Tags: collapse* + debt*

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  1. Debt is a key factor in creating an economy that operates using energy.

    A generally overlooked problem of our current system is the fact that we do not receive the benefit of energy products until well after they are used. This is especially the case for energy used to make capital investments, such as buildings, roads, machines, and vehicles. Even education and health care represent energy investments that have benefits long after the investment is made.

    The reason debt (and close substitutes) are needed is because it is necessary to bring forward hoped-for future benefits of energy products to the current period if workers are to be paid. In addition, the use of debt makes it possible to pay for consumer products such as automobiles and houses over a period of years. It also allows factories and other capital goods to be financed over the period they provide their benefits. (See my post Debt: The Key Factor Connecting Energy and the Economy.)

    When debt is used to move forward hoped-for future benefits to the present, oil prices can be higher, as can be the prices of other commodities. In fact, the price of assets in general can be higher. With the higher price of oil, it is possible for businesses to use the hoped-for future benefits of oil to pay current workers. This system works, as long as the price set by this system doesn’t exceed the actual benefit to the economy of the added energy.

    The amount of benefits that oil products provide to the economy is determined by their physical characteristics–for example, how far oil can make a truck move. These benefits can increase a bit over time, with rising efficiency, but in general, physics sets an upper bound to this increase. Thus, the value of oil and other energy products cannot rise without limit.

    Research involving Energy Returned on Energy Investment (EROEI) ratios for fossil fuels is a frequently used approach for evaluating prospective energy substitutes, such as wind turbines and solar panels. Unfortunately, this ratio only tells part of the story. The real problem is declining return on human labor for the system as a whole–that is, falling inflation adjusted wages of non-elite workers. This could also be described as falling EROEI–falling return on human labor. Declining human labor EROEI represents the same problem that fish swimming upstream have, when pursuit of food starts requiring so much energy that further upstream trips are no longer worthwhile.

    If our problem is a shortage of fossil fuels, fossil fuel EROEI analysis is ideal for determining how to best leverage our small remaining fossil fuel supply. For each type of fossil fuel evaluated, the fossil fuel EROEI calculation determines the amount of energy output from a given quantity of fossil fuel inputs. If a decision is made to focus primarily on the energy products with the highest EROEI ratios, then our existing fossil fuel supply can be used as sparingly as possible.

    If our problem isn’t really a shortage of fossil fuels, EROEI is much less helpful. In fact, the EROEI calculation strips out the timing over which the energy return is made, even though this may vary greatly. The delay (and thus needed amount of debt) is likely to be greatest for those energy products where large front-end capital expenditures are r
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  2. The system acts as if whenever one pump dispenses the energy products we want, another pump disperses other products we don’t want. Let’s look at three of the big unwanted “co-products.”

    1. Rising debt is an issue because fossil fuels give us things that would never have been possible, in the absence of fossil fuels. For example, thanks to fossil fuels, farmers can have such things as metal plows instead of wooden ones and barbed wire to separate their property from the property of others. Fossil fuels provide many more advanced capabilities as well, including tractors, fertilizer, pesticides, GPS systems to guide tractors, trucks to take food to market, modern roads, and refrigeration.

    The benefits of fossil fuels are immense, but can only be experienced once fossil fuels are in use. Because of this, we have adapted our debt system to be a much greater part of the economy than it ever needed to be, prior to the use of fossil fuels. As the cost of fossil fuel extraction rises, ever more debt is required to place these fossil fuels in use. The Bank for International Settlements tells us that worldwide, between 2006 and 2014, the amount of oil and gas company bonds outstanding increased by an average of 15% per year, while syndicated bank loans to oil and gas companies increased by an average of 13% per year. Taken together, about $3 trillion of these types of loans to the oil and gas companies were outstanding at the end of 2014.

    As the cost of fossil fuels rises, the cost of everything made using fossil fuels tends to rise as well.

    3. A more complex economy is a less obvious co-product of the increasing use of fossil fuels. In a very simple economy, there is little need for big government and big business. If there are businesses, they can be run by a small number of individuals, with little investment in capital goods. A king, together with a handful of appointees, can operate the government if it does not provide much in the way of services such as paved roads, armies, and schools. International trade is not a huge necessity because workers can provide nearly all necessary goods and services with local materials.

    The use of increasing amounts of fossil fuels changes the situation materially. Fossil fuels are what allow us to have metals in quantity–without fossil fuels, we need to cut down forests, use the trees to make charcoal, and use the charcoal to make small quantities of metals.

    Once fossil fuels are available in quantity, they allow the economy to make modern capital goods, such as machines, oil drilling equipment, hydraulic dump trucks, farming equipment, and airplanes. Businesses need to be much larger to produce and own such equipment. International trade becomes much more important, because a much broader array of materials is needed to make and operate these devices. Education becomes ever more important, as devices become increasingly complex. Governments become larger, to deal with the additional services they now need to provide.

    f an increasing share of the output of the economy is funneled into management pay, expenditures for capital goods, and other expenditures associated with an increasingly complex economy (including higher taxes, and more dividend and interest payments), less of the output of the economy is available for “ordinary” laborers–including those without advanced training or supervisory responsibilities.

    As a result, pay for these workers is likely to fall relative to the rising cost of living. Some would-be workers may drop out of the labor force, because the benefits of working are too low compared to other costs, such as childcare and transportation costs. Ultimately, the low wages of these workers can be expected to start causing problems for the economic system as a whole, because these workers can no longer afford the output of the system. These workers reduce their purchases of houses and cars, both of which are produced using fossil fuels and other commodities.

    Ultimately, the prices of commodities fall below their cost of production. This happens because there are so many of these ordinary laborers, and the lack of good wages for these workers tends to slow the “demand” side of the economic growth loop. This is the problem that we are now experiencing.

    The Two Pumps Are Really Energy and Entropy

    Unlike the markings on the pump (gasoline and ethanol), the two pumps of our system are energy consumption and entropy. When we think we are getting energy consumption, we really get various forms of entropy as well.

    The first pump, rising energy consumption, seems to be what makes the world economy grow.

    The second pump in Figure 3 is Entropy Production. Entropy is a measure of the disorder associated with the extraction and consumption of fossil fuels and other energy products. Entropy can be thought of as a loss of information. Once energy products are burned, we have a portion of GDP in the place of the energy products that have been consumed. This is why there is a high correlation between energy consumption and GDP. As energy products are burned, we also have an increasing pile of debt, increasing pollution (that our sinks become less and less able to handle), and increasing wealth disparity.
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  3. Before the global financial crisis, a rise in raw-materials prices used to be bad news for the economy and stocks in general. Since central bank easy-money policies took off, that's become a thing of the past.

    One possible explanation is the level of exposure that banks and investors have to the industry. The 5,000 biggest publicly traded companies tracked by Bloomberg in the iron and steel, metals and mining, and energy sectors have a combined $3.6 trillion in debt, according to their most recent financial reports, double what they had at the end of 2008.
    Gushing IOUs

    Much of the increase is due to money that was borrowed to dig mines and wells whose output, at previous prices, would have easily repaid most maturing bonds and loans. But as commodity prices have tumbled, so has the ability of companies to meet their obligations. The Bloomberg Commodity Index is still only 3.9 percent higher than a 25-year low hit on Jan. 20.

    Five years ago, those companies tracked by Bloomberg had more operating income than debt, on average. Now, it would take them more than eight years' worth of current earnings, without provisioning for interest, taxes, depreciation or amortization, to clear their combined net obligations.

    It's unclear where the other portion of the $3.6 trillion in liabilities lies but probably, most of it is owed to banks. If the remaining $1.5 trillion is indeed on the balance sheets of financial institutions, that would represent about 1.5 percent of the total assets of all the world's publicly traded banks. That doesn't seem very significant, or any cause for concern. But to put it in some context, U.S. subprime mortgages represented less than 1 percent of listed banks' assets at the end of 2007.
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  4. my core prediction for 2016 is that all the things that got worse in 2015 will keep on getting worse over the year to come. The ongoing depletion of fossil fuels and other nonrenewable resources will keep squeezing the global economy, as the real (i.e., nonfinancial) costs of resource extraction eat up more and more of the world’s total economic output, and this will drive drastic swings in the price of energy and commodities—currently those are still headed down, but they’ll soar again in a few years as demand destruction completes its work. The empty words in Paris a few weeks ago will do nothing to slow the rate at which greenhouse gases are dumped into the atmosphere, raising the economic and human cost of climate-related disasters above 2015’s ghastly totals—and once again, the hard fact that leaving carbon in the ground means giving up the lifestyles that depend on digging it up and burning it is not something that more than a few people will be willing to face.

    Healthy companies in a normal economy usually have P/E ratios between 10 and 20; that is, their total stock value is between ten and twenty times their annual earnings. Care to guess what the P/E ratio is for Amazon as of last Friday’s close? A jawdropping 985.

    At that, Amazon is in better shape than some other big-name tech firms these days, as it actually has earnings. Twitter, for example, has never gotten around to making a profit at all, and so its P/E ratio is its current absurd stock value divided by zero. Valuations this detached from reality haven’t been seen since immediately before the “Tech Wreck” of 2000, and the reason is exactly the same: vast amounts of easy money have flooded into the tech sector, and that torrent of cash has propped up an assortment of schemes and scams that make no economic sense at all. Sooner or later, as a function of the same hard math that brings every bubble to an end, Tech Wreck II is going to hit, vast amounts of money are going to evaporate, and a lot of currently famous tech companies are going to go the way of Pets.com.

    my best guess at this point is that photovoltaic (PV) solar energy is going to be the next big energy bubble.

    Solar PV is a good deal less environmentally benign than its promoters like to claim—like so many so-called “green” technologies, the environmental damage it causes happens mostly in the trajectory from mining the raw materials to manufacture and deployment, not in day-to-day operation—and the economics of grid-tied solar power are so dubious that in practice, grid-tied PV is a subsidy dumpster rather than a serious energy source. Nonetheless, I expect to see such points brushed aside, airily or angrily as the case may be, as the solar lobby and its wholly-owned subsidiaries in the green movement make an all-out push to sell solar PV as the next big thing.
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  5. Because of the differing underlying cause compared to prior low-price cycles, we should expect oil prices to fall, perhaps to $20 per barrel or below, without much of a price recovery. We are now encountering the feared “Peak Oil,” because much of the cheap oil has already been extracted. Peak Oil doesn’t behave the way most people expected, though. The economy is a networked system, with high oil prices adversely affecting both wages and economic growth. Because of this, the symptoms of Peak Oil are the opposite of what most people have imagined: they are falling demand and prices below the cost of production.

    If low prices don’t rise sufficiently, they can cut off oil production quite quickly–more quickly than high prices. The strategy of selling assets at depressed prices to new operators will have limited success, because much higher prices are needed to allow new operators to be successful.

    Perhaps the most serious near-term problem from continued low prices is the likelihood of rising debt defaults. These debt defaults can be expected to have a very adverse impact on banks, pension plans, and insurance companies.
    Tags: , , , by M. Fioretti (2016-01-04)
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  6. The argument, in other words is this: technology adoption through substitution affects semi-skilled, middle income wage earners the most, leaving low-skill and high-skill workers, but fewer workers between the extremes.
    Technology isn’t to blame

    Fears that automation is keeping companies from hiring new workers and exacerbating income inequality are overblown, in part because the oft-repeated productivity gains from information technology are often illusory in the first place. As the economist Robert Solow quipped in 1987, “You can see the computer age everywhere but in the productivity statistics.”

    Daron Acemoglu and his economics team at MIT evaluated data on the US manufacturing sector in 2013 and found no evidence of information technology-driven productivity gains or significant reductions of workers due to IT.

    They found that in IT-intensive manufacturing, payroll growth was not significantly different than in other manufacturing, and neither was the quantity of product shipped. Thus the productivity gains that information technology delivers are not readily apparent in an industry where IT is dominant.

    Separately, in his book, Capital in the twenty-first century, Thomas Piketty also presents a different view on the impact of information technology on inequality. Piketty wrote that as compared to earlier waves of innovation such as the steam engine and electrical power, the “revolution in information technology” is “less disruptive to modes of production and does » less to improve productivity.”

    He also notes that wealth inequality has grown higher in the US than in Europe despite the fact that technological change has affected all countries at the same level. Productivity change has been the same across countries, and thus there must be some other explanations besides information technology for inequality in the US.
    The real culprits

    More likely culprits behind the slow return of jobs since the recession are a drop in business dynamism, macroeconomic problems such as a lack of credit and delayed hiring because investments are slow to pay off.

    The formation of new business has historically been one of the positive side effects of a downturn, but business dynamism has been in decline since the recession as US businesses collapsed faster than they formed, according to the Brookings Institution. And those that did had an average of just 4.7 workers in 2011, compared with 7.7 in 1999.

    Furthermore, the number of firms owned by people under 30 years old – important to the introduction of innovations that increase productivity – is at a 24-year-low. Since there were fewer younger firms after the recession, the delay in increasing overall productivity could have led to delays in business recovery and hiring of new workers.

    Macroeconomic factors may also be at work, particularly the availability of credit.
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  7. The 'death of peak oil' has been much exaggerated, writes Paul Mobbs. Take out high-cost 'unconventional' oil and production peaked ten years ago, and even North America's fracking and tar sands boom has failed to open up new resources both big enough to make good the shortfall, and cheap enough to reward investors. We really do need to be thinking 'beyond petroleum'.

    It wasn't simply the economic failure of fracking (covered in The Ecologist last December) and the subsequent collapse in drilling (covered in January). The news from the USEIA was far more grim for those who understood its deeper meaning. Their press release was very matter-of-fact:

    "EIA's most recent Drilling Productivity Report (DPR) indicates a change in the crude oil production growth patterns in three key oil producing regions... The DPR estimates include the first projected declines in crude oil production in these regions since publication of the DPR began in October 2013."

    In the shale oil producing areas of Eagle Ford, Niobrara, and the Bakken, production had reached a peak and was beginning to decline. What the USEIA is not clear about is whether this is the result of recent economics, or some longer-term trend.

    This message was echoed a few weeks later in the Post Carbon Institutes's new analysis of Marcellus shale production, along with a warning about the future prospects:

    "Industry invariably drills its best prospects first, hence the cheapest gas is being exploited now. Infinite faith in technology cannot make up for the realities of geology. These realities are showing up now in the most productive counties."


    'Peak oil' - or the peaks of other resources such as copper or rare metals - is not equivalent to 'running out'. The 'peak' is the point in time when half the available non-renewable reserve has been extracted - somewhere between a half and two-fifths through the lifetime of the resource.

    From that point on it gets progressively harder to maintain production. Supply begins to fall, and both the energy and resources expended to produce a given quantity of the resource begins to increase exponentially over time.

    This effect is the result of the interaction of geology and economics:

    Geology gives a natural distribution of resources - with a few large high-quality deposits, a slightly larger number of middling-quality deposits, and a lot of very small low-quality deposits.
    Economics dictates we use the easiest to exploit and cheapest first, which means we use the biggest, easiest to access ones. Over time what's left gets progressively harder and more expensive to produce as we work through the 'stock' of the resource.

    The difficulty is that when we're talking about essential industrial minerals and energy resources, tight supply and rising prices - like the trends operating across the decade of the 2000s - can destabilise the economy.

    That's very bad for business and our resource-consuming lifestyles.

    In 2008 the crash came. What was worse, the warning signs related to the problems of finite energy supplies, ecological limits and debt were ignored; their message smothered beneath billions of pounds and trillions of dollars of quantitative easing.

    As billions poured into the banks, all the bankers could do in the midst of a recession was to lend to the few large industrial investment projects which were under-way - such as 'fracking' in the USA, or the housing market in Britain.

    The quiet reality of North American oil

    Canada produces a lot of conventional and unconventional oil - a large proportion of which gets sent to the USA. This fact is used as a positive message by the tar sands lobby to promote their industry.

    What that message misses is that the whole of the continent of North American acts as a single market - in part due to NAFTA.

    Mexico used to supply a lot of oil to the USA too, but production in the Cantarell field peaked in 2003 and is now in decline. For the last few years all that those increases in Canadian production have done is to roughly keep pace with the decline of Mexico's production.

    In the USA, yes they've produced a lot of new oil and gas from shale. What's equally significant is that, as a result of the economic downturn, they're also consuming 10% less oil than they were before the crash.

    Within the North American energy system, the impacts of the US economic recession on consumption is every bit as important as all those fracking rigs. In the global context too, the recent Chinese economic slowdown is a major factor in OPEC having the ability to floor the price of oil, thereby curtailing unconventional sources of oil.

    The figures are clear - we've peaked!

    If we take the data from the BP Annual Statistical Review for 2014, global oil supply was higher than in any other previous year. Peak oil averted? - arguably not.

    BP's figures include fracked shale oil, Canadian tar sands, and natural gas liquids from unconventional gas production. As outlined recently by the USEIA and Post Carbon Institute, shale oil is beginning to hit the limits of production. In Canada too, production is being constrained by a lack of new investment due to currently low prices.

    The other major factor is that, even amongst conventional producers, all is not rosy. Six nations produce half the worlds oil, three of which have peaked conventional production; 14 produce 75%, six of which are arguably past their conventional oil peak.

    For the last decade fracking and tar sands have produced enough oil to influence the global figure - but only by a few percent. Strip out that few percent of unconventional oil (let's ignore the gas liquids for now) and that small buffer evaporates.

    Once shale production falls significantly, or Mexico or another key producer begins to hit the steeper part of their depletion curve, or just a few more oil producers reach their peak, production will fall more steeply - portending yet another global energy, then economic crisis.

    The data on this and other ecological issues indicates that the core of neoliberal theory - of continual growth, technological progress and monetary wealth creation - is fatally flawed.
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  8. This kind of unsustainable situation has in fact already arrived, if Gail's view is correct. In this comment on her blog she sums up exactly what she thinks will happen:

    It depends on how quickly the failure of banks brings the whole system down. I think the most likely scenario is that the next big crash is the last one. We had a big crash in 2008, and were temporarily saved from it. The next one seems likely to be much bigger, and thus to be much harder to avoid the consequences of.

    My expectation is that oil prices will go lower than they are now, and that debt defaults will start hitting the system. Some of these defaults will relate to derivative bets gone wrong. This will start hitting in the next few months. We should be feeling the effects by late in 2015 or early 2016. Oil production will start going down in 2015, and we won’t be able to get it back up again.

    I don’t see prices bouncing back up again much, expect perhaps briefly in the next few months (and probably to less than $100 barrel), as people speculate that our problems are temporary. I don’t think shale drillers will be able to qualify for more debt, and this will prevent production from increasing again. There will be similar problems with new oil sands investment.
    Tags: , , , by M. Fioretti (2015-05-16)
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  9. Shale debt, falling prices and slack demand has tight oil producers in trouble. And yet, there is still burgeoning production. Why? Well, we’ve seen this before. It’s the shale debt redux. Operators did it a few years ago in natural gas and prices have yet to recover. Unfortunately cheap money in the form of debt can mean poor investment choices for businesses and for investors. But it can also lead to an aberrant market because operators deep in debt won’t curtail production even though it is glutted. Debt coupons simply have to be met.

    The shale revolution has always been funded by massive debt. Operators who were drilling for gas back in 2009-2011 used debt extensively. And just like now, they overproduced. By 2011, supply exceeded demand by four times. Then prices tanked. It is curious that so few asked the questions: why did they produce so heavily and glut the market; and why did they continue to produce into a glutted market? The answer is really quite simple. Many couldn’t afford to pull back production to help stabilize prices. Had they done so, they would not have been able to meet their debt payments. So they kept pumping…and pumping…and pumping.

    And now they’ve done it again.

    Much of the debt issued by shale operators has been high yield or what is commonly referred to as junk. According to the Wall Street Journal:

    “Junk bonds have financed the U.S. shale boom, and now the sharp drop in oil prices could lead to a massive wave of defaults on that high-yield debt.”

    JP Morgan Chase estimates that as much as 40% of this junk debt may be defaulted on by shale companies in the next two years if prices stay below $65/bbl. Yeah, you read that right…40%! Prices are currently trading around $45/bbl and operators are still pumping huge amounts of crude into the market so a $20/bbl price rise would seem unlikely.

    This picture is complicated enormously by the overwhelming need for cash by shale operators. Energy was the fastest growing sector of junk debt in 2014 and is the largest chunk of the high yield market.
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  10. who will pay all this debt? The answer is simple – our children and grandchildren will have to pay.

    Debts are always, above all else, a claim on future production, to be paid out of future earnings, either directly or through taxation. And if for some reason governments manage to keep on kicking these debts ever further down the road, as they tend to do, it will still be our children and grandchildren that pay the price, through lower earnings and a generally poorer world, because debts always have to be paid, one way or another. If this wasn’t the case, then we must have found a way to create something out of nothing. A miracle!

    But there’s nothing miraculous about the current situation. It might be the case that banks do in fact create money out of nothing, in the form of credit, but unless that money is backed by real wealth creation in the underlying economy, all that credit creation must devalue the currency, which would normally lead to inflation. I say ‘normally’, because this doesn’t seem to be happening anymore, despite the best efforts of various western (and Japanese) governments, who are more concerned now with the opposite problem: deflation, or falling prices.

    It’s not immediately obvious why price inflation remains subdued, but I think there are two main reasons. Firstly, all this new money hasn’t gone into general circulation, it’s stayed within the financial system, to the benefit of the wealthy, boosting asset prices and inequality.

    The second reason, I think, is to do with the globalization of wages, which are being held down because over half of all real industry now takes place in China and other emerging economies. When we pay less for goods and services, we must expect to earn less ourselves, because ultimately all exchanges in the marketplace represent an exchange of labour.

    We can summarize the global economic problem in one sentence: Not enough people are doing the right kind of work anymore. By this I mean that the real wealth-creating sectors of the economy are employing fewer and fewer workers as a percentage of total population.

    Upon further investigation into the sources of all wealth and what happens to all the money that ends up in the financial system, I worked out that around one third of all economic activity during recent years was fuelled by debt, rather than by real wealth creation, and this has led to a situation now in which around a third of supposed wealth, as represented by money, doesn’t actually exist, because it’s based on credit that is itself a claim on future production.

    This huge claim on future production is bound to make the world a poorer place. For one thing, it means that a great many government promises, and possibly private promises too, will not be kept. By this I mean promises for future pension and welfare payments in particular, because the wealth that supposedly backs these promises doesn’t actually exist.
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