 Tuesday, October 10, 2006
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Reality Check
James Howard Kunstler
Against the background of everything
else happening in the financial markets is the apparent circumstance of
peak oil. Even The New York Times joined the chorus in a Sunday
editorial, saying:
Our
demand for petroleum products strains the limits of the global capacity
to supply them. In past decades, if a pipeline broke in Nigeria, Saudi
Arabia might compensate by setting workers to pumping more oil. Now,
with little additional capacity, rising prices are necessary to balance
out supply and demand.
No more increasing capacity = peak oil.
It's as simple as that. We now have nine and a
half months of "rearview mirror" action to look back and see that world
oil production has retreated from its all-time high of just over 85
million barrels a day (m/b/d) achieved in December 2005 (just as
geologist Kenneth Deffeyes of Princeton had predicted). For 2006,
production has remained in the 84 m/b/d range every month reported so
far, while demand has exceeded that.
Texas oil man Jeffrey Brown, a commentator at
TheOilDrum.com, the outstanding oil discussion group on the Internet,
makes the point that Saudi Arabia is at the same point statistically
(in terms of ultimate recoverable reserves) that Texas was at in 1972
when production there peaked. The world's four greatest oil fields are
in depletion (Burgan [Kuwait], Daqing [China], Cantarell [Mexico], and
Ghawar [Saudi Arabia]) and these have accounted for over 14 percent of
the world's oil production. (Ghawar alone accounts for over 60 percent
of Saudi Arabia's production.) The North Sea has peaked and production
there is "crashing." Venezuela has peaked and its oil is shitty heavy
crude. Indonesia (an OPEC member) has peaked and is now a net oil
importer. Nigeria's political chaos is making production increasingly
difficult-to-impossible. Production in the Canadian tar sands is not
making up for losses elsewhere. The US is down to about a four-year
supply of conventional crude and condensates while we import 70 percent
of the oil we consume. Discovery of new oil (including Chevron's
largely hypothetical deepwater "Jack" finds) is barely covering a
fraction of the world's consumption. So it goes....
Where finance is concerned, the basic
implication of peak oil is pretty stark: an end to industrial expansion
(i.e. "growth"). All the alternatives to oil will not keep the
industrial economies expanding -- they can only slow down a
contraction, and only marginally so. The trouble with this picture is
that finance is a system that uses paper markers to represent the hope
and expectation for the expansion of wealth. These markers are
currencies, stocks, bonds, option contracts, derivatives plays, and
other certificates that are traded in open markets. If there is no
longer any hope of increased wealth in the world, then all those
tradable paper markers become losers. Their value unwinds and imagined
piles of wealth evaporate into thin air.
The unwinding process depends on the
psychology of the people who own these certificates. If they do not
understand the global oil situation and its implications, then they
will continue to hope for and expect expanded wealth, and thus continue
to regard their paper certificates as credible markers of value. And
that is largely the case at the moment, since most of the playas in the
financial markets are not paying attention to the peak oil story, or
don't believe it is for real.
Two special and transient circumstances are
now propping up the financial markets. One is that for practical
purposes the world is virtually at peak, meaning this is an
extra-special time of strange behavior (like the point in the apogee of
a steep sub orbital flight in which passengers become momentarily
weightless). Supply and demand for oil are only beginning to go out of
whack (that is, demand just barely exceeding supply). Even at this
early stage, the oil markets themselves are showing stress, as hoarding
behavior sets in and induces wider swings of price volatility. But
these swings in oil prices -- such as the one we're in right now, where
prices have crashed 20 percent since the panic buying (hoarding) of
June and July -- send false signals to the financial playas. The main
false signal is that all is well on the global oil scene...there's no
real supply problem...and hence no threat to the continuing expansion
of industrial production and its associated wealth-generating
activities. This signal just tells the playas to buy more paper
markers. Thus, the stock market goes up.
The second special and transient circumstance
is that so much wealth has already accumulated along the way to peak,
that financial markets take on a life of their own -- as existing
wealth "invests" itself in more paper markers hoping and expecting to
"grow" into even more wealth. The problem here is that existing wealth
is actually being squandered, since the paper markers will only lose
value as the hopes and expectations vested in them dissolve in
disappointment. But we haven't quite reached that point yet.
In simply bidding the markets up, the system
has spun off even more gobs of presumed wealth. Some of this
"liquidity" -- say, in the checking accounts of people who work for
Goldman Sachs -- has found its way into Manhattan condominiums, or
Aspen McMansions, and filtered through the system to everyone from the
lawyers who write up the pre-nuptial agreements to the guys who sell
the furniture to the people who drive the delivery trucks that bring it
to the door, to the men laying tiles in the new bathrooms.
The basic insanity of a system that presumes
vastly increased wealth where none will occur, has led to further
distortions in finance. The most obvious one is the so-called housing
bubble. The misplaced extreme expectation in the ever-increasing value
of paper wealth, led to the hijacking of mortgages by financial playas
who bundled them into odd lots of tradable debt (promises to pay) and
used them to leverage abstruse bets (hedges) on the behavior of other
kinds of paper markers (currencies, interest rate differentials,
commodity prices) -- very profitably as long as all playas believed
that industrial societies that run all oil would continue to grow, to
produce more wealth. The level of abstraction in these rackets -- their
distance from the reality of productive activity --is self-evident.
But they were so successful that the
profligate creation of ever more mortgages became an increasingly
reckless and irresponsible enterprise. Contracts were made with
house-buyers who had no record of credit worthiness and often no real
proof of income. Contracts were made on terms (interest payments) that
were deceptive, even ruinously false, for the house-buyers. The
reckless reassignment of lending risk into ever more abstract layers of
deferred obligation, and the ease of credit that ensued, allowed
millions of ordinary people to acquire real property on unrealistic
terms, which had the affect of bidding up the price of houses that
these owners will eventually have to surrender for nonpayment.
That process is now underway. The
reckless creation of mortgages had the further effect of stealing
demand for house-building from the future. So many new houses were
built and then sold to people who will probably have to surrender them,
and then so many more beyond that were built in the expectation and
hope that reckless mortgage creation would continue forever, that there
is now a massive over-supply of total existing houses while the pool of
suckers for new ruinous mortgages has shrunk to zero.
Similar excesses in all the other
lending and debt sectors, including "non-performing" credit card
obligations and government deficits, will also unwind and thunder
through the system.
Meanwhile, the false signal from the oil
markets that has been broadcasting for eight weeks will come offline
and a new signal will come on as prices go back up. The pause in
bidding for future oil induced by the panic over-buying of the summer
will end. The heating season is here. It's 40 degrees out in upstate
New York this morning and the furnace is cranking. The Chinese and the
Indians and even the people in France have not stopped using oil, even
if Americans have put their Winnebagos up on blocks for the season.
As the price of oil goes back up, the
financial markets will get a new signal that running industrial
societies has just gotten more expensive again. That will dampen hopes
and expectations for increased wealth from these societies. Meanwhile,
the air will be coming out of millions of mortgages, and the loss of
value will spread among playas holding these bundles of mortgage debt
(i.e. promises that money spent on houses is being paid back, which it
won't be). At the same time the houses themselves will lose value as
the pool of potential buyers shrinks to nothing. That is, the inflated
value (high price) of these assets will deflate.
As this occurs, there will be far fewer
wage-earners putting up additional houses, fewer furniture sales, fewer
trips by delivery truck drivers and fewer tile-jobs in the McBathrooms.
This is why I view the fall melt-up of the
stock markets as a swan dive. We're at the apogee now, just as the
world is at the apogee of its oil production. I confess, I thought the
reality of our economic predicament would be recognized by the playas
and their markets sooner than it has. It turns out the the chief luxury
of the final cheap oil blowout has been the artificial support of
unrealistic hopes and expectations.
Buy and read Kunster's important book: The Long Emergency!
Visit Kunstler's website
