Worldwide food production: no collapse yet

This is a result of some number crunching I did, comparing the amount of cereal grains produced to world population level:

I chose a three year average because the original had huge yearly swings while this gives a reasonably good idea of where things have been heading. It also takes into consideration the fact that cereals can be stored over the long term, which means that high production one year can help service demand the following year.

I chose cereal grains since these are a staple food and indicates generally the potential for future famines (as production decreases).

What it shows is that, so far, there have been no significant negative impacts on world food production in the past 50 years. There was a marked decline between 1985 and 2003 that needs to be explained, but production since 2003 has risen quickly.

The reason for looking at per capita figures (tonnes of grain produced divided by world population) is to see whether or not production levels are exceeding population: It's all well and good for cereal production to increase but it is another thing altogether if population is increasing faster than cereal production.

You can see the effect of the "Green Revolution" between 1963 and 1986.

I created this spreadsheet and graph to see whether or not Peak Oil and Global Warming had affected global food production. So far the answer is that they haven't yet.

A few years ago there were various food riots around the world tied to increasing prices. See here and here. It seems that, in hindsight, these problems were probably a result of local issues arising out of the Global Financial Crisis.

It's also true that grain prices have increased and this is due to increased demand from developing countries like China. Notwithstanding these facts and the consequences of them (richer people increasingly consuming more of the available food than poorer people) worldwide cereal production is still better now than at probably any other time in history.

Sources:

World Population Figures: Source.
Cereal Production 1961-2010 (World total; Cereals total; Production quantity): Source.
Cereal Production 2011-2012 (estimates): Source.

No Peak Now?

Monbiot has given up on Peak Oil:

The facts have changed, now we must change too. For the past 10 years an unlikely coalition of geologists, oil drillers, bankers, military strategists and environmentalists has been warning that peak oil – the decline of global supplies – is just around the corner.

...

Peak oil hasn't happened, and it's unlikely to happen for a very long time.

A report by the oil executive Leonardo Maugeri, published by Harvard University, provides compelling evidence that a new oil boom has begun. The constraints on oil supply over the past 10 years appear to have had more to do with money than geology. The low prices before 2003 had discouraged investors from developing difficult fields. The high prices of the past few years have changed that.

...

There is enough oil in the ground to deep-fry the lot of us, and no obvious means to prevail upon governments and industry to leave it in the ground. Twenty years of efforts to prevent climate breakdown through moral persuasion have failed, with the collapse of the multilateral process at Rio de Janeiro last month. The world's most powerful nation is again becoming an oil state, and if the political transformation of its northern neighbour is anything to go by, the results will not be pretty.

But The Oil Drum says that the Harvard study is flawed:

So, there now comes an Energy Study from Harvard which boldly states that this is rubbish - that by 2020, global production will be at 110.6 mbd and these concerns that most of us have at The Oil Drum (inter alia) are chimeras of the imagination.

...

The amount of oil in the region tapped by the well is finite, and when it is gone it is gone, whether from a vertical well that shows gradual decline with time, or from the horizontal well that holds the production level until the water hits the well and it stops. I am not sure that the author of the report understands this.

...

The report further seems a little confused on how horizontal wells work in these reservoirs. As Aramco has noted, one cannot keep drilling longer and longer holes and expect the well production to double with that increase in length. Because of the need to maintain differential pressures between the reservoir and the well, there are optimal lengths for any given formation. And as I have also noted, the report flies in the face of the data on field production from the deeper wells of the Gulf of Mexico.

More on EV Batteries

I've been doing some more thinking about Electric Vehicles and the battery technology that will drive it to eventually replace internal combustion cars.

In the previous article I pointed out that Electric Vehicle Battery Packs need to have an energy density of around 675 Watt-hours per kilogram (Wh/kg) if they are to have an equal range to today's petrol-powered cars. I also pointed out that the Nissan Leaf - the world's first truly mass-produced electric car - has a battery pack with an energy density of around 131.57 Wh/kg. This means that the Leaf only has an effective range of approximately 117km (72 miles). "Range Anxiety" is truly a problem for Leaf owners - even though the total cost of charging the Leaf is lower per kilometre than the cost of filling up regular cars with petrol (the equivalent fuel efficiency for the Nissan Leaf is 2.4 litres per 100 km - 99 miles per gallon).

As a result of this study, I've done some more number crunching - this time taking into consideration various different types of vehicle. The Nissan Leaf is essentially a "Compact Car" or "C-Segment" vehicle. The other electric car that is dominating the EV market is the Mitsubishi i-Miev. The i-Miev is different to the Leaf in that it is a "Subcompact" or "B Segment" vehicle (also known as a Kei Car). This means it has a smaller engine (47kw compared to 80kw in the Leaf) and is lighter (1080kg compared to 1521kg). Thus the cars can't really be compared.

So what I did was examine the various different types of cars and work out just how much battery density needs to increase before the range of that particular vehicle class can be effectively equaled by an EV.

The image from my spreadsheet is too large to post here, so click here to see it directly. I obviously need to explain it, so have it open in one tab while looking at this page and flick between them.

Each different column colour represents a vehicle class. We have Subcompact / B Segment all the way up to Full SUV / J Segment. In each of those columns I have also included a base vehicle to use by way of comparison. Since we recently bought a VW Caddy, I decided to stick pretty much with Volkswagens as far as possible, with the notable exception of the Australian Ford Falcon and Range Rover. Each of these vehicles is given a fuel economy figure in Litres per 100km (to convert to mpg, click here). I've also included the size of each fuel tank, in both litres and in weight, as well as in kilowatt hours of storage. The cars I used all had petrol, not diesel, engines.

Column B shows energy storage in Wh/kg. This assumes that, as technology improves, more and more power is able to be stored in an EV battery.

All those numbers from column 9 downwards, and from column D onwards, are the range (in kilometres) of each vehicle class according to the energy storage numbers in column B. The most important cell in this section, and the spreadsheet, is F19, showing 117km range at 131.57 Wh/kg for a compact car. This is the base figure for the Nissan Leaf that I mentioned above and in my previous post.

The important figures are shown there in bold. I'll dot point them here:

• Subcompact (VW Polo): 600 Wh/kg for 600km range.
• Compact (VW Golf): 675 Wh/kg.
• Mid Size (VW Passat): 785 Wh/kg
• Compact SUV (VW Tiguan): 950 Wh/kg
• Full Size (Ford Falcon): 1100 Wh/kg
• Mid SUV (VW Toureag): 1300 Wh/kg
  
• Full SUV (Range Rover): 2800 Wh/kg
  

As you can see, it is obvious that 675 Wh/kg may be enough to completely control the Subcompact and Compact markets, but as soon as you take bigger vehicles into consideration, the energy density needs to be higher. And this shows how the market will react as time goes by: the smaller, lighter vehicles will become more dominated by EVs than the bigger, heavier vehicles.

I've also placed another figure to look at: the energy density needed for the vehicle to have a range of 1000km. This is an important figure (though arbitrary) that will affect EV design. If we assume, for example, that battery energy density reaches 1300 Wh/kg (and thus control the mid sized SUV market), what would happen to the subcompact market? Well according to the spreadsheet, such a vehicle would have a range of 1300km, more than twice what is probably needed. When this occurs, it is very likely that EVs will have less space dedicated to battery packs and more space dedicated to other aspects, such as greater boot space and leg room. Thus the cars will have an ever increasing usability.

This is not outside the realms of possibility. Think about the battery packs needed to power your mobile phone or laptop - they have been decreasing in size and increasing in energy intensity for some time. The same should be true for EV battery packs.

Now the second part of the graph needs some explanation. It is essentially the application of Moore's Law to battery technology in column B (column C is the multiplier for the spreadsheet, so ignore that unless you wish to check my figures - which you are welcome to). Moore's Law, in this case, assumes that battery energy density will double every two years. If we take this year (2011) to be the year when battery packs of 131.57 Wh/kg are currently available to the market (ie the battery packs for the Nissan Leaf), then you can see the sort of battery energy density that could be theoretically available as years go by.

If we take...

• a range of 300km to be the sort the market will respond to positively (and thus begin to be competitive with petrol driven vehicles),
  
• and if we see a range of 600km to be the sort that will completely control the market (and make petrol driven vehicles obsolete),
  
• and a range of 1000km to be the point at which these vehicles begin to reduce the amount of space needed for battery packs (and thus increase usability by having more space),
  
• and if we apply Moore's Law to battery technology...

...then we will see the following:

• Subcompact EVs will begin to be used in number from 2014. They will begin to control the market in 2016. They will begin to increase usability from 2017 onwards.
• Compact EVs will begin to be used in number from 2014. They will begin to control the market in 2016. They will begin to increase usability from 2018 onwards.
• Mid-Size EVs will begin to be used in number from 2015. They will begin to control the market in 2016/2017. They will begin to increase usability from 2018 onwards.
• Compact SUEVs will begin to be used in number from 2015. They will begin to control the market in 2017. They will begin to increase usability from 2019 onwards.
• Full Size EVs will begin to be used in number from 2015. They will begin to control the market in 2017. They will begin to increase usability from 2019 onwards.
• Mid-Size SUEVs will begin to be used in number from 2016. They will begin to control the market in 2018. They will begin to increase usability from 2020 onwards.
• Full-Size SUEVs will begin to be used in number from 2018. They will begin to control the market in 2020. They will begin to increase usability from 2022 onwards.
  

Now I don't really know too much about how the car market reacts to new vehicles and how long it takes for them to be taken up by the market, but it is probably likely that 2014-2016 will be the years when the electric car begins to hit world markets in number.

Battery technology is the key to EV Growth

In order for Electric Vehicles to enter the mainstream and compete equally with petroleum powered vehicles, battery technology must improve.

I consider the Nissan Leaf to be the one of the most important electric vehicles on the market today. Unlike the Prius or even the Volt, the Leaf is not a hybrid electric vehicle but a completely electric one. It is powered by an electric motor and energy is stored in the car's battery packs. The Leaf will not need to be "filled up" with petroleum, it needs to be plugged in to ensure that its rechargeable batteries have enough juice to keep the Leaf going.

The problem is that, while the cost of charging a car with electricity is very low compared to the cost of filling up a car with petroleum, the range of the Leaf is disconcertingly small. "Range anxiety" prevents many Leaf owners today from driving their vehicles beyond the normal commute. As a result it is more likely to be owned by people who already own petroleum powered cars that have greater range that they can use when needed. Nissan says that the Leaf's range is 160km but that is a very optimistic figure which does not take into account normal driving patterns: an "eco" mode ensures that acceleration is lower than it could be. In "normal" mode, and taking into account the need for air conditioning, heating, and music, the range of the Leaf is more likely to average out at 117km.

(Such normal driving patterns also lower the range of petroleum powered vehicles as well - it's just that we don't notice it too much because the car's range is still reasonably high).

After consulting the specs of my own comparable vehicle (A Mitsubishi Lancer) I have determined that modern cars need a range of around 600km. This would mean that, in order to properly compete, the Nissan Leaf's batteries would need to store 5.128205128 times more energy than it does currently.

And this is where the engineering challenges can be quantified.

The Automotive Energy Supply Corporation (AESC) is the company that builds the Battery Packs for the Nissan Leaf. Have a look at the specs on their product here.

From these specs we notice a number of things:

1. The Nissan Leaf does not have one battery pack, but 48 individual packs located under the car's floor.
2. According to the Leaf's specs, the total amount of energy stored in these 48 packs is 24 kilowatt hours (Kw/h).
3. Therefore, each battery pack contains, on average, 500 W/h.
4. Each individual battery pack weighs 3.8kg.
5. Therefore, the energy density of each battery pack is 131.57 W/h per kilogram.

So in order for the Leaf to have a 600km range, each battery pack should store 2.56 Kw/h of energy, which means that the energy density of these battery packs must increase to approximately 675 Wh/kg (while assuming no increase in volume).

Of course battery technology is progressing in leaps and bounds - anyone who owns a mobile phone or laptop knows that storage capacity has improved considerably over the last five years. Nevertheless while the technology is moving forward, we need to remember that there is usually a lag between the technology being discovered and its ability to be mass produced at a reasonably low price.

I am quite confident that these technological and industrial goals can be met some time in the next 10-12 years.

Cost of US oil consumption as percentage of GDP

The most recent figure is for 2011-Q2, which comes in at 1.17%.

With oil prices now $20 cheaper than 2011-Q2, 2011-Q3 will likely see a drop.

Methodology:

The average oil price for the quarter is multiplied by oil consumption for the quarter, which is then measured as a percentage of nominal GDP.

Sources:

• West Texas Intermediate, price averaged out for quarterly figure. Link.
• US Oil Consumption, quarterly. Link.
• Nominal GDP, quarterly. Link.

Notes:

• Orange lines represent recessions (annual decline of real GDP per capita)
• Yellow line represents historical average of 0.82% of GDP.

Peak Oil: All signs point to yes

This diagram comes from The Oil Drum:

I was initiated into the world of Peak Oil some time in 2004. Initially I thought it was a bunch of scary tinfoil hat wearing nonsense - partly because some tinfoil hat wearing people were promoting it (not you Dave!). The deeper I dug, however, the more the evidence piled up. The tinfoil hats were replaced by serious looking academics with qualifications from reputable universities and experience working in petroleum geology. They pointed out that data consistently showed that individual oil fields had an oil production rate like a bell curve, and that less and less oil comes out once the "peak" of the curve has been reached  - which usually comes when the oil field is half empty.

The problem was, and still is, that many are under the false understanding that oil supplies will simply run out suddenly. They are buoyed by market reports showing that oil reserves have another 100 years production left in them. Thus they are ignorant of the fact that, when the majority of the world's oil fields reach 50%, worldwide production will drop.

The graph above shows very clearly that this moment has arrived. Depending upon which metric you use, oil production has either reached a plateau now, or reached one about five years ago.

Being an econophile before I understood Peak Oil, I naturally assumed that price signals would motivate the market to increase production. Yet if an increase in production is geologically impossible what happens when demand increases? When supply is constrained and cannot rise to market demands, what happens?

Simple: Production remains the same, while prices skyrocket. The graph above shows this phenomenon so clearly that you would have to be cognitively deficient not to notice. Some time in 2004 the price of oil begins to rise due to increased demand. This demand was not met by an increase in production, as the graph shows. Oil production then simply sits at the same level for some years. Oil producers are literally unable to pump the stuff out fast enough to meet demand. Oil prices double from their 2004 levels. Then they triple. Then they reach a peak in 2008 before demand destruction hits - the Global Financial Crisis.

Since then prices have dropped. But notice that they have begun skyrocketing again.

Many years ago I blogged about a "perfect economic storm" to hit the US. While I didn't know the date I knew that it would happen. I knew that Peak Oil would be the major cause. What I didn't realise was the extent by which the US economy had over-geared itself and when this occurred I became far more worried than I had before. It was as though I had predicted the arrival of the largest category 5 hurricane in history, only to realise that it would be a category 6 hurricane (which doesn't exist of course, but that's not the point).

If there's anyone out there who is still doubtful about Peak Oil, remember this: If an increase in price doesn't lead to an increase in production, then there is something preventing an increase in production. If this phenomenon is experienced worldwide by many different and disparate sources, then production must be limited by more than just human choices.

Scientists have proven the existence of Peak Oil. The evidence is clear and unambiguous. Moreover it has been experienced by the entire world economy for the past 7-8 years. What more evidence is needed?

And until we wean ourselves off oil, the lag on economic growth will continue. Policy decisions needed to be made in 2004 and weren't. They need to be made NOW.

Bigger government is needed for the US economy - OSO's New Deal

This graph from Calculated Risk has been worrying me for a while:

The most noticeable thing about this particular recession is just how long it has taken for unemployment to recover - or not recover as the case is. But this is not an isolated case. The 2001 recession took ages for unemployment to recover, as did the 1990 recession. Obviously something has happened to the US economy that has prevented quick employment recovery even while GDP recovers.

I'm still trying to work out what that is. I have at theory but that will come in another posting.

What is obvious though is that the market is just not creating enough jobs. While the cause might be debatable, the result is not.

But what is needed to fix this is not just another round of stimulus packages. What is needed is a structural expansion of government spending. In essence, the US government needs to spend more.

Of course readers of this blog might wonder if I have changed my mind from recent times when I advocated austerity. The problem is that the word "austerity" has ended up becoming synonymous with spending cuts - which is the favoured position of conservatives. While I have advocated spending cuts in the area of military spending I came to the conclusion that the only way the US could ever hope to cut enough spending to make any difference would be to destroy Medicare or Social Security (and I don't use the word "destroy" lightly - you'd be looking at cuts of over 50% to make any difference). The alternative is to raise taxes - and that is the option I have always promoted. I still define this as "austerity" since it causes pain, but it is not the preferred description of the word in these times.

What I have done, though, is change my position on the market's ability to recover properly. I would've been happy for Obama to cut military spending and raise taxes in order to run a small deficit (at the least) but do little else while the economy stumbles, falls and eventually recovers from my austerity package. Now I realise that the economy wouldn't recover - at least not quick enough to make any difference.

So here's my big government solution:

More government spending.

I would create the following long term or permanent programs:

1. Universal Health Care. This would involve "Medicare for all" and would probably increase the size of government by 4-5% percent of GDP. So you're looking at an increase in government spending from around 25% of GDP to around 29-30% of GDP. This would naturally have the effect of Keynesian stimulus but the result would be healthier citizens - something that would boost the productivity of workers. The increase in spending relative to GDP would be permanent.
   
2. Building a renewable energy infrastructure. This would involve the eventual shutting down of all coal and gas powered power stations and the building of renewable alternatives to replace them. Developing nuclear reactors based on the Thorium & Molten Salt technologies would be acceptable but I can't get over the sheer availability of deep geothermal power: they would be expensive to develop and build but once they're there they will last for many decades. To fast-track the building of these, a renewable energy sector would take at least 10 years to complete. But as we can see from the military buildup during world war 2, all it takes is the will to do it. This would radically reduce America's carbon emissions. An upgrading of America's electricity grid would also accompany this. You're looking at adding another 1-2% of GDP being spent on this over a ten year period.
   
3. Mandate and support an electric car industry. This would involve a legal framework preventing the sale and registration of carbon-emitting cars by a certain date (say 10 years in the future) but would also need substantial government investment in battery technology. The Nissan Leaf, the first real "electric car" sold to the market, still has only a short range. Inventing batteries that hold more power is essential if electric cars are to effectively replace their petroleum or lpg powered competitors. Spending on this program would also build a nationwide network of recharging stations to ensure that no electric car is out of recharging range. Not only would such a program reduce carbon emissions, they would also reduce America's dependence upon oil and mitigate the problem of Peak Oil. Add another 1% to GDP being spent on this over a ten year period.
   
4. Set up a national water grid. This would involve potable water being distributed over all states and towns throughout a national network of water pipes and purification plants. This would ensure that any future droughts in the US (brought on by global warming) would not affect town and urban water supplies. It would theoretically mean water sourced from Seattle finding its way to Texas through this proposed water grid. While this would require a huge amount of work, a lot of the work would simply involve connecting up disparate water infrastructure and bringing standards up to a national level. You could probably add 0.1% to 0.5% of GDP on this over a ten year period.
5. Provide a national child tutoring strategy. This would involve the hiring of personal tutors to deliver numeracy and literacy skills to the nation's Kindergarten,1st and 2nd grade students. Each student would receive one hour of personal tutoring per week at the school they attend during the school year. While this will not have any immediate economic benefit apart from increasing the money velocity, it will eventually produce adults who are better educated and more likely to succeed at employment and less likely to end up in jail. All economic benefits. I'm not sure how much this would cost but you'd be looking at at least 0.1% of GDP being spent on this program on an ongoing basis. Additional tutoring, say in 3rd grade and above, would increase this effect even further.
   

Less money on Defense

America does not need to spend huge amounts on national defense. Of course it is important that some level of defense spending exist to defeat any potential attacker, but I am convinced that the most bloated, most inefficient and most corrupt sector in government spending is in defense contracting. Reducing military expenditure may not even reduce America's military strength, it will make the whole contracting system better.

In fact I would suggest a change in the way the whole contracting thing works. Rather than contracting out to companies who design weaponry and other military items, the government should actually do this themselves. Let's say we want to build the fictional B-5 supersonic stealth bomber. Instead of contracting out the design to Boeing, the design is actually made by government employees working in a government building somewhere. Once the design is complete, they then contract out the parts building to the defense companies - and ensure that common parts can be made by many different manufacturers in order to reward the productivity and profitability that would arise in a competitive environment. The B-5 could even be manufactured by different aerospace companies, with Boeing manufacturing some, Northrop Grumman some more, and Lockheed Martin the rest.

Higher Taxes - especially for the rich and corporations

Alongside this substantial increase in spending should be a substantial increase in taxation. I don't believe that deficits don't matter and there is a need for the debt to be paid down. Since we can no longer rely upon the market to provide enough economic growth to increase tax revenue,  the government will simply have to step in, increase spending and increase taxation. In fact I would argue that the increase in taxes should be substantially higher than any increase in spending. I would advocate not only an increase in spending (outlined above) but an increase in taxes so high that a budget surplus is created. It is expected that any economic pain generated by this increase in taxation would be matched by the economic gain of the increase in government spending (above)

There are many ways to achieve this - one way is to increase the highest marginal tax rate. Another is to introduce a Tobin Tax.

My preferred method of taxing the financial market would be to create a market capitalisation tax: public companies being taxed incrementally on a daily basis according to their market capitalisation (share price multiplied by amount of shares). In fact I would adjust the tax according to the average p/e ratio in order to punish over-investment - if the p/e ratio of the whole sharemarket is too high, then there will be an increase in the market capitalisation tax. If the p/e ratio falls down low, then the tax would also be lowered. This system would not only generate income for the government to balance its finances, but would also act as an "automatic stabiliser" for the financial industry - punishing the market if it approaches unsustainable investment bubbles, encouraging the market if it there is not enough investment.

OSO's New Deal

Of course once the spending I have outlined above runs out over ten years (with the exception of Medicare and the tutor system), we would also assume that government debt would have been paid off by the increases in tax revenue. What then? Well I'm happy, once America has reinvented its energy, transport and water infrastructure, for taxes to drop. Hopefully the success of my "New Deal" would see so much economic and social success that Norquisters, Randians and Supply Siders would descend into obscurity. It would also force political conservatives to be more centralist, where they can be far more effective at promoting non-extremist conservative policies and ideas (conservatism does, after all, still have many considerable strengths once the extremism is removed from it).

So what are the chances of this occurring? Probably none. Rather, I expect the coming downturn to turn people against Obama and vote for a crazy Republican in 2012, ensuring a Republican controlled congress as well. What they would do from there is anyone's guess, but I doubt that any polices they do enact will do anything except make things worse.

US Inflation for February will be big

Here's a screencap of my spreadsheet.

Monthly M0 grew in February by 8.1%, which means an annualised increase of 97.24%.

There are only three other monthly results since 1954 (where my M0 figures begin) when M0 increased faster than this, and that was October 2008, November 2008 and December 2008 during the market panic of that period. Those three months were also beset with some very severe deflation. It was this huge increase in liquidity by the Fed which helped prevent a deflationary collapse. Put simply, the inflationary pressure caused by the increase in M0 was able to balance out the deflationary effect of the crisis.

Since we're not in a similar situation (ie not in an imminent credit crisis), February's sizable M0 increase (the fourth largest in history) would have a large inflationary effect.

On the surface, annual inflation is still benign:

• November 1.1%
• December 1.4%
• January 1.7%

Yet these annual figures hide the monthly results which, annualised, are:

• November 1.5%
• December 5.2%
• January 4.8%

All these figures you can see on the screencap link to my spreadsheet I've given. And if you have checked that out you will also see the notation "QE2" to the far right of the November row. QE2 is, of course, the announcement by Ben Bernanke that the Fed will create $600 billion of money by fiat and use it to buy back government bonds.

Oil prices have popped up, partly due to Libya but mainly due to supply issues (ie Peak Oil), which means that the inflationary effect of QE2 will run straight into the inflationary effect of high oil prices. Bad news for the recovery.

Another graph proving Peak Oil

Take a look at this graph from The Oil Drum:

Those in the past who deny Peak Oil have tended to do one of two things. The first is to attack the actual science behind it, trying to disprove Hubbert's Curve. The second is to argue that there is plenty of slack within oil productive countries to meet demand. What the graph shows is that neither of these are true.

One of the basic tenets of economics - in fact the basic tenet - is that of supply and demand. If demand increases, so should price; if supply increases, prices should drop. What we see in this graph is that from about 2003 onwards, demand for oil was not met by supply. Despite the myriad sources of oil supply all over the world, not enough oil was produced to keep prices down. Between 2003 and 2008, prices essentially tripled. Yet over the same period, supply hardly moved.

So if Hubbert's Curve was wrong, and oil reservoirs can just keep pumping out as much oil as is needed, then why didn't oil producers simply increase production between 2003 and 2008? Moreover, why hasn't production increased since 2005?

And if there is plenty of slack for oil producers and so many new oil projects up and running to take advantage of the high price of oil (which is still historically high despite the worst recession since the 1930s), then why isn't production increasing?

This graph seems to clearly indicate that not only was the theory of Peak Oil correct, but that the peak has already occurred - in 2005.

The Limits of Climate Scepticism

Occasionally The Economist gets it right:

I woke up the other morning to find that I would have to confront yet another headache-inducing attempt to phase-shift my perception of reality, and that this would require wading into historical accounts of the collection and homogenisation of temperature data. On December 8th, a climate-change sceptic named Willis Eschenbach posted what he called the "smoking gun" of climate change data manipulation: a series of graphs of the uandjusted historical record of the temperature-monitoring site at the airport in Darwin, Australia, plotted against the same data as adjusted for various error factors ("homogenised") by the Global Historical Climate Network, or GHCN. Mr Eschenbach claimed the adjustment was so arbitrary, it had to be evidence of intentional manipulation.

(and then, after a lengthy piece exploring the evidence and dismissing Eschenbach's claims)

So, after hours of research, I can dismiss Mr Eschenbach. But what am I supposed to do the next time I wake up and someone whose name I don't know has produced another plausible-seeming account of bias in the climate-change science? Am I supposed to invest another couple of hours in it? Do I have to waste the time of the readers of this blog with yet another long post on the subject? Why? Why do these people keep bugging us like this? Does the spirit of scientific scepticism really require that I remain forever open-minded to denialist humbug until it's shown to be wrong? At what point am I allowed to simply say, look, I've seen these kind of claims before, they always turns out to be wrong, and it's not worth my time to look into it?

Well, here's my solution to this problem: this is why we have peer review. Average guys with websites can do a lot of amazing things. One thing they cannot do is reveal statistical manipulation in climate-change studies that require a PhD in a related field to understand. So for the time being, my response to any and all further "smoking gun" claims begins with: show me the peer-reviewed journal article demonstrating the error here. Otherwise, you're a crank and this is not a story.

I couldn't have written it better myself. It's a pity that The Economist doesn't have the same sort of attitude towards Peak Oil.

Windy weekend in Spain delivers record amount of renewable energy to grid

Da Guardian:

Wind energy provided more than half of Spain's total electricity needs for several hours over the weekend as the country set a new national record for wind-generated power.

With high winds gusting across much of the country, Spain's huge network of windfarms jointly poured the equivalent of 11 nuclear power stations' worth of electricity into the national grid.

At one stage on Sunday morning, the country's wind farms were able to cover 53% of total electricity demand – a new record in a country that boasts the world's third largest array of wind turbines, after the United States and Germany.

For more than five hours on Sunday morning output from wind power was providing more than half of the electricity being used. At their peak, wind farms were generating 11.5 gigawatts, or two-thirds of their theoretical maximum capacity of almost 18GW.

The new record, which beat a 44 % level set earlier last week, came as strong winds battered the Iberian peninsula.

The massive output of wind turbines meant the Spanish grid had more electricity than was needed over the weekend. In previous years similar weather has forced windfarms to turn turbines off but now the spare electricity is exported or used by hydroelectric plants to pump water back into their dams — effectively storing the electricity for future use.

That last sentence is important - energy was stored. Although wind and solar energy is dependent upon atmospheric conditions, if enough electricity is generated then excess power can be stored. Pumped-storage hydroelectricity is a mature technology that has been used all over the world for decades but is dependent upon good locations for a hydroelectric dam. Other energy storage solutions include Flywheel energy storage, (in which excess energy is turned into mechanical energy which then drives a generator when energy is needed) Hydrogen storage (in which excess energy is used to turn water into hydrogen and oxygen through electrolysis, which is then turned back into electricity via a fuel cell) and Thermal Energy Storage (in which molten salt is heated directly by the sun and the heat used to drive a steam turbine during both day time and night time). None of these solutions prevents a loss of energy, but neither does the pumped-storage hydroelectricity that we have used for decades.

The more renewable energy a grid takes on, the greater will be the need to develop energy storage for the grid.

All things being equal

As a predictor of economic and financial gloom it is always tempting and wonderfully schadenfreude-like to say I told you so. In fact, I did this the other day.

But I've got to admit that I did not expect the current crisis to freeze out the credit markets as quickly and as terribly as it has done. My feeling over the past few years has been that the coming recession would be a gradual affair with many stops and starts. I predicted that the driving force behind the slowdown would be Peak Oil, and that the effect of declining oil production would lead to a Depression-like economic hit - though with a difference. What was this difference? Not much deflation, no severe decline in GDP and no big unemployment spikes beyond 20%. Instead, we would see a severe restriction in economic growth over a long period which would see unemployment levels being persistently high but without spiking. Probably the best post I made about this subject was back in March.

Yet somehow my prediction was too conservative. It seems like the US economy was much more fragile than I thought, and the current crisis seems to be leading into a more 1930s type depression with big falls in GDP and big spikes in unemployment.

One of my favourite little phases that I have created is "All things being equal - but all things are not equal". This is, in a sense, a way of describing a "Salient Oversight" - a part of the equation that has been missed. That I should be guilty of a salient oversight is wonderfully ironic.

So what is this salient oversight that I had missed? It began a little over two months ago when I saw this graph:

I even posted about it here.

The first time I saw that graph it frightened the heck out of me. It still does. The reason is not because it somehow disproved my basic belief that Peak Oil would create a horrible depression. Rather, it showed me that the US economy was ripe for disaster anyway.

Let me explain the issue with this graph. The graph shows that US credit market debt exceeds GDP by around 350%. The fact that credit markets have debt levels that exceed GDP is obviously not always a problem - the 1950 to 1980 period never saw credit market debt increase or decline precipitously despite a series of recessions and periods of high and low inflation.

But then, of course, we see the 1930s spike. That spike did not cause the great depression - it was a result of it. Moreover, credit market debt increased during that period not because people were borrowing lots in that period (the opposite in fact), but because GDP was declining while debt levels slowly increased.

And then we see the exponential curve from 1985 until today. By itself, any exponential curve should warn us of terrible danger. The lesson? The US economy was ripe to collapse. The high oil prices from 2004 onwards - brought about by production plateaus being reached as a precursor to oil supply peaking - and the subsequent interest rate hikes was what eventually set off the current crisis.

Back in 2005 I predicted that there were four things which which would create a "perfect economic storm" that would severely damage the US and world economy. These were:

1. Peak Oil
2. US Government debt
3. The collapse of the housing bubble (now referred to as the subprime meltdown)
4. An unsustainable current account deficit
   

In retrospect, the enormous amounts of credit market debt were not a 5th reason I should've added. This is because reasons 3 & 4 - the housing bubble and the current account deficit - were integral parts of the credit market debt. As the curve continued exponentially upwards and the credit market continued to create massive levels of debt, a housing bubble formed along with the desire of the market to invest in US Dollar assets (which led to a current account deficit).

But as I have mentioned before, none of this has removed the threat of Peak Oil. Instead, it has made the situation intolerably worse. Peak Oil was always going to cause a massive economic shift - but that it should occur during a time when the world's economy was already at a turning point is a horrible convergence of events. In many ways I feel like the forecaster who predicted a category 5 hurricane and the deaths of thousands, only for the hurricane to be category 6 (if that were possible) and cause the deaths of tens of thousands.

So now that I am even more gloomy, what will happen?

It is obvious that the current economic crisis will result in a substantial contraction in world economic output. This crisis was of its own making but was set off probably earlier than expected because of high oil prices that were the direct result of oil production plateaus. The economic contraction will inevitably result in a drop in demand for oil, but the danger posed by Peak Oil still remains. Once the world economy begins to recover, oil production issues will stifle growth and economic expansions will be severely limited. Unemployment levels are likely to spike high in places, and in the US I believe that unemployment levels in the "teens" is likely. Moreover, while a recovery will result in employment growth, the continued high oil price of oil will keep unemployment levels uncomfortably high for many years.

Again, the only solution to this is for the US and other countries to follow the austerity guidelines of the Washington Consensus that I have posted about here. Moreover, in order to wean ourselves off oil dependence, nations must invest in public transport and in the design of electric road vehicles.

And as for you, the reader, I simply suggest that you pay off debt as fast as you can and live within your means.

No gas in Charlotte, North Carolina

From the Charlotte Observer:

Much-needed fuel appears to be on the way to the western Carolinas, including Charlotte, even as honking rush-hour commuters idled in lines and occasionally fought at stations that weren't out of gas.

At least one man was charged with pulling a gun during a dispute at a gas pump, police say.

Witnesses told Taylorsville police that Todd Lackey pointed a .45-caliber handgun at another driver after they pulled up to a pump at the same time and started arguing. Lackey fled, but witnesses got his license plate number and police later charged him with assault by pointing a gun.

Earlier Thursday, a deputy director for the U.S. Department of Energy told local officials that a large shipment of gasoline should arrive in Asheville and Spartanburg, S.C., today and "an extremely large shipment" in Charlotte tomorrow, Charlotte Mayor Pat McCrory said.

During a news conference at the Government Center uptown, McCrory said he had spoken to Energy Department Acting Deputy Secretary of Energy Jeffrey Kupfer, who told him about the shipments.

Motorists in Charlotte have waited in line for hours over the last two days as fuel shipments dried up because Gulf hurricanes temporarily disrupted refinery production. Rush hour commuters in Thursday afternoon traffic slowed down as they passed gas stations, looking for tell-tale bags on the pumps.

Many of the stations ringing Charlotte's uptown were out of gas. On South Boulevard at Ideal Way a small Shell station was crammed with cars that were lined up for blocks waiting, clogging traffic, honking and slowing the afternoon rush.

Update:
Here's a US gasoline supply graph from The Oil Drum:

We told you so (sadly)

Econ bloggers like myself have been saying for years that a big crash was coming. This sort of prediction was not the sort of thing you would find in the deepest, darkest corners of the internet amongst conspiracy theorists and DIY economists - rather, it was the result of study, thinking, logic and discussion.

As a result, we Cassandras (the red headed lady you can see in the picture) have been cursed with the knowledge of the future without the means to convince anyone who mattered.

My own prediction came about in August 2005. In that prediction I spoke about a "perfect storm" (a phrase that was not used as often as it is now of course) which included four main points:

• A housing market crash.
• A US Dollar crash.
• Rising oil prices caused by peak oil.
• Government debt becoming unsustainable.

It would be nice to think that I was the only one saying these things, but credit where it's due - a whole host of doomsayers were discussing these issues before I took them up. But, as far as I know (and this is self-promotion time), I was the only one to put them all together.

And it's annoying because if I had the means I could have made myself quite rich if I had invested enough money into markets I knew would be affected. Back in 2004 when I first understood Peak Oil I was kicking myself with annoyance that I didn't have the means to purchase shares in oil companies that I knew would shoot up as Peak Oil got worse.

And it's annoying also because people in power were totally ignorant of the dangers. Take Ben Bernanke - in July 2007 he was assuring everyone around the world that the subprime bubble was contained. One month later the market tanked and since then the world has been in perpetual economic crisis. Why is it that people like Bernanke get to be in well paid positions of power while Cassandras like myself, who saw the coming storm, get ignored.

As soon as Bernanke dropped rates last year I made the prediction that oil would go beyond $100. In January of this year I predicted that the US would be stagflating. In March this year I even proposed my own version of The Big Bailout^TM that has since become rather important.

The reason why I posting this is that I'm feeling rather cheesed off. I don't like the fact that the world is about to go through the Second Great Depression^TM. I don't like the fact that people are losing jobs and going through emotional and financial stress, leading to marriage breakdowns, suicide and crime. I don't pretend to hope for a utopia but I I unashamedly believe that good policy and foresight can help limit the damage caused by human stupidity.

So there is no schadenfreude, no gleeful shouts of joy over rising bankruptcies, rising unemployment and economic decline amongst us economic Cassandras. Only head shaking and annoyance.

What if?

One of my great fears is that this current economic crisis will lead to a crash in the value of the US Dollar. This is something I have been predicting since at least 2005 and now seems more certain than ever.

Of course, what prompts me to write this is the recent drop in the US Dollar. Is this the beginning of the end? I honestly don't know. The thing about predicting economic trends the way I do is that the event occurring is more certain than when it occurs. The US Dollar may jump back up to last week's levels in the next 24 hours, but the downward trend is more likely to occur at some point than any time before. It's like geologists making predictions about earthquakes or volcanic eruptions - the signs are all there that it will happen, but the actual time and date is unknown. When it comes to the US Dollar crashing, the same principle is in effect.

So, assuming I am correct, what will happen to America after the Dollar crash?

1. Economic decline - even more.

It's hard to imagine, but the most obvious effect of a currency crash is economic decline. In normal circumstances this would be bad enough, but, if judicious economic and financial analysts are to be believed, America is already facing the worst economic conditions since the Great Depression. The subprime bubble has spread financial contagion all throughout the US. Big companies are going bankrupt, the sharemarket is volatile and unemployment is rising. And that is all happening before a dollar crash.

If and when the dollar crashes, the effects of the crash will reverberate throughout the economy. While the current credit crisis is hitting mainly financial firms while manufacturing and services take some serious collateral damage, a crash in the dollar will heighten these effects. Banks and financial firms that could have been saved from bankruptcy won't be saved. Firms that could've survived battered and bruised will go under. People who would've been able to keep their jobs throughout the original crisis will lose them. A dollar crash will take the damage already done and make it worse.

In terms of official statistics, you can already see GDP reclining. 2008 Q3 will most likely see economic decline when the stats get released in October. Unemployment, already at 6.1%, is likely to increase. But a dollar crash will make these worse. GDP will continue to decline for 2 or more quarters after the dollar crash, and unemployment will continue to rise.

As I have pointed out above, economists and financial analysts see this crisis as being the worst since the Great Depression. This means that unemployment is likely to reach, at the very least, the levels of the early 80s recession - 10.8% in November and December 1982. Now add to this the dollar crash and you can add a few more points to that level. Unemployment of 12% or more is likely.

2. Inflation and the policy problems that follow it.

The most obvious effect of a dollar crash will be a substantial increase in inflation. The United States is a consumer-based economy rather than a producer-based economy. This means that much of America's economic life depends upon the consumption of imported goods. If and when the dollar crashes, the price of all goods and services will increase.

A dollar crash will make imported goods more expensive to import. Americans will therefore find that everything from gasoline to teddy bears will begin to cost more.

Debate still rages over whether this crisis will lead to increased inflation or deflation. The "Deflationistas" - those who believe that prices will drop - argue that a credit crunch of the sort we are experiencing has historically led to deflation, that is, falling price levels. These people are actually correct in a sense, as any economic contraction leads to lower levels of demand for goods and services, which will inevitably lead to downward pressure on prices. Unfortunately, these deflationistas don't take into account something as serious as a crash in the dollar. If the value of the US dollar is ignored in calculations, then deflation is a natural conclusion for those who are studying the current credit crisis. The problem is, though, that recent history - namely the 1997 Asian Economic Crisis and the 1998 Russian economic crisis - shows that any credit crisis in economies with floating currencies (ie, currencies that are traded in the marketplace and change in value accordingly) eventually leads to capital flight - a situation in which people take assets and money out of an economy in order to invest it in another. What happened in 1997 and 1998 was that investors ran from Asia and Russia and invested in the US Dollar.

So, in the midst of the worst financial crisis in over seventy years, a dollar crash would inevitably lead to upward pressure on prices- namely, inflation. What these inflationary levels might become depends upon how far the currency crashes - the more the currency crashes, the higher inflation will get.

In the midst of this situation, what can the government do? Very little I'm afraid. The only government institution charged with the task of controlling inflation is the Federal Reserve Bank. Faced with a dollar crash and spiralling inflation, what would the Fed do? Standard monetary policy is for central banks to raise interest rates to control inflation. In the past, the Federal Reserve has indeed lifted rates whenever inflation began to worry them.

The problem with raising interest rates is that, while it ends up controlling inflation, it also acts to dampen economic activity. If the Federal Reserve should raise rates in response to inflation brought about by the dollar crash, the effect upon an already deteriorating economy would be devastating. Yet to keep rates low and to endure inflation in the hope that the economy might be given a chance to recover is a process which has historically never worked - the 1970s, for example, saw central banks all over the world ignore inflation and focus on employment and economic growth. Despite this, neither the economy nor levels of employment nor inflation were ever fixed. It was only until Paul Volcker bit the bullet and killed off inflation with high interest rates in the early 1980s that inflation, economic growth and employment ended up getting fixed. In other words, the only way for central banks to improve economic conditions and levels of employment is to focus solely upon inflation. In our particular situation, with a potential dollar crash looming, the only thing the Federal Reserve Bank could do in response is to raise rates.

I need to reiterate: There is nothing that the President, Congress or the Federal Reserve Bank can do to solve this problem. The only thing they can do is to limit the damage and remove the policies that caused the problem in the first place. As I have mentioned before, the only thing that the Government can do is:

• Cut military spending
• Raise taxes on the rich
• Run a budget surplus and pay off public debt
• Use interest rates to keep inflation low
• Regulate the financial industry with more common sense laws
• Fire Ben Bernanke
  

As I said, none of these things will solve the crisis, but they will give a better grounding for the eventual economic recovery.

I would also add to this list the following:

• Institute a Universal Health Care system, and raise taxes to pay for it.
  

I don't put this here just because I'm a pinko commie subversive, but because it also makes economic sense. The United States of America could cut its total health care costs by one third if it instituted a Universal Health Care system similar to those already in operation in other Western nations. The US spends around 15% of GDP on health care while comparable Western nations spend around 10% of GDP and have the same - if not better - health outcomes. Cutting health care costs by deprivatising and regulating the health industry will have enormous social and economic benefits.

3. A Current Account Surplus as America recovers.

Although I often joke that a dollar crash will be "financial armageddon", I know that things will eventually turn around. Even the great depression ended, although those who suffered through it thought it might never end. The same is true in this case. The current crisis added to a dollar crash will cause some very serious economic damage, but a recovery will naturally follow (although the speed of this recovery might not be as fast as people hope).

One thing that will happen as America - and the world - recovers from an economic disaster and dollar crash is that the US will eventually become a net exporter. Moreover, the United States will eventually end up running a current account surplus. This will be the natural effect of a dollar crash.

If and when the US Dollar crashes, one result will be that American goods and services - even manufactured goods - will become more competitive on the world market. While the dollar crash will naturally hurt every part of the economy, international demand from US manufacturing will increase. America's economic recovery will be in many ways due to an increase in demand for American goods. Instead of being a consumer nation, the US will become a producer nation after the dollar crash.

Moreover, it is also likely that the world's producer nations - especially those who have run massive trade surpluses like Japan and China - will end up becoming consumer nations. This will be because the dollar crash will end up overturning current trade balances. It may seem strange to believe that Japanese consumers might end up buying US manufactured goods, but, if a dollar crash occurs then the natural corollary will be a rise in the value of the Yen and other world currencies. When a currency rises, imported goods become cheaper to buy and exported goods become more expensive to sell.

4. A New International Economic Order.

One eventual result of this crisis will be a new economic world order. I'm not talking conspiracy theories or a one world government here, I'm talking about a more integrated world economy in which trading nations agree to abide by treaties that will determine what sort of policies are implemented in national economies.

Such treaties already exist. Supranational entities like the United Nations, the World Bank, the International Monetary Fund and the World Trade Organisation all exist as a way of creating and developing international co-operation in economic areas. An even more advanced supranational entity - the European Union - has even greater power over how member countries may run their affairs.

For anyone who insists upon national sovereignty, such entities are despicable and evil. For those of us who know just how important common rules and policies are for international economic well-being, such entities are exceptionally important (although certainly not perfect).

The importance of any future economic agreement rests upon the damage done at present. Although the US is a sovereign nation and its economic downturn is entirely its own fault, the damage that it will create will spread around the globe. No nation linked in with the world economy will escape damage, although it is clear that the US will be the nation most badly affected. Given that this is the case - that one nation's economic stupidity can lead to economic pain for all nations - economic treaties and agreements will be put in place to ensure that all nations who participate in the world economy follow "the rules" to prevent their own contagion from affecting everyone else. One aspect of this agreement may be common monetary policy, whereby central banks will pursue the same goals, such as having common inflation targets. Another agreement may be universal rules applied to financial sectors, which would not only prevent economic problems in one nation, but in all nations who are part of the treaty. In America's case, accounting principles would be better suited following international rules rather than the homegrown American ones.

Conclusion

For some, a dollar crash will lead to financial armageddon. But, just like in the Great Depression, the United States and the rest of the world will recover and learn from the mistakes that were made. Unemployment may sky-rocket and the economy may decline, but they will both recover eventually.

Unfortunately I'm not as confident as I could be at this point. Peak Oil will make it very difficult for economies to recover over the next 10-20 years, while Global Warming won't stop just because humans have had some economic problems. Both of these issues will require much thought and changes in economic and social behaviour - changes which will cost but which are necessary if people's lives are to be saved. Moreover, the economic and social challenges posed by both Peak Oil and Global Warming need a workable economy to be faced.

An open wager with T. Boone Pickens

Dear Mr Pickens,

Just recently you stated to the media that you expected oil prices to return to record levels by the end of 2008.

Sir, you are a man who sticks by his word, so I would like to make a wager with you if that is at all possible. Why? Because I think your prediction will be dead wrong.

Mr Pickens, you are a man who has spent decades making billions of dollars out of the oil industry. I, on the other hand, am a 39 year old self-taught economist who works as a substitute high school teacher.

Nevertheless, I believe that you are dead wrong on this, and I would like to challenge you to a wager.

I have stated on this blog recently my belief that oil prices will drop below $100 within the next 12 months. I stand by this prediction, even though it disagrees with yours.

As a result, I would like to make a bet with you on this matter. The bet will go as follows:

• In order for T. Boone Pickins to win the bet, the price of West Texas Intermediate must equal or exceed $147.28 per barrel on or before December 31st, 2008.


• In order for One Salient Oversight to win the bet, the price of West Texas Intermediate must be below $100 at any point on or before December 31st, 2008, and must never equal or exceed $147.28 during that period either.


• If West Texas Intermediate prices neither drop below $100 nor equal or exceed $147.28 on or before December 31st, 2008, then neither individual will win the bet.

I'm trying to work out an appropriate amount. I'm willing to place US$100 on the line. I will leave it up to you to determine your own amount.

Yours sincerely,

Neil Cameron
aka "One Salient Oversight"
Newcastle, NSW, Australia

Peak Oil and Blood Pressure

When you have your blood pressure taken, you might recall that the doctor/nurse taking it reports as, for example, "120 over 80", or "110 over 70", or, if you're dead "0 over 0".

The two numbers that are given represent your blood pressure at two different moments in time. The first measurement, which is always higher, is called Systolic. The number given represents your blood pressure at the beginning of the "cardiac cycle". In other words, it measures blood pressure at the point when your heart beats. The second measurement is called Diastolic, and measures what your blood pressure is when your heart is not beating - that is, when it is in between beats.

So, you have two measurements - one when your heart is working at maximum output, and one when your heart is at rest in between one beat and the next.

Now as far as I understand, while both levels are important in measuring whether a person's blood pressure is healthy or not, the presence of high diastolic (ie at rest) blood pressure is a rather serious problem. The idea that a person's blood pressure may be too high while the heart is at rest is an indication of serious problems with their health.

So, what's this got to do with Peak Oil? Well, allow me to make the following important assertion:

The economic stress caused by Peak Oil will not be quantified by how high oil prices rise, but by how low oil prices don't drop.

Okay, so the allegory goes like this: Oil prices are like blood pressure in that the record price of oil ($147.27 on 11 July 2008) represents a systolic price - the maximum price of oil that the market is willing to pay under current economic conditions. But, with the clear presence of demand destruction caused by current economic strains (including the effects of high oil prices and the subprime meltdown to name just two), the price of oil is now dropping.

But, just as a diastolic reading can be too high, so can the price of oil when it falls. If Peak Oil is true and there is a geological limit to how much oil can be extracted, then it stands to reason that this will not just create record high oil prices, but also oil prices that are too high when demand has fallen.

(Of course, as Neil from the Young Ones points out, "some metaphors don't bear close resemblance". One problem with the allegory I am using here is that low blood pressure is a serious health risk too, whereas extra low oil prices are an economic benefit, all things being equal.)

This problem was brought home to me today by a post from The Energy Report titled "Rider of the Storm":

It seems like Mother Nature is the only thing supporting this market as demand destruction might have more long term impact on the market than anything Gustav can throw at us. Even after Katrina oil demand dropped and so too did prices....

Take for example the news from the Energy Information Agency that revised downward its June oil demand by a stunning number. The EIA said that US oil demand in June was 793,000 barrels a day less than previously reported. That is down a whopping 1.17 million barrels a day from the same period a year ago and the lowest level for any June since 1998. That comes out to be 5.6% less than a year ago....

What is becoming clear to the market is the demand pullback in the US is rising to the level of historic proportions. Even the EIA is now saying that the drop in demand should send oil below $100 a barrel. The Chief of the EIA, Guy Caruso, said that prices could fall below $100 a barrel on slowing global demand and rising production in the US, Brazil and Canada, and from OPEC states such as Saudi Arabia and Angola. While Caruso said "most of the risk is on the upside," and that it was not the official EIA prediction but added that a scenario of falling oil prices is "now closer to 50-50" if worldwide spare production capacity continues to increase from the current 1.5 million barrels per day (b/d) to 3-4 million b/d while global oil demand softens. Caruso then says that that scenario is now more realistic than any time in the past five years.

(h/t Naked Capitalism)

That's a pretty serious revising of figures. What it indicates is that high oil prices in the last 12 months have caused major shifts in market behaviour in the US economy. Not only are people buying less vehicles, but people are driving less. We are now seeing the natural result of high oil prices - a drop in demand. This is a classic economic phenomenon - when demand begins to outstrip supply, prices rise and demand drops. This is the sort of phenomenon even economists in the 19th century were well aware of.

Back in the early days of Peak Oil awareness (say, 2004 or so), it was very common to read articles by peakniks declaring that oil prices could actually rise to over $100 per barrel. At the time they were laughed off as cranks and idiots (me being one of those who laughed derisively at the prediction). Well, of course, the peakniks were right and no one's laughing now.

Even so, back in those days were some rather extreme peakniks who did start flirting with the idea of $1000 per barrel. These extreme peakniks (of which I vaguely remember and thus have no direct link to back up my assertions) were probably quite unaware of economic factors like demand destruction. Fortunately, as Peak Oil began to grow in public awareness, its ideas matured as judicious experts began to critically examine both the realities of geology (Hubbert's Peak) along with basic economic theory. "Demand Destruction" therefore became a mainstream idea amongst Peakniks in the last 2 years, and this has, again, been borne out by the data just released by the EIA.

Back in July I stated that I expected that oil would drop below $100. I am now even more firm in that idea and if oil breaks below the $100 barrier this year I will not be surprised at all. Demand destruction (America and other countries using less oil) will result in a drop in the oil price.

But, of course, that is expected. Even without accepting Peak Oil, a lowering in the price of oil was always going to occur. Peak Oil ignorant commenators and "experts" will probably use this latest report to prove their assertions that the high price of oil is merely the result of "speculation" and can be lumped together with the entire commodities market. In their minds, oil and commodities will, at some point in the next few years, return to "normal" levels.

So, same data, different conclusions. But it will be the next two years that will vindicate Peakniks - not by some magical rise in the price of oil back to $149 per barrel again, but by the stubborn refusal of the market to lower the real price of oil back to pre-2004 levels.

So what will the price of oil be? That depends, of course, in just how far the world economy contracts. A real price of $40 per barrel may actually be reached again - but this price will still be too high for the market to consider reasonable. And when the world economy begins its recovery (as is inevitable), then any increased economic activity will be severely limited by relatively high oil prices occurring again. And these prices don't have to be up around record levels to stunt any recovery - they may still be below $100 to make life difficult for the market.

It may well be that $147.27 per barrel remains the permanent oil price record. While this may be a long way away from $1000 per barrel predictions which floated around Peakniks back in 2004, and even a long way from the $200 per barrel mooted by some experts recently, it will not somehow prove that Peak Oil was wrong. The market will always price goods and services by taking many factors into account. The world economy in 2007 may have been able to continue when oil prices reached $75 per barrel, but may not be able to handle a $75 price in 2010, even when taking inflation into account.

So, to summarise my prediction - I predict that oil will drop below $100 in the next 12 months, but remain too expensive for the market to be happy with over the next 3 years.

And that, of course, will keep the diastolic blood pressure of the economy at dangerous levels.

No way out

I just viewed this disturbing graph at Mish, which he got, in turn, from the Telegraph.

Now I like Mish. I think he's wrong on inflation but he's pretty much right about everything else. Moreover he's a serial pessimist like myself.

Mish's opinions of what is going on are worth reading. In regards to the US Broad money supply in this graph, he says this:

I have been talking about this all year. The bottom line is that one has to look not only at what M3 is doing, but why it is doing it. Nearly everyone got this wrong.

M3, of course, is a measure of the total amount of money churning around an economy. Money is created by a central bank (in this case, the Fed) and then created by the commercial banks who take it in as deposits and lend it out and then take it in as deposits again. The process of money creation is known as fractional-reserve banking.

Like any commodity, the amount of money churning around an economy depends upon the forces of both supply and demand. Since commercial banks respond to economic conditions (by either lending money out or keeping it), the money supply is affected by the overall money demand.

What this graph shows us is that money growth in the US has slowed to a trickle - and has dropped drastically since May. Such a sharp drop is indicative of a major economic upheaval - in other words, a recession.

Yet, as Mish is quite happy to point out, such a process is naturally deflationary. There is always a relationship between the rate of inflation and the growth of the money supply. Any reduction in the money supply would therefore have a deflationary effect upon an economy. With this in mind, Mish is convinced that "inflationistas" like myself have got it completely wrong, and that we should be preparing ourselves for an onset of deflation.

But while this is true in theory - and by theory I mean learning the results of hundreds of observations throughout history that have more or less provided empirical instances of it working this way - why is inflation still running so high? Not only is headline inflation running at 5.7%, but the markets were rocked in the last 12 hours by a report showing that producer prices have rocketed upwards by 9.8% over the previous year - an increase not seen in decades.

So, on the one hand, we have a report showing that the money supply is undergoing a severe change, a change that has a deflationary effecy. But, on the other hand, we have consumer and producer price reports that clearly show dangerously high inflation. Moreover, both sets of data depend upon economic activity in the first half of 2008.

So what is going on? Is it the problem inflationary or deflationary?

Sadly, it is neither. When a series of economic shocks hit together as they are now, the effect upon economic growth will be profound.

In a previous post, I created this analogy to describe what is going on:

Imagine you own a house on a flood plain. One day, your house catches on fire. At exactly the same moment, a massive rainstorm hits upriver and causes a flood. You look at your burning house and think "Thank goodness, some water to put the fire out". But the flood is only one metre deep - enough to cause major damage to the bottom half of your house. Meanwhile the top half of your house burns away and no fire engine can get to you to put it out. So the top half of your house burns up while the bottom half rots away underwater.

The fact that the housing bubble is deflationary does not mean that inflation caused by high oil prices fixes it. After all, it is quite possible that house prices will fall greatly while everything else in an economy rises horribly. No, instead we have multiple shocks hitting the economy and no way of mitigating them. The property bubble popping may have flooded your house, but the high oil prices are burning up the roof.

Put another way, if an investment bubble pops at the same time as oil prices go through the roof, the result won't be a balancing out. Instead, you'll have a double shock to the economy while prices remain reasonably stable.

One thing is important to realise when understanding how inflation and deflation can be linked to money supply and money demand, and that is this: Even if the money supply contracts, supply may still exceed demand. In this scenario, both GDP and M3 are contracting, but inflation is rising because the demand for money is falling faster than the money supply.

This is, of course, a nightmare scenario because no policy tool is able to solve both problems at once. Monetary policy's ability to help the economy recover is rendered useless because any tightening of the money supply to reduce inflation will simply result in an even greater economic loss while an expansion of the money supply will result in dangerous levels of inflation. You can't win, in other words.

With this in mind, the only real solution is to wait until the market sorts itself out. Despite the deleterious effect that high interest rates would have upon contracting economies, the only thing central banks can and should do is control inflation. Keeping a lid on consumer and producer prices - even during a stagflationary recession - will not "cure" the problem but will help to limit medium-term economic damage. On the other hand, nations which have low levels of net public debt (ie not many of them) could probably afford to increase spending and run deficits to boost aggregate demand.

Unfortunately, this is what I believe is occurring now. This is why growth in M3 is dropping sharply while inflation is rising sharply. We're not undergoing one economic shock, but two or maybe even three at once - and while one shock results in deflation, another shock results in inflation. And while it is entirely possible that the inflationary and deflationary effects may cancel each other out, the effects of a double or triple shock will devastate economic growth.

No. There is nothing we can do except to learn from our mistakes. We can't solve the current crisis through monetary or fiscal intervention so we need to limit the damage while letting the market sort itself out over time (a painful period which may take years). In order to prevent this sort of event occurring again would probably require a combination of much stricter monetary policy (which would have prevented an investment bubble from forming) and foresight into understanding any supply limits for essential goods (such as the peaking of crude oil production).

Lessons from Italy and Australia

If the United States is to avoid a long term fiscal disaster, it needs to learn from other nations. America cannot continue to ignore the lessons learned from other countries in the blinkered belief that manifest destiny or divine intervention somehow makes it different from the rest of the world and not subject to the same set of rules.

Now usually when I say this sort of thing I am often pushing forward something wonderful that is present in non-American countries that America could use. Universal health care, increased public education and stricter gun laws come to mind here.

This time, however, I am going to use a negative example as well as a positive one. Rather than just showing America what it could become if it does the right thing, I am also going to show what America could become if it does the wrong thing.

In previous posts (here and, more recently, here) I have pointed out that the fiscal irresponsibility of the US Federal government is, by itself, a clear threat to medium-long term economic growth. When combined with other factors (namely Peak Oil, the subprime mortgage crisis and an unsustainable current account deficit), its negative effect is amplified.

When a government does not have enough tax revenue to fund its expenditures, it turns to the market to borrow the required amount. Government bonds are an integral part of credit markets worldwide and function as a baseline measurement for corporate bonds and mortgages and other forms of debt-based activity.

Notwithstanding the part that government debt plays within the world's financial markets, if a government runs deficits over the long term then the debt to GDP ratio increases. In the case of the United States, this number is probably somewhere between 40 and 60% of GDP.

The country that I am setting up as a warning for America to heed is Italy. The following image is one I scanned from a pdf file about the 2007 Italian Budget (download here. pdf, 627.2kb):

This is obviously not a detailed report on the budget, but it gives more than enough information for our purposes.

There are two very important figures in this budget summary. The first is the section marked burden of national debt, which totals €74,564 million. The second is the bottom section marked redemption of national debt, which totals €189,099 million.

That first figure - burden of national debt - represents the interest repayments that the Italian government has to make on its borrowings. Like all bonds, government bonds first have to pay back interest and then, once it matures, the principal. This figure in the budget represents the amount of interest they have to pay on bonds owing. The second figure - redemption of national debt - is the amount of money the government pays back on maturing bonds.

Together, the amount of money the Italian government spends on debt servicing (interest plus paying back principal) is €263,663 million.

Now let's put that number in perspective.

€263,663 million represents a whopping 41.2% of the Italian government's spending in 2007. According to the same document, Italy's GDP in 2007 was estimated to be €1.475 trillion, which means that debt servicing also represents 17.9% GDP.

Such figures almost defy comprehension. Italy's net public debt is around 107% of GDP. Moreover, Italy's public debt has been at this size or even higher for more than a decade (it was 113.6% in 1999).

By way of comparison, America's fiscal irresponsibility is mild. Debt servicing so far represents 15.75% of government spending and 3.13% of GDP - figures that are dangerously high but not as extreme as Italy's.

This is not the place to discuss in detail the reasons for Italy's fiscal nightmare - the nature of Italian politics is probably a major contributing factor. The fact that Italy's political leaders have been unable to find bipartisan support to control government spending has meant impoverishment for their nation.

But just how impoverished is Italy? After all, they are a sophisticated and educated western nation with a high standard of living. That may be true, but the key to understanding how impoverished they are is to examine the opportunity costs of such massive debt servicing.

From a leftist point of view - the point of view which supports high levels of government spending to support universal health care, free and/or cheap public education and so on - the €263,663 million in debt servicing (41.2% of the budget) is money that could have been used for public spending. Education spending in 2007, for example, was €50,066 million. Health spending was €11,661 million. Public order and safety spending was €21,122 million. Every Eurodollar spent in debt servicing was money not spent on improving the nation's social services.

But the leftist view is not the only valid one. From a more economically conservative point of view, that €263,663 million was money that could have been returned to people and businesses in the form of lower taxes. And imagine what sort of tax rates they could have been - 17.9% of GDP not taken up by the taxman.

The message here is clear - governments that have run long term deficits have, over the long term, created a combination of less government services and higher taxes. Money that could have gone into government spending or lower tax rates are instead being used to pay back a national credit card bill that, in the case of Italy, defies logic.

Fiscal responsibility is therefore not a left/right issue. From whatever ideological position you come from, ensuring that public debt does not spiral out of control must be a common goal.

Italy does, of course, have a number of natural advantages. As part of Europe they are in close proximity to an immensely rich and wealthy group of nations that have enriched it through trade. The fact that Italy has adopted the Euro means that any concerns that investors have in Italy's financial position are cushioned by the economic strengths of other nations that have adopted the Euro as well. This fact is tempered, however, by the fact that many other nations in the Eurozone have problems with fiscal irresponsibility as well - though nowhere near that of Italy's (with the notable exception of Belgium).

The good news is that it is possible for politicians - even those in Italy - to work together in a bipartisan way to fix their budgets. The solution is actually simple - either increase revenue or decrease expenditure and run a fiscal surplus over many years. When it comes to politics, however, this is easier said than done, especially when increasing revenue means raising taxes and decreasing expenditure means cutting spending on health, education and public welfare.

While the Clinton years are often seen as a period of intense political partisanship, it is important to remember that the Democratic president and a Republican Congress - for all their bitter fighting - were able to agree very early on to fix the nation's public debt. The result was a series of budget surpluses late in Clinton's second term (helped in no small part by the 1990s Tech boom) and a reduction in national debt. Although Bush and the Republican Congress have ruined this since 2001, there is every reason to believe that a bipartisan solution can be found. Sadly, however, the current political discourse rarely mentions the fiscal imblances which means that, when the next US president takes office in 2009, neither Republicans nor Democrats will see balancing the budget as a priority.

There is one country that has, however, managed to eliminate net public debt - and has done so without resorting to profits from oil but from pure budgetary discipline. That nation is Australia.

Australia's fiscal example should stand as an example to other nations. In 1996 when the conservative Howard government came to power, net public debt was around 20% of GDP. While this was quite small in comparison to other nations - both now and at the time - steps were taken very early to cut spending. So although net debt was comparatively small, it was never allowed to increase. Importantly, cuts to spending were made when unemployment was moderately high - at around 8%. This meant that, when the economy recovered from the effects of the spending cuts, economic growth in the years that followed produced large and growing budget surpluses and steady improvements in unemployment. Moreover, the government could then afford to make incremental tax cuts on an annual basis - a process that was quite politically rewarding. Since 2005, unemployment has dropped below 5%, big budget surpluses are run regularly, income tax rates are lower than ever and net public debt is now negative.

The Howard government did, of course, lose power in 2007, which shows that no poitical party should rely solely upon economic performance to drive their political fortunes. Nevertheless, Australia should serve as an example of what can be achieved if politicians take a long view on important things like fiscal responsibility.

It is likely that the effects of Peak Oil and the subprime meltdown will be far reaching. Countries that are fiscally weak like Italy will either be forced into making painful fiscal readjustments or else run their nations into bankruptcy-in-all-but-name by increasing their deficits. On the other hand, countries like Australia will be in a more flexible position and will have room to cut taxes or increase public spending.

What will become of America, though? While I would like to think that America could avoid Italy's fate I am not at all certain that bipartisan steps can be made to rectify the situation before net public debt hits record levels - say between 75-85% of GDP.

One thing is certain, however, and that is that America's fiscal position will determine its influence in the world over the next 20 years. If America should go down Italy's route, you can almost guarantee that America, as a society and as an economy, will be a pathetic reflection of what it was for most of the 20th century.

In the face of a semi-permanent energy crisis along with the spectre of global warming, what the world of the 21st century needs is a strong, free America. Being fiscally responsible is an important step in that direction.