Wednesday, January 21, 2009

ASPO Examines the Economy and Peak Oil: December 2008

Excerpts from the Association for the Study of Peak Oil and Gas (ASPO-Ireland) December 2008 Newsletter. The full article is available here.

In years ahead, analysts may look back on the current crisis and identify its causes. They may conclude that oil demand had begun to outpace supply around 2005, when the production of Regular Conventional Oil passed its peak. The shortfall was however relatively small and was partly met without undue difficulty by a modest reduction in consumption.

But as prices began to firm, oil traders and other speculative financial institutions began to take a position in the market, which had the effect of driving up the price. Gradually the process built momentum as huge notional profits were reaped from the appreciating asset. In a conventional market such movements would soon be countered by increased production, but in the case of oil, there was no spare capacity to release, and the speculative surge fed on itself leading to an extreme escalation in price which reached about $150 a barrel by July 2008. However as this peak [in prices] was approached, the traders began to conclude that a limit was close and began to buy future options at lower prices, which began to undermine the price in a self-fulfilling process. In parallel the high prices began to undermine many other aspects of the economy with for example airlines and automobile manufacturers facing difficulties. They themselves relied heavily on debt, which itself was traded between banks without adequate genuine collateral, and were forced to unload their speculative oil positions in order to try to shore up their failing businesses. Gradually the whole edifice collapsed, and oil prices fell to around $50 a barrel, although nothing particular had changed in the actual supply/demand relationship.

The flaw in the system was to treat a finite resource whose production was largely controlled by the immutable physics of the reservoir as if it were a normal commodity capable of responding to ordinary market pressures. If the price of potatoes increases, farmers can grow more and the market responds, but oil is different.

Governments responded to the crash by pouring yet more money, itself lacking genuine collateral, into the system in the mistaken belief that this would restore the position of assumed eternal growth, and quite possibly the stock market will respond positively as traders sense a new upward direction. They have no real interest in reality: their job being to try to reap rewards from short term movements.

But if there is an economic recovery, that would serve to increase the demand for oil, which is in a sense the lifeblood of the modern world, and oil prices would again begin to surge. Probably, it will take several such vicious circles before governments and, more important, people at large at last come to grasp the reality of the situation, which will likely prompt radical changes in the human condition.

The election of Mr Barrack Obama seems to have been greeted with rapture in the United States and around the world. Certainly he projects an attractive personality and speaks fluently and well, but the main enthusiasm seems to lie in his mixed racial background. Part of his family emanates from Kenya, possibly having some Arab blood, and the Irish stake claim to other antecedents. Some observers hope that his election will spell regime change and the end of the so-called War on Terror, which seems to have failed to extend global economic hegemony. On the other hand, his election, which required massive funding, suggests that he relied on more than the simple ballot box. Indeed, the financier, Rahm Emanuel, who has apparently served in the Israeli Army and is the son of a former member of the Irgun Zvai Leumi terrorist movement, has been appointed as Chief of Staff, suggesting that the established influences will remain in power. But by all means, most people welcome the change, and look forward with enthusiasm to new policies with which to face the unfolding situation, imposed ultimately by dwindling oil-based energy.

The new Presidency will certainly have to work a radically new situation for which no one is truly prepared. Even the leading American intelligence organisation, the National Intelligence Council (NIC) has issued a report entitled Global Trends 2025: A World Transformed which concludes that the days of US global economic and military power are over, foreseeing an end to the western model of economic liberalism, as the State is forced to take a more active role.

Meanwhile, desperate efforts are being made around the world to shore up the crumbling financial system. For example, the Bank of England has radically reduced interest rates in a country facing a severe recession, effectively taking money from savers to give to spenders.

The Government has evidently failed to grasp the underlying causes of recession and hopes that pumping a bit of money into the system will restore it to its previous condition. That was premised on eternal economic growth, which is a somewhat unrealistic proposition for a Planet of finite dimensions, but Governments subject to re-election are by nature short-term in their thinking.

The reporting of economic parameters: the official US numbers are apparently also highly suspect. The US Bureau of Labor Statistics (BLS) reports that US Consumer Price Inflation (CPI) is running at 5%, having changed the procedure for doing so in 1990. According to, a more realistic estimate would be 13%. The Federal Reserve Bank no longer reports the so-called M3 for the creation of new money, but the same source suggests it is currently running at 13%, contributing to inflation. Officially, Gross Domestic Production (GDP) has increased by 2%, whereas the alternative source suggests that it is declining at 3%. Likewise, official estimates of unemployment at 6% contrast with the alternative estimate of 15%. Added credibility for the alternative assessment comes from no less than General Motors, which reports that global passenger car sales fell by 6% during the Third Quarter of this year. Apparently, various hidden agencies related to the Federal Reserve Bank may be manipulating gold and silver prices, which have fallen since the financial crisis broke. The fall does not seem a natural response, given that gold is the traditional safe haven in times of stress and growing inflation. Indeed according to the August issue of the Bank Participation Report, Bear Stearns had a large short position on COMEX silver at the time of its forced merger with JP Morgan in March. The transfer was undertaken by the US Treasury under somewhat dubious procedures. No doubt gold holdings are also involved in the labyrinthine dealings.

One is led to conclude that the entire Stock Market, including especially the oil market, has become a thoroughly debased speculative institution. In earlier years, investors clubbed together to build a specific project, such as a canal or railway, with the resulting dividend being the prime motivation. Things seemed to have gone wrong when such investments were traded on markets by financial institutions which naturally can have no serious knowledge of the underlying business or the true value to be placed upon it.

1 comment:

Anonymous said...

Note that Islamic finance hasn't been hurt by the crisis of confidence in the USA financial industry.