Stagflation and Peak Oil: How Related Are They? (Part I) 25 comments
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Two terms that definitely scare investors (at least those who don't know what implications both have on their portfolio) are Stagflation and Peak Oil. One (Stagflation) might be happening soon but could be avoided, while the other (Peak Oil) might not happen soon, but cannot be avoided.
I'll leave the exact definition up to someone smarter than I, but Stagflation basically means a sustained period of slower than normal growth, combined with a period of higher than normal inflation. While there are a few ways that it could be caused (I'm sure that a war would do it), an extreme spike in the price of a vital commodity would be the most likely reason. The disruption of oil in 1973 (causing an extreme spike in the price of crude) caused Stagflation for much of the decade, resulting in an extreme hike in the price of almost everything, while salaries weren't going up to match. This was repeated in the early part of the 1980s. Since then, inflation has been very much in check.
Peak Oil is a term which has caused much confusion. If you simply based our consumption rate of oil on what is in the ground, we'd have enough oil for the next 500 years. However, not all of the oil is in fact recoverable (although the percentage is going up with improved drilling techniques, such as horizontal drilling). There is a limitation on how fast we can get oil out of the ground for two reasons. One, if you were to pump out oil too fast early on in a well's life, it will reduce the pressure that forced the oil to come out of the ground in the first place. While such techniques as pumping in large volumes of water (aquifiers) has worked to sustain the pressure on many of the Saudi's fields, engineers are cautious to keep the flow at a sustainable rate. The second part is that many of Todays largest fields have been producing for decades. Hubbert's Peak refers to the fact that most wells begin to reduce the amount of oil that can be produced (daily) from a well once the field reaches 50% of its recoverable oil. Many of the superfields that provide much of today's oil (Ghawar in Saudi, Cattarell in Mexico) are either at this stage or are close to it.
So, are the two items linked? Undoubtedly!
The world's oil consumption has increased dramatically in the past few years, driven by not only Emerging markets, but by the increasing consumption of many products that use a large amount of oil to produce (computers are a big user of oil, which most people are not aware of, as there is a lot of components which use a lot of oil in their manufacturing process).
Are we in Peak Oil today? Not sure that anyone knows for sure, but it seems obvious that we are getting close. Techniques to increase the volume of liquids in the refining process have helped to cover up the fact that the world's oil production is near the top, if not already there.
The price of oil seems to have reflected this. Despite the recent demand reduction in the past few weeks, oil consumption has continued to rise faster than production for years, despite prices rising many times over.
It is now becoming apparent that the high price of crude has creeped its way into many aspects of life. Transportation companies have started to charge large fuel surcharges on their deliveries. The costs of many goods that are imported from overseas is starting to rise. And, for anyone that has taken a flight recently, the fuel surcharge seems to be more than the cost of the flight. This is starting to make its way into everyday life, with companies no longer being able to absorb the extra costs and being forced to raise prices.
Can the situation get any better?
Logic says...not anytime soon. Despite recent oil finds in Brazil, and the recent confirmation of massive deposits of crude in the Arctic, none of these recent discoveries will be online this decade. Even when they do come online, the cost per barrel will be extraordinary, compared to the easy flowing crude from the Middle East. And, if many of the large oil field go into decline, we'll need this new oil just to keep up with current production.
How will this play out?
Ben Bernanke and other heads of the Central Banks will definitely earn this keep in the next few years. Bernanke, in particular, might have to choose completely between propping up a failing economy with more cheap money (lowering interest rates) or facing inflation head on (raising rates) sooner than later.
Lowering interest rates will certainly spur economic activity, at least at first. However, if you thought that the US dollar was low now, imagine if he cuts rates by 50-100 basis points. It would make the greenback one of the worst currencies on the planet. This may also spur some further talk of pricing crude in a currency other than the US dollar. It would also cause a lot less investment in the US Treasuries by foreign entities. Finally, inflation would absolutely go ballistic, pushing well over 10% in no time...
Raising interest rates will certainly kill some economic activity, at least at first. However, it would help to stabilize inflation, at least slow it down. The problem is going to be...housing. Many Americans (and their homes) are highly leveraged. I'm not sure how much Bernanke could raise rates before the rate of people walking away from their home sky-rocketed. The amount of debt is much greater than at any time in history in the US, and even 2-3% rate hikes would be devastating (imagine if we had 15-18+% rates like in the late 70s / early 80s!)
When you balance out the two, it appears that Bernanke may try to walk the line (keep rates a bit higher, to ward off inflation, but not too high as to cause a further credit crisis). Will he succeed? I'm not sure, but I would plan on making your portfolio more adaptable to this environment (see my next article for more ideas).
Remember another important factor. If we are really at Peak Oil, this is going to make the problems much, much worse. Oil may have no choice but to hit $200 a barrel just to crimp demand. Combining this with escalating food costs, it will definitely put us in a prolonged recession...
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This article has 25 comments:
The Wealth effect in the Asian community rears up to expect more in terms of goods, that's a gimme. But the prospect of better nutrition? that has not been factored into the Oil Demand Equation and that by its lonesome will exacerbate oil demand regardless of Demand Destruction elsewhere. Food demand has just begun its ascent, only the first shot has been fired accross the bow, the ship slowed but next year more shots will be fired.
Until the Dollar is removed from the worldwide pricing structure, the float will continue to rise and more dollars in the system will lead to further inflation.
According to energy investment banker Matthew Simmons, global oil production is now declining, from 85 million barrels per day to 60 million barrels per day by 2015. During the same time demand will increase 14%.
This is like a 45% drop in 7 years. No one can reverse this trend, nor can we conserve our way out of this catastrophe. Because the demand for oil is so high, it will always be higher than production; thus the depletion rate will continue until all recoverable oil is extracted.
Alternatives will not even begin to fill the gap. And most alternatives yield electric power, but we need liquid fuels for tractors/combines, 18 wheel trucks, trains, ships, and mining equipment.
We are facing the collapse of the highways that depend on diesel trucks for maintenance of bridges, cleaning culverts to avoid road washouts, snow plowing, roadbed and surface repair. When the highways fail, so will the power grid, as highways carry the parts, transformers, steel for pylons, and high tension cables, all from far away. With the highways out, there will be no food coming in from "outside," and without the power grid virtually nothing works, including home heating, pumping of gasoline and diesel, airports, communications, and automated systems.
This is documented in a free 48 page report that can be downloaded, website posted, distributed, and emailed: www.peakoilassociates....
That's the trouble with forcasting.
The Macks will get you every time.
Please refer to Yertle the Turtle by Dr. Seuss.
The giant world-wide oil cartel will collapse after Bush leaves the White House.
Internet will collapse it (remember: travel the image, not the item). Alternative energy sources will collape it. The end of the use of the US military to maintain cartel disipline will collapse it. Home use for more activities like work, exercise, entertainment, food growth, electric generation, and etc. will collapse it.
Now, if only the miss-allowcation of resources by governments in the USA would be reduced, paradise would be won.
Good Luck.
Many thank for your comments...
Pico -- I do agree that Peak Oil would be a scary sight. Hopefully though conservation/demand destruction and alternative fuels, it isn't as bad as expected. Hydrogen is many years away, so it may be a bad period for a while....
Paultaut -- All one has to do go to the grocery store to see what you are refering to. Seems to be a push to "do things like our ancestors used to", referring more to eating local, less fertilizers, etc. I don't see it...
CJ -- I had the pleasure of meeting Matthew Simmons at the World Oil show last year. God, I hope he is wrong, but he tells a compelling case....
Sorgmot / CLH -- The purpose of my article was not to scare, to propogand or anything else. It is to face the reality that the current problems may be much greater than most people are aware of. Choose to ignore them, if you will, but the reality is that most investors will get pummelled over the next few years. I do appreciate your comments, even those that might not be flattering!
What are we to make of a nonsensical statement like "If you simply based our consumption rate of oil on what is in the ground, we'd have enough oil for the next 500 years."
Are you trying to create the feel-good illusion that there is an ample supply if we only used it wisely? Enough oil for what? Plastic laptop computer cases to the exclusion of all other uses? A world population of 500,000 people who still drive Hummers? Get real.
The problem with your scenario is that the net energy (or Energy ROI) for the remaining sources of fossil fuels will get closer and closer to 1, so no matter how high the price of oil or oil-substitutes gets, it still won't be a money-maker to use close to 1 barrel of oil to get 1 barrel out. And, for enough "demand destruction" to occur so that the world's total production per day (which is already going down) matches the world's increasing demand (from China, India and everywhere else that hopes to consume at Western rates), entire economies will have to collapse to pre-industrial levels of consumption.
Any way that happens, it won't be nice.
Corn ethanol has kept gasoline prices down because it is a substitute for Gas not an additive. On the other side of that coin is the rising cost of the food and feed that corn destruction has enabled.
You want lower oil now at the expense of the future. A decision has to be made but it will not be until it will be another case of "if only we had known". You know but are in denial.
There is no great answer to this dilemma except to start developing alternative energy sources as quickly as possible and conserve as much as possible. Even then, we are faced with decades of seriously reduced quality of life and much social upheaval and anarchy. Meanwhile, take care of yourself and don't expect any help from anyone who doesn't know you by your first name.
233131 / Bruno -- Being that I make a good living selling to Oil Companies, I know a bit about this. In most cases, either the formation is too tight, or the well is not economical to drill, so most fields tend to produce less than 20% of what is in the ground. If we had the correct technology, and the business case to do so, we would likely be able to get up to 70% of the oil from any field out. But, it would only make sense if Oil was well north of where it is.
Dean -- Ultimately, Bernanke might have to hit almost 0%, to keep things afloat. I just think we are in for a nasty time period, no matter what he does....
Paultaut -- one answer might be the upcoming plug-in hybrids. They will take up to 5 years to see any serious market penetration, but they will also raise the expected MPG well above where they are now for consumers who dont regularly do long trips..
Nope. Horizontal brings it up faster, that's all it does. Applies mostly to onshore and near shore wells. Requires enormous expertise and good geophysical data.
I believe that we can work our way out of these serious problems with solar, wind and more use of our own resources (including shale). Instead of 300 million to bail out banks and foolish homeowners, why not 300 million for construction of nuclear power plants to fuel that plug-in hybrid? How about requiring solar farms for new housing developments (if there is ever another one)? Etc. Good luck.
- so does the viability of alternate sources of energy;
- so does the r & d investment in energy;
- and so does opposition to drilling in sensitive environmental areas, open pit coal sands mines and nuclear power.
the trick is to slow the change in pricing so that the market has time to adapt.
the method we currently use worldwide to price oil needs to be studied and an alternative implemented. the oil producers are telling you that this process is exaggerating the prices - are we smart enough to get it?
having worked for the oil minister of a gulf country, i can tell you that one of the primary assumptions in this article is not correct.
thefitzman.blogspot.co...
the fact that our "leaders" can't acknowledge this very basic economic fact and instead of focusing on an energy policy are focusing on using the "crisis" to take over the financial system and nationalize the housing mortgage market should tell us something: energy will be used by our own government as a way to control the people (religion has been used in this respect, but energy will be the ultimate control). this strategy by our government will of course have serious implications for our currency, investments, and markets (negative implications of course). so, ride energy investments while you still can, but buy gold and take possession of it for use when our fiat currency is printed into oblivion.
Another aspect of "peak oil" is the psychology of the market. When everyone knows that oil is a declinning resource like gold there is little fear in betting on the long case for future prices. This aspect is a fact of human nature and no amount of reasoning or cajoling is going to cause traders to "be nice" and not speculate on future increases.
galewhitaker: Hang in there.