The Oil Drum | Matt Mushalik: Links Between Peak Oil and Financial Crisis; also Updated Graphs

137 comments on Matt Mushalik: Links Between Peak Oil and Financial Crisis; also Updated Graphs

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aardvark on February 1, 2009 - 10:57am

I think the current financial is related more to peak cash flow than to peak oil.

It would be interesting to see two graphs similar to your 1d: One for oil exporting countries, and one for oil importing countries, showing the dollar inflows and outflows.

I think they would show some pretty dramatic peaks and valleys.

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Nate Hagens on February 1, 2009 - 11:23am

It's much more complicated than that. Peak per capita net energy caused political and social pressures which resulted in credit overshoot. I wrote a preliminary comment on it a few months ago, and have something in peer review on how this phenomenon is finally resulting in the failure of financial capital as a marker for real capital - we are still in the early stages. Next step is the European bank dominos falling. Barclays, UBS, Credit Swiss, ING, Fortis, Nordea, etc. After that is the sovereign credits. What will Bretton Woods II look like? It's anyones guess, though linking to natural resources (which is what should happen), is of low probability - too many at the negotiating table still think the environment is part of the economy, and not vice versa. Milton Friedman lives on...

Ravaioli: But there are many other environmental problems ...

Nobel Laureate Friedman: Of course. Take oil, for example. Everyone says it's a limited resource: physically it may be, but economically we don't know. Economically there is more oil today than there was a hundred years ago. When it was still under the ground and no one knew it was there, it wasn't economically available. When resources are really limited prices go up, but the price of oil has gone down and down. Suppose oil became scarce: the price would go up, and people would start using other energy sources. In a proper price system the market can take care of the problem.

Ravaioli: But we know that it takes millions of years to create an oil well, and we can't reproduce it. Relying on oil means living on our capital and not on the interest, which would be the sensible course. Don't you agree?

Nobel Laureate Friedman: If we were living on the capital, the market price would go up. The price of truly limited resources will rise over time. The price of oil has not been rising, so we're not living on the capital. When that is no longer true, the price system will give a signal and the price of oil will go up. As always happens with a truly limited resource.Why an illusion?

Ravaioli: Because we know it’s a limited resource.

Nobel Laureate Friedman: Excuse me, it's not limited from an economic point of view. You have to separate the economic from the physical point of view. Many of the mistakes people make come from this. Like the stupid projections of the Club of Rome: they used a purely physical approach, without taking prices into account. There are many different sources of energy, some of which are too expensive to be exploited now. But if oil becomes scarce they will be exploited. But the market, which is fortunately capable of registering and using widely scattered knowledge and information from people all over the world, will take account of those changes

From Economists and the Environment

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markincalgary on February 1, 2009 - 12:15pm

The conversation between Ravaioli and Friedman is interesting as it's par for the course when the physical science-minded converse with the economically-minded. Both parties are talking across one-another and, from each of their perspective, they are both correct and both wrong.

But I've had so many of these sort of conversations on exactly the same topic, that I've given up and have shifted focus to the immediately practical (building a sustainable home and a secure supply of food). There comes a time when one has to stop arguing about what to do so that it can just be done.

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WebHubbleTelescope on February 1, 2009 - 1:38pm

Do you realize that we may have gone up and past peak without any real analysis, either economic or scientific, that has gone beyond heuristics?

The issue is that we may hit the next problem with the same lack of insight. We still need to think, which inevitably leads to arguments.

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Nate Hagens on February 1, 2009 - 1:55pm

Unfortunately, science has collectively lost its ability to keep up with events. Neither peak oil nor global warming, nor human brain behavioral science will ever be 'proven' before resource depletion mitigation and adaptation have long been necessary.

How could it be otherwise? Humans evolved to use heuristics. Science is a relatively new phenomenon. If everyone in the USA understood the derivation of the logistic shaped discovery model, would we suddenly change our behaviours?

And regarding the next problem - I agree. We still need to think, and argue, and act.

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dohboi on February 1, 2009 - 2:44pm

So, any votes or guesses on what "the next problem" will be?

I think it is the need to deeply reassess our basic goals as a culture and our self-assessment as a species. We have to move from trying to find new energy sources and other ways for humans to maximize themselves (thereby maximizing their negative impact on the living world), to discovering humane ways to limit ourselves and to move to a much, much lower state of energy and resource use.

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Nate Hagens on February 1, 2009 - 3:46pm

So, any votes or guesses on what "the next problem" will be?

I think the next symptom will be an explosion of social inequity. There is already a great deal of pent up anger on the one-sided nature of government bailout of banks and certain industries. The economic aftershocks are going to destroy the middle class in wealthy countries, and drop living standards for all but the very rich in the poorer countries.

If rich people were smart (or rather, could optimize on other than dollars), they would realize that unless some large scale distribution and allocation changes are made, they won't be able to enjoy either their wealth nor their superior social ranking for much longer. Lower resource affordability per capita is going to stretch social democratic principles to their breaking point, (and beyond, in my opinion)

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Paul_the_engineer on February 1, 2009 - 4:30pm

Nate:

I'm sure you know of Dmitry Orlov's "Reinventing Collapse" about his observation of the breakdown of fhe former USSR. Every peak oiler should read this, and although I do not agree completely with Orlov, what he has to say will definitely challange the reader's thinking.

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Nate Hagens on February 1, 2009 - 4:38pm

I know of it, but have not read it. It joins an ever growing list of things to read and things to do - can't I just take a pill and have it fuse into my awareness or some such?

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710 on February 1, 2009 - 8:23pm

In grade school we had an assignment to come up with an original invention, just to write about it and draw it. I came up with a homework machine. It read all your assigned material for you and then manufactured a pill you could take which contained the knowledge.

The plans, however, disappeared. Sorry.

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Gail the Actuary on February 1, 2009 - 9:00pm

As a short-cut, you can read my 1,000 word post about Dmitry Orlov's book, found here.

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Luke H on February 4, 2009 - 9:52pm

Similarities between the soviet empire's collapse and ours will likely be as similar as the U. S. westward expansion and Russia's great expansion to the east were. In other words they will be very dissimilar.

My totally American perspective had me misread what our breaking the USSR by upping the stakes in the arms and political dominance races. I figured if a man had a fairly poor field for crops and had to keep taking all of the profits he made off that field and spending them on defense of that field from his rival who had a very good field he would soon come to the point where defense would take up the resources needed to make the field produce. No more profit and lots of weapons, does he sit back and quit adding to defense and thus lose the perimeter areas of his field to his rival or use his weapons since that is what he has invested all his weapons in. I was wrong as I expected the later and as we all know the former is what actually occured.

So how come I so misjudged. Well I grew up in mid America, no enemies had been near our productive soil for over a century. Our country had grown rich picking off one failing empire after another. We just never think about giving up any of what is ours. If all we have left of our profits is the guns we have built with them, we will not sit by and watch our 'territory' dwindle without firing every shot we have. IMNSHO

But maybe as we early boomers fade this mindset will fade as well, one can hope.

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WebHubbleTelescope on February 1, 2009 - 6:34pm

How could it be otherwise? Humans evolved to use heuristics. Science is a relatively new phenomenon. If everyone in the USA understood the derivation of the logistic shaped discovery model, would we suddenly change our behaviours?

Not everyone, but the people that matter would understand it.

Watch closely how the global warming/climate change discussion gets swayed by "heuristics" versus "real models". The heuristics crowd are basically the anti-GC people, who do not have real theories of their own, but they twist and turn trends to fit their agenda. The pro-GC people do have the real derivations on their side, yet the heuristics angle that the pearl-clutchers latch on to tends to sway them the other way. (i.e. "gee, its been warm for a few days in a row, heuristics say it will stay warm, and therefore GC is not real"). So it comes down to whether we believe the scientists or the others.

On the other hand, in the oil depletion debate, it is basically all heuristics. Each side, the pessimists AND the cornucopians, use heuristics to argue their correctness. Economists, like Milton Friedman, who gets quoted upthread, have a love-hate relationship with mathematics. If you read Naomi Klein's Shock Doctrine, you can get an idea of the weird attitude that Milton had with regard to economics as a science. In a sense, all he wanted to do was test all his "empirical theories", however he could. But he was modeling adaptive human behavior which is bound to failure.
Excerpt from book:

I agree that science is a relatively new phenomena. The math of stochastic processes only got popularized in the 1950's and early 1960's by some classic texts. This opened the field way up. I have debated in my own mind whether King Hubbert was even aware of these ideas. And since he was first, the inertia of his heuristics have gained some weight that has become hard to dislodge.

BTW, that linked article by Gigerenzer uses heuristics as a way to adapt. It again does not explain anything, other than implying that humans do feel some intuition toward a good heuristic. After all, it does reinforce positive feedback (like the temporary warming trend would reinforce a positive feedback to dismiss global warming). I do simulations for a living and I can fake almost anything I want using visualization rendering, yet I do not claim to explain anything if I go that route. This is sometimes referred to as gaming physics as opposed to real physics. Gigerenzer is basically explaining engineering adaptation, not fundamental understanding.

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Nate Hagens on February 1, 2009 - 7:35pm

Thanks WHT - I think that is the longest comment you ever made without a formula -(of course some of it was a quote...;-)

Heuristics are better explained in some of Gigerenzer's books - but basically what he is getting at (as well as many behavioral economists) is that we evolved to be adaptation executors, not rational utility maximizers. In English, this means we have a 'quiver' of short-cuts to think about and care about things that were important than our evolutionary past. 'Money' and 'markets' are not among those things, but 'danger' and 'social hierarchy' and 'relative vs absolute' are.

Regarding scientific method, I think even those that are trained in the scientific method often either don't use it as they were trained, or use it as a tool towards a (conscious or unconscious) desired end. So often in my brief academic career have I seen bad papers published because of who wrote them, and excellent papers be rejected because they were by unknowns or on an unpopular topic within the establishment. In sum, there is a fine line between science and pseudoscience. Combine this with our belief systems and one can't totally rely on peer-review as the gold standard of truth.

Regarding CC, I think that we won't know how other forcings add/subtract/interact with human carbon emissions fully for some time, so there are heuristics involved with that sort of modeling too. And overlaying it all are our belief systems - I watched a movie about the Crusades last night (of which there were 12 different Crusades, which I did not know), and it scared, though didn't surprise me how far people will go based on a belief.

I agree with the rest of your comments.

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WebHubbleTelescope on February 2, 2009 - 12:27am

So often in my brief academic career have I seen bad papers published because of who wrote them, and excellent papers be rejected because they were by unknowns or on an unpopular topic within the establishment.

Aye, we'll see how this plays out. TOD, more than anyplace I have seen on the internet, has a chance to break out of this rat-hole and succeed based on pure merit. As a real meritocracy. This is so damn fun.

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Gail the Actuary on February 2, 2009 - 12:07pm

It seems to me that the world has come to believe that both science and economics have great power, and that they can develop models which will accurately forecast what will happen in the future.

We have started to see evidence that our modeling ability is not really as great as researchers would like us to believe. We have been seeing the economic models failing for a variety of reasons--one of them, the assumption that the economy can be expected to grow and grow, as more and more resources become available.

It seems like 99% of the world still believes the economic models, even though they are failing, because they have been drilled so much into our heads. (Will we have a U or V shaped rebound?) I fear the climate change models may not live up to expectations either, because of the inherent difficulty in modeling complex situations (together with finite resources), but that does not stop faith in the models. If nothing else, faith that the model is right gives us the feeling of power over our future, and this is very attractive.

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WebHubbleTelescope on February 2, 2009 - 11:04pm

I don't think economics is a science. You have to strip away the voodoo to get to a salient model. It's possible to do this but the discipline occupies a no man's land of uncategorized applied math. Econometrics has tried to break away from economics but the association between the disciplines is still too close. Bizarre how this works out and how wrong most of the stuff is.

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dohboi on February 5, 2009 - 1:26am

Climate models have, of course, already failed spectacularly. Most recently, the IPCC models predicted that Arctic ice wouldn't approach total melt till near the end of the century or much later. Within a very few months, it became clear that this was wildly optimistic. Numerous accelerating ("positive") feedbacks had been overlooked.

"If nothing else, faith that the model is right gives us the feeling of power over our future, and this is very attractive." Very nicely put. I think there is a similar comfort to certain conspiracy theories--if you think you can put a face or a set of faces behind a calamity, it makes it more understandable and in principle controllable by some form of human agency. But if you think everything is just spinning wildly out of control because of general stupidity, cupidity..., it can seem too scary to contmplate.

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aardvark on February 2, 2009 - 9:23am

This is one of the most chilling things I've ever read.

"My theory says that if there is a shortage, prices will rise. They have not risen, therefore there is no shortage."

"But Prof, physical reality says oil stocks are limited."

"Economically, they aren't."

Errr... Prof, if the model doesn't correspond with physical reality, you are supposed to change the model, not ignore the reality.

This is like the guy falling off the 30-storey building calling out, "All right so far!" as he passes the second floor.

In some weird, blinkered bubble of reality, he *is* 'all right so far.' And Milton Friedman might sell him life insurance; but I sure as hell won't, because I can see a bigger picture.

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Nowhere on February 2, 2009 - 5:59pm

Economics theory is built around production of goods that are manufactured from supplies.
It assumes that production is unlimited, and that price and demand determine rate of production. When it becomes unprofitable to make something, the price rises or production stops. Substitutions occur when there are acceptable ones. At this point in time there is no price equivalent substitute for Oil. If you price oil in terms of horsepower it would be worth thousands of dollars per barrel.
Energy or oil is not manufactured and not unlimited. Energy is converted from one form to another.
Energy is not created. The conversion process or return on energy is important and limits the supply. Therefore traditional economics does not apply to specific energy resources.

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WisdomfromPakistan on February 1, 2009 - 5:41pm

What? Are you serious? Do you really think physicists are wrong in saying that fossil fuels were made in hundreds of millions of years, therefore, are practically non-renewable?

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FMagyar on February 2, 2009 - 8:28am

What? Are you serious? Do you really think physicists are wrong in saying that fossil fuels were made in hundreds of millions of years, therefore, are practically non-renewable?

Oh yeah, and don't forget the geologists, chemists, biologists, ecologists, paleontologists...etc... then along come the economists and explain to the people why non of that matters and we can all just ignore reality and grow our economies forever.

Guess who gets listened to?

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Russ on February 1, 2009 - 12:34pm

Friedman's argument reminds me of an analysis I read of why Hotelling's (sp?) Rule of prices breaks down - because oil has never been priced as a physically scarce resource.

You have to separate the economic from the physical point of view.

That seems to be neoclassicism in a nutshell - economic theology unanchored from physical (or any other) reality.

Also, how can oil be treated as this easily substitutable good, as if it's just one of many kinds of beer you might buy, and if they're out of Molson Export, just get Molson Golden?

This physically vast, technologically intricate, and monumentally expensive infrastructure can't just be scrapped in a few weeks and replaced with whatever substitute economists are thinking of. This changeover clearly requires tremendous planning and investment far in advance of when the prices would chronically signal the market, "It's time to switch".

That is, if the change is going to be an orderly retreat rather than a rout.

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nelsone on February 1, 2009 - 12:58pm

Peak per capita net energy caused political and social pressures which resulted in credit overshoot.

Fascinating take on financial overshoot - bread and circuses on credit - sure looks that way.

But there's more than personal and public debt at work in the credit crisis: PO had nothing to do with the CDS explosion, which was more about deregulation of the markets, including repeal of Glass-Steagall in 1999. Now we have notional values of CDS's floating around that are apparently an order of magnitude larger than the global GDP, but no one knows for certain.

It's that uncertainty together with the potential for insurmountable losses that's paralyzed all the lenders. So IMO there's more than one source for financial overshoot.

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dohboi on February 1, 2009 - 1:25pm

Actually I think decades of steady growth in the net energy supply left powerful people with the feeling that regulation or any other kind of limits just get in the way of the apparently infinite wealth creation. Ever-growing supplies of liquid energy, I would say, helped foster an attitude that any investment will win, and that the less restrictions there were on investments, the more winning could happen. This was of course insanity, but an insanity in part induced by the giddiness of the ever greater availability of a certain energy-dense, black, viscous fluid.

These wild investments started to unravel when the infinite growth started to stall.

A friend of mine studied businesses in the oil-rich gulf states. Most of them were total shams, but their owners all knew that the sheik would supply them with more cash whenever they needed it. Clearly all these business will continue as long as oil revenues flow in, and all these businesses will go belly up soon after the oil revenues dry up.

Saying this is because of the bad business practices rather than because of the always-ready supply of cash is rather academic, IMHO.

A similar thing happened here, just once or twice removed. As it turned out, many of the banks could in fact go to the "sheik" (gov) for a bailout here too. But not all. And this sheik is already in hock up to his eyeballs.

But you are certainly right that the CDS's and other derivative-type scams are the big scary beast that people are still not talking about.

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WebHubbleTelescope on February 1, 2009 - 1:51pm

"..., but no one knows for certain."

If you think about it, this lack of knowledge also preceded the oil crisis. In that case, some people did know, i.e. Hubbert and a few others, but we never had the certainty because of the imprecise foundation of our knowledge.

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Jason Bradford on February 1, 2009 - 1:45pm

OMG, I have never seen this particular exchange. Absolutely mind-blowing.

Aside from the usual moronic points re. physical but not economical...etc. What really got to me was that he doesn't seem to comprehend what pricing on the margin does!

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sunnata on February 1, 2009 - 2:15pm

I don't think Milton Friedman would get the idea of Diachronic Competition, us competing with our descendants. But luckily the new religion of economics has signed as all up to this great new experiment of infinite substitution which discounts Diachronic Competition at the margin.
Its a bit like the financial musical chairs that just finished! Luckily the politicians are now playing the game with great gusto.

I think I've had an OMG moment :(

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Dryki on February 1, 2009 - 11:38pm

competing with our descendants

That has been one of the few spots of hope for me of late, where my 20 something friends get up and tell the bastards at city council - my 50 something sometimes friends - that they know where they live. Because it's going to come to that. I'm all for issuing communities an adequate supply of tar and feathers. Better than AKs and dcit , though no doubt, being human, we will need some of the latter. Can TOD members get a discount on AKs? Is that a Professor Goose question?

The generation 30-50 something, needs to write itself off, to dedicate itself to the younger. Not as in momma-bear or poppa-bear feeding their own young, but to make the paradigm shift from entitlement to "pay it forward".

Out of all the trillions in the bank looting and plunder, what would $5B have done for permaculture, Martensen asked a little while ago? Permaculture aka the next generations.

cfm in Gray, ME

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crobar on February 2, 2009 - 10:39am

Remember, there is no Nobel prize for economics, just the Swedish bank prize in honour of the memory of Alfred Nobel. He didn't mention economics in his will, and you should not take the prize or their winners too seriously.

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