Monday, September 24, 2012

Seneca and Hubbert global collapse scenarios put into modern perspective:

            A friend of mine sent me a link a few weeks back with an article written by Ugo Bardi an Italian professor, with an interesting take on Seneca’s view that growth happens at a much slower pace than irreversible economic contraction.  Comparing it to the Hubbert curve, which reflects natural resource production curves; he sees a similar upward path as the Hubert curve, but a much steeper path on the way down for the global economy.  His basic argument is that environmental damage, coupled with resource scarcity is the kind of trigger that can lead to global economic freefall.  Being that he is a physical chemistry professor, naturally he used math to prove his point.

            My own personal view on the issue of an eventual collapse is that both the Hubbert curve, which many peak oil theorists believe that our global economic curve will follow, given crude oil’s importance to the economy and Ugo Bardi’s mathematical approach to predicting this trajectory are not likely to represent the real picture.  A more complete picture in my view can be achieved by observing the interaction between resources, the market, innovation, fiscal and monetary policy and politics in response to the initial pressure on society, due to resource constraints on economic growth.

Current Realities:

            We have to realize that we entered the era of resource constraints during the last decade.  Oil prices are up about 500% from a decade ago, despite half a decade of anemic global economic growth, and food prices are up about 150% since 2000.  We now have two global food riot events on the historical record.  The first happened in 2008, and the second during the winter of 2010-11, known as the Arab spring.  Many believe that we are headed for a third such event in just the past five years, this coming winter. 

If I was to pinpoint the exact year when we entered the early stages of resource constraint dominated economic environment, the year I would pick is 2005, which is the year when now looking back, we can say with certainty that we are on a conventional crude oil production plateau.  Price and technological innovation may be able to nudge production volumes up, while geological and increasing geopolitical constraints will continue to push downward on production capacity, but as we will register year after year of production going forward, the multi year average since 2005, and until production will enter irreversible decline will more or less average 2005 production levels, within a 2-3% range, as it does now as we are in the seventh year post- plateau.

Is Hubert’s curve accurate for predicting global liquid fuel production?

            When Hubert’s prediction of the peak in US oil production turned out to be remarkably accurate, it gave rise to a growing tide of believers in the concept that global oil production will follow a similar path.  There is one aspect however which they failed to account for in both assessing US production going forward as well as understanding the trajectory of the world’s capacity.  They failed to factor in for the fact that the market for oil is a global one.  There was no market reaction to the event of the US peak in oil production in the early 1970’s, because it was a local event.  There was a definite price triggered market reaction to the event of the peak in global conventional oil in 2005, which changes things drastically.

While we can claim that conventional oil production continues to be on a production plateau, total liquids production, which includes unconventional oil, as well as other liquids that are not quite oil, did register an increase of about .5% per year on average since 2005.  That may be only half of long term historical increase rates in the last few decades, but it does nevertheless present the world with a very different scenario than the predicted permanent decline in production which was supposed to take the entire global economy down the same path of permanent decline.  The global economy may never be the same again as of 2005, but it is still limping along at a reduced rate of average growth.

            The response of the believers of peak oil theory was to point out that this cannot possibly go on forever.  They expect conventional production to fall off the plateau at any moment.  At that point, unconventional liquids can only keep the total liquids tally on a plateau at best, or perhaps not even that much.  I personally cannot pretend that we can predict with accuracy that moment when this will happen.  It is only an obvious given that it will happen, and I do believe that there is a way to estimate the maximum time we have left before that happens.

Going back to the basics of original oil resources in the ground:

            We should start with the most basic estimate of the conventional global oil volume initially in the ground.  This is likely to be the most reliable variable.  Most estimates ranging from the USGS, and EIA to various independent geologists put this number in the 5-7 trillion barrel range.  It is therefore entirely reasonable in my view to assume a 6 trillion barrel total resource base.  Of that volume, about 40% is thought to be recoverable with current technology being applied today.  That would give us 2,400 billion barrels which would ultimately be recovered.  We cannot however count out the power of the market and human innovation, helped by fiscal and monetary policy to change that number.  I believe the estimate such as the one made by Exxon-Mobil that ultimately about 60% of the oil will be extracted from conventional fields is reasonable enough.  That would give us a number of 3,600 billion barrels which will ultimately be recovered.  We produced about 1,100 billion barrels already.

            Here I will diverge from the Hubbert model somewhat in predicting the end of the plateau.  I will assume that decline will set in, not when total production equals remaining proven reserves, but when the halfway point will be reached between production and oil that will ultimately be recovered.  Thus we can get the maximum length of the current plateau, which should be accurate within a range of a decade at least.  Remember that I am interested in the maximum potential, not the earliest when this event might happen:

3,600 billion barrels /2 = 1800 billion barrels (halfway point) – 1100 billion barrels already produced = 700 billion barrels /25 billion barrels (current yearly production) = 28 years left.

            This means that the maximum length of the current plateau can take us all the way to 2040.  We should also remember that we also have as large a volume of unconventional oil in the ground as we do conventional.  Recovery rates will never come even close to what we can potentially see with conventional oil, but we have to remember that as long as we can maintain the market signal to go after more of this volume, the human ingenuity as well as our desire to exploit an opportunity will make more and more of these resources available.  In essence, 2040 may not represent the point of complete collapse following either the Hubbert or the Seneca curve, but rather a point of further worsening of the situation.  It is therefore conceivable that I may die of old age and still not live to see the point of complete collapse (I am turning 33 this week).

Justification for this view:

            We already saw the market reaction to the rise in prices experienced in the last decade.  There has been an undeniable trend of growth in unconventional oil production thanks to the market’s signal to produce these resources, due to a favorable price environment.  The result has been that total liquid fuel production did not plateau, never mind decline.  At the current price range of $80-120 a barrel, we have many new sources which can become viable, whereas a decade ago they were not.

            In the absence of this market reaction, peak oil would have indeed happened as many intelligent people predicted it would.  If oil prices today would only be $30-40 a barrel, which is still an increase of about 300% from the late 1990’s, current global production of liquid fuels would only be about half of today’s production volume, and the Hubbert curve, or even the Seneca curve would have already proven themselves to be correct.  With the new factor of the market’s reaction in place, the Hubbert curve scenario did not hold.  That is not to say that peak oil is not a real and inevitable scenario.  I cannot emphasize enough that we should not be complacent, because like I said, the world economy will never be the same again as of 2005, because the age of cheap oil has ended.  Things will only get worse gradually, and our ability to fix this problem will diminish due to the resulting erosion of our capabilities by slow attrition as a result of our misguided efforts to invest our remaining resources in trying to go back to the old economy, which is no longer a possibility.  The point when growth is no longer possible at all will not come for perhaps many decades to come.  A decelerating growth path will however feel like a permanent stagnation and even recession for most, even before the point of no growth will occur.

The interplay between resource scarcity & fiscal, financial and market reactions:  The determinant of future economic trajectory.

            If we follow closely the evolution of the world’s economy since 2007, there is a very obvious trend we need to acknowledge.  The financial collapse, which many attribute to a variety of different causing factors, led to monetary and fiscal stimulus as the drivers of continued normalcy, which is still far away from going back to the booming times.  In essence, there is a lot more money being injected into the economy than before.  With a new commitment by the European Central Bank (ECB) to print money in order to be able to purchase sovereign Euro denominated bonds, as well as the new commitment on the part of the US Federal Reserve to inject money into the economy via a mortgage backed securities buying spree, the one thing we can be sure of is that there will be more money chasing opportunities and assets.

            Based on the evolution of the markets and the economy in the past few years, there is one important trend that is becoming more and more clear.  There are three classes of assets which benefit from the inflow of all the freshly printed money.  There is a definite grab towards assets which may lead to great returns.  These assets may be somewhat risky, but the reward is worth the risk.  Thus we see the great innovative companies, such as Apple do relatively well.  We also see the money flow to a few stock markets around the world such as Mongolia’s, which no one else would think of playing, except for some institutions with spare cash such as banks, who received it from the Federal Reserve in exchange for junk assets.  These investments do come with some risk, but the potential for returns is worth allocating some funds to.

            Another important asset class which seems to be a favorite for those receiving free money from the central banks is the safe haven status sovereign bond market.  In this category enters the US, German, Canadian and a few other sovereign debt issuers which are seen as safe from the threat of political upheaval or default.

            The last asset class is made up of inelastic commodities.  These assets only become a magnet whenever there is a hint of tightness in the supply demand balance.  The main commodities where there has been tightness lately are the ones I already mentioned, oil and food.  As we saw in the 2007-09 period, given the realization that supply is falling behind demand, money will flow into assets such as oil with the expectation that prices will rise until sufficient demand destruction will occur.  At that point, speculators will head for the exit causing the price to crash as it did from almost $150 a barrel to $35 a barrel in the 2008-09 period.

            The next stage was a stabilization in a price range which facilitated the influx of marginal sources of oil and other oil substitutes.  The price range of $80-120 a barrel is now the new normal that the economy will tolerate but not enjoy, while producers will find it satisfactory for their need to produce the marginal resources at a profit. 

            The cycle we already witnessed will be repeated.  Every time the stabilization point will happen at a higher price level, making it possible for the continued rise in liquid fuel production.  With every cycle, we will see more and more victims as the market will adjust again and again towards the need to make all other production inputs cheaper as the price of inelastic commodities will continue to rise.  High wage, and high environmental and human rights protection administrative entities will be abandoned as we already witnessed this process unfold for a few decades now.  The basic social safety net we came to depend on in a post agrarian world will also gradually disintegrate.  The stagnated power of the consumer will dictate for the need to cut costs everywhere else to accommodate the rise in price of the inelastic commodities.  Life will become more and more difficult and unpleasant, but this does not yet signal collapse, just a gradual worsening of our lives.  This worsening will not be felt equally by all, so there will be plenty of people who will not even realize what is happening.  This trend towards a worsening of living standards, including the worsening environmental health, a decline in the access to the possibility of earning a living through being paid a decent wage, a decline in social mobility as well as a decline in financial stability due to the gradual gutting of the social safety net, will be gradual enough for most not to notice the actual trend.  The root cause of the trend will not be discussed in the mainstream because the viable solutions, such as the one I proposed in my book do not necessarily fit in with currently established left/right ideology.  Thus the chance of solutions being implemented is very slim.  In fact, there will be many false solutions floating around, many of which will in fact only serve to advance the agenda of certain elites. 

The tax cut to stimulate the economy scheme is a classic example.  These schemes will only serve to further gut the basic economic structure of our society, by allowing the elites to keep more of their income, rather than contributing to some of the basic needs of society, such as the basic social safety net, infrastructure, education and other collective needs.  Government deficits will become worse as their revenues will be cut, while the expected growth in revenue due to economic growth will not materialize as a result of the tax cuts.

As bad as all this may sound, none of it means that we are looking at complete collapse any time soon. It is as I said, just a gradual worsening of our situation which started last decade, and will continue without consensus on why it is happening, or what to do about it.  The next stage towards the endgame is the spread of authoritarian practices on the part of government.  This will only happen most likely decades from now as people will lose trust in politicians and their claims that we can go back to the good old days.  Authoritarian practices will be very stealthy at first, and then gradually it will intensify and become more obvious and naked.  At some point repression will rely on consensus that disobedience will be met with punishment.  This stage can last a very long time as we can see with countries like North Korea, where despite many periods of intense hardship and inhumane living conditions, including mass starvation, there is little chance of the system being shaken internally, nor is there a chance that it can be done by external sources, given their choice to go nuclear.

It should be important to make note of the fact that the march of democracy throughout the world has also been reversed last decade.  It is still too early to realize it, but it is not just a temporary reversal but a new trend.  The Arab spring and such events might grab the media’s attention and make it seem like this is not the case, but repression is becoming the new reality for many societies around the world.  Democracy will increasingly become just a formality, as is the case in Iran, Russia, Iraq and many other places where elections are indeed held but are far from free, fair, and most importantly conductive to making the will of the people resonate in government.

Summing up all these variables, it is far from realistic to expect the collapse scenario presented by Hubbert’s fans, or by mathematical formulas that prove the Seneca effect to be our expectation as presented by Ugo Bardi.  It looks more like what we should expect is that following our arrival to the top of the hill, there is a long, relatively gentle slope on the way down.  Eventually it will end in a deep canyon, but it might take many decades or even centuries for us to reach that canyon, if we take all the above mentioned factors into account.  We should remember however that while on the way up, we quickly became accustomed to the benefits of growth, we will find it increasingly hard to cope with constantly worsening living standards, and we will find it very hard to adjust.  We should also remember that even if the downward slope is gentle, once we start rolling down on it, it becomes hard to reverse course, because with time the momentum will become stronger, while we will become weaker.  So if we are to address this situation, we better do it now, even if we are not faced with imminent doom, but a gradual decline in our collective standard of living, because it will still be very painful, and while perhaps it will not seem so bad when measured collectively, there will be many mini, family and even community size collapses within the collective.  This could affect any one of us.

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