinant une dévaluation de sa monaie. Si l’on considère que les classes moyennes pauvres à qui s’adresse les subprime ne possède que ce type de capital : le capital monétaire c’est affaiblir une classe qui vient d’accepter de prendre des risques sur l’avenir à un niveau trop haut. Historiquement, c’est sur ce même mécanisme que Louis XVI en France a fait chuter son économie : en financant une guerre par de la dette tout en voulant éviter une dévaluation qui aurait entrainer l’appauvrissement des plus pauvres, ce système à tenu jusqu’à la faillite de l’Etat et la révolution et fanalement le non remboursement de la dette et donc une disparition d’actif équivalente, je n’en suis pas sûr mais je suppose que les emprunts russes d’avant la révolution furent soumis aux mêmes facteurs.

    Par ailleurs un facteur imprévu est venu mettre son grain de sable dans un engrenage déjà fort hasardeux : l’euro! par sa force et sa base industriel l’euro a pris de la valeur à mesur que l’économie Américaine s’affaiblissait dans ces fondamentaux tout en gardant une apparence de stabilité. Ce phénomène a entrainer un accroîssement de l’infaltion aux US venant encore affaiblir cette classe moyenne sur qui les US reposaient leurs espérances de croissances! C’est le même phénomène que l’on observe en UK avec la perte de valeur de la livre face à l’euro.

    Les matière premières quant à elles ont subie plusieurs facteurs. Tout d’abord l’abandon de la PAC et la création d’une filière de bioéthanol forte en europe pour répondre aux déficites de prix a couplé le cout alimentaire aux couts énergétiques. Ensuite l’accroîssement de l’économie a engendré des tention sur le marché pétrolier que les ouragans aux US n’ont pas arrangés. Si l’on concidère qu’une famille pauvre consomme essentiellement de l’energie pétrol et de la nouriture c’est une inflation de 50% qu’elles ont eu à subir dans les pays du tiers monde et sans doute aux alentour de 10% dans les pays industrialisés hors zone euro. En effet la BCE n’a qu’un but : juguler l’inflation à un taux acceptable. Cette politique si elle limite l’action économique de la BCE renforce concidérablement et systématiquement l’euro face au dollar. De plus les économiste savent comment créer de l’inflation mais pas réellement l’arréter ce qui entraine la fameuse stagflation. Cette inflation a encore était appuyé par les investissement colossaux enregistré en asie faisant passer tous les Etat de cette région hors Japon à une inflation à deux chiffre et venant exacerber la tention sur les marchés énergétiques et alimentaires par voie de conséquence. En effet, faire reposer la croissance sur les classe moyenne faible revient à faire reposer la croissance sur une classe qui ne peut se fournir de bien produit sur son propre territoire eu égar à sa capacité de financement.

    Il y a plusieurs conséquence à tierer de cela.
    Tout d’abord c’est sur la guerre que les US ont basés leur croissance depuis 45, mais cette guerre n’est plus véritablement productrice de richesse pour les US, mais pour les pays asiatique. De plus la guerre est une économie de destruction et ne saurait donc dans iun bilan globale produire de la richesse!
    Ensuite les fluctuations expnentiel des marché de matières premières sont toutes liées est sont du à la disparition de l’élément stabilisateur q’était la PAC et à l’accroissement des investissement en Asie fondés sur une économie de destruction de richesse et d’appauvrissement des porteurs de cette croissance : la classe moyenne faible.
    Enfin le suivit des financiers dans cette politique et les cotions qu’ils lui ont apporté à cosé la destruction de leurs actifs avec le chute du système.

    La réponse logique de l’humanité est donc en deux temps :

    arréter les guerres aux mépris des pertes d’influance et de puissance diplomatique et remboursser les dettes ou accepter la disparission des capitaux, car il y a bien eu destruction de capital. En fait si les US continu à rembourser en faisant tourner la planche à billet, ils vont détruire le dernier élément stabilisateur de leur économie : la valeur du dollar

  5. Whether or not peak oil was the primary cause is perhaps academic. Whatever the answer I think it’s undeniable that peak oil was a major factor in the current recession. Maybe it triggered the housing bubble to burst or maybe it would have burst right then anyway. Who knows?

    Jeff Rubin, a chief economist of an investment bank points out that every oil price spike since the war has caused a global recession and that this one, an increase of 500%, was the biggest of all. He also points out that the recession was already underway in Europe and Japan BEFORE the collapse of the financial system.

    See: http://www.theoildrum.com/node/4727

    The credit crunch is said to have started in 2007. The global oil supply stopped expanding 2 years before that in 2005.

    In January and May last year Bush visited Saudi Arabia to ask them to increase oil output. I guess he knew just how important the cheap supply of oil was for his and the world economy.

    Finally the Financial Times is now waking up to the fact that maybe oil had something to with it:

    http://www.ft.com/cms/s/0/14ad3e38-2243-11de-8380-00144feabdc0.html?nclick_check=1

  6. Check out Did oil price volatility cause the financial crisis?. This article convinced me troubling changes are brewing.

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