Oil As Money and the Decline of Energy Earnings 24 comments
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The Oil Drum posted a must read essay yesterday by Chris Cook, formerly of the International Petroleum Exchange. Cook suggests that the only real money is in fact energy. And, that the world should eventually migrate to a monetary system based on that reality.
Whether one agrees, disagrees, or simply needs more time to digest such an idea, let’s contemplate the 10 Year chart of the Dow Jones Industrial Average in terms of the price of Oil (click to enlarge).
There are myriad observations to make here. I don’t wish to be either too simplistic or reductionist. However, one simply has to wonder that the decline in Net Energy globally is what ails the global economy. The Dow was at its highest when oil was cheap near the turn of the millennium. The Dow, expressed as a cash equivalent, was buying 600-700 bbls in that period. Now the Dow is buying about 150 bbls of oil.
If we can free our minds for a moment of how many bbls of oil the world produces, and the current dollar level of the Dow, and think more about Net Energy, then certain insights can unfold over the above chart. It’s good to think generally here, and thematically. So here goes: we know that the Energy Return on Energy Invested–the EROEI–of nearly all energy resources is in decline, globally. In other words, it used to take only a single barrel’s worth of energy to extract a hundred barrels of oil. My Twitter pal @alexismadrigal is currently reading Dan Yergin’s The Prize, and is finding some juicy examples of the high rates of return found, in the early days of oil. But now, in this century, we find that the EROEI for Oil, Natural Gas and Coal is now in steep decline.
While complex, the answer is obvious: it takes alot more energy to drill for deepwater oil, to vibrate rock to release Natural Gas, and to extract Coal from old mines where the easy coal was sucked dry 100 years ago. The global EROEI of oil has descended to an average now of 12 to 1.
In the last 10 years, global EROEI has gone into steeper decline.
And that’s what the DOW chart may be expressing. Again, there are myriad other factors in play that have produced the chart you see above. But the primacy of energy is without question a major influence here. Industrial companies need to extract profits from their activity that is over and above their energy costs. If their business-wide costs are infused with energy–from the food their employees need to eat to the heating and cooling of buildings–then their earnings, and their earning quality is going to decline. While that concept will be obvious to all, now add in the notion that the quality of energy earnings is also in decline.
If energy costs to an economy are rising in nominal terms, and the quality of energy earnings (EROEI) is now also in steep decline, then we would want to look for signs that the aggregate profits of the entire economy are in decline. And the above chart of the DOW may be an expression of this phenomenon.
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$150 oil was a wake-up call and things are changing. More has transpired since oil peaked and the result is likely worse than the peak price of oil or gold. That fewer people have the means to sustain themselves independtly, and that in turn will create a demand for a greater scale of economy.
If you're worried about WW3, I'd rather have medicine and guns than gold, and if you're worried about retirement, I'd rather save in a mix of stocks, bonds, gold, oil, silver, platinum, copper, sugar, wheat, etc.
Keeping all your money in a shoebox in your house might not be the best idea in the world regardless of how much you like the assets inside that box. I wouldn't say keeping a little metals or cash on hand is a bad idea, but are you really going to trust your retirement to a shoebox under your bed?
I'm not quite saying that energy is the only real money. I'm saying firstly that energy is a good common standard for exchange, and secondly that energy-based currency could be a useful global reserve currency to the dollar.
ie it could be a good common currency, but certainly not a single currency.
Energy is one basis for currency - the others IMHO are:
(a) land/location - which backs over two thirds of money ever created, as mortgage-backed loans; and
(b) knowledge/ intellectual capital - which backs most Equity, and a great deal of unsecured credit, if you think about it
I actually see land/l ocation as potentially the most important backing for currencies with purely domestic redeemability (international acceptability is another issue).
Land basis for currency is not a new idea : John Law came up with it in 1705, but rather ruined the implementation in France in 1719 with the Mississippi Bubble (and thereby leading - some say -to the Louisiana Purchase).
I set out here
www.slideshare.net/Chr...
in Dublin, how unitisation of property/land value could be a solution for the Credit Crunch, and I might shortly submit an article on that, too, if people are interested....
"...Robert Underwood Ayers asked if economic growth could
be explained by improvements in energy efficiency. Instead of using total energy consumed as an input, he used the amount of energy that actually did useful work, productive energy . Using an analytical method similar to the German researchers, he determined that increases in energy productivity were responsible for 70% of U.S. economic growth. His model generated a prediction of U.S. economic growth during the 20th century that almost exactly matched actual growth.
So, it is not technological advance in general that explains the
“residual” 80% of economic growth. Increases in the consumption of energy account for 54%. Refining the analysis, improvements in energy productivity (a technology) explain 70%, almost all of Solow’s residual. Seventy percent of economic growth comes from increases in the productive energy we use.
There is good news and bad news in this explanation of economic
growth. The good news is that increased efficiency in energy use pays big economic dividends. Using energy more efficiently will offset reductions in the amount of available energy. A kilojoule saved is a kilojoule earned.
The bad news is that we have a measure of the extent to which
economies are dependent on energy. One can say that energy is the fundamental currency of an economy. Every 1% decrease in productive energy will, in Western economies, cause a roughly 0.7% decrease in the size of the economy.
Oil, which supplies about 40% of our energy, is expected to decline by 3-7% after the oil peak. Let’s use 5%. So, using a crude math, without substitutes, our economy would shrink by 2% annually. Every year until we find a solution.
....As technologies have advanced and material wealth grown, the world has become increasing inter-connected and inter-dependent. We have instantaneous world-wide communications. An event in any part of the world can be known globally in minutes. Globalization is another name for connectivity....Cheap energy has enabled connectivity.
...Complexity refers to the number and specialization of institutions, regulatory bodies, technologies and procedures that accompany economic growth. All of these take energy to maintain them.
...Every level, every new organization, even every regulation requires energy. Every time a government department is added, more office space is built: more energy to heat the work place, more telephones, computers, paper, etc. Travel is required to get to work and to get the job done.
...Tiered complexity adds less and less to productivity in the corporate world, non-profit sector, education, military, you name it. ...Every layer requires energy. We have been able to create systems of complexity because energy has been cheap and we can afford to add non-productive layers to our social and economic organization. Complexity breeds complexity.
...As our problems grow – many of which are outcomes of complexity – we add more institutions, procedures and regulations in attempt to solve them. This is not an argument against institutionalism or regulations. And we do find ways to get more out of our energy sources. Yet, even increased energy efficiency goes, in part, to adding complexity.
In the decades ahead our problems are going to get even bigger. We are going to have a depression caused by lack of our most important energy resource. We will fight a depression with less energy. Governments helped ease the Great Depression with massive expenditures of energy on building infrastructures. Governments will not be able to that in a depression caused by energy shortages. And, we will need to tackle the effects of global warming and a shrinking energy economy on a global
scale. The problem is we will have less energy to use. That means that we will have to shed complexity, while solving global problems.
On the home front, during the energy descent our national, provincial and local institutions will have to down-size with the declining economy. We will simplify. The effects can be described as reductions in layers and scale. We will first shed the layers with the lowest returns on energy invested. Reductions in scale will follow layer divestment, but some of the localization of politics and economy will occur because they address new realities.
It is possible that a transition from complexity to simplicity will
have as great an impact on the quality and order of the energy descent as will reductions in wealth. Our social fabric is adjusted to our level of complexity and connectivity. Simplification will be,
fundamentally, a shift in our political economies (plural is
intentional). Our governments need to work out relationships that are suited to an energy-poor depression.
We will need to shift from a top-heavy national/provincial governance to regional governance. Currently, our laws prohibit almost all of the autonomies that the energy descent economy will require."
Oil has been the primary energy source, supporting the pyramid and will be untill the end of this technology cycle. Your 12:1 eroei for oil average cannot be correct. 12:1 is the average for all energy sources (eg. Windpower has 20:1)
With all the water pumped up in S. Arabia eroei there is ~10:1.
Average oil eroei now about 3:1. Tar sands about 1:1. or even less.
Now these are all using a standardized metric.
By your definition we have to include eg. protecting the shipping lanes and war effort in oil eroei equation. Then oil eroi has been negative over your charts history. Hence the decline.
Cook's scheme would be a very sophisticated form of bartertrade.
We are in big, big doo doo when the oil runs out. 7 billion people are depleting it in a hurry.
In surface mining of coal, for example, while larger machines may be more efficient, above a certain size the risk of their breakdown is such that you are better, for example, with 14 smaller, and less efficient shovels than with 1 larger bucket excavator.
Heading Out
That oil spiked as the dollar tanked is no coincidence.
We could create accounts I guess and have a credit card attached to your "energy account" but that does not seem like money quite as much since there are many people that would not be able to use a credit card system. The homeless are the first that come to mind along with most of africa and south america that has no technology outside of the cities to support such a program.
Gold still seems to fit the bill best as money. Unfortunatley we are stuck with fiat.
There is nothing new about the concept of a hard currency, but there is a huge difference between currency use even if only going back to 2000, and currency use now. There is no advantage whatsoever to tying the dollar to gold or any other commodity because anyone with more then a few months living expenses saved up has the option of investing their savings anywhere they like. The dollar is just another commodity. Most large companies (Dow components, for example), nearly all of which have world wide exposure and multi-currency exposure and hedges, treat the dollar just like any other commodity.
-Matt
I also recommend reading Chris Cook's article, but I still think gold is real money too.
Careful with Yergin (I'm not a fan).
But let's not forget that gold takes a lot of energy to mine and refine. In an energy scarce world, the supply of gold will remain limited - and my gold has a good chance of retaining its value.
Maybe this one? One of my favourites...
stockcharts.com/h-sc/u...
On Apr 06 11:31 PM WesAttaway wrote:
> It is easy to dismiss this chart and the analysis, if you want to
> put your head in the sand. However, the correlation is just too
> tight to ignore. Maybe the gold bugs can come up with a better chart,
> but I doubt it.
seekingalpha.com/user/...
and here:
seekingalpha.com/user/...
Oil sands are a bad idea also:
"... by 2020 Canada’s bitumen mining might produce 5 million
barrels/day — after tens of billions of capital costs, with
incalculable costs to Alberta’s environment (much of it will look like
the moon). That assumes sufficient water and natural gas inputs..."
and good article here:
www.greenpeace.org/int...