Articles in topic "Economics/Finance"
Posted by nate hagens on September 20, 2013 - 12:27am
Twenty-one years ago I received an MBA with Honors from the University of Chicago. The world became my oyster. Or so it seemed. For many years I achieved status in the metrics popular in our day ~ large paychecks, nice cars, travel to exotic places, girlfriend(s), novelty, and perhaps most importantly, respect for being a 'successful' member of society. But it turns out my financial career, shortlived as it was, occurred at the tail end of an era ~ where financial markers would increasingly decouple from the reality they were created to represent. My skill of being able to create more digits out of some digits, (or at least being able to sell that likelihood), allowed me to succeed in a "turbo" financial system that would moonshot over the next 20 years. For a short time I was in the 1% (and still am relative to 'all humans who have ever lived'). Being in the 1% afforded me an opportunity to dig a little deeper in what was really going on (because I quit, and had time to read and think about things for 10 years). It turns out the financial system, and therefore my career, was based on some flawed assumptions that 'worked' in the short run but have long since become archaic, putting societies at significant risks.
Around 30% of matriculating undergraduate college students today choose a business major, yet 'doing business' without knowledge of biology, ecology, and physics entirely misses first principles ~ my too long but also too short summary of the important things I wasn't taught in business school is below.
The story of oil limits is one that crosses many disciplines. It is not an easy one to understand. Most of those who are writing about peak oil come from hard sciences such as geology, chemistry, and engineering. The following are several stumbling blocks to figuring out the full story that I have encountered. Needless to say, not all of those writing about peak oil have been tripped up by these issues, but it makes it difficult to understand the “real” story.
The stumbling blocks I see are the following:
1. The quantity of oil supply available is primarily a financial issue.
The issue that peak oil people are criticized for missing is the fact that if oil prices are high, it can enable higher-cost sources of production–at least until these higher-cost sources of production prove to be too expensive for potential consumers to buy. Thus, high price can extend oil production for longer than would seem possible, based on historical patterns. As a result, forecasts based on past patterns are likely to be inaccurate.
There is a flip side of this as well that economist have missed. If oil prices are low (for example, $20 barrel), the economy is likely to be very different from what it is when oil prices are high (near $100 barrel, as they are now).
My major point when I gave my talk at the Fifth Biophysical Economics Conference at the University of Vermont was that our economy’s overall energy return on investment is already too low to maintain the economic system we are accustomed to. That is why the US economy, and the economies of other developed nations, are showing signs of heading toward financial collapse. Both a PDF of my presentation and a podcast of the talk are available on Our Finite World, on a new page called Presentations/Podcasts.
My analysis is with respect to the feasibility of keeping our current economic system operating. It seems to me that the problems we are experiencing today–governments with inadequate funding, low economic growth, a financial system that cannot operate with “normal” interest rates, and stagnant to falling wages–are precisely the kinds of effects we might expect, if energy sources are providing an inadequate energy return for today’s economy.
Commenters frequently remark that such-and-such an energy source has an Energy Return on Energy Invested (EROI) ratio of greater than 5:1, so must be a helpful addition to our current energy supply. My finding that the overall energy return is already too low seems to run counter to this belief. In this post, I will try to explain why this difference occurs. Part of the difference is that I am looking at what our current economy requires, not some theoretical low-level economy. Also, I don’t think that it is really feasible to create a new economic system, based on lower EROI resources, because today’s renewables are fossil-fuel based, and initially tend to add to fossil fuel use.
Adequate Return for All Elements Required for Energy Investment
In order to extract oil or create biofuels, or to make any other type of energy investment, at least four distinct elements described in Figure 1: (1) adequate payback on energy invested, (2) sufficient wages for humans, (3) sufficient credit availability and (4) sufficient funds for government services. If any of these is lacking, the whole system has a tendency to seize up.
EROI analyses tend to look primarily at the first item on the list, comparing “energy available to society” as the result of a given process to “energy required for extraction” (all in units of energy). While this comparison can be helpful for some purposes, it seems to me that we should also be looking at whether the dollars collected at the end-product level are sufficient to provide an adequate financial return to meet the financial needs of all four areas simultaneously.
My list of the four distinct elements necessary to enable energy extraction and to keep the economy functioning is really an abbreviated list. Clearly one needs other items, such as profits for businesses. In a sense, the whole world economy is an energy delivery system. This is why it is important to understand what the system needs to function properly.
A June 6, 2013, article from Reuters is titled, “Lawmakers in new drive to slash Iran’s oil sales to a trickle.” According to it,
U.S. lawmakers are embarking this summer on a campaign to deal a deeper blow to Iran’s diminishing oil exports, and while they are still working out the details, analysts say the ultimate goal could be a near total cut-off.
My concern is that the new sanctions, if they work, will put the United States and Europe in a worse financial position than they were before the sanctions, mostly because of a spike in oil prices.
How much reduction in oil exports are we talking about? According to both the EIA and BP, Iranian oil exports were in the 2.5 million barrels a day range, for most years in the 1992 to 2011 period. In 2012, Iran’s oil exports dropped to 1.7 or 1.8 million barrels a day. Recent data from OPEC suggests Iranian oil exports (crude + products) have recently dropped to about 1.5 million barrels a day in May 2013.
If the ultimate goal is “close to total cut-off,” an obvious question we should be asking ourselves is whether it makes sense to handicap world oil production by close to 2.5 million barrels relative to 2011, or close to 1.5 million barrels relative to May 2013. Oil prices have spiked in the past when there has been an interruption in world oil supply. Why wouldn’t they this time? Furthermore, who are really handicapping: Ourselves or Iran?
Recently, I explained how high oil prices can bring on financial collapse for oil importers. In this post, I’ll discuss the flip side of the situation: how oil exporters reach financial collapse.
Unfortunately, we have many examples of countries that were oil exporters, but are dealing with collapse situations. Egypt, Syria, and Yemen all have had political disruptions since 2011. These may not be called financial collapse, but they all took place as the country’s oil exports decreased and as the price of imported food rose. Another example is the Former Soviet Union (FSU). It collapsed in 1991, after a period of low oil prices, in what looks very much like a financial collapse.
There are several dynamics at work in the financial collapse of oil exporters:
- Oil exporters are often dependent on oil export revenue to fund government programs.
- The need for government programs grows as population grows and as the price of food rises.
- The amount of oil that can be extracted in a given year often declines over time, as initial stores are depleted.
- Exports often decline even more rapidly than oil supply, because of rising oil consumption as population grows.
In general, high oil prices are good for oil exporters (except the effect on food prices). At the same time, oil importers strongly prefer low oil prices. As a result, we end up with a price tug of war between oil importers and oil exporters.
One additional issue is declining Energy Return on Energy Invested. Countries often have the option of reducing their rate of decline by adding production in areas which are more expensive to drill (say deeper, smaller locations offshore Norway) or by using enhanced oil recovery methods. Such approaches add costs (and energy use), and further add to the price that oil exporters need for their product.
Egypt, Syria, and Yemen
Egypt, Syria, and Yemen are three countries that the press would say are suffering from the continuing impact of the Arab Spring revolutions, which began in 2011, or of civil war. The similarity of the oil production and consumption charts for the three countries (shown below) suggests that declining oil exports likely played a major role as well.
A friend asked me to put together a presentation on our energy predicament. I am not certain all of the charts in this post will go into it, but I thought others might be interested in a not-so-difficult version of the story of the energy predicament we are reaching.
My friend also asked what characteristics a new fuel would need to have to solve our energy predicament. Because of this, I have included a section at the end on this subject, rather than the traditional, “How do we respond?” section. Given the timing involved, and the combination of limits we are reaching, it is not clear that a fuel suitable for mitigation is really feasible, however.
Energy makes the world go around
Energy literally makes the world turn on its axis and rotate around the sun.
Energy is what allows us to transform a set of raw materials into a finished product.
Energy is also what allows an us to transport goods (or ourselves) from one location to another. Services of any type require energy–for example, energy to light an office building, energy to create a computer, and human energy to make the computer operate. Without energy of many types, we wouldn’t have an economy.
In my view, wages are the backbone an economy. If workers have difficulty finding a job, or have difficulty earning sufficient wages, the lack of wages will be a problem, not just for the workers, but for governments and businesses. Governments will have a hard time collecting enough taxes, and businesses will have a hard time finding enough customers. There can be business-to-business transactions, but ultimately somewhere “downstream,” businesses need wage-earning customers who can afford to pay for goods and services. Even if a business produces a resource that is in very high demand, such as oil, it still needs wage-earning customers either to buy the resource directly (for example, as gasoline), or to buy the resource indirectly (for example, as food which uses oil in production and transport).
It is not just any wages that are important. It is the wages paid by private companies (rather than governments) that are important, as the backbone to the economy. Governments tend to get their revenues from private citizens and from businesses, both of which are dependent on wages of private citizens. There are a few pieces outside of this loop, such as taxes on imports from foreign countries. With the advent of free international trade, this source is disappearing. Another piece outside the US wage-loop is taxes on resource extraction, if these resources are exported.
Instead of using the analogy of a backbone, perhaps I should say that wages are the base that ultimately determines the quantity of goods and services an economy can afford.
Obviously there are other kinds of income, such as “rents,” but these, too, ultimately come from wage earners. Furthermore, businesses cannot earn money to pay dividends unless some consumer, somewhere, can afford to buy the goods and services their business is selling.
I have written recently about how the proportion of Americans with jobs rose to a peak, and since has been declining.
I decided in this post to look at the dollars these workers are earning. In particular, I decided to look at wages, other than government wages, adjusted to today’s cost level using the “CPI- Urban,” cost index of the Bureau of Labor Statistics. I discovered that these wages are doing very poorly. I also discovered a disturbing connection between high oil prices and flattening or declining wages. Putting all of these pieces together suggests a connection to “Limits to Growth.”
Globalization seems to be looked on as an unmitigated “good” by economists. Unfortunately, economists seem to be guided by their badly flawed models; they miss real-world problems. In particular, they miss the point that the world is finite. We don’t have infinite resources, or unlimited ability to handle excess pollution. So we are setting up a “solution” that is at best temporary.
Economists also tend to look at results too narrowly–from the point of view of a business that can expand, or a worker who has plenty of money, even though these users are not typical. In real life, the business are facing increased competition, and the worker may be laid off because of greater competition.
The following is a list of reasons why globalization is not living up to what was promised, and is, in fact, a very major problem.
1. Globalization uses up finite resources more quickly. As an example, China joined the world trade organization in December 2001. In 2002, its coal use began rising rapidly (Figure 1, below).
In fact, there is also a huge increase in world coal consumption (Figure 2, below). India’s consumption is increasing as well, but from a smaller base.
We are used to expecting that more investment will yield more output, but in the real world, things don’t always work out that way.
In Figure 1, we see that for several groupings, the increase (or decrease) in oil consumption tends to correlate with the increase (or decrease) in GDP. The usual pattern is that GDP growth is a little greater than oil consumption growth. This happens because of changes of various sorts: (a) Increasing substitution of other energy sources for oil, (b) Increased efficiency in using oil, and (c) A changing GDP mix away from producing goods, and toward producing services, leading to a proportionately lower need for oil and other energy products.
The situation is strikingly different for Saudi Arabia, however. A huge increase in oil consumption (Figure 1), and in fact in total energy consumption (Figure 2, below), does not seem to result in a corresponding rise in GDP.
At least part of problem is that Saudi Arabia is reaching limits of various types. One of them is inadequate water for a rising population. Adding desalination plants adds huge costs and huge energy usage, but does not increase the standards of living of citizens. Instead, adding desalination plants simply allows the country to pump less water from its depleting aquifers.
To some extent, the same situation occurs in oil and gas fields. Expensive investment is required, but it is doubtful that there is an increase in capacity that is proportional to its cost. To a significant extent, new investment simply offsets a decline in production elsewhere, so maintains the status quo. It is expensive, but adds little to what gets measured as GDP.
The world outside of Saudi Arabia is now running into an investment sinkhole issue as well. This takes several forms: water limits that require deeper wells or desalination plants; oil and gas limits that require more expensive forms of extraction; and pollution limits requiring expensive adjustments to automobiles or to power plants.
These higher investment costs lead to higher end product costs of goods using these resources. These higher costs eventually transfer to other products that most of us consider essential: food because it uses much oil in growing and transport; electricity because it is associated with pollution controls; and metals for basic manufacturing, because they also use oil in extraction and transport.
Ultimately, these investment sinkholes seem likely to cause huge problems. In some sense, they mean the economy is becoming less efficient, rather than more efficient. From an investment point of view, they can expect to crowd out other types of investment. From a consumer’s point of view, they lead to a rising cost of essential products that can be expected to squeeze out other purchases.
A person might think from looking at news reports that our oil problems are gone, but oil prices are still high.
In fact, the new “tight oil” sources of oil which are supposed to grow in supply are still expensive to extract. If we expect to have more tight oil and more oil from other unconventional sources, we need to expect to continue to have high oil prices. The new oil may help supply somewhat, but the high cost of extraction is not likely to go away.
Why are high oil prices a problem?
1. It is not just oil prices that rise. The cost of food rises as well, partly because oil is used in many ways in growing and transporting food and partly because of the competition from biofuels for land, sending land prices up. The cost of shipping goods of all types rises, since oil is used in nearly all methods of transports. The cost of materials that are made from oil, such as asphalt and chemical products, also rises.