This recent essay by Art Berman may be the best historical analysis of oil and its relationship with the economy I’ve read.
Here is my simplified summary of Berman’s analysis:
- both supply and demand for oil have recently fallen
- oil demand has fallen more than oil supply
- this despite an all-time record amount of debt conjured to stimulate the economy
- which means the global economy is contracting and is in serious trouble
- the contraction was underway before the virus – the virus accelerated but did not cause the contraction
- the problem began in 1974 when oil prices increased above the level that the economy can grow without debt growing faster
- we’re not going to run out of oil, we’re going to run out of people that can afford oil
- the problem being geologic and thermodynamic in nature, has no business as usual fix, and will continue to worsen
Berman’s analysis is consistent with the conclusions of the other leading minds on the energy-economy relationship: Gail Tverberg, Tim Morgan, Nate Hagens, and Tim Garrett.
The most interesting question, by far, when viewed from 10,000 feet is why do none of our political or intellectual or business leaders understand the most important influence (energy) on the thing they care most about (economic growth)?
The answer of course is that the human species evolved to deny unpleasant realities.
As an aside, recall that Eric Weinstein, the brilliant physicist/hedge fund manager whom I recently wrote about as a case study in denial believes correctly that economic growth and scientific advancement slowed in the late 70’s, but he doesn’t understand the cause despite thinking about it a lot. It’s no wonder that the much lesser intellects of almost all economists don’t have a clue what’s going on.
Berman believes that our economy, being a dissipative structure, will either collapse or spontaneously re-organize itself into a simpler form that uses less energy. I suppose the virus lockdown is a good example of a spontaneous lower energy re-organization. I put my money though on some form of collapse in the not too distant future. Despite a surfeit of entitled citizens, we could weather a significant reduction in living standards because we in the developed world consume so much more than we need to survive, however, the unprecedented debt bubble we have created by denying reality blocks a civil contraction.
Berman concludes that as the economy necessarily simplifies and we live much poorer lives, our energy mix will shift to lower productivity energy sources like wind and solar. My response to this is maybe. It’s more likely that Berman is denying the reality of his own analysis.
I can see solar panels being used for low power/high impact applications like, for example, LED lighting and pumping water into a gravity fed cistern. But it is unlikely and probably impossible that we will heat our homes, or cook our food, or cultivate and harvest our crops, or mine and smelt our minerals, or transport ourselves and our necessities with solar and wind.
When our solar panels and wind turbines wear out some decades in the future it is unlikely that the sophisticated factories and complex supply chains needed to manufacture and install replacements will exist. If some do exist to supply elite customers, like the military, most citizens probably won’t be able to afford their products.
I expect reality denial will prevent us from ever acknowledging peak oil and its offspring human overshoot. Instead, our consensus story all the way to a medieval lifestyle, at best, will likely be that there’s plenty of oil if the other tribes would stop using so much and we just need to elect someone tougher to deal with them and get our economy growing again.
Acknowledging our genetic tendency to deny reality would be a good thing because we might then focus on the best response to our overshoot predicament which is to rapidly reduce our population. Other wise responses can be found here.
Here’s the excerpted conclusion from Berman’s essay, but it’s definitely worth your time to read the whole thing for the data backing up these conclusions.
The Great Simplification
Energy is the economy. Money is a call on energy. Debt is a lien on future energy.
What is happening to oil markets and to the global economy is not because of a virus. The virus greatly accelerated what was already happening. Things won’t go back to normal when the virus ends.
The expansion of energy and debt have been leading toward some sort of reckoning for at least the last fifty years. That day of reckoning has been brought forward by coronavirus economic closures.
Oil prices had averaged $25 per barrel from the end of World War II until 1974 when average prices doubled (Figure 9). From 1979 through 1986, oil price soared to an average of $86 per barrel. These massive economic dislocations resulted in use of debt to maintain economic growth.
Excessive debt was the leading cause for the Financial Collapse of 2008. The crisis was resolved with more debt and monetary policies that ushered in the present era of central bank primacy in the world financial system.
Quantitative easing, near-zero interest rates and high oil prices led to the first wave of the tight oil boom. Over-investment resulted in over-supply and price collapse in 2014. By February 2016, WTI price reached $33 and investors rushed in to support the second wave of the tight oil boom.
WTI reached $72 by mid-2018 but by then, investors had begun to abandon tight oil as well as oil companies in general. The coronavirus economic closure brought monthly average prices to $17 in April, 2020—the lowest month on record. Unlike early 2016, investors weren’t writing any checks this time.
U.S. production may be 50% lower by mid-2021 than at year-end 2019. The implications for U.S. geopolitical power and balance of payments are staggering. It seems likely that the economy will weaken as government support for the unemployed decreases
I doubt that we are on the cusp of either a global energy crisis or the end of the oil age. It is more likely that both supply and demand will fall in tandem as the global economy contracts.
These observations are at odds with the mainstream view that both supply and demand are recovering. Some might concede that I am correct for the present but that things will improve and return to normal although it may some time.
Figure 10 shows credit growth and credit impulse for the United States from 1960 through the first quarter of 2020. Credit impulse is the change in flow of credit (debt) relative to economic activity (GDP).
Spikes in credit impulse correlate well with the oil-price shocks of the 1970s and 1980s. The extraordinary U.S. comparative inventory drawdown of early 2017 through the second quarter of 2018 also corresponds to credit impulse anomalies.
The chief feature of Figure 10, however, is that the magnitude of the first quarter 2020 credit impulse was more than twice as large as any previous increase. Moreover, GDP growth was either neutral or positive during previous spikes but was negative (-10%) for the first quarter of 2020. Also, oil prices were increasing during earlier periods but prices were decreasing in early 2020.
Ilya Prigogine was a chemist who won the 1977 Nobel Prize for his work on dissipative structures and self-organization. Dissipative structures are physical systems that release considerable heat as they consume ever-greater energy to support their growth and increasing complexity. A crisis occurs when growth can no longer be supported by available energy resources. The system either collapses or spontaneously re-organizes itself into a simpler form that uses less energy.
Empires, organizations and economies are dissipative structures. So is the human brain.
My friend Nate Hagens has applied some of Prigogine’s ideas to his own research about world energy, economics and ecology. He believes that we are on the cusp of something quite different from the scenarios suggested by Ahmed, and Goehring and Rozencwajg.
Hagens predicted a global economic decline in the 2020s and publicly expressed that opinion before the Covid pandemic. The main reason for decline, he stated, was too much debt undertaken to continue consuming and growing the economy. The virus has accelerated its timing and may result in contraction greater than the 30% drop during the Great Depression.
The Great Simplification will occur when the credit-supported part of the economy is removed. Economic activity will contract and less energy will be needed because it will be increasingly unaffordable to many parts of the population. People will be forced to adjust living standards downward and self-organize around energy with greater emphasis on local supply chains and regional economies.
I expect that the mix of energy sources will be similar initially. That will probably change as declines to meet the decreased carrying capacity of a society deprived of fossil energy productivity. Then, I imagine the world will move increasingly toward lower productivity energy sources like wind and solar. A viable economy may very well be created based heavily on wind and solar. It will, however, support a much poorer world than we have known for many decades in the world’s advanced economies.
Most ideas and analyses about future trends in energy and the economy fail to recognize that they are the two aspects of the same thing. That is why they are so far off the mark. This basic misalignment is painfully obvious because the energy sector represents only 2.5% of the S&P 500 valuation but underlies probably 95% of U.S. GDP.
That is what Hagens calls energy blindness1.
1I call it energy denial.