Video

#SaxoStrats
Sterling has been dented by the risk of a no-confidence vote in Prime Minister Theresa May. Meanwhile, oil remains bid on persistent Saudi Arabian tensions, and the "old correlation" is back between yields and equities.
Article / 24 March 2014 at 8:15 GMT

Why peak oil signals the world's end, or at least the one we know

Chief Economist & CIO / Saxo Bank
Denmark

By Joel Guglietta

While global financial markets are still levitating somewhere between the stratosphere and the Kingdom of Asgard, by 60°24′31″ North and 172°43′12″ West, in the middle of nowhere, an isolated island of 137.857 sq-mi holds the key of three major economic developments and risks:

  1. November 2013, Lawrence Summers raised the question whether the “secular stagnation” and the impossibility for the US and other major economies to grow without the help of recurring bubbles was not doomed to become the “new normal”.
  2. March 2014, the Conference Board released a study (figure 1) showing the falling trend in global total factor productivity, i.e. in the share of output not explained by the “accumulation of factors” (more on this economic jargon below).
  3. March 2014 again, the NASA published a research paper answering to “widespread concerns that current trends in resource-used are unsustainable, but possibilities of overshoot/collapse remain controversial”. This study tells us that, based on a well-known prey-predator model to which they add “wealth and economic inequality”, a total collapse is “very difficult to avoid” (figure 2).  

w
Source: The Conference Board, January 2014

3
Source: NASA, 2014

1. - The tragic fate of the fat caribou, or why we have to fear the reindeer of St Matthew more than the wolves of Wall-Street

During World War II, the US Coast Guard decided to install long range aids to navigation in St Matthew Island, a remote rock in the Bering Sea in Alaska, and to stock emergency food source there. In August the same year, they released 29 reindeer (known as caribou in North America) on the island as a backup food source for the 19 men stationed there. As World War II drew to an end, the Coast Guard left the island and, by the same token, the population of reindeer growing unchecked as their only predators, the 19 men on duty there, were sent back home. It followed a dramatic boom & burst of population dynamics (figure 1). From 1944 to 1966 the number of these herbivores, which did not have to worry anymore about any predator and ate all the available lichen, increased from 29 to 6,000. In 1957, their body weight was found to exceed that of reindeer in domestic herds by 24.5 percent among females and 46.6 percent among males. Then, the following winter, as they faced a limited food supply to sustain their number and their massive body weight, they underwent a crash die-off, the population falling from 6,000 to 42 (figure 3).

There is a lot of food for thought in this story. First, as the NASA study suggests, when one species (for example the top 1 oercent living in the Galapogos, another rock ,as I put it in a paper issued last year “Why Kings of Galapagos are long equity under (mild) Mugabenomics?”) thrive to the abject detriment of another one (the lichen, or the “bottom” 99%), bad things eventually happen.

2
Source: The Conference Board, TED, January 2014

1
Source: Manicore

Second, and more generally, the point of this story boils down to the mundane fact that resources are everything, and when they vanish, the transition from a given state to another one, namely from unchecked growth and exuberance to complete obliteration, is dramatic most often than not. This holds all the more true for the key resource, i.e. oil, which brings us to the second chapter of our tale. 

2. - The peak-oil: a conspiracy theory or a mandatory mathematical truism?

Most of the discussions on oil hover around the question of “reserves”. I am going here to state the obvious but the key argument to keep in mind is that these reserves are meant for one and only purpose: oil production. ….woooh!, that’s new, next please! Okay, but bear with me. Till someone proves me I am wrong, I assume that the volume of Earth is finite, so that oil reserves are finite.  Now, for a given stock of non-renewable resource, all production functions obey to the same law: they start from zero, grow to a maximum and decline to zero in a “bell-shape” way (figure 4). Now, the area under this curve is called the integral of the production function and it is strictly equal to the oil reserves. Because oil reserves are finite, the integral is necessarily convergent and because they are non-renewable the production function (the derivative function of the oil reserve) cannot have another form than a bell shape. You can stretch it, you can squeeze it, but the general form is this one and not any other. This is mathematical certainty like 2+2=4. The peak-oil is a mandatory mathematical truism, not a “conspiracy theory”.

Obviously, the key question is: the “peak-oil”, is it for now?

Well, running the risk of stating one obvious thing after another, I assume that we all agree that a compulsory task to perform before extracting oil from the ground is to find it. This has profound implications as this makes us certain that a peak is mandatory given the resource potential of the oil field. It also tells us that the higher the proven reserves and the bigger they are with respect to production, the closer the peak of oil production (remember: the integral is the area under the production curve). If I take the example of the United-States, as evidenced by King Hubbert, there is a 35-year lag between discovery and production (figure 5). If evidence proves Hubert peak was a bit bad on timing, possible production curves, based on the world ultimate reserves. i.e. total extractable petroleum, suggest that the peak is now.

4
Source: Laherrere, 2003

f
Source: Manicore

This is old story and, as the world still goes around, one could dismiss all this analysis. However, what is new is that business conditions are becoming more challenging for the oil majors as figure 7 suggests. Indeed since 2009, the capital expenditures of ExxonMobil, Royal Dutch Shell and Chevron have increased by 39-89 percent while their production has stalled. This is the balance-sheet-based proof that the peak-oil is happening now.

d
Source: Wall Street Journal

Now, the last point on the peak-oil, and this is key to understand the third and last chapter of our tale. We have to keep in mind that when we hear that we still have for 20 or 30 years of oil ahead of us it does not mean that we live the “good life” for the next 2 to 3 decades with constant consumption and then, the year after, we fall straight to zero consumption in a crash die-off as our reindeer herd experienced. Actually, consumption will be following the bell-shaped production function, it will be a slow death, and in the meanwhile, as the oil majors experience, the massive rise of capital expenditure will be weighting on the marginal energy return of energy. Indeed, according to Kopits, total upstream industry spendind since 2005 has been USD 4 trillion (about USD 2.5 trillion spent on legacy crude oil production), and legacy oil production has declined by 1 mmb/d since 2005. By comparison, between 1998 and 2005 the industry spent USD 1.5 trillion on upstream development and added 8.6 mmb/d to total crude production. This declining energy return in energy production, which is nothing but the by-product of declining/exhausting oil reserves and the very fact we are experiencing the peak-oil, drives the whole economy down.

Indeed, though we live in the age of the “information technology” it is worthwhile to remember that the information society is an energy ogre (not mentioning the globalisation mantra which gives a central role to the transport industry which consumes two-third of total oil). For example, according to ASU engineer Eric Williams 227 to 270 kilograms (or 500 to 594 pounds) of carbon dioxide are emitted in manufacturing a laptop computer. Mark Mills , the CEO of the Digital Power Group, teaches us that a medium-size refrigerator will use about 322 kW-h a year whereas the average iPhone uses about 361 kW-h a year once the wireless connections, data usage and battery charging are tallied up.

3. - There is something deeply wrong about macro-economic theory

So how all this relates to the “secular stagnation” scenario and all the fall in total factor productivity. Well, this is where things get a little bit technical and where our tale comes (finally!) to an end.

Most economists are big fan of more or less complex equations designed to explain everything in a highly stylised fashion. In this quest, in order to explain the origin of economic growth, they use the so-called Cobb-Douglas production function which states that GDP (Y) is a function of technology (A), capital (K) and labour (L). More precisely, the Holy Grail equation takes this form: Y = A * Ka * Lb, with “a” and “b” the elasticity of production to capital and labour. Total factor productivity is for instance derived from this equation.

Now, as the purpose of this equation is to explain the origin of economic growth, let’s put ourselves in the shoes of the Neanderthals. While we are planning to go in the wild to bring back some proteins to the tribe, we look around us. We do find sturdy arms, sturdy legs and few well-functioning brains. In a word, we find “labour”. Do we find “capital”? A broad and outstanding No! However, as the time goes by, our species is evolving. We will find primal energy in the form of fire, and then, at a very latter stage fossil energy and we will understand how to use it. “Capital” will appear at a much latter stage based on accumulated labour (whatever it is “inspiration”, aka knowledge, or “transpiration”, aka sweat and hard work) and the use of energy around us.

The point is very simple: the central equation explaining economic growth is plain wrong and we need to transform it in order to make capital an inner feedback loop to the system as it is mentioned in the Report to the Club of Rome (2003) or suggested by Jean-Marc Jancovici . How to do this?

Well in order to make things simple, let’s assume that returns to scale are constant (if I multiply resources by 2, output will be increased by 2, which fares as a reasonable assumption) so that we get b = 1-a, and therefore Y = A * Ka * L1-a. Now, let’s make the capital K dependent on energy (E) and labor (L) (or accumulated labor, (integral of L), so that K = c * E * L (with “c” a constant and simply labour which does not change the qualitative properties of the model). Our equation becomes: Y = A * ba * Ea * L.  

Add to this new equation a reasonable assumption about the dynamics of labour (I assume a logistic function for the dynamics of the population with a sharp increase followed by an asymptotic rise) and the knowledge we have gained over the shape of the oil production function and thus of the dynamics of how available reserves evolve, we can build a toy-model and easily simulate the path of the economy (figure 8) on an oil(energy)-dependent computer. This toy-model clearly shows how sensitive an economy can be to the downward shift in oil-production during and after the peak-oil.

Do not get me wrong here. I do not believe that the Stone Age ended because we were short of stones. My point comes down to say that we are smack in the middle of an energetic transition, that this transition has a much more profound current negative effect that many can believe and that the world as we know is coming to an end, evolving towards “something else”. The hope here is that, flawed economic models, lack of political will to manage this energetic transition or ideological foolishness from the Talibans of the “all-green” regarding the nuclear energy as “evil”, will not drive us toward the tragic fate of the reindeer herd of St Matthew Island and other unfortunate raging bulls (figure 9). Indeed, the NASA research suggests that high wealth inequality is sufficient to create a total collapse. Add inequality regarding access to energy, water and food (agriculture is oil-dependent too) on the top of that, and we have a Mad-Max-Moment ahead of us. In this state of urgency, do we attend a rise in global capex in renewable energy that could make us more optimistic? Well, unfortunately not. Global investment in renewable energy fell 11 percent in 2013 to USD 254 billion according to Bloomberg New energy Finance. This is the second decline in renewable investments since 2001. So, yes the crash die-off of our fat caribous is unfortunately still a scenario.

v
Source: Joel Guglietta

Joel Guglietta is Managing Director of OCTIS Asset Management in Singapore

3y
fxtime fxtime
Great article .
3y
FelixMaxim FelixMaxim
@=%$ !
3y
Anteaus Anteaus
..which is why we need stop wasting a billion dollars a day on so-called 'renewable' wind and solar energy -which cannot replace oil no matter what- and concentrate our funding and efforts on perfecting advanced nuclear such as thorium LFTR or fusion.

The choices are simple; move forward to a more advanced technology than fossil fuel, use existing unsafe nuclear tech and risk a few more Chernobyls, or go back windmills and the Middle Ages. I'd go for moving forward.to better things. Even if we fail -which is unlikely- at least we gave it our best try.
3y
Arlene Johnson Arlene Johnson
I proved the thesis that oil is abiotic in my 19th edition. Russia has more oil than any other country including Saudi Arabia because of what they were forced to do after WW II ended. Oil is not a fossil fuel, and it is not finite. The powers-that-be just want you to think that because they want to charge increasingly higher and higher prices for it.
3y
JennyB JennyB
Excellent article, thanks.
We no longer have any options if we intend to avoid a brutal cull of our species and others. We have to pursue nuclear fission as fast as possible (and fusion in the hope of useful generation in the short time left). We'd have stood a much better chance if politicians had admitted the obvious a long time ago, when enough facts were available.
We should pursue renewables as well, but only those with real, large-scale potential such as the PS10 solar power tower in Spain, rather than governments paying lip-service to the problem with small subsidies.
A huge proportion of world budget should be going into energy alternatives. There is no other way for life even close to how we know it, to continue.
Nuclear energy has some risks but it has a VERY safe history, far safer than coal, gas or oil extraction, both in environmental terms and in human safety. The occasional largish incident but almost no smaller ones - and current technology is safer still.
3y
weef weef
"a brutal cull of our species and others" - do we really need 7+ billion of our species on this planet?

Anteaus - " we need stop wasting a billion dollars a day on so-called 'renewable' wind and solar energy -which cannot replace oil no matter what- and concentrate our funding and efforts on perfecting advanced nuclear such as thorium LFTR or fusion. "

Is really a dumb statement - Gran Canaria (for example) generates 30% of its electrical energy from wind farms. Advanced Nuclear Technologies generate electricity - so if that technology can replace oil, as you assert, then any technology capable of producing electricity - to include fussion/windpower/solar energy will suffice.
3y
JamieShepherd1 JamieShepherd1
Its naive to call any given technology the 'answer', or to say another technology 'fails', because it doesn't give base load, isn't as cheap as coal, or whatever. Energy is fungible. If you have enough electricity, cheap enough, you can turn it into oil, or gas, or aviation fuel. Hitler turned coal into diesel, off-peak electricity pumps water back up into hydro-dams in Wales.

Ultimately, we need a mix of energies which are renewable in some way (or at least last a very long time). Like nature, this mix is an ecosystem - electricity to power computers and industry, liquid fuel to power aviation, nuclear to give baseload, and smart grids to minimise supply-demand imbalances.

The best way is to develop every feasible idea, then let the market adopt the mix of technologies that fills every niche. My money is on LFTR Thorium liquid salt nuclear, uranium nuclear has high risks. Wind, solar, tidal, on down from there. Forget fusion, waste of time. Forget biofuel (need crops for food!!)
3y
James Donaldson James Donaldson
Of course our civilization is heading for the rocks. One has to ask how much wealth is enough?
A huge previous civilization was wiped out & this one is just about to do the same as every nation now acquired nuclear weapons to threaten each other with. Right now the world has a number of serious flash points. For instance North Korea can act as she is because her Ally is China, Russia & Iran. China is pushing Japan to react over some islands over raw materials there. Then China is pushing around Philippines and South Korea over the Yellow Sea.

In the Middle East there are two factions who truly hate each other, the Sunnies and the Shiias.

Iran has been sabre rattling for some time, showing its nuclear arsenal. Now Saudi Arabia is doing the same.
The Bible shows that these two protagonists are ready to attack each other. Iran is Allied with China, Russia and North Korea and of course Turkey. Turkey wants to re-establish its Neo Ottoman Empire/grouping. Shortened Kingdom7Info
3y
James Donaldson James Donaldson
Continued
In the Middle East there are two factions who truly hate each other, the Sunnies and the Shiias.
Iran has been sabre rattling for some time, showing its nuclear arsenal. Now Saudi Arabia is doing the same.
The Bible shows that these two protagonists are ready to attack each other. Iran is Allied with China, Russia and North Korea and of course Turkey. Turkey wants to re-establish its Neo Ottoman Empire or grouping.
Any one of these may blow into a nuclear conflict however the Iran /Arabia one is a very detailed prophecy and its components are assembling very fast.
The predicted coming fiery conflict will destroy the economy because the Tar and oil pits found all over Arabia ignite. Kingdon7Info
3y
James Donaldson James Donaldson
Continued
As the Messiah says if he did not stop it no life would be saved. So we start the wars because of greed and avarice he has to stop it.
We are one mad decision away from the beginning of the end of this civilization in the same way as the the flood occurred that destroyed that civilisation. Oh and the Ark of Noah has been discovered in turkey at the foot hills of the Mountains. of Ararat. The huge wooden beams it is constructed of is unique as it does not have tree rings plus it is held together by iron rivets. Samples of both were sent back to laboratories for analysis plus the width and length match up to the Bible measurements. The Turkish government have confirmed it authenticity and opened a tourist center. So many archaeological discoveries are being discovered in the middle east that confirm the biblical account Kingdom7Info
3y
JXXXB JXXXB
@JamesDonaldson you are spouting deluded fantasies - biblical prophecy ? in the modern world ? come on, it's all nonsense !!!
3y
Mona Vine Mona Vine
James Donaldson, Which version of the bible are you reading from? and references please. you can't expect people to just take your word for it.
Relevant articles for you

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Tradingfloor.com permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Tradingfloor.com and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Tradingfloor.com is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Tradingfloor.com or as a result of the use of the Tradingfloor.com. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through Tradingfloor.com your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. Tradingfloor.com does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer
- 沪ICP备13028953号-1

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail