Crude Oil Lows?

We are still waiting confirmation that crude oil prices have completed their forecast lows. Notwithstanding one more low, potentially down to our target of US$12 per barrel, we anticipate the recovery of the oil market.

We expect oil prices to recover slowly, reaching as high as US$80 – $95 per barrel before entering a stagnating, equilibrium phase lasting many years and keeping oil prices in a long term trading range between US$30 per barrel and US$60 per barrel. Long term over supply will continue to keep this market under pressure despite the potential for geopolitical shocks occurring from time to time.

The coming oil price movement is typical of a commodity market that has been through a major boom and bust phase. Once we have confirmed the lows are in, we can more accurately define the next phase of the crude oil market.

Global Warming and its Economic Risks

Benjamin Hulac looks into the impact of global warming on the economic side.

Climate change is the most severe global economic risk of 2016, the World Economic Forum said yesterday.

The nonprofit economic analysis institution, set to convene next week in Davos, Switzerland, for its yearly meeting, has labeled climate change or related environmental phenomena—extreme weather, major natural catastrophes, mounting greenhouse gas levels, water scarcity, flooding, storms and cyclones—among the top five most likely and significant economic threats the world faced in each of its annual reports since 2011.

The 2016 report, the latest installment of a report the WEF has published since 2007, marks the first time an environmental risk tops the rankings.

“Climate change is exacerbating more risks than ever before in terms of water crises, food shortages, constrained economic growth, weaker societal cohesion and increased security risks,” Cecilia Reyes, the chief risk officer of Zurich Insurance Group Ltd., one of the organizations that worked on the report, said in a statement.

The WEF document does not paint a sanguine picture.

North America’s eastern seaboard, East Asia, Southeast Asia and the South Pacific are particularly exposed to extreme weather patterns and natural catastrophes, according to the report—a survey conducted in the fall of 750 experts, who answered questions about 29 types of global risk, like cyberattacks, government instability and weapons of mass destruction.

Global climate change threatens top producers of wheat, corn, rice and other agricultural commodities, the report notes. Recent years illustrated the “climate vulnerability of G-20 [Group of 20] countries such as India, Russia and the United States—the breadbasket of the world.”

Hot, dry and tense
Climate change is compounding and amplifying other social, economic and humanitarian stresses globally. It is linked to mass and often forced migration; violent conflict between nations and regions; water crises; and, as the world population rises and simultaneously gets hotter, food shortages, the report reads.

“Forced displacement is already at an unprecedented level,” the authors continue, referring to emigration.


In this hotter, water-scarce future, tensions will likely grow between nations.

“Unless current water management practices change significantly, many parts of the world will therefore face growing competition for water between agriculture, energy, industry and cities,” the authors write.


A growing business awareness
Following the worldwide financial meltdown of 2008, the people WEF surveyed listed the collapse of investment prices as the most likely and most grave hazards. Yet that trend shifted.

“Environmental worries have been at the forefront in recent years,” the authors wrote, “reflecting a sense that climate change-related risks have moved from hypothetical to certain because insufficient action has been undertaken to address them.”


Paris ‘a starting point’
Economists, regulators and financial experts have become increasingly vocal about climate risks.

Governor of the Bank of England Mark Carney, in a September speech at Lloyd’s of London headquarters, said the warming climate could “bring potentially profound implications for insurers, financial stability and the economy.”


“It’s a risk that needs to be managed,” Bernhardt said. “The challenge, historically, is that it’s been treated as an uncertainty.”


Ideological divisions in Economics undermine its Value to the Public

In October Russell Roberts, a research fellow at Stanford University’s Hoover Institution,tweeted that if told an economist’s view on one issue, he could confidently predict his or her position on any number of other questions. Prominent bloggers on economics have since furiously defended the profession, citing cases when economists changed their minds in response to new facts, rather than hewing stubbornly to dogma. Adam Ozimek, an economist at Moody’s Analytics, pointed to Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis from 2009 to 2015, who flipped from hawkishness to dovishness when reality failed to affirm his warnings of a looming surge in inflation. Tyler Cowen, an economist at George Mason, published a list of issues on which his opinion has shifted (he is no longer sure that income from capital is best left untaxed). Paul Krugman, an economist and New York Times columnist, chimed in. He changed his view on the minimum wage after research found that increases up to a certain point reduced employment only marginally (this newspaper had a similar change of heart).

Economists, to be fair, are constrained in ways that many scientists are not. They cannot brew up endless recessions in test tubes to work out what causes what, for instance. Yet the same restriction applies to many hard sciences, too: geologists did not need to recreate the Earth in the lab to get a handle on plate tectonics. The essence of science is agreeing on a shared approach for generating widely accepted knowledge. Science, wrote Paul Romer, an economist, in a paper* published last year, leads to broad consensus. Politics does not.

Nor, it seems, does economics. In a paper on macroeconomics published in 2006, Gregory Mankiw of Harvard University declared: “A new consensus has emerged about the best way to understand economic fluctuations.” But after the financial crisis prompted a wrenching recession, disagreement about the causes and cures raged. “Schlock economics” was how Robert Lucas, a Nobel-prize-winning economist, described Barack Obama’s plan for a big stimulus to revive the American economy. Mr Krugman, another Nobel-winner, reckoned Mr Lucas and his sort were responsible for a “dark age of macroeconomics”.


Moreover, hard sciences are not immune from ideological rigidity. A recent study of academic citations in the life sciences found that the death of a celebrated scientist precipitates a surge in publishing from academics who previously steered clear of the celebrity’s area of study. Tellingly, papers by newcomers are cited far more heavily than new work by the celebrity’s former collaborators. That suggests that shifts of opinion in science occur not through the changing of minds so much as the displacement of one set of dogged ideologues by another.

Agree to Agree

But even if economics is not uniquely ideological, its biases are often more salient than those within chemistry. Economists advise politicians on all manner of important decisions. A reputation for impartiality could improve both perceptions of the field and the quality of economic policy.

Achieving that requires better mechanisms for resolving disputes. Mr Romer’s paper decried the pretend “mathiness” of many economists: the use of meaningless number-crunching to give a veneer of academic credibility to near-useless theories. Sifting out the guff requires transparency, argued John Cochrane of the University of Chicago in another recent blog post. Too many academics keep their data and calculations secret, he reckoned, and too few journals make space for papers that seek to replicate earlier results. Economists can squabble all they like. But the profession is of little use to anyone if it cannot then work out which side has the better of the argument.



Mathiness in the theory of economic growth“, Paul Romer, American Economic Review, Papers and Proceedings, 2015.

The macroeconomist as scientist and engineer“, Gregory Mankiw, Journal of Economic Perspectives, 2006.

The moral narratives of economists“, Anthony Randazzo and Jonathan Haidt, Econ Journal Watch, 2015.

Political language in economics“, Zubin Jelveh, Bruce Kogut and Suresh Naidu, Columbia Business School Research Paper Number 14-57, 2015.

How politically diverse are the social sciences and humanities? Survey evidence from six fields“, Daniel Klein and Charlotta Stern, Academic Questions, 2004.

Does science advance one funeral at a time?“, Pierre Azoulay, Christian Fons-Rosen and Joshua Graff Zivin, NBER Working Paper 21788, 2015.

Global Warming or is NOAA is Messing with Temperature Data Collection?

Climatologist Patrick J, Michaels writes in WSJ:

An East Coast blizzard howling, global temperatures peaking, the desert Southwest flooding, drought-stricken California drying up—surely there’s a common thread tying together this “extreme” weather. There is. But it has little to do with what recent headlines have been saying about the hottest year ever. It is called business as usual.

Surface temperatures are indeed increasing slightly: They’ve been going up, in fits and starts, for more than 150 years, or since a miserably cold and pestilential period known as the Little Ice Age. Before carbon dioxide from economic activity could have warmed us up, temperatures rose three-quarters of a degree Fahrenheit between 1910 and World War II. They then cooled down a bit, only to warm again from the mid-1970s to the late ’90s, about the same amount as earlier in the century.

Whether temperatures have warmed much since then depends on what you look at. Until last June, most scientists acknowledged that warming reached a peak in the late 1990s, and since then had plateaued in a “hiatus.” There are about 60 different explanations for this in the refereed literature.

NOAA’s alteration of its measurement standard and other changes produced a result that could have been predicted: a marginally significant warming trend in the data over the past several years, erasing the temperature plateau that vexed climate alarmists have found difficult to explain. Yet the increase remains far below what had been expected.

It is nonetheless true that 2015 shows the highest average surface temperature in the 160-year global history since reliable records started being available, with or without the “hiatus.” But that is also not very surprising. Early in 2015, a massive El Niño broke out. These quasiperiodic reversals of Pacific trade winds and deep-ocean currents are well-documented but poorly understood. They suppress the normally massive upwelling of cold water off South America that spreads across the ocean (and is the reason that Lima may be the most pleasant equatorial city on the planet). The Pacific reversal releases massive amounts of heat, and therefore surface temperature spikes. El Niño years in a warm plateau usually set a global-temperature record. What happened this year also happened with the last big one, in 1998.

Global average surface temperature in 2015 popped up by a bit more than a quarter of a degree Fahrenheit compared with the previous year. In 1998 the temperature rose by slightly less than a quarter-degree from 1997.

Without El Niño, temperatures in 2015 would have been typical of the post-1998 regime. And, even with El Niño, the effect those temperatures had on the global economy was de minimis.

Read the full article here.

What is afflicting Famous Economists

Jonathan Newman looks at what is afflicting Famous Economists ( Paul Krugman).
There’s a new trend among famous economists, from Krugman to Cowen. It was started by Adam Ozimek with a simple question: “Has a single economics study changed your mind on an important issue?” Economics as a field of study has been branded “too ideological” with warring camps defending dogmatic fortresses as opposed to unbiased, independent scholars carefully testing theories and reporting their results and methods for replication by others. As a result, many economists are answering Ozimek and pointing out the times they changed their views in light of new findings.
The Economist says they are defending the profession, but the trend really shows just how unscientific and ideological mainstream economics has become.

Economics and Science

According to The Economist, the trend is just one more step toward the goal of unbiased, non-ideological economic science:
But even if economics is not uniquely ideological, its biases are often more salient than those within chemistry. Economists advise politicians on all manner of important decisions. A reputation for impartiality could improve both perceptions of the field and the quality of economic policy.
Of course many of these mind-changing moments involve dropping even the simplest and fundamental results in economics for platforms for increased state intervention. Krugman, for example, cites his turn on minimum wage laws after he read the famous empirical paper by Card and Krueger and others. He doesn’t explain why the standard theory is wrong, just that it must be wrong because the data say so.

The Logic of Action

Economics is also a science, but the subject matter for economics is categorically different. Humans can choose. This very fact actually serves as the basis for the entire structure of economic theory. Recognizing this point is critical for selecting and preserving an appropriate method for economics.

The Place for Data in Economics

Laboratory experiments and real-world observation cannot somehow refute economic theory because economics deals in counterfactuals, which are never realized and cannot be observed in the real world.
This is not to say that good economists should ignore data. In fact, a good economist would revisit theory in the face of curious data that doesn’t seem to go along with theory. Also, economic history relies on the skillful use of data and theory to help explain events of the past.

Economic Ignorance, not Enlightenment

So, this new trend among prominent economists, far from defending economics as a science and a profession, actually reveals the unscientific and ideological proclivities of mainstream economics.
Readily dropping standard results in economics because the newest econometric trick revealed something strange with the newest data from the Bureau of Labor Statistics shows economic ignorance, not enlightenment. It shows that many economists don’t understand the fundamentals of economics and the logic of action.
When data conflicts with theory, the scholarly thing to do would be to find the source of the disconnect. This could be an error in the way the data were measured or an error in the application of the data to a specific economic theory. Of course, the theory itself could be wrong, too. Either way, some explanation is in order. An ideologue would discard one or the other without any reason except to maintain their own ideology or to switch ideological camps.
The above originally appeared at

Interview: Jean Botti, Chief Technology Officer, Airbus

Stuart Nathan interviews Jean Botti.

Barely any engineering sector depends as much on the development of new technology as aerospace; and although it’s often defence that’s seen as the part of the sector where most development takes place, recent years have seen civil aerospace also being the cradle of much new development. The tightening of regulations on the environmental profile of flying, along with new materials and processes, have all driven R&D in the sector. For Airbus, the world’s second-largest aircraft manufacturer, it’s taken the technologies of flight in some unexpected directions.

The small size of the E-Fan aircraft has led some to dismiss the project as a sideshow, but Botti insists that it represents a serious long-term goal for Airbus. The ultimate aim of the project is to develop an electric airliner, initially with around 100 seats, which the company is currently calling E-Thrust. “This is a learning curve for us. We have to start with the small aircraft with power in kilovolts, and work up to megavolts. We couldn’t possibly do it in one go.”

Part of the goal of the E-Thrust project – but only part – is environmental. When the aircraft’s engines run on battery power, the aircraft produces no emissions. “If you look at where the world trends are heading by the 2030s, with increased numbers of people in cities and the rise of megacities, there will inevitably be more and more congestion and pollution,” Botti said. “And if you look at where the most polluted part of the city is, in general it’s around the airport; I’m not only talking about CO2 and NOx here, but also about noise pollution. It has to be better to take off and land with very quiet electric engines.” He added that aircraft could arrive and depart later at night and in the early hours without disturbing the neighbours.

As this implies, these electric airliners are likely to be hybrids, with an on-board generator charging the batteries and feeding the motors. This also allows the option of charging the batteries via ‘windmilling’ the propellers when the aircraft is slowing down; precisely analogous to recovering energy during braking in a hybrid car. “This does mean that you emit greenhouse gases when the aircraft is in cruise,” Botti admitted, “but certainly no more than a standard aircraft does; with windmilling, probably less.”

In formal terms, E-Thrust and its family won’t even be Airbus products; the company has created a new subsidiary called Voltair to commercialise the technology; symbolic of the clean break it represents from its more-established turbojet-powered aircraft families. “We didn’t want to mix the message,” Botti said. Voltair operates out of new premises in Toulouse: “When I created the plant that will make E-Fan, I had the objective that young engineers will start up and become the experts that we need in the future to make larger electric aircraft; that’s knowledge that currently doesn’t exist,” he added. Technology development is looking at new batteries and motors using high-temperature superconductors; Botti even mentioned the possibility of nuclear fusion to power such aircraft. “We are not looking at next year or even next decade with this project, and we want to keep such possibilities in mind, even if they seem very far-fetched now,” he said.

Source: Airbus

Subdued Demand, Diminished Prospects

IMF looks at the World Economic Outlook.

Global growth, currently estimated at 3.1 percent in 2015, is projected at 3.4 percent in 2016 and 3.6 percent in 2017. The pickup in global activity is projected to be more gradual than in the October 2015 World Economic Outlook (WEO), especially in emerging market and developing economies.

In advanced economies, a modest and uneven recovery is expected to continue, with a gradual further narrowing of output gaps. The picture for emerging market and developing economies is diverse but in many cases challenging. The slowdown and rebalancing of the Chinese economy, lower commodity prices, and strains in some large emerging market economies will continue to weigh on growth prospects in 2016–17. The projected pickup in growth in the next two years— despite the ongoing slowdown in China—primarily reflects forecasts of a gradual improvement of growth rates in countries currently in economic distress, notably Brazil, Russia, and some countries in the Middle East, though even this projected partial recovery could be frustrated by new economic or political shocks.

Risks to the global outlook remain tilted to the downside and relate to ongoing adjustments in the global economy: a generalized slowdown in emerging market economies, China’s rebalancing, lower commodity prices, and the gradual exit from extraordinarily accommodative monetary conditions in the United States. If these key challenges are not successfully managed, global growth could be derailed.

Source: International Monetary Fund

Potential of Bitcoin Tech

By Nathaniel Popper.

A well-known former JPMorgan Chase executive, Blythe Masters, has raised $52 million from several big banks for a start-up built on the technology underlying the Bitcoin virtual currency.

The start-up Digital Asset Holdings, based in New York, said on Thursday afternoon that it had raised the money from 13 financial institutions, including Ms. Masters’s former employer, JPMorgan, as well as Citi, BNP Paribas and Santander.

At the same time, the company also announced that it had signed a deal with Australia’s primary stock exchange, ASX, to provide technology that would speed up the settlement and transfer of money after stock trades. ASX Limited is also making a big investment in Digital Asset Holdings.

Digital Asset Holdings has based its technology on the blockchain concept that was introduced by the virtual currency Bitcoin. The blockchain is the database in which all transactions on the Bitcoin network are recorded. Unlike typical databases, the blockchain is maintained by users in a decentralized fashion. That has led many in the financial industry to hail it as a faster — and more reliable — alternative to existing transaction systems.

Many financial institutions have been looking at ways to use a blockchain to modernize financial transactions by cutting out various middlemen from the markets. The Nasdaq stock exchange has already integrated blockchain technology to improve stock trading.

Ms. Masters gave the technology a big boost when she announced her involvement with Digital Asset Holdings in early 2015. She left JPMorgan the previous year after a career during which she became one of the best-known figures in the financial industry.

Big questions remain, however, about how blockchain technology can be used in the real world, and so far talk of its potential has raced ahead of real-world uses.

In recent months, this disparity has caused some concern about the companies that are trying to raise money to build start-ups on the blockchain concept, including Digital Asset Holdings.

Potential investors said that it took Ms. Masters longer than expected to pull together her funders — and that some big-name banks ultimately declined to participate.

But Ms. Masters ended up raising more money than the $35 million that had been previously discussed. This round of fund-raising values Digital Asset Holdings at $100 million.

The Australian exchange company said that Digital Asset Holdings would help it develop new technology for the processes that take place after a stock is actually traded.

“Distributed Ledger Technology could provide a once-in-a-generation opportunity to reduce cost, time and complexity in the post-trade environment of Australia’s equity market,” the chief executive of ASX, Elmer Funke Kupper, said in a statement.

The other investors include CME Ventures, ABN AMRO, Santander’s innovation arm, Deutsche Börse Group, Accenture, Broadridge Financial Solutions, the Depository Trust and Clearing Corporation, and PNC Financial Services.


Oil Price Predictions

In 2011 we forecast that crude oil prices would in the long term move towards US$12.00 per barrel. Oil prices just touched US$50.00 per barrel, well on our way towards our target.

Whilst oil has considerable potential for a counter rally we believe this rally will only relieve the oversold nature of the market.

Implications for the oil price collapse are profound with business and consumers benefiting from the lower prices. This may stimulate low consumer price inflation, strong stock markets and real estate prices as consumers take advantage of increased disposable income. Our Bull Market Argument outlines how this phase reflects the 1921 – 1929 period in US economic history, also known as the “Roaring 20’s”.

Debt based on high oil prices will suffer of course and could trigger banking issues. If perceived by markets as a negative phenomenon, the impact is highly deflationary and could pull the world into a global deflationary spiral and depression. This is in line with our Bear Market Argument.

We anticipate oil prices to consolidate between US$40.00 to US$80.00 for the rest of 2015 and potentially into 2016 before the long term downtrend carries prices down towards our target. (More specific consolidation targets to be posted later).

World Oil Production at 3/31/2014–Where are We Headed?

Gail Tverberg blogs on Our Finite World.

The standard way to make forecasts of almost anything is to look at recent trends and assume that this trend will continue, at least for the next several years. With world oil production, the trend in oil production looks fairly benign, with the trend slightly upward (Figure 1).

Figure 1. Quarterly crude and condensate oil production, based on EIA data.

Figure 1. Quarterly crude and condensate oil production, based on EIA data.

If we look at the situation more closely, however, we see that we are dealing with an unstable situation. The top ten crude oil producing countries have a variety of problems (Figure 2). Middle Eastern producers are particularly at risk of instability, thanks to the advances of ISIS and the large number of refugees moving from one country to another.

Figure 2. Top ten crude oil and condensate producers during first quarter of 2014, based on EIA data.

Figure 2. Top ten crude oil and condensate producers during first quarter of 2014, based on EIA data.

Relatively low oil prices are part of the problem as well. The cost of producing oil is rising much more rapidly than its selling price, as discussed in my post Beginning of the End? Oil Companies Cut Back on Spending. In fact, the selling price of oil hasn’t really risen since 2011 (Figure 3), because citizens can’t afford higher oil prices with their stagnating wages.

Figure 3. Average weekly oil prices, based on EIA data.

Figure 3. Average weekly oil prices, based on EIA data.

The fact that the selling price of oil remains flat tends to lead to political instability in oil exporters because they cannot collect the taxes required to provide programs needed to pacify their people (food and fuel subsidies, water provided by desalination, jobs programs, etc.) without very high oil prices. Low oil prices also make the plight of oil exporters with declining oil production worse, including Russia, Mexico, and Venezuela.

Many people when looking at future oil supply concern themselves with the amount of reserves (or resources) remaining, or perhaps Energy Return on Energy Invested (EROEI). None of these is really the right limit, however. The limiting factor is how long our current networked economic system can hold together. There are lots of oil reserves left, and the EROEI of Middle Eastern oil is generally quite high (that is, favorable). But instability could still bring the system down. So could popping of the US oil supply bubble through higher interest rates or more stringent lending rules.

The Top Two Crude Oil Producers: Russia and Saudi Arabia

When we look at quarterly crude oil production (including condensate, using EIA data), we see that Russia’s crude oil production tends to be a lot smoother than Saudi Arabia’s (Figure 4). We also see that since the third quarter of 2006, Russia’s crude oil production tends to be higher than Saudi Arabia’s.

Figure 4.  Comparison of quarterly oil production for Russia and Saudi Arabia, based on EIA data.

Figure 4. Comparison of quarterly oil production (crude + condensate) for Russia and Saudi Arabia, based on EIA data.

Both Russia and Saudi Arabia are headed toward problems now. Russia’s Finance Minister has recently announced that its oil production has hit and peak, and is expected to fall, causing financial difficulties. In fact, if we look at monthly EIA data, we see that November 2013 is the highest month of production, and that every month of production since that date has dropped from this level. So far, the drop in oil production has been relatively small, but when an oil exporter is depending on tax revenue from oil to fund government programs, even a small drop in production (without a higher oil price) is a financial problem.

We see in Figure 4 above that Saudi Arabia’s quarterly oil production is quite erratic, compared to oil production of Russia. Part of the reason Saudi Arabia’s oil production is so erratic is that it extends the life of its fields by periodically relaxing (reducing) production from them. It also reacts to oil price changes–if the oil price is too low, as in the latter part of 2008 and in 2009, Saudi oil production drops. The tendency to jerk oil production around gives the illusion that Saudi Arabia has spare production capacity. It is doubtful at this point that it has much true spare capacity. It makes a good story, though, which news media are willing to repeat endlessly.

Saudi Arabia has not been able to raise oil exports for years (Figure 5). It gained a reputation for its oil exports back in the late 1970s and early 1980s, and has been able to rest on its laurels. Its high “proven reserves” (which have never been audited, and are doubted by many) add to the illusion that it can produce any amount it wants.

Figure 5. Comparison of Russian and Saudi Arabian oil exports, based on BP Statistical Review of World Energy 2014 data. Pre-1985 Russian amounts estimated based on Former Soviet Union amounts.

Figure 5. Comparison of Russian and Saudi Arabian oil exports, based on BP Statistical Review of World Energy 2014 data (oil production minus oil consumption). Pre-1985 Russian amounts estimated based on Former Soviet Union amounts.

In 2013, oil exports from Russia were equal to 88% of Saudi Arabian oil exports. The world is very close to being as dependent on Russian oil exports as it is on Saudi Arabian oil exports. Most people don’t realize this relationship.

The current instability of the Middle East has not hit Saudi Arabia yet, but there is increased fighting all around. Saudi Arabia is not immune to the problems of the other countries. According to BBC, there is already a hidden uprising taking place in eastern Saudi Arabia.

US Oil Production is a Bubble of Very Light Oil

The US is the world’s third largest producer of crude and condensate. Recent US crude oil production shows a “spike” in tight oil productions–that is, production using hydraulic fracturing, generally in shale formations (Figure 6).

Figure 6. US crude oil production split between tight oil (from shale formations), Alaska, and all other, based on EIA data. Shale is from  AEO 2014 Early Release Overview.

Figure 6. US crude oil production split between tight oil (from shale formations), Alaska, and all other, based on EIA data. Shale is from AEO 2014 Early Release Overview.

If we look at recent data on a quarterly basis, the trend in production also looks very favorable.

Figure 7. US Crude and condensate production by quarter, based on EIA data.

Figure 7. US Crude and condensate production by quarter, based on EIA data.

The new crude is much lighter than traditional crude. According to the Wall Street Journal, the expected split of US crude is as follows:

Figure 8. Wall Street Journal image illustrating the expected mix of US crude oil.

Figure 8. Wall Street Journal image illustrating the expected mix of US crude oil.

There are many issues with the new “oil” production:

  • The new oil production is so “light” that a portion of it is not what we use to power our cars and trucks. The very light “condensate” portion (similar to natural gas liquids) is especially a problem.
  • Oil refineries are not necessarily set up to handle crude with so much volatile materials mixed in. Such crude tends to explode, if not handled properly.
  • These very light fuels are not very flexible, the way heavier fuels are. With the use of “cracking” facilities, it is possible to make heavy oil into medium oil (for gasoline and diesel). But using very light oil products to make heavier ones is a very expensive operation, requiring “gas-to-liquid” plants.
  • Because of the rising production of very light products, the price of condensate has fallen in the last three years. If more tight oil production takes place, available prices for condensate are likely to drop even further. Because of this, it may make sense to export the “condensate” portion of tight oil to other parts of the world where prices are likely to be higher. Otherwise, it will be hard to keep the combined sales price of tight oil (crude oil + condensate) high enough to encourage more tight oil production.

The other issue with “tight oil” production (that is, production from shale formations) is that its production seems to be a “bubble.”  The big increase in oil production (Figure 6) came since 2009 when oil prices were high and interest rates were very low. Cash flow from these operations tends to be negative. If interest rates should rise, or if oil prices should fall, the system is likely to hit a limit. Another potential problem is oil companies hitting borrowing limits, so that they cannot add more wells.

Without US oil production, world crude oil production would have been on a plateau since 2005.

Figure 9. World crude and condensate, excluding US  production, based on EIA data.

Figure 9. World crude and condensate, excluding US production, based on EIA data.

Canadian Oil Production

The other recent success story with respect to oil production is Canada, the world’s fifth largest producer of crude and condensate. Thanks to the oil sands, Canadian oil production has more than doubled since the beginning of 1994 (Figure 10).

Figure 10. Canadian quarterly crude oil (and condensate) production based on EIA data.

Figure 10. Canadian quarterly crude oil (and condensate) production based on EIA data.

Of course, there are environmental issues with respect to both oil from the oil sands and US tight oil. When we get to the “bottom of the barrel,” we end up with the less environmentally desirable types of oil. This is part of our current problem, and one reason why we are reaching limits.

Oil Production in China, Iraq, and Iran

In the first quarter of 2014, China was the fourth largest producer of crude oil. Iraq was sixth, and Iran was seventh (based on Figure 2 above). Let’s first look at the oil production of China and Iran.

Figure 11. China and Iran crude and condensate production by quarter based on EIA data.

Figure 11. China and Iran crude and condensate production by quarter based on EIA data.

As of 2010, Iran was the fourth largest producer of crude oil in the world. Iran has had so many sanctions against it that it is hard to figure out a base period, prior to sanctions. If we compare Iran’s first quarter 2014 oil production to its most recent high production in the second quarter of 2010, oil production is now down about 870,000 barrels a day. If sanctions are removed and warfare does not become too much of a problem, oil production could theoretically rise by about this amount.

China has relatively more stable oil production than Iran. One concern now is that China’s oil production is no longer rising very much. Oil production for the fourth quarter of 2013 is approximately tied with oil production for the fourth quarter of 2012. The most recent quarter of oil production is down a bit. It is not clear whether China will be able to maintain its current level of production, which is the reason I mention the possibility of a decline in oil production in Figure 2.

The lack of growth in China’s oil supplies may be behind its recent belligerence in dealing with Viet Nam and Japan. It is not only exporters that become disturbed when oil supplies are not to their liking. Oil importers also become disturbed, because oil supplies are vital to the economy of all nations.

Now let’s add Iraq to the oil production chart for Iran and China.

Figure 12. Quarterly crude oil and condensate production for Iran, China, and Iraq, based on EIA data.

Figure 12. Quarterly crude oil and condensate production for Iran, China, and Iraq, based on EIA data.

Thanks to improvements in oil production in Iraq, and sanctions against Iran, oil production for Iraq slightly exceeds that of Iran in the first quarter of 2014. However, given Iraq’s past instability in oil production, and its current problems with ISIS and with Kurdistan, it is hard to expect that Iraq will be a reliable oil producer in the future. In theory Iraq’s oil production can rise a few million barrels a day over the next 10 or 20 years, but we can hardly count on it.

The Oil Price Problem that Adds to Instability

Figure 13 shows my view of the mismatch between (1) the price oil producers need to extract their oil and (2) the price consumers can afford. The cost of extraction (broadly defined including taxes required by governments) keeps rising while “ability to pay” has remained flat since 2007. The inability of consumers to pay high prices for oil (because wages are not rising very much) explains why oil prices have remained relatively flat in Figure 3 (near the top of this post), even while there is fighting in the Middle East.

Figure 3. Comparison of oil price per barrel needed (Brent) with ability to pay. Amounts based on judgement of author.

Figure 13. Comparison of oil price per barrel needed by producers (Brent) with ability to pay. Amounts based on judgment of author.

When the selling price is lower than the full cost of production (including the cost of investing in new wells and paying dividends to shareholders), the tendency is to reduce production, one way or another. This reduction can be voluntarily, in the form of a publicly traded company buying back stock or selling off acreage.

Alternatively, the cutback can be involuntary, indirectly caused by political instability. This happens because oil production is typically heavily taxed in oil exporting nations. If the oil price remains too low, taxes collected tend to be too low, making it impossible to fund programs such as food and fuel subsidies, desalination plants, and jobs programs. Without adequate programs, there tend to be uprisings and civil disorder.

If a person looks closely at Figure 13, it is clear that in 2014, we are out in “Wile E. Coyote Territory.” The broadly defined cost of oil extraction (including required taxes by exporters) now exceeds the ability of consumers to pay for oil. As a result, oil prices barely spike at all, even when there are major Middle Eastern disruptions (Figure 3, above).

The reason why Wile E. Coyote situation can take place at all is because it takes a while for the mismatch between costs and prices to work its way through the system. Independent oil companies can decide to sell off acreage and buy back shares of stock but it takes a while for these actions to actually take place. Furthermore, the mismatch between needed oil prices and charged oil prices tends to get worse over time for oil exporters. This lays the groundwork for increasing dissent within these countries.

With oil prices remaining relatively flat, importers become complacent because they don’t understand what is happening.  It looks like we have no problem when, in fact, there really is a fairly big problem, lurking behind the scenes.

To make matters worse, it is becoming more and more difficult to continue Quantitative Easing, a program that tends to hold down longer-term interest rates. The expectation is that the program will be discontinued by October 2014. The reason why the price of oil has stayed as high as it has in the last several years is because of the effects of quantitative easing and ultra low interest rates. If it weren’t for these, oil prices would fall, because consumers would need to pay much more for goods bought on credit, leaving less for the purchase of oil products. See my recent post, The Connection Between Oil Prices, Debt Levels, and Interest Rates.

Figure 4. Big credit related drop in oil prices that occurred in late 2008 is now being mitigated by Quantitative Easing and very low interest rates.

Figure 14. Big credit related drop in oil prices that occurred in late 2008 is now being mitigated by Quantitative Easing and very low interest rates.

Because of the expectation that Quantitative Easing will end by October 2014 and the pressure to tighten credit conditions, my expectation is that the affordable price of oil will start dropping in late 2014, as shown in Figure 13. The growing disparity between what consumers can afford and what producers need tends to make the Wile E. Coyote overshoot condition even worse. It is likely to lead to more problems with instability in the Middle East, and a collapse of the US oil production bubble.


I explained earlier that we live in a networked economy, and this fact changes the way economic models work. Many people have developed models of future oil production assuming that the appropriate model is a “bell curve,” based on oil depletion rates and the inability to geologically extract more oil. Unfortunately, this isn’t the right model.

The situation is far more complex than simple geological decline models assume. There are multiple limits involved–prices needed by oil producers, prices affordable by oil importers, and prices for other products, such as water and food. Interest rates are also important. There are time lags involved between the time the Wile E. Coyote situation begins, and the actions to fix this mismatch takes place. It is this time lag that tends to make drop-offs very steep.

The fact that we are dealing with political instability means that multiple fuels are likely to be affected at once. Clearly natural gas exports from the Middle East will be affected at the same time as oil exports. Many other spillover effects are likely to happen as well. US businesses without oil will need to cut back on operations. This will lead to job layoffs and reduced electricity use. With lower electricity demand, prices for electricity as well as for coal and natural gas will tend to drop. Electricity companies will increasingly face bankruptcy, and fuel suppliers will reduce operations.

Thus, we cannot expect decline to follow a bell curve. The real model of future energy consumption crosses many disciplines at once, making the situation difficult to model.  The Reserves / Current Production model gives a vastly too high indication of future production, for a variety of reasons–rising cost of extraction because of diminishing returns, need for high prices and taxes to support the operations of exporters, and failure to consider interest rates.

The Energy Return on Energy Invested model looks at a narrowly defined ratio–usable energy acquired at the “well-head,” compared to energy expended at the “well-head” disregarding many things–including taxes, labor costs, cost of borrowing money, and required dividends to stockholders to keep the system going. All of these other items also represent an allocation of available energy. A multiplier can theoretically adjust for all of these needs, but this multiplier tends to change over time, and it tends to differ from energy source to energy source.

The EROEI ratio is probably adequate for comparing two “like products”–say tight oil produced in North Dakota vs tight oil produced in Texas, or a ten year change in North Dakota energy ratios, but it doesn’t work well when comparing dissimilar types of energy. In particular, the model tends to be very misleading when comparing an energy source that requires subsidies to an energy source that puts off huge tax revenue to support local governments.

When there are multiple limits that are being encountered, it is the financial system that brings all of the limits together. Furthermore, it is governments that are at risk of failing, if enough surplus energy is not produced. It is very difficult to build models that cross academic areas, so we tend to find models that reflect “silo” thinking of one particular academic specialty. These models can offer some insight, but it is easy to assume that they have more predictive value than they do.

Unfortunately, the limits we are reaching seem to be financial and political in nature. If these are the real limits, we seem to be not far away from the simultaneous drop in the production of many energy products. This type of limit gives a much steeper drop off than the frequently quoted symmetric “bell curve of oil production.” The shape of the drop off corresponds to (1) the type of drop off experienced by previous civilizations when they collapsed, (2) the type of drop-off I have forecast for world energy consumption, and (3) Ugo Bardi’s Seneca cliff.  The 1972 book Limits to Growth by Donella Meadows et al. says (page 125), “The behavior mode of of the system shown in figure 35 is clearly that of overshoot and collapse,” so it tends to come to the same conclusion as well.