Archive for Setembro, 2014

“Everyday miracles we take for granted — bananas in the grocery store; you can walk into a Whole Foods and buy snow crabs from Alaska — I mean it’s just. … It’s this kind of stuff I think that has really changed the way we think and the way we view the world.

The most powerful woman 2000 years ago was Cleopatra, and her idea of a good time was to row up and down the Nile, having 60 men — with some encouragement from the whip and the lash — pull her up and down the Nile. Well, you yoke 60 men to some oars and you can generate six horsepower: about what we have in a lawnmower. A typical driver has 200 horsepower at their command. There was no engine on the planet 200 years ago much larger than 30 horsepower. And now every American has access to an engine that is six times larger than that you could have found on the surface of the globe 200 years ago. We’re climbing up the heat ladder. …

We’re living like gods right now. And our challenge is to figure out how to return to earth, how to become mortal again. In an energy sense, we’re not living like royalty. We’re not living like Cleopatra. We’re living like gods. And this life has made us sort of insane. …

Living like gods, we have no experience with going sailing off a depletion cliff. We have no cultural strength or wisdom that would really guide us in this moment. What do we do?

Randy Udall

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Oil and other commodity prices have recently been dropping. Is this good news, or bad?

Figure 1. Trend in Commodity Prices since January 2011. Brent spot oil price from EIA; Australian Coal from World Bank Prink Sheet; Food from UN's FAO.

I would argue that falling commodity prices are bad news. It likely means that the debt bubble which has been holding up the world economy for a very long–since World War II, at least–is failing to expand sufficiently. If the debt bubble collapses, we will be in huge difficulty.

Many people have the impression that falling oil prices mean that the cost of production is falling, and thus that the feared “peak oil” is far in the distance. This is not the correct interpretation, especially when many types of commodities are decreasing in price at the same time. When prices are set in a world market, the big issue is affordability. Even if food, oil and coal are close to necessities, consumers can’t pay more than they can afford.

A person can tell from Figure 1 that since the first part of 2011, the prices of Brent oil, Australian coal, and food have been trending downward. This drop in prices continues into September. For example, as I write this, Brent oil price is $97.70, while the average price for the latest month shown (August) is $105.27. It is this steeper, recent drop, which many are concerned about.

We are dealing with several confusing issues. Let me try to explain some of them.

Issue #1: Over the short term, commodity prices don’t reflect the cost of extraction; they reflect what buyers can afford.

Oil prices are set on a worldwide basis. The cost of extraction varies around the world. So it is clear that oil prices will not match the cost of extraction, or the cost of extraction plus a reasonable profit, for any particular producer.

If oil prices drop, there is a temptation to believe that this is because the cost of production has dropped. Over a long enough period, a drop in the cost of production might be expected to lead to lower oil prices. But we know that many oil producers are finding current oil prices too low. For example, the Wall Street Journal recently reported, “Royal Dutch Shell CEO: Can’t deny returns are too low. Ben van Beurden prepared to shrink company in order to boost returns, profitability.” I wrote about this issue in my post, Beginning of the End? Oil Companies Cut Back on Spending.

In the short term, low prices are likely to signal that less of the commodity can be sold on the world market. Commodities such as oil and food are very desirable products. Why would less be needed? The issue, unfortunately, is affordability. Affordability depends largely on (1) wages and (2) debt. Wages tend to be fairly stable. The likely culprit, if affordability is leading to lower demand for desirable products like oil and food, is less growth in debt.

Issue #2: Economic growth tends to produce a debt bubble. 

Many economists believe that technological innovation is the key to economic growth. In my view, economies need a combination of the following to have economic growth of the type experienced in the last 100 years:1

(Increase in debt) + (cheap-to-extract fossil fuels) + (cheap-to-use non-fossil fuel resources) +  (technological innovation)

In such a case, debt keeps increasing as an economy grows. Unfortunately, this economic growth is only temporary, because resources tend to become more expensive to use over time, making the “cheap” resources required for economic growth disappear.

The problem underlying the rising cost of resources (both for fossil fuels and others) is that we tend to use the cheapest-to-extract resources first. Technological innovation continues to occur, but as diminishing returns hit both fossil fuels and other resources, there are larger and larger demands on technology to keep costs in line with what workers can afford. Eventually, the cost of resources (net of technological improvements) rises too much, and economic growth is cut off. By this time, a huge mountain of debt has been built up.

Let me explain further how this happens. Without fossil fuels, the world is pretty much stuck with the goods that can be made with wood, or from other basic resources such as animal skins, cotton, flax, or clay. A small quantity of metal and glass goods can be made, but deforestation quickly becomes a problem if an attempt is made to “scale up” the quantity of goods that require heat in their production.2

Once inexpensive coal became available, its availability opened the door to technological innovation, because it provided heat in quantity that had not been available previously. While ideas such as the steam engine had been around for a long time, the availability of inexpensive coal made the production of metals needed for the steam engine, plus train tracks and railroad cars, available at reasonable cost.

With the ability to make steel and concrete in quantity (both requiring heat) came the ability to make hydroelectric dams and electrical transmission lines, thus enabling electricity for public consumption. Oil, as a liquid fuel, paved the way for widespread use of additional innovations, such as private passenger automobiles, mechanized farm equipment, and airplanes. Between coal and oil, many workers could leave farming and begin jobs in other sectors of the economy.

The transformation that took place was huge: from wooden tools and human or animal labor to a modern industrial society. How could such a big change take place? Before the change, the ability to generate a profit that might be used for future capital investment was very limited. Also, the would-be purchasers of products made in an industrial economy were very poor. I would argue that the only way of bridging this gap was debt. See my earlier posts, Why Malthus Got His Forecast Wrong and The United States’ 65-Year Debt Bubble.


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