Peak Watch

Tilting At Windmills and Energy Literacy

I want my, I want my MTV...
Money for nothin' and
Chicks for free
    —Dire Straits, Brothers In Arms (1984)

I thought about calling this column A Bittersweet Victory, but this isn't the time to gloat. With the oil price bouncing around between $125 and $135/barrel, and both the trucking and airline industries in trouble, it seems like time to declare victory.

I chose Tilting At Windmills and Energy Literacy instead because we are now being bombarded with ludricrous suggestions about how to get out of a crisis brought about by a gradual peak & decline of world oil production, a trend which has been evident for three long years now. An energy literate public and media would be able to debunk this nonsense, filtering out the noise that obscures the true signal.

It would be satisfying if those of us who have argued that a near-term peak (bumpy plateau) in world oil production would have severe economic effects could take credit for the surge of "peak oil" awareness in the media, but that assessment would be wrong. Press reports rarely consult knowledgeable sources, and the recent appearance of Robert Hirsch on CNBC was the notable exception that proves the rule.

It's mostly the oil price that's doing the talking now, not anything any of us said or did. Thus our society has now moved from complacency to near panic. This was predictable.

A New Agenda?

When Paul Krugman writes a column entitled Stranded in Suburbia, it's probably time for some of us to move on. The old agenda, at least for me, was straightforward analyses showing that the world's oil supply was in trouble or studying the economic effects of pricy oil. We need a new agenda. What will our new mission be? Let's quote Krugman, adding some commentary in italics, to explore this question. I believe a take-no prisoners-approach is warranted here. ("..." indicates omitted text.)

I have seen the future, and it works...

Krugman can hardly say he sees a future that doesn't work

If Europe’s example is any guide, here are the two secrets of coping with expensive oil: own fuel-efficient cars, and don’t drive them too much...

The two secrets. That's all there is to it? Is Europe really a guide?

Notice that I said that cars should be fuel-efficient — not that people should do without cars altogether. In Germany, as in the United States, the vast majority of families own cars... But the average German car uses about a quarter less gas per mile than the average American car. By and large, the Germans don’t drive itsy-bitsy toy cars, but they do drive modest-sized passenger vehicles rather than S.U.V.’s and pickup trucks.

Germany's land area is 137,858 square miles. It would fit neatly inside Texas (268,601 square miles). 

In the near future I expect we’ll see Americans moving down the same path [as Germany]. We’ve already done it once: over the course of the 1970s and 1980s, the average mileage of U.S. passenger vehicles rose about 50 percent, as Americans switched to smaller, lighter cars...

As a typical liberal economist, Krugman believes efficiency and substitutes are all that's required to counter exorbitant oil prices. Unlike the 1970's and 1980's, we are facing what Kunstler calls the "long emergency" in which the volumes of liquid fuels available to us decreases over time. Once you make one set of efficiency moves, you've got to make another, and another. Inevitably, some people will be, and not in The Rapture sense, Left Behind. At the very least, this means no car at all.

Admittedly, the next few years will be rough for families who bought big vehicles when gas was cheap, and now find themselves the owners of white elephants with little trade-in value. But raising fuel efficiency is something we can and will do.

If you live in suburbia and need to make long commutes you can't afford, and you can't trade in your SUV to get a smaller more efficient car, and you're up to your ears in credit card debt, your mortgage debt exceeds your house's value, and you're living from paycheck to paycheck, what exactly are you supposed to do to fix all this?  Even if you somehow manage to keep your job? Krugman doesn't say.

Can we also drive less? Yes  —  but getting there will be a lot harder... Any serious reduction in American driving will require more than [canceling vacations, riding the few buses available]  —  it will mean changing how and where many of us live.

To see what I’m talking about, consider where I am at the moment: in a pleasant, middle-class neighborhood consisting mainly of four- or five-story apartment buildings, with easy access to public transit and plenty of local shopping.

It’s the kind of neighborhood in which people don’t have to drive a lot, but it’s also a kind of neighborhood that barely exists in America, even in big metropolitan areas. Greater Atlanta has roughly the same population as Greater Berlin — but Berlin is a city of trains, buses and bikes, while Atlanta is a city of cars, cars and cars (that's I-85 pictured left).

And in the face of rising oil prices, which have left many Americans stranded in suburbia — utterly dependent on their cars, yet having a hard time affording gas — it’s starting to look as if Berlin had the better idea.

Changing the geography of American metropolitan areas will be hard. For one thing, houses last a lot longer than cars. Long after today’s S.U.V.’s have become antique collectors’ items, millions of people will still be living in subdivisions built when gas was $1.50 or less a gallon.

How will people be able to live in "subdivisions built when gas was $1.50 or less a gallon" when gas is $7.50/gallon or more? Are these suburbanites going to live off the garden in the backyard? Band together to tear up some of that concrete and asphalt to make more tillable acreage? No, they'll need to unload their houses.

OK, let me see if I've got this right¹. You're out there in suburbia, this isn't Germany, the Housing Bubble has collapsed, credit is tight, you can't trade in your SUV, a Prius (or future Plug-in Hybrid) is unaffordable, and now you've got to sell your house and move someplace where you can work and shop locally. But you can't unload your house because nobody want it. Are you just going to walk away from your mortgage? And what about soaring real estate prices for the desirable locations? Like where Krugman lives? How exactly is all this going to work? Krugman doesn't say.

Infrastructure is another problem. Public transit, in particular, faces a chicken-and-egg problem: it’s hard to justify transit systems unless there’s sufficient population density, yet it’s hard to persuade people to live in denser neighborhoods unless they come with the advantage of transit access...

Good point! Germany has trains, buses and bikes. The U.S. does not. Maybe we ought to be building them like there's no tomorrow, the chicken or egg problem notwithstanding?  But where are the resources we need going to come from to rebuild our neglected, aging infrastructure in an inflationary world caused by diminishing available energy?

It takes a long time to come to grips psychologically with the potential implications of peak oil. Krugman has just started thinking about it. He's a newbie, he's in the early stages. So, education is one role I can see taking on as time goes on. Energy literacy is important because Americans need to know what to expect in the future out to 2020 and beyond. People require a reality check.

So, don't get your "peak oil" views from a Born-Again Paul Krugman. What he doesn't say is more important than what he does say. You need to ask the hard questions that Krugman doesn't address. You need to read between the reassuring lines, exercise some critical judgment, and take a hard look at where you stand.

Asking hard questions and looking for answers is not the same as saying that civilization is on the verge of collapse and we're all doomed, although that outcome lies within the realm of possibility—it's important to acknowledge this because it spurs people to action. I hope Americans will band together to make things work out, even with less and less energy to go around over the long run. It needn't be the Dark Ages, but it will definitely be different. This is a common point of confusion both outside and even within the "peak oil" community itself.

In the interest of energy literacy, let's do some clarifying and debunking. Learning how to spot a phony argument is a critical skill if you're going to get serious about preparing for the Long Emergency.

Tilting At Windmills

I chose a couple illustrative stories more or less at random from the plethora of examples available lately.

• Scott Simon of NPR's Weekend Edition interviewed economist Phillip Verleger² about gasoline prices on May 24th. Verleger opined "that if demand drops significantly and if refiners do many of the things they're planning to do, we could easily see $2.00/gallon gasoline within 4 or 5 years."
  

  Verleger noted that "there's [heavy] crude oil sitting on ships off Iran that the Iranians can't sell." The problem is that "there's not enough light sweet crude oil" to support diesel demand because of a disruption to Nigerian supply and "because the U.S disrupted supply by putting light crude into the Strategic Petroleum Reserve." Oh, my! From the Oil & Gas Journal's Why suspension of SPR price can lower oil prices by editor Bob Tippee (May 16, 2008).

  "Under bipartisan pressure from Congress, the Department of Energy on May 16 announced it is suspending by as much as 13 million bbl [35,000 barrels per day] this year's acquisition of crude for the Strategic Petroleum Reserve" [SPR]...

  In his Senate testimony, Verleger noted that a leap in crude prices last year away from 2006 levels coincided with DOE's revival of acquisition of crude for the SPR. About 33% of crude acquired for SPR is sweet.

  Verleger estimated that SPR purchases lowered global supply of light, sweet crude by as much as 0.3% and raised the price by perhaps 10%. At the time, the light, sweet crude price was $94/bbl.

  35,000 barrels per day going into the SPR represents 0.17% of America's daily oil consumption. That's between one and two tenths of a percent. That's a drop in the bucket. Grasping at such straws is not a solution to the global production peak of light sweet crude (Chris Skrebowski, editor of Petroleum Review). That Iranian crude is crappy, it's a nightmare to refine, and the Iranians won't lower the price they want for it.

  The bogus argument made by Verleger (and OPEC) is that there is insufficient capacity to refine all the lousy oil we have into the middle distillates we need (kerosene, diesel, jet fuel, heating oil). We are being asked to believe that there is a glut of this lousy oil out there waiting for the refining capacity to catch up. Tain't so, not true. Only OPEC has some spare capacity, and there's not much of that, heavy, sour oil or not (ASPO-USA, September 19, 2007). Everyone cites this Iranian example because it's the only one they have.

• The House of Representatives voted to sue OPEC by a vote of 324-84. From Let's Sue OPEC! That'll Teach Them! (Energy Tribune, May 21, 2008).

  When it comes to energy policy, Congress goes from dumb to dumber. The latest example: a bill passed by the House of Representatives on May 20 that will allow the U.S. government to sue OPEC for conspiring to raise prices. There are several reasons why the bill, which passed by a margin of 324 to 84, makes no sense. I’ll focus on two: reciprocity and hypocrisy... [Read the article and see Robert Rapier's R-Squared Energy Blog for some details]

  The other problem with the House measure is its blatant hypocrisy. Congress has restricted drilling in the U.S. by making (for example) the Arctic National Wildlife Refuge [ANWR] and other areas off-limits to oil and gas exploration...

  On the bright side, there is a hilarious (and insightful) video from Yahoo! Finance featuring Aaron Task and Henry Blodget that covers our elected leaders' "pathetic" response to  the oil crisis, including suing OPEC—good luck with that! says Aaron Task (click on the picture left).
  

  As the Energy Tribune notes, it is hypocritical of the U.S. to demand that OPEC meet our energy needs while we refuse to pursue all the supply options at hand. Moreover, trade relations go two ways. We want to exercise our God Given Right to cheap oil, and Saudi Arabia could demand cheap wheat in return. Saudi Arabia's water depletion problems have led to peak wheat in the Kingdom. As Rapier points out, we can plant and harvest wheat every  year—until our favorable climate gives out—but once the Saudi oil is gone, it's gone. We are demanding that Saudi Arabia sacrifice their sole source of wealth so we can drive our cars and not make any sacrifices of our own.

  But the House of Representative says screw those Arabs!  This reminds me of (a slightly altered version of) the great Dire Straits tune Money for Nothing—I want my, I want my SUV! More than one person has said that adult life (or the Congress) is a lot like high school. High school? It looks more like preschool to me. OPEC will act in their own self-interest. That's what people do unless you coerce them. We are not in position to threaten OPEC. (See Iraq.) Suing OPEC is not a way out of our predicament.
  

I could have used other horror stories, including the current confusion over ANWR—this subject requires a column of its own—or oil company executives explaining how the oil markets work in testimony before a Senate inquisition. Perhaps the first thing we should do is offer a free energy literacy program to all members of Congress. Maybe then they'll stop Tilting at Windmills and get about the serious business of meeting the oil crisis head-on.

Won't Be Fooled Again

There may be short-term "corrections" of the oil price in the next few years in which the price falls a bit for a few weeks or a few months. Don't be fooled. This oil crisis is here to stay. All the effective solutions are on the demand-side. Efficiency, conservation and proximity are the keywords. If Americans are going to make meaningful sacrifices and adjustments, they will need to understand the issues. They will need to be energy literate.

Contact the debunker at dave.aspo@gmail.com

Notes

1. Krugman has got all his ducks in a row—he lives in a "pleasant ... neighborhood ... with easy access to public transit and plenty of local shopping." This is posh Princeton, New Jersey, Krugman is talking about, not Atlanta, Phoenix, Los Angeles, Denver, or God Forbid, Las Vegas. God Bless the Child, Billie Holiday sang, Whose Got His Own. You would be amazed at the extent to which a person's personal circumstances influence their view of the world. Comfortable people are eager to tell stressed-out people what they should be doing. So it goes.

2. Where did the NPR's Scott Simon dig this guy up? Verleger called in from his hometown, Aspen, Colorado. Playground of the rich, Aspen is not exactly Everytown USA. See the Krugman note just above.

Our Phony Economy

Damn, we're in a tight spot!
    —Everett McGill (George Clooney) in Oh Brother, Where Art Thou?

(Note: it's all oil prices all the time in the media, so if you want to know fundamentals behind why oil prices are rising, read last week's column.)

Harpers Magazine assigned this column's title to congressional testimony¹ by Jonathan Rowe in its June, 2008 issue. Rowe's basic observation is that Gross Domestic Product [GDP] measures not only wealth, but "illth" as well. If the rate of onset of Adult Diabetes is soaring—it is—then "expenditure [on medical care] and motion [patient/care provider activity]" goes up, although this is not a welcome development for those suffering from this disease. The GDP grows and growth is always deemed to be good.

That term "the economy": what it means, in practice, is the Gross Domestic Product—a big statistical pot that includes all the money spent in a given period of time. If the pot is bigger than it was the previous quarter, or year, then you cheer. If it isn't bigger, or bigger enough, then you call Federal Reserve Chairman Ben Bernanke up here and ask him to do some explaining. The what of the economy makes no difference in these councils [Congress]. It never seems to come up. The money in the big pot could be going to cancer treatments or casinos, violent video games or usurious credit-card rates.

Rowe has been arguing for common sense since at least 1999—"A human economy is supposed to advance well-being. That is elementary" (Washington Monthly, March, 1999).  Perhaps Rowe's argument could be more aptly called "Our Misleading Economy," for not only does GDP mislead us by including all sorts of detrimental things, but the actual growth measurements themselves are, for lack of a better word, phony.

Why is understanding that the economic data is spurious important? First, such data does not accurately measure the amount of financial distress in people's lives and thus attempts to cover up (as in Watergate) economic ill health. However, people know—or should know—their own situations and can easily see the effects of inflation every time they fill up at the pump or go to the grocery store. 

More importantly, bogus data enables bullish predictions about a short, mild recession, or even no recession at all, to be followed by more "growth." Cheerleading is meant to boost confidence, and seeks to get people to buy into the "more spending is better" assumption—buy more cars, more Fritos^© corn chips, more iPods, more ... everything, which obviously includes oil and its refined products. Buy more even if you can't afford it—run up those credit cards. Apparently, this strategy is not working (graph left). And not only are high oil and gasoline prices here to stay, but an overwhelming majority of people believe they are here to stay (USA Today, May 13, 2008).

Those of us who write about the longer term oil supply issues know the dangers inherent in this kind of happy talk. For example, the EIA actually predicts that Brazil will produce some 3 million barrels per day (b/d, all liquids) later this year, whereas their generally flat production now stands at 2.26 million b/d (ASPO-USA, May 14, 2008). Brazil will not reach the lofty goal the EIA has set for them this year, or even come close. If pigs had wings, they could fly.

Skewed expectations, for both oil and the economy as a whole, will eventually lead us down the garden path to ruin. There's really not a lot of difference between counterfeit oil supply predictions and doctored growth numbers for retail sales in April, 2008. All bogus numbers, whether they come from the EIA or the Bureau of Labor Statistics, are part and parcel of attempts to manage our behavior to keep the growth party going.

Pollyanna Creep

John Mauldin's The Fed at the Crossroads takes a pessimistic look at retail sales in April.

Many commentators, looking for a bullish lifeline, have pointed to the fact that retail sales grew in April by 1.8% over this time last year. But that is truly grasping at straws. Just last November they were growing at 6% year over year and have been dropping relentlessly for the last six months. And as good friend and data maven Greg Weldon points out, retail sales last November were 1.3% over inflation and now are a negative 2.1% below inflation. Retail sales are clearly headed down. (Weldon Financial, a must-read for those who need in-depth analysis of all things and data economic)

But there was growth. Gasoline sales were up 16.3%. And food sales were up 6.1%. 77% of the increase in retail sales this year has been from increases in food and gas sales. If you take out food and gas, retail sales are down by about 2% in the last three months.

This higher gas and food spending is all in your head, your eyes are deceiving you, the Guardian facetiously reported on May 14, 2008. This is worth quoting at length.

High gasoline prices got you down? Come to the land of seasonal adjustment, where the sun is always shining and gas prices fell 2 percent last month.

What? You paid more? Well, in the real world, gasoline prices did rise by a sharp 5.6 percent in April from a month earlier, but the way that the Bureau of Labor Statistics adjusts the figures to smooth out seasonal oddities, it appeared to be down in the consumer price index released on Wednesday. "The drop makes absolutely no sense. Where does the BLS buy their gas?" asked Mark Vitner, senior economist at Wachovia...

Another branch of the very same U.S. government, the Department of Energy's Energy Information Administration [EIA], said average retail gas prices actually shot up 9.5 percent in April from March. To compare EIA and BLS gasoline price data, [look at the graph above].

It has to do with how the Bureau of Labor Statistics compares current price trends with the norm. Typically, gasoline prices rise sharply in April as the arrival of warmer weather encourages people to drive more. The government data is adjusted to reflect that pattern so that it can highlight variations from the trend. Because gas prices did not rise as much last month as they typically do in April, the seasonal adjustment showed that prices fell.

Note: To be fair, the EIA does try to report energy prices accurately.

The BLS is entitled to compare this April's price hike with the historical trend. They are not entitled to adjust that price increase (i.e. the data) via a "seasonal adjustment" according to that trend.

Fraudulent reporting of April's gasoline price increase by the BLS is a minor league deception. To get to the major leagues, you need to look at John Williams' Shadow Government Statistics. Williams tracks "pollyanna creep," the official government rule changes that have put a rosy gloss on how the economy is doing over the last 25 years. As described in Kevin Phillips' Numbers Racket: Why the economy is worse than we know, Williams calculates the numbers for GDP, the consumer price index (CPI), and unemployment based on the pre-creep rules (Harpers Magazine, subscription required, May, 2008). The graph above and directly below are taken from Phillips' article.

Using the old rules yields some startling results. The first graph (above left) shows that inflation is currently 12% based on the pre-1983 criteria, whereas the "official" number is just over 4%, including energy and food. The government estimate makes several dubious assumptions, one of which is the infamous hedonic adjustment. Back in 2005 an inflation debate was brewing over intangibles at the mall—

To most people, when the price of a 27-inch television set remains $329.99 from one month to the next, the price hasn't changed.

But not to Tim LaFleur. He's a commodity specialist for televisions at the Bureau of Labor Statistics, the government agency that assembles the Consumer Price Index. In this case, which landed on his desk last December, he decided the newer set had important improvements, including a better screen. After running the changes through a complex government computer model, he determined that the improvement in the screen was valued at more than $135. Factoring that in, he concluded the price of the TV had actually fallen 29 percent.

Mr. LaFleur was applying the principles of hedonics...

No comment I could make would improve your understanding of the absurdity of this adjustment to the CPI. You're still paying $329.99 for the the TV with or without the improved screen which you may or may not want.

The next graph (left) compares the "official" unemployment rate with the percentage you get if now excluded categories are put back in, including part-time, discouraged and other marginally-attached workers. This calculation shows that unemployment is actually around 9%, not just over 5% as the government reports.

One more egregious example suffices to drive out point home. As reported at the mortgage industry blog mariah.com, the BLS apparently did not like the negative personal savings rate (graph left) so they replaced it with a more cheerful graph (graph below left). The new BLS graph, which can be found here, is presented without explanation for the change, which we wouldn't even know about unless someone had saved the older version.

Although there are different ways to calculate the personal savings rate, the St Louis Fed concludes that "despite these measurement problems, the recent decline of the U.S. personal saving rate to low levels seems to be a real economic phenomenon and may be a cause for concern for several reasons. After examining several possible explanations for the trend advanced in the recent literature, [we] conclude that none of them provides a compelling explanation for the steep decline and negative levels of the U.S. personal saving rate." No doubt the BLS employed an alternative method yielding a happier result for its personal savings rate calculations and then made the revision. Not that it makes any difference.

The BLS has traveled so far down the Road to Perdition that all of our trust in their economic metrics must evaporate.

An Orwellian Nightmare

The oil supply question concerns our future quality of life. Jonathan Rowe reminds us that "a human economy is supposed to advance well-being." Escalating energy prices threaten our well-being. How can one warn others about likely dire economic effects resulting from very high liquid fuel prices if there is no official recognition that those effects even exist? Or even acknowledgment of the price increases themselves?

This Orwellian nightmare poses yet another obstacle, a big one, to promulgating a correct understanding of what is really happening as the oil price continues to rise in an economy that has multiple failures (ASPO-USA, May 14, and March 26, 2008). Websites like the Prudent Bear or iTulip warn us about the possibility of hyperinflation, the detrimental aftereffects of the Housing Bubble, new bubbles on the horizon, or other disasters (ASPO-USA, February 13, 2008). There were warnings about the Housing Bubble on the web for years before the market tanked. Thank God for the internet. Nevertheless, merrily we roll along, living in the phony economy Big Brother has invented for us.

Contact the author at dave.aspo@gmail.com

1. I have taken the liberty of publishing the Harpers Reading, which is a reprint of Rowe's "testimony delivered March 12 before the Senate Committee on Commerce, Science and Transportation." I assume therefore, that this text is in the public domain and that this constitutes "fair use."

The Age of Aquarius

When the moon is in the Seventh House
And Jupiter aligns with Mars
Then peace will guide the planets
And love will steer the stars
This is the dawning of the age of Aquarius
      —from the musical Hair (1968)

I wonder if much of the debate about the run-up of oil prices could be resolved simply by looking at this graph.

   

                               World Oil Supply & Demand (all liquids) from 2003-2007
                                            Source: EIA supply and demand data

As you can see, world oil demand surpassed the available supply in 2007. Demand rose 7.51% during period shown while supply only rose 6.26%, with all of that increase occurring in 2003-2004. The EIA demand numbers measure the quantity of oil demanded. When the quantity demanded exceeds supply, the extra consumption must be met by draws on inventories.

                                 Source: Economagic Data Series up to last week

The oil price rose precipitously throughout 2007 (graph above). In September 2007, the average monthly price ($79.93/barrel) finally surpassed the previous record ($74.41/barrel) set in July, 2006. The price has climbed pretty steadily ever since, with only two months, December, 2007 and January, 2008, not showing a net oil price increase (defined therein, ASPO-USA, April 9, 2008).

Maybe it's just a coincidence that the price started its steep rise during the same year that available supply fell below demand. Why does the crude oil price keep rising? Econ 101 helps us out here.

1. There has been no downward shift in the global demand curve accompanying the price rises over the last 8½ months. On the contrary, the demand curve seems to be moving up and to the right (graph below). Subsidized oil demand in China, the OPEC countries and other developing economies shields consumers from price increases. Consumption in the OECD countries (including the U.S.) is largely inelastic (i.e. insensitive to price increases) in the short to medium term.
2. High prices since 2003 have not stimulated a supply-side response that allows the oil markets come into balance at a new equilibrium price. The world's oil supply has been almost perfectly inelastic since 2004 (first graph above).

This one-two punch forms the meat & potatoes of the oil price hikes — everything else is gravy. The Nymex WTI price and the price on other exchanges all over the world has shattered the inflation-adjusted highs of 1980, so we no longer have to deal with the obligatory references to the previous record anymore. Thank God for small favors.

It's Not An Oil Price Bubble

Some economists like lots of gravy with their meat & potatoes, never passing up a chance to transform the essentially simple into the marvelously complex. Without the benefit of a longer term perspective on the fundamentals, it is always possible to analyze shorter term price movements to death, although Paul Krugman eschewed such confusion in The Oil Nonbubble, New York Times, May 12, 2008.

The Wall Street Journal's Bubble Isn't [a] Big Factor in Inflation surveyed 53 economists to see what their gustatory preferences were. The gravy-lovers, 20% of those surveyed, thought speculation or central bank policy was responsible for the recent oil price hikes (graph left). The rest were meat & potatoes people, and eight of them actually said that "supply constraints" were the most important factor driving energy inflation. Bravo!

A CNBC analyst noted that demand had not increased by 43% , so why has the price moved up by that much in 2008? (Actually, 35.5% over the January average price.) Shouldn't something else be driving the price?

First, the relationship between price and demand needn't be one-to-one and linear, meaning that an X% price increase does not necessarily require an X% increase in demand (3rd graph above, I suppose this is why he's on CNBC and I'm not.) Most of price rise since the beginning of the year is still driven by the fundamentals. Nonetheless, some reputable economists (e.g. James Hamilton's Commodities and the Fed: Answering the Skeptics) believe that a growing supply & demand imbalance is insufficient to explain the steepness of the price rise during 2008. Be this as it may, there is always some slop in the oil price taking the form of premiums on the "base" price resulting from different factors.

My best guess is that the base (floor) price is now somewhere around $110/barrel and the current premium, which is ≅ $15/barrel, results from investors (a.k.a. speculators) riding the oil (commodities) price wave as a hedge against uncertainty in the financial markets the shaky dollar, and the economic slowdown in the United States. They're surfing! These commodity transactions are encouraged by the low interest rates and low upfront costs on buy orders. But remember, there have also been some significant supply disruptions in Nigeria lately, where production fell 250,000 barrels per day from March to April of this year.

Prices may fall later this year, but will not likely dip below the $110/barrel floor price. It is actually more likely that the price will continue to rise this year, as Goldman Sachs believes, because 1) stuff happens, e.g. deepwater project delays, project cost inflation, blown-up pipelines, and 2) we are now living in Flatland.

Living in Flatland

I put together a non-OPEC forecast for 2008/2009 a few months ago and I'm already prepared to revise it downward. (ASPO-USA, February 20, 2008—I was critiquing the EIA's much more optimistic estimates.)

Flatland (graph left) does not include OPEC natural gas liquids, which is the normal accounting method. The source is the current EIA all liquids data from the beginning of 2007 through April of 2008. The scale intentionally de-emphasizes insignificant monthly differences, which are the only kind of differences there are in the last 16 months for the countries shown and non-OPEC liquids as a whole.

Russia was chosen because their production has been the primary driver of non-OPEC liquids growth in the 21st century. Russian production is flat.

China was chosen because anything they can not produce themselves puts additional pressure on the world oil markets. Chinese production is flat.

Brazil¹ was chosen because this deepwater superstar is supposed to be the main driver of non-OPEC growth in 2008 and 2009. Brazilian production is flat.

We can not depend on OPEC, so we can expect only modest rises in the oil supply in 2008. Things don't look so good so far, do they?  (Read Sleepwalking Toward the Oil Precipice, ASPO-USA, April 30, 2008.) Flatland forms the important part of the Big Picture outside of OPEC, which I no longer expect to change much. Brazil will likely compensate for any Russian declines and add a bit more heavy oil, China can not get out of their production plateau, etc.

An End to Confusion? — The Age of Aquarius

I remember when "refinery bottlenecks" were thought to be a key factor driving the oil price rise. We don't hear that one anymore. The narrative is always shifting but has remained consistent in one important respect: the media has grasped at any straw they can find to deny the ongoing shift in market fundamentals that has been underway since 2004. This pattern is starting to change, as we see in Amid High Oil Prices, Danger Signs in Production (New York Times, April 18, 2008). The heretofore not-very-savvy Jad Mouawad, in keeping with his mission to never mislead us, now reports some three years after the fact that there are some warning signs that world oil production is faltering. I never thought I'd live to see the day.

Maybe I'll stop using the phrase "peak oil." This common term was used in Why $120 oil is good (CNN Money, May 8, 2008)—

"The market is starting to send a signal: You got to get your alternative in line," said Robert Kaufmann, director of Boston University's Center for Energy and Environmental Studies. "Societies that ignore this kind of signal do so at their own peril."

Kaufmann isn't promoting the so-called "peak oil" theory - he doesn't think the world is quickly running out of oil.

[Note — Kaufmann spoke at ASPO-USA's 2006 Boston Conference]

My brief correspondence with CNN Money reporter Steve Hargreaves about his incorrect inference—"peak oil" does not mean the world is quickly running out of oil— has convinced me that the phrase "peak oil" is now sufficiently debased so as to be all but useless in persuasive writing. I generally know who to thank for Hargreaves' casual doom-ridden understanding of this phrase, which reflects a now common misconception among the media and the public, but I won't play the blame game, and I can't change Human Nature.

Every petroleum engineer, everybody in the oil business, knows what it means to say that an oil field, or a country, or the whole world, has "peaked." But it's hard enough to persuade others of the dangers of "peak oil" without having to fight through a boatload of confusion about what "peak oil" means. Maybe I'll say "global maximum volumetric flow rates" or something like that. Distorted semantics is not a battle I want to fight, and did not choose to fight. Life's too short, and this is the Age of Aquarius, is it not?

Harmony and understanding
Sympathy and trust abounding
No more falsehoods or derisions
Golden living dreams of visions
Mystic crystal revelation
And the mind's true liberation
Aquarius!
Aquarius!

Contact the author at dave.aspo@gmail.com

Notes

1. A fuller treatment of Brazil is coming soon. That article will discuss what we can expect from the Tupi and Carioca fields in the next decade. The latest update for Brazil shows that Petrobras' oil (including gas liquids) output is flat at about 1.8 million barrels per day (b/d). Petrobras produces almost all of Brazil's oil.The EIA's April number for Brazil (2.26 million b/d) also includes sugar cane ethanol.

Sleepwalking Toward the Oil Precipice

The foolish man seeks happiness in the distance; the wise grows it under his feet.
     —James Oppenheim

The time has come to discuss what we can expect from OPEC as it relates to our prosperity in the coming decade. After 2010, crude produced outside the cartel will plateau and gradually decline, so any growth in the conventional oil supply must come from OPEC.

OECD policy-makers and consumers must now understand that OPEC's short term policy on supply-side relief, which is not to provide any, is also their longer term policy. Do not count on OPEC to bail us out of the oil crunch. We must adjust our expectations to reflect reality, not our hopes and dreams.

Delusional expectations placed upon OPEC's ability and willingness to expand the oil supply are going to make our lives untenable within a few short years. Harmful price impacts are already happening now. For most citizens, future impacts will far outweigh questions about who the next president of the United States will be as things stand now. In the absence of a major and immediate policy shift in the United States that aims to substantially reduce our oil consumption, it will be OPEC, not our elected government or "Big Oil" companies, that sets the minimum (floor) prices for liquids fuels.

This week brings news that OPEC president Chakib Khelil "does not rule out oil prices reaching $200 a barrel, even though supply is adequate, because the market is driven by the dollar's slide."

[Khelil] added: "The prices are high due to the fact of the recession in the United Sattes and the economic crisis which has touched several countries, a situation which has an effect on the devaluation of the dollar, and therefore each time the dollar falls one percent, the price of the barrel rises by $4, and of course vice versa," he was quoted as saying in brief remarks to journalists on Sunday.

He added that: "If this (the dollar) strengthens by 10 percent, it is probable that (oil) prices will fall by 40 percent" [Note — to $71.35/barrel at today's price]

... "But I don't think that an increase in production would help lower prices, because there is a balance between supply and demand and the stocks of gasoline in the United States have recorded a surplus and are at their highest level for five years."

Note — Khelil's assertion about current U.S. gasoline stocks is false (graph left). Falling gasoline stockpiles are now at the top of the 5-year average for April, and below that average for other months. On the other hand, large harmful diesel price hikes and shortages are occurring all over the world.

Although it is true that there is a negative correlation between the dollar's value and oil prices—the latter rises as the former falls—there is no good reason to believe that the plunging dollar has caused the price shocks of the last 8 months (both references are to James Hamilton's Econbrowser).

Khelil's thoughts on the oil price are simply another in a long series of excuses OPEC puts forth to justify their production policies. OPEC's president is actually saying that $200/barrel oil in the next few years is OK as far as they're concerned.

Two Views of Your Future

We need to set realistic expectations about OPEC's future contributions to the oil supply. I have come to see that most people do not share my enthusiasm for graphs, tables and simple arithmetic, but if your future prosperity rested on understanding these numbers and what they mean, you would make the effort, right? That's my challenge to you. My job is to present the material as clearly as I possibly can.

The first graph¹ comes from PFC Energy's Global Liquids Supply Outlook, a presentation by Bob MacKnight given on March 26, 2008. The graph shows the non-OPEC crude oil peak in 2010, but focus your attention on the "Call on OPEC" crude oil.

You can see three lines showing three separate scenarios for OPEC crude oil output growth out to 2020, one for yearly additions of 1.1%, one for 1.7%, and a third for 2.4%. These are the low, middle and high cases, respectively. As you can see, most world oil growth depends on OPEC crude (and natural gas liquids) production after 2010.

In PFC's low growth scenario, OPEC must supply 33 million barrels per day (mmb/d) to the world market in 2010, 37 mmb/d in 2015 and 46 mmb/d in 2020. Each growth scenario requires ever-higher OPEC crude production levels as shown, e.g. 37-45 mmb/d in 2015 spans the low to high growth cases.

Our second visual aid, Table 1.5 from OPEC's 2007 World Oil Outlook, shows OPEC's evaluation of the call on themselves in their reference case. Let's calculate the shortfall between OPEC's reference case and PFC's low growth scenario. OPEC's reference case in 2007 did not include Ecuador, which joined the cartel in November, 2007. You may thus add Ecuador's 0.5 mmb/d to OPEC's reference case for each year.

Subtract the adjusted OPEC Crude number in the table from PFC's Low Case number in each year Y.  In 2010, the shortfall is 33 − 30.7 = 2.3 mmb/d. In 2015, the shortfall is 2.7 mmb/d. In 2020, the shortfall is 6.7 mmb/d. 

You can now easily see that OPEC's call on itself is lower than PFC's lowest growth case² by a wide, ever-increasing, margin. I daresay that the reference case reflects what OPEC intended to produce—as of 2007—regardless of our expectations. It matters not whether these expectations come from the EIA, the IEA, IHS Energy/CERA, Wood Mackenzie, CGES or any other "experts" you care to name. Only OPEC's opinion matters here because they are in the Driver's Seat in 2010 and thereafter.

Are you going to pin your hopes on OPEC changing the call on itself upward as the years unfold? Think about their sit-on-your-hands policy, their persistent claims that the "market is in balance," Khelil's unconcerned view of $200/barrel oil ... well, I hope not.

It's Worse Than You Think

Although the foregoing paints a bleak picture, the situation is actually worse than you might think. OPEC's reference case may now be viewed as overly optimistic. Some points to consider are listed below. Things get a bit complicated in #1 and #3, so please be patient.

1. OPEC's average monthly production in 2008 (from the IEA's April Oil Market Report ) is 32.28 mmb/d, so you might say "Well! OPEC is producing more to ease the tight world market." OPEC is mostly adding to its total average monthly output by acquisition, not greater production in the core "OPEC 11". Angola joined the cartel in early January, 2007. Ecuador joined in November, 2007. There are now 13 countries in OPEC. Average monthly crude output was 29.71 mmb/d in 2006, and 30.66 mmb/d in 2007 adding in Angola's 1.61 mmb/d (= 29.05 mmb/d for the "OPEC 11"). Take the 2008 output number and subtract both Angola and Ecuador. The total for the "OPEC 11" is 29.97 mmb/d. This number has hardly moved over the last 27 months.

   The adjusted OPEC reference case total of 30.7 mmb/d in 2010 implies production of 28.30 mmb/d from the core "OPEC 11" if we assume current output levels for Angola and Ecuador (= 2.4 mmb/d). This is actually a decrease of 1.41 mmb/d from the 2006 level before either country joined the cartel.

   Summing up, total output from the usual suspects—Saudi Arabia, the UAE, Kuwait, Iran, Iraq, Nigeria, Algeria, Venezuela and the others—is assumed to be below the 2006 level in 2010 in OPEC's 2007 reference case. OPEC's Table 1.5 shows that the call on its crude is actually lower in 2010 than it was in 2005.
   

2. How much of this OPEC production will be available for export? Less than there used to be according to CIBC's OPEC's Growing Call on Itself. Consumption is rising in the Persian Gulf countries and elsewhere. Read the CIBC report and The Sierra Club Solution for a discussion of the export trends (ASPO-USA, January 30, 2008).

3. Recent Saudi statements seem to indicate an official change in policy that further confirms the Paradigm Shift position (ASPO-USA, June 20, 2007). This argument states that the Saudis and other oil exporters will not produce their oil in an unconstrained way to meed world demand. King Abdullah told us that "I keep no secret from you that when there were some new [oil] finds, I told them, 'no, leave it in the ground, with grace from god, our children need it'." Saudi Oil Minister al-Naimi validated the King's remarks in the Arab News (April 20, 2008).

   Top oil exporter Saudi Arabia has no plans to embark on further capacity expansion as long-term oil demand forecasts fall and alternative fuel supplies rise, the Saudi oil minister told industry newsletter Petroleum Argus.

   The holder of the world’s largest oil reserves sees no need to go beyond its 2009 capacity target of 12.5 million barrels per day “at least up to 2020,” Minister of Petroleum and Mineral Resources Ali Al-Naimi said.

   Long-term future energy demand forecasts have fallen sharply, he said in the interview given to the weekly on April 11, casting doubt on the need for more Saudi oil.

   Demand forecasts have fallen as low as 106 million bpd in 2030, down from previous estimates as high as 130 million bpd. The world currently consumes around 86 million bpd.

   This development adds a new wrinkle to what we already knew about Saudi intentions. See The Saudis Are Blowing Smoke Again, ASPO-USA, March 12, 2008. Saudi Arabia's (i.e. OPEC's) low demand projections could be called "a self-fulfilling prophecy" in so far as lower OPEC output after 2010 will price many consumers out of the oil markets. Worse yet, PFC's projection (graph left) shows that even unconstrained OPEC production would only boost world production to less than 100 million barrels per day by 2015 in any case! That's it, that's all there can be and ever will be based on PFC's depletion estimates for OPEC as a whole. (Look through their presentation.)
   

   PFC's low growth case exceeds OPEC's reference case after 2009. But without substantial new contributions from the Saudis over the next decade—we have now been told there won't be any—the reference case itself now appears to be too generous. Oil minister al-Naimi is now asking us to look at OPEC's "low growth" scenario instead of the reference case as shown in Table 4.2 of their 2007 World Oil Outlook (graph left). Take the adjusted shortfalls calculated above for OPEC's reference case for each year and then add the negative number given in Table 4.2. The OPEC crude shortfalls with respect to PFC's low 1.1% growth case are now as follows: 3.6 mmb/d in 2010; 6.1 mmb/d in 2015; 13.5 mmb/d in 2020.

   We have moved further into negative territory regarding OPEC's response to PFC's call in the low growth scenario. If this isn't bad news, I don't know what is.

4. If the foregoing isn't alarming enough, consider that substantial increase in OPEC production in the coming decade would require major contributions from Iraq, Nigeria and Venezuela, now that we know that a 12.5 mmb/d production capacity from the Saudis is all we're going to get. (All links are to past ASPO-USA columns.) Prospects for large production increases from these three countries is unlikely for reasons peculiar to each.

We have now set realistic expectations about OPEC's future contributions. They will not produce enough crude oil in the next 12 years to meet even a minimal growth scenario. Few subjects are more important than the potential contribution of OPEC crude to world production as we move toward 2020.

I hope you have been able to negotiate through this sometimes tortuous discussion because there is little else I can do personally to convince you that we're all in Big Trouble. In the New York Times' The Big Thirst, the inestimable Jad Mouawad, who is now coming to his senses, quoted former peak oil skeptic Vaclav Smil—

“The country has been living beyond its means,” said Vaclav Smil, a prominent energy expert at the University of Manitoba. “The situation is dire. We need to do relative sacrifices. But people don’t realize how dire the situation is.”

Unless we take some drastic actions, it will be All OPEC, All the Time after 2010 when you will turn on the radio or switch on the TV to listen to the inevitable stories about whether gasoline will finally hit $5 or $6/gallon. But in 2008, our public discourse on the oil situation is still a joke. We need to stop blathering about the boosting the Strategic Petroleum Reserve, opening up ANWR, taking OPEC to court, cutting federal taxes on gasoline, raising taxes on Big Oil, punishing speculators, counting on imaginary cellulosic ethanol, waiting for mass production of plug-in hybrids, and all the other nonsense we are bombarded with every day.

We are sleepwalking toward the oil precipice. OPEC will not meet the fantastic expectations placed upon it by the "experts." I can only hope that Americans grasp this reality soon, because all we're doing right now is rearranging the deck chairs on the Titanic.

Contact the author at dave.aspo@gmail.com

Notes

1. You will see that non-OPEC crude, condensate, oil sands, and natural gas liquids (NGL) are bundled together with OPEC natural gas liquids. This is standard accounting, because OPEC NGL output is not restricted by the cartel's quota system. Therefore, it is always put on the non-OPEC side of the ledger.

2. OPEC has a "high growth" scenario that only slightly changes the calculations made here. The deficits for this boom scenario work out as follows: 2.4 mmb/d in 2010; 1.8 mmb/d in 2015; 5.3 mmb/d in 2020.

Has Russia's Oil Production Peaked?

Good night, and good luck.
    —Edward R. Murrow

Has Russia's oil production peaked? The answer might as well be yes in so far as their smallish medium-term growth possibilities are fairly well-delineated and longer term growth will require levels of investment that are not likely to to be forthcoming in time to remedy the situation. This report is a follow-up to For Russia, An End to Growth is In Sight, which establishes the basis for this view (ASPO-USA, August 15, 2007).

What you need to know about Russia's future oil production is as easy as 1-2-3.

1. The slowdown in Russia's output growth since 2003 is crystal clear (graph below left, Wall Street Journal).
2. The small set of large (≥ 50,000 b/d) new fields coming on-stream by 2012 is precisely known. Mature depleted Russian oil basins (Western Siberia, Tartarstan) and tough new fields (Eastern Siberia, Far East) require huge investments in infrastructure, new wells, enhanced oil recovery, etc. to maintain or add to production.
3. Government policy does not cap oil output but rather impedes exploration & production activity with burdensome tax rates on Russian oil companies. The Federation—Vladimir Putin and his sidekick Dmitry Medvedev—also hassles and seeks to eject foreign operators (and their capital) after they have exhausted their usefulness, e.g. Shell at Sakhalin-2.

There is no compelling reason to believe that Russia will break out of the current plateau—€”permanent decline?—of oil production as it did after 1999. Even if Russia changes policies that currently stifle investment to promote future production, that money will work, increasingly in vain, to maintain, not grow, oil output. And even if a modest medium-term gain of 2-3% over current production levels should somehow be achieved by 2012, that will very likely be the end of the line for Russia production growth.

The fact that the skittish oil markets have finally noticed that Russia's output growth is flagging doesn't add much to what anyone who has looked at the situation and can interpret a graph already knows. As for optimistic expectations, those are usually the product of standard bureaucratic dogma that "all will be well," ignorance following from an inability to subtract, or our typically human emotional investment in a happy future—not the data and its reasonable interpretation.

Fuzzy Data and Expectations

This update is prompted by the news that Russia's production fell 1-2% in the first quarter of 2008, depending on the type of data examined. The Wall Street Journal's Russian Oil Slump Stirs Supply Jitters cited the IEA's calculation that production of 10 million barrels per day (b/d, crude oil + condensate + gas liquids) was down 1% in the 1st quarter compared with 2007, noting that "industry watchers and Russian officials generally blame the country's production slowdown on a combination of weather and tight electricity supplies in some parts of the country." Electricity? That's another subject.

Reuters cited Russian Energy Ministry data indicating that "oil production [crude + condensate] edged down to 9.76 million barrels per day from 9.79 million b/d in February, and well below the post Soviet high of 9.93 million b/d reached in October last year." The preliminary EIA data is slightly higher than the Russian official data, but shows the same winter trend.

Despite the discouraging results in the 1st quarter, the IEA's March, 2008 Oil Market Report (graph left) was still forecasting that Russia crude output would grow this year by as much as 250,000 barrels per day. They have now revised that forecast down to an all liquids addition of only 0.8% while taking a "cautious approach" according to IEA analyst David Fife.

The IEA's sudden wariness, which has never been apparent before, has caused them to withhold their future Russian forecast "pending [the] spring results, which could eliminate weather-related distortions typical of winter months" (AP, April 15, 2008). Their hesitancy is absurdly shortsighted—€”Russia's fate does not depend on any winter's weather conditions or what happens in the Spring quarter of this year. The agency is now, like Napoleon during the harsh Russian winter of 1812/13, in retreat.

Optimism still abounds in some quarters. The Wall Street Journal cites some hopeful sources—

Many Russian oil officials say the industry could still resume growth. Some Western analysts point to more optimistic data and forecasts. Citigroup said in a report late last month that it expects Russian oil volumes to increase by 1.5 million barrels a day between now and 2012, largely thanks to new projects in eastern Siberia. Still, it cautioned: "Russian oil production growth is no longer to be taken for granted." Russia's energy ministry expects a rise of 1.8%...

Note: Citigroup's happy projection provides for an increase of ≅‰… 15% within 4 years!

Citigroup's economists are surely an authoritative source on future Russian output, but perhaps it would behoove us to look at the investment issues and what the facts are on—and under—the ground in order to maintain some perspective about what's going on here. First, the finances.

Pressure on Investment in the Russian Oil Sector

The IEA's February Oil Market Report gives us the basic facts about Russian taxes on operators. "Russian oil companies pay three separate taxes on their activities," including—

1. A royalty on crude production; taxed at 22% after certain allowances
2. An export tax; based on the market price of Urals crude in the preceding two months. Light products attract a 30% discount on the tax charged and fuel exports benefit from a 60% discount.
3. A corporate profit tax of 24%, charged on net income, in common with other industries.

This added up to $65/barrel as of last February and the net profit for Russian oil companies was only about $10/barrel at that time. This staggering tax burden cuts significantly into the amount Russian operators have left over for exploration & production. It thus comes as no surprise that Rosneft is borrowing money, secured by crude oil export contracts, to finance its short-term debt (from Moscow journalist Sergei Blagov in Jamestown Foundation's Eurasia Daily Monitor, February 28, 2008). Can Rosneft can carry out its investment plans in Eastern Siberia?

In December 2005, Rosneft paid some $260 million for a license to develop the East Sugdin oil and gas field, with reserves of some 200 million tons of oil and more than 40 billion cubic meters of gas...

In order to achieve significant production growth, Rosneft plans to invest 50 billion rubles ($2.04 billion) in Eastern Siberia this year, and up to 600 billion rubles ($24.5 billion) through 2020, [Rosneft CEO Sergei] Bogdanchikov said. Rosneft expansion plans for Eastern Siberia largely rely on the Vankor oil deposit, which has estimated reserves of 500 million tons, he said. However, Bogdanchikov complained that the company's investment resources were limited, as it faced a tax burden of some 60%, while oil companies outside Russia pay about half that amount...

... Rosneft may still acquire new licenses, but developing new oil and gas fields in Eastern Siberia would require billions of dollars in investments. Therefore, it remains to be seen whether Rosneft's expansion could prove economically viable in the longer term.

Deutche Bank oil and gas analyst Leonid Mirzoyan states that "Rosneft is still unlikely ... capable of footing the expensive bill for developing the Vankor field on its own" (Moscow Times, April 3, 2007). Rosneft has been snapping up development licenses and shares, but they are overextended. How will Rosneft finance future development at Sakhalin-III, Vankor, North Vankor, Yurubcheno-Takhomskoye, East Sugdinsky, Verkhnechonsk and all the rest while continuing to drill more and more wells to get expanded production from older (former Yukos) properties like top Western Siberian subsidiary Yuganskneftegaz? And still pay their taxes? Rosneft's CEO Bogdanchikov doesn't know, and neither does anybody else.

Although plans have been announced to cut taxes by an estimated $4.2 billion in 2009, Leonid Fedun, vice president of OAO Lukoil, remains unimpressed. The Wall Street Journal quotes Fedun as saying that "Russia's oil industry needs $1 trillion of investment during the next 20 years just to maintain production of 10 million barrels a day." Lukoil will see a savings of about $1 billion after 2010, which will speed up development of the Filanovsky field in the Russian sector of the North Caspian. In line with Fedun's pessimistic view, Lukoil recently cut its 2008 growth forecast from 5% to 1.8-2.0%.

Various optimistic estimates—€”including Citigroup's absurdly cheerful private report, one presumes—have used Russian oil company growth targets to justify their forecasts. Forward-looking statements from TNK-BP, Rosneft or Lukoil are becoming increasingly worthless as a guide to future activity in light of the lack of capital available for exploration & production. Russia also has a paucity of large new fields coming on-stream and must fight off declines stemming from depletion in their mature oil basins.

Continuing Depletion and New Oil Fields

Lukoil's Fedun believes  Russia has peaked now (Yahoo! News, April 14, 2008). Here is what he told the Wall Street Journal about both the short and longer term prospects—

In an interview, Leonid Fedun, vice president of OAO Lukoil, one of Russia's biggest oil companies, said a mild winter and higher temperatures mean Siberia's icy ground is less stable, making it harder to move drilling rigs between oil wells.

He acknowledged that the fall also reflects a longer-term trend -- the depletion of Siberia's older fields. "Western Siberia is repeating the fate of Prudhoe Bay, with a time lag of five to six years," he said. "When the well's productivity falls, you have to keep drilling more and more. You've seen it in Alaska and the Gulf of Mexico, and now you're seeing it in Siberia."

It will come as no surprise¹ to veteran peak oil observers that Western Siberia is going the way of Alaska or the North Sea. Putting this in context, much of Russia's production growth in the last few years came from the offshore Sakhalin-I Chayvo field in the Far East, which peaked at 250,000 barrels per day in February, 2007. Rosneft now expects Sakhalin-I output to fall to about 160,000 barrels per day in 2008. Exxon Neftegas was drilling record-setting new wells at Chayvo back in April, 2007 but production will never return to peak levels at Sakhalin-1.

Declines at Sakhalin-1 must be offset by the implementation of year-round production of 70,000 b/d at Sakhalin-II, the Yuzhno-Khylchuyuskoye ("YK") field in Timan-Pechora, which will likely produce 150,000 b/d sometime in 2009, and an unknown contribution from Rosneft's Vankor in East Siberia starting this year. Rosneft has set its sights on 500,000 barrels per day from Vankor by 2015. (See These Are the Good Years for an update on factors affecting Vankor, ASPO-USA, February 20, 2008.) A few other large (≥ 50,000 b/d) projects are listed at 2008 Megaprojects page at Wikipedia, including the Salym field expansion which will likely add another 62,000 b/d in 2010.

Scheduled new projects delimit Russia's ability to expand oil production in the medium term. If one makes the conservative assumption that Russian output outside of the projects mentioned here will decline in the 2-3% range each year from now on, it is easy to see that Russia's post-Soviet growth is coming to an end. New project delays would only make the situation worse. Managing decline rates in the existing production base (in the medium term) depends directly on how much investment is available for new wells, new drilling technology (e.g. laterals) and enhanced oil recovery. There are tax discounts on some of these activities.

An End to Growth is Still In Sight

Everyone will have to wait & see how Russia fares in the next few years, but the only surprises will be on the downside—the limited upside possibilities are already mapped out. The Federation's growth is constrained by lack of investment, too few new large projects coming on-stream, and the geological facts of life.

It appears that Putin's policy is to intentionally restrain development through onerous tax burdens on Russia's oil companies. The Urals Blend is selling at $109.66 today. Perhaps Putin truly understands, like the Saudis apparently do, that keeping some of Russia's oil in the ground is a better longer term strategy than producing it in an unfettered way now and accruing future rate of interest returns on the unburdened revenues. All things considered, Russia is the largest crude + condensate producer in the world, and Vladimir Putin is no dummy.

Contact the author at dave.aspo@gmail.com

Notes

1. Read part 1 (For Russia, An End to Growth is In Sight) for a thorough discussion of developments in Russia.

 

An Unconventional Play in the Bakken

The devil is in the details
      —German Proverb

Last week the U.S. Geological Survey (USGS) released its long-awaited reassessment of the undiscovered recoverable oil potential in the Bakken Formation of North Dakota and Montana. The USGS estimated "mean undiscovered volumes of 3.65 billion barrels of oil," which sounds like a lot. Senator Byron Dorgan (D-ND), who commissioned the study, was delighted with the result, saying "this is great news, this is 25 times the amount of the previous assessment."

Oil is now being produced in the Elm Coulee section (graph left) of the Bakken and more oil will be produced there and elsewhere as the years go by. Although one can quibble about the USGS numbers—and we will—the more important question is what will the oil flows be from the Bakken?

A proper understanding of the likely conversion rate of Bakken recoverable oil to flows (measured in barrels per day) reveals that this unconventional play will have little effect on peak oil concerns or America's perilous oil dependency. This understanding comes from an examination of the geology and production practices in the Bakken.

Bakken Geology and Oil Production

Often called the Bakken "shale," the productive sandstone lithofacies lie within the formation's middle member sandwiched between the shale source rocks above and below, as shown in the graph (left) from Julie LeFever of the North Dakota Geological Survey. Landmark's Bakken Horizontal Best Practices Review indicates that the highly pressurized productive (pay) layers have a net thickness of 6-15 feet, low porosity (8-12%), low permeability (0.05-0.5 millidarcies) and a water saturation of 15-25%. The oil produced is light, with an API gravity of 42°. The pay zones have only minor natural fracturing according to Landmark and other sources.

All of these reservoir characteristics combine to make the Bakken play unconventional, which for the non-specialist means that it is challenging to lift this oil out of the ground.

What makes the Bakken play possible? As LeFever says, "technology has finally caught up to the Bakken Formation. The ability to fracture stimulate these horizontal wells is what makes this play work." Operators must drill down vertically about 10,000 feet and then "kick out" almost as far (± 9500 feet) horizontally through the productive sandstone layers. These long-length laterals maximize wellbore contact with the reservoir. Accordingly, wells must be widely spaced (e.g in 320 acre parcels).

The reservoir must be stimulated along the lateral drill length by the injection of fracturing fluids combined with a proppant to hold the fractures open to improve the permeability—the ability of a rock's ability to transmit fluids to the borehead.

It takes great human and technological skill to steer the drill bit horizontally through the pay layer. A large number of drilling and well completion design decisions—open hole or cement liner?—must be made to maximize well productivity. Many well designs have been unsuccessful. A "lessons learned" interview with Halliburton's Tom Lantz reveals the complexities of drilling at the Bakken. Operators must study spectral log data and carry out sophisticated well completion diagnostics. Sometimes older or unsuccessful wells can be revived using this sort of data.

All of this is very expensive. An AP report North Dakota shale oil recoverable tells the story—

According to Jim Ehrets, a Denver-based geologist with Headington Oil Co. of Dallas, it costs about $5 million to drill a well tapping the middle Bakken, and companies need crude prices of at least $50 a barrel to make it economical. Even with crude prices now double that, "there still is a ton of risk," he said.

Given the expense and complexity of drilling in the Bakken, it is no wonder that there is "a ton of risk" for operators—success is not guaranteed. The risk is so large that "drillers began sharing technology about two years ago on how to recover the oil" according to the AP report.

What about the successful wells? Unfortunately, a successful well at the Bakken will produce a few hundreds, not thousands, of barrels of oil per day. Landmark's 3000 foot horizontal well simulation (graph left) reveals that in the best case, with a permeability after hydraulic fracturing of 0.66 milladarcies, the well would produce 150,000 thousand barrels (averaging 375 stock tank barrels per day) after 400 days or so (purple line). As the curve shows, cumulative production declines dramatically thereafter, leveling off at approximately 370,000 barrels over the well's lifespan of 18+ years.

Elm Coulee provides a real-world snapshot of Bakken production as it stood in 2006. Headington Oil Company has made some useful data available that helps us evaluate how things might go in the future. Here are the pertinent facts & figures—

• The cumulative oil production 6 years after discovery is 32 million barrels. Production from about 350 wells had reached 1.6 million barrels in March, 2006. This works out to 53,000 barrels per day with an average well producing about 152 barrels per day.

• About 520 square miles are under development and there were 20 drilling rigs working continuously as of November, 2006.

• Headington estimates ultimate recovery from the area will be somewhere in excess of 250 million barrels, assuming ≅ 500,000 barrels will be ultimately recovered per square mile.

Combining Headington's Elm Coulee data with the Landmark simulation, we can draw the following conclusions—

• Well productivity drops off rapidly after the first year or so of production. If other parts of the Middle Bakken are as productive as the drilled parts of Elm Coulee, and constant large investment in drilling activity in the western Williston Basin continues, we might see peak production somewhere in excess of 100,000 barrels per day. This is an educated guess, but this estimate is not off by an order of magnitude, i.e. we are talking about peak production rates in the very low hundreds of thousands, not millions, of barrels of oil per day.

• It will likely take another 5-10 years to ramp middle Bakken production up to its peak level as described just above.

To put this in perspective, the ultra-deepwater Thunder Horse field in the Gulf of Mexico is supposed to produce at a peak level of 200,000 barrels per day in fairly short order should British Petroleum get its act together and put the field on-stream. Once Thunder Horse produces at peak rates for a while—assuming it reaches BP's target production capacity—declines thereafter are likely to be fairly steep. The middle Bakken, which likely will never produce as much as Thunder Horse at peak production, will also have a much shallower decline curve. Production will go on for decades in the Bakken, but thousands and thousands of wells will be required to extend the play over those years.

It's the size of the oil tap flow, not the size of the ultimately recoverable oil tank, that matters for peak oil calculations. But how much oil will eventually be recovered from the Bakken? Let's take a brief look at the USGS numbers.

Skepticism About the USGS Estimates

With oil near $114/barrel today, surely we can all agree that the era of cheap, abundant oil is over. The USGS has played a significant role in leading us to the present crisis in so far as their estimates have abetted complacency about future oil supply problems.

The U.S. Department of Energy uses the Geological Survey's extravagant estimates directly (e.g. the IEO 2006) to predict future discoveries and reserves growth numbers. These putative reserves predictions are then used to dismiss peak oil concerns. Over the last several years, the EIA's demand-driven model, which implicitly assumes that these huge recoverable reserves volumes will be produced as needed, has consistently served up erroneous predictions about future oil prices.

The inflated USGS estimates for the Bakken are no exception to the historical pattern, although some people are catching on that salvation does not lie just around the corner. As noted above, the USGS came up with a mean (≅ F50) estimate of 3.645 billion technically recoverable barrels of oil in the 5 assessment units (AU) of the Bakken-Lodgepole total petroleum system (TPS, graph left). Here are the tabulated estimates and the some key text from the USGS fact sheet—

The assessment of the Bakken Formation indicates that most of the undiscovered oil resides within a continuous composite reservoir that is distributed across the entire area of the oil generation window (fig. 2) and includes all members of the Bakken Formation. At the time of this assessment, only a limited number of wells have produced from the Bakken continuous reservoir in the Central Basin–Poplar Dome AU, the Eastern Expulsion Threshold AU, and the Northwest Expulsion Threshold AU. Therefore, there is significant geologic uncertainty in these estimates, which is reflected in the range of estimates for oil (table 1 [graph above left]).

Here are some telling—damning?—observations and comments on the USGS results—

1. Operators in Elm Coulee, which forms part of the Elm Coulee-Billings Nose AU, were skeptical about the USGS estimates. The International Herald Tribune reported that "Donald Kessel, vice president of Houston-based Murex Petroleum Corp., said he believes the Geological Survey's assessment of how much oil can be recovered in the Bakken may be a little on the high side. "That's a lot of zeros," Kessel said Thursday [about the 3,645,000,000 barrels].

2. The Elm-Coulee-Billings Nose AU has the smallest mean estimate, coming in at 410 million barrels, yet that is the only part of middle Bakken play undergoing extensive development. Headington's guess was somewhere in excess of 250 million barrels for "the area", but it is not clear whether this is just for Elm Coulee, or also includes some other parts of the Survey's assessment unit.

3. The USGS indicates that its largest estimates are for the areas where, by its own admission, "only a limited number of wells have produced." This includes the Eastern Expulsion Threshold AU, for example, where the Survey estimates an astonishing 973 million undiscovered and unrecovered barrels. There's always more oil where you haven't looked, according to the USGS.

4. Middle Bakken expert Tom Lantz (link op. cit.) has this to say about the geology of some of the undeveloped but supposedly oil-rich assessment units covered by the USGS—

   Certainly the thrust of the Middle Bakken play is moving north and east into the deeper sections of the basin in North Dakota. Since the lithology changes from higher quality dolomitic facies to a lower quality sandy/silty facies, the reservoir does not seem to be nearly as forgiving in North Dakota ... as it is in the original play area [Elm Coulee]. The ultimate extent and duration of the play will hinge on how effective we are in understanding these changes and tailoring the drilling and completion designs to exploit this lower quality reservoir. [emphasis added]

That's enough—you get the idea. It's hard to swallow the Geological Survey's story.

The Middle Bakken play is nevertheless a success story. Given the difficult geology of the oil-bearing reservoirs, sophisticated lateral drilling and well completion technology has been applied to allow the recovery of relatively large amounts of high-quality oil. Congratulations to those intrepid operators who are lifting oil out of the Middle Bakken. Despite this success, however, the Middle Bakken is clearly not an answer to our peak oil problems and dependency on foreign oil.

Contact the author at dave.aspo@gmail.com

Lost At Sea

If I look confused it's because I'm thinking
     —Samuel Goldwyn

If you're not confused, you're not paying attention
     —Tom Peters

It is crucial for those warning others about the dangers of peak oil to look at the effects of increasing oil prices (graph left) on economic growth. For some years to come, peak oil constraints will be manifest in the oil price, not in disruptive, recurring and systemic spot shortages—at least in the United States. What effects have oil price increases had on real U.S. GDP growth in the last 7 years? To be honest, nobody really knows—yet. We will all find out eventually.

There is no peak oil supply shock until world production of oil derived from fossil fuels production (crude + condensate + gas liquids) actually begins its irreversible decline sometime in the next decade. Until then, the correct answer to most peak oil inquiries is price, price, price as slow or no supply growth coupled with ever-higher energy costs creates more and more unsatisfied demand. Substitutes and efficiency measures (e.g. plug-in hybrids) will not save our bacon, despite what optimistic policy wonks and pandering presidential candidates say (NPR's Morning Edition, April 7, 2008).

Oil is not like iPhones. No studies link real GDP and iPhone price trends. Keith Sill, a senior economist¹ with the Philadelphia Fed, tells us why oil prices are important in his The Macroeconomics of Oil Shocks.

Oil prices matter for the economy in several ways. Changes in oil prices directly affect transportation costs, heating bills, and the prices of goods made with petroleum products. Oil price spikes [shocks] induce greater uncertainty about the future, which may lead to firms’ and households’ delaying purchases and investments. Changes in oil prices also lead to reallocations of labor and capital between energy intensive sectors of the economy and those that are not energy-intensive. For these reasons and others, oil price increases may lead to significant slowdowns in economic growth...

With the release of the latest unemployment numbers, most observers are convinced that the United States is now in recession following the dramatic GDP growth slowdown (0.6%) in the 4th quarter of 2007. Most attribute the apparent recession to the credit crisis resulting from the collapse of the Housing Bubble. (See A Recipe For Disaster, ASPO-USA, March 26, 2008.)

What about the role of the oil price in the economic slowdown? For economists, this remains an open, and perhaps unanswerable, question. Macroeconomic models can not explain the complex, non-linear historical relationship between oil prices and GDP, especially over the last 6 or 7 years, although researchers like the University of Michigan's Lutz Killian are trying to explain why Not All Oil Price Shocks Are Alike.

The big open question concerns the lack of a recession—up to now?—despite rising oil prices since 2002 (graph left from the BEA). It's worth noting that average GDP growth in the last 6 quarters is 2.18%, whereas growth in the 6 quarters previous to that period was 3.13%.

All this should be considered in light of the fact that what you don't know is often more important than what you do know.

No Oil Price Relief For Consumers

Current evidence² points to a downturn in both U.S. GDP growth and oil consumption which has not been accompanied by a decrease in the oil price. This is the worst of all possible worlds for American consumers.

The EIA data now indicates that U.S. oil demand fell off 3.7% between December, 2007 and January, 2008. That's a huge drop off, far larger than the usual seasonal pattern (last year's decrease was 1.2%). The 4-week period ending March 28th shows a more modest 1.3% decrease compared to the previous year. Other preliminary data for the 1st quarter of 2008 suggests that "U.S oil consumption has declined in the first quarter by nearly 475,000 barrels a day as compared to last year" according to the Associated Press report Drop in US first-quarter oil use appears most since Sept. 11 terror attacks—

Jan Stuart, economist at UBS Securities LLC in New York, said "Macro [economist] folks won't officially label the U.S. economic environment a recession for some time, but at first glance (first-quarter) oil data sure look bearish," in a report Thursday.

Preliminary data for February and March, subject to revision, show that pressures from record-high crude oil and products prices and the uneasy U.S. economy have continued to cut deeply into demand. [emphasis added]

This last statement in the AP story begs for explanation. How can U.S. demand be down nearly ½-a-million barrels a day in the 1st quarter while oil prices continue to rise? (This story is about oil market fundamentals, I will not be discussing dollar value or trading effects on the price.) The monthly average oil price series from economagic for NYMEX WTI shows a 10.7% jump to $105.56 in March over February. The price at this moment is $107.80, up this week on news that OPEC will not be raising production again—no surprise there!

The standard explanation for rising prices over the last several years is the global demand shock brought about by soaring consumption levels in the developing economies, including both the oil exporters (e.g. Russia, Saudi Arabia) and the Asian economies (e.g. China, India). Since rising oil prices have occurred in a context of global GDP growth, including the United States, they have been seen as a sign of health, not a drag on economies. Dr. James Hamilton explained the situation back in 2005 in his Economic consequences of the high price of oil.

By contrast, global oil production has increased steadily during the current episode [in 2004].³ The run-up has been caused this time not by a shortage of supply but rather by booming world demand (see What's up with oil prices?). The strong world economic growth that produced this demand overall must be regarded as good economic news, not bad. And although we have again seen West Texas intermediate [WTI] nearly double from $28 in September 2003 to $54 today [in 2005], this time the increase required a year and a half rather than just three months.

Both the gradualness of the price move and the circumstances attending it have left consumers and firms substantially less nervous about the current economic situation than they were in August of 1990, with none of the postponing of spending decisions that characterizes most economic downturns. U.S. car and light truck sales are only down 1% for the first five months of 2005 compared with the first five months of 2004, hardly enough to bring the auto sector to its knees, let alone the rest of the economy with it.

None of the factors mitigating the effects of oil price increases that Hamilton cites in June, 2005 are true now in April, 2008. The average monthly oil price has gone up 42.3% over the past 9 months, an increase that can hardly be called gradual. This looks a lot like an "oil price shock."

Consumer confidence is dropping like a stone, the consumer spending growth rate (graph left) has taken a sharp downturn, and the anecdotal evidence reveals that consumers are postponing spending decisions, according to the Wall Street Journal's Personal Spending Up Mere 0.1%, But Inflation Pressures Are Muted (March 29, 2008). Hamilton recently commented on the continuing downturn in auto sales at his weblog Econbrowser. Consumer spending growth appears to have slowed after the post-hurricane oil price increases in the 3rd quarter of 2005.

It is clear that high oil prices during a recession can not be a a good thing. What is not clear is whether prices will stabilize at their current level for a while during the downturn or continue to rise. Now that the current situation is somewhat clear, let us turn to the question of macroeconomic effects of high oil prices.

Lost at Sea

It is hard to tease out how much of the current downturn is due to higher oil prices as opposed to the rest of the mess we face. For some time now, observers like A. Gary Shilling have predicted that consumer spending was about to crash after the housing collapse due to alarming trends in savings rates and debt service payments.

So it is difficult to argue now that the oil price has been the prime mover in the not-yet-official U.S. recession. We're cast adrift, lost at sea, on this crucial issue.

Past recessions have often been preceded by oil price shocks, however, and Hamilton states that "both theory and evidence [are] consistent with the interpretation that [the oil price/recession] effect results from the disruption of the pattern of spending by consumers and firms on items whose utilization is sensitive to energy prices and supplies." See Questioning Peak Oil Economic Assumptions for a discussion of the relationship between oil prices and recessions (ASPO-USA, November 28, 2007).

Based on Hamilton's work, Keith Sill (op. cit.) presents an accessible model of the effects on GDP growth of net oil price increases resulting from exogenous oil shocks. An oil price shock is exogenous when it originates outside the U.S. economy e.g. the price shock resulting from the supply disruption caused by the Iran-Iraq war in October, 1980. Such a shock is not a feedback from the needs of the growing economy itself, as Hamilton posited back in 2005 when he noted that oil price hikes had not caused a recession in the United States.

Net oil price increases (1st graph left) reflect price movements in a given period—the previous 36 months in Sill's example—which serve as a "good proxy" for exogenous changes in oil prices and have a "more stable relationship with real output (GDP) growth." The net oil price increase is zero if a given month's average price is lower than some prior month in the 3-year series. Otherwise, the net oil price increase is the percentage increase from the previous highest month's price.

Sill uses a statistical analysis (a regression) and an impulse response function to measure the "dynamic effect of an exogenous oil shock on real GDP growth." Here's the main result:

Figure 6 [2nd graph above left] shows that an increase in the net price of oil leads to a drop in real output growth that gradually increases over time until it reaches a maximum four quarters after the shock hits. After that, the growth rate of real output gradually recovers, so that after about three years, the effect of the oil shock has largely worn off and real output growth is back on its trend path (in the figure, the trend growth rate of real output has been removed). The impulse response function indicates that a 10 percent increase in the price of oil results in real output growth falling 0.55 percent at its maximum impact. This translates into about a 1.4 percent permanent reduction in the level of real output. Even a modest external increase in the net price of oil has a significant impact on real output, according to our analysis. [emphasis added]

To evaluate this result, let's look at net oil price increases over the last 2 and ½ years. Only positive (non-zero) results are shown. A quarterly net increase is the average of the months in that quarter.

Quarter	Net Oil Price Increase
2005 III	5.30%
2006 II	2.70%
2006 III	1.63%
2007 III	2.46%
2007 IV	5.83%
9/07 - 11/07	8.33%
2008 I	3.83%

Discussion: There haven't been any oil price shocks exceeding 10%. Rather, we've had a series of mini-shocks. The three-month period 9/07-11/07 does not fall within a single quarter, but shows the largest increase (8.33%) occurred last fall. That's a hefty new oil price rise.

The standard view (e.g. Hamilton, 2005, op. cit.) is that increases since 2002 had little effect—compare with the real GDP numbers in the BEA graph—because the oil price was riding atop the economic growth wave. The GDP numbers bear this out until quarter IV of 2005. GDP growth is erratic and down on average thereafter, but this is coincident with the collapse of the Housing Bubble (graph left). No oil price signal is detectable.

What about net oil price increases that have occurred in the last 6-7 months? If Sill's model has any validity in 2008, the 9/07-11/07 price shock (8.33%) would have effects on real GDP 4 quarters or so after the increase. This drag effect on real output would occur in the latter part of this year just when the economy will be trying to emerge from the current supposed recession according the standard view.

For the recent price hikes to count as a real "oil price shock" for economists, the event would have to be exogenous to the U.S. economy. At first glance, this appears to be the case in so far as U.S. GDP growth has slowed considerably during the recent period and oil consumption is down (see the EIA numbers above.) This view may be correct, but is complicated by the price effects on oil consumption and any positive feedbacks to the U.S. economy following from increased oil consumption elsewhere—these feedbacks come primarily China and other Asian economies who trade with the U.S.

The bottom line is that we still do not know what effects all these ever-more painful oil price increases are having on the U.S. economy. We are still lost at sea.

To sum up, we have beat this horse to death without coming to any firm conclusion. It seems obvious that Americans can not absorb these net oil price increases over and over again, especially in a slumping economy, without incurring some very substantial losses sooner or later. Peak oil remains primarily a price phenomenon for now, but it's hard to sort out the effects because the messed up U.S. economy has multiple failures. The effects of oil price escalation on real U.S. GDP growth will be revealed over time, and it is hard to avoid the conclusion that the eventual outcome will not be salutary for American consumers.

Contact the author at dave.aspo@gmail.com

Notes

1. Sill took the time to speak with me while I was preparing this column. My thanks to him.
2. I say "consumers" because that is the commonly accepted term. As far as I'm concerned, the downfall of our civilization began when American citizens were commonly labeled "consumers" in the 1970s.
3. Obviously, Hamilton wrote this in 2005 before he and the rest of us became aware that world oil production was entering a 3-year plateau (EIA data).

—

First Things First

Experience has shown, and a true philosophy will always show, that a vast, perhaps the larger portion of the truth arises from the seemingly irrelevant.
     —Edgar Allan Poe

On March 19th, 2008, the Air Force successfully completed another in a series of tests designed to switch their planes over to synthetic fuel blends made partly from a  Fisher-Tropsch (F-T) coal-to-liquids (CTL) process. In 2006 the Air Force successfully flew a B-52 using the new fuel mix. The latest demonstration involved a B-1B Lancer, which flew at supersonic speeds over Texas and New Mexico using a blend of F-T and JP-8 jet fuel.

"The goal is to have every aircraft [certified for] synthetic fuel blends by 2011," said Maj. Don Rhymer, assigned to the Air Force Alternative Fuels Certification Office. "By 2016 we hope at least 50 percent of this fuel will be produced domestically."

Will the Air Force's scheme be implemented? Coal-to-liquids conversion emits lots of carbon dioxide but produces a viable substitute for diesel and jet fuel made by refining crude oil. An epic battle is shaping up between those concerned about climate change and those seeking to lower their transportation fuel costs and enhance their energy security. But this the right battle to fight?

The Air Force Pushes For Coal-to-Liquids

Although the Air Force program is currently purchasing gas-to-liquids synfuel purchased overseas, they are pushing for a CTL facility to be built in Montana. While coal is plentiful in the American West, natural gas is far too precious in the North American market to be used as the input for F-T conversion. McClatchy's Air Force leads push to liquefied coal fuel  (March 30, 2008) tells the story—

With every $10 rise in the price of a barrel of oil costing the Air Force $600 million, the service is converting its entire 6,000-plane fleet to run on a synthetic fuel mixture. Tentative plans call for construction of a coal-to-liquid fuel plant at a Montana air base...

Air Force officials have been testing synthetic fuels based on coal or natural gas. They plan to certify the fleet of nearly 6,000 aircraft to fly on a 50-50 blend of synthetic fuel and traditional petroleum-based jet fuel by 2011.

Assistant Air Force Secretary Bill Anderson said the search for affordable, cleaner-burning alternative fuels was driven by economic and national-security concerns.

Let's state the obvious up front—the Air Force is surely "peak oil aware." Branches of the military and the intelligence services do scenarios planning. "The United States would be all but powerless to protect the American economy in the face of a catastrophic disruption of oil markets, high-level participants in [Oil Shockwave] concluded yesterday."

Even without a large oil shock like those of the 1970s, relentless price increases and the possibility of declining global liquids output leading to supply shortfalls in the U.S within the next decade has led the Air Force to the coal-to-liquids solution. If the Air Force thought we're going to be swimming in oil by 2016, their target implementation date, they would not be proposing using F-T to meet their jet fuel needs.

Many obstacles stand in the way of the Air Force's plan. The climate change lobby is not going to roll over on the issue, which creates a bad precedent and provides momentum for carbon-intensive F-T operations in the United States. "I think across the board there is going to be opposition from the environmental movement," said John Topping, the president of the Climate Institute in Washington. "I'd say it's going to be almost universal because of the climate concerns" (McClatchy). The Congress will probably have a Democrat majority after the fall elections. This likely means tough sledding for the Air Force.

As awareness of the climate problem grows in the United States, the economic squeeze brought on by higher oil prices brings pressure to implement supply-side solutions to alleviate soaring diesel fuel costs.

Diesel Fuel For Truckers?

On April 1st, truckers staged a slowdown to protest high diesel prices. Truckers Protest Fuel Costs tells the story (Associated Press).

Tons of freight idled across the country Tuesday as independent truckers pulled their rigs off the road while others slowed to a crawl on major highways in a loosely organized protest of high fuel prices.

Using CB radios and trucking Web sites, some truckers called for a strike Tuesday to protest the high cost of diesel fuel, hoping the action might pressure President Bush to stabilize prices by using the nation's oil reserves.

"The gas prices are too high," said Lamont Newberne, a trucker from Wilmington, N.C., who along with 200 drivers protested at a New Jersey Turnpike service area. "We don't make enough money to pay our bills and take care of our family." [emphasis added]

Last week's A Recipe For Disaster touched on the record-high prices for diesel fuel in the United States, which is now $4.025/gallon according to AAA's Daily Fuel Gage Report. The big rigs get only 5 or 6 miles to the gallon, so long-haul truckers' profit margins are now disappearing. Trucker Lamont Newberne told the AP that "a typical run carrying produce from Lakeland, Fla., to the Hunt's Point Market in The Bronx, N.Y., had cost $600 to $700 a year ago. It now runs him $1,000".

According to data compiled by the ATA and the Air Transport Association, the 2007 fuel bill for all U.S. passenger and cargo airlines was $41.2 billion, but the diesel tab for moving goods by truck was $112.6 billion (graph left). Trucking fuel consumption far surpasses use for air travel.

Clayton Boyce, a spokesman for the American Trucking Association (ATA), says his group "is pushing for a number of measures to keep the prices down or to otherwise help truckers, including allowing exploration of oil-rich areas of the U.S. that are now off limits...." It would take years and years to get any diesel fuel from the outer continental shelves, presuming there are commercial oil reserves out there. Where is the diesel supply going to come from? The Air Force's Anderson has it all figured out—

With the Air Force paving the way, Anderson said the private sector would follow — from commercial air fleets to long-haul trucking companies.

"Because of our size, we can move the market along," he said. "Whether it's (coal-based) diesel that goes into Wal-Mart trucks or jet fuel that goes into our fighters, all that will reduce our dependence on foreign oil, which is the endgame."

A beleaguered trucking industry will seize the opportunity initiated by the Air Force to push for coal-to-liquids. It won't matter politically that such production, like drilling on the outer continental shelves, is many years away, providing no tangible relief for truckers any time soon. It won't matter that the quantities of diesel produced will be fairly small, or that coal-to-liquids using an F-T process are exorbitantly expensive and present technological hurdles, despite the success of South Africa's SASOL, which operates the only CTL plant running anywhere in the world today.

Between A Rock and A Hard Place

A heavyweight bout is coming soon between the climate lobby, who are trying to reduce carbon dioxide emissions, and the transport industry, which wants cheaper liquid fuels. The latest issue of the Oil & Gas Journal contains a comprehensive special report GTL, CTL finding roles in global energy supply that sheds light on the conflict (by Iraj Isaac Rahmim, March 24, 2008). The coal-to-liquids data (chart left) buttresses the positions of both the climate and transportation antagonists. The data comes from a National Energy Technology Laboratory (NETL) study for the Air Force.

A 50,000 barrel-per-day CTL plant configured as NETL specified will produce 27,819 barrels of diesel and 22,173 barrels of naphtha, which is a principle component of jet fuels like the Jet-B used in the Air Force's certification tests. The F-T process also produces small amounts of lubes and waxes, which can be hyrdrocracked to make more diesel or naphtha. The naphtha itself "[can] be steam-cracked to syngas and recycled back to the F-T reactor to increase production of high quality diesel" according the Oil & Gas Journal report. These numbers will appeal to the transportation industry.

The NETL data also shows that the envisioned F-T plant will produce 32,481 tons of carbon dioxide running at full capacity every day, a ratio of 1.32 tons of CO2 to every ton of coal burned. Without carbon capture, compression and sequestration (CCS) technology, CTL is viewed as a disaster from the climate perspective. This CTL plant would emit 11.8 million tons of carbon dioxide operating at full capacity over a year's time.

Let's put this in perspective. Carbon dioxide emissions declined by 1.3 percent in 2006 to 5,877 million metric tons according to the EIA (Science Daily, May 24, 2007). The 50,000 barrel-per-day CTL plant would add 0.2% to the U.S. 2006 emissions. On the other side of the debate, the U.S. consumed an average of 5.818 million barrels of (kerosene-type) jet fuel and (middle) distillate fuel oil (mostly diesel) in the 4 weeks ending March 28th, 2008 according to the EIA's latest Weekly Petroleum Status Report. The CTL plant's output is 0.8% of this total.

A number of CTL projects are on the drawing board in the United States (chart left from the Oil & Gas Journal). Rentech and Peabody have formed a partnership to look into the feasibility of two 10-30 thousand barrel-per day projects, one in Montana and another somewhere in the Midwest. Only one of the projects listed is larger than the CTL specification used in the NETL study.

None of the projects are anywhere close to implementation because of several factors listed by Rahmim, including 1) uncertainty about future carbon policy and the CCS option and 2) unit CAPEX costs running between $70,000 and $100,000 per barrel of capacity.

First Things First

The coming battle between climate activists and those in the transportation industry is strangely discordant with peak oil concerns. We want to reduce carbon dioxide emissions, right? We want the transportation segment of the economy to function, right? The debate doesn't focus on the main issues. First, global middle distillate (diesel) production has been flat for some time now and is not expected to increase much, if at all, in the future. Second, expensive substitutes such as coal-to-liquids will not be available at scales that make much difference in any time frame we might care about to relieve the supply side of the equation. And there are insufficient railroads to replace long-haul trucking or air freight.

Looking out a decade from now, carbon emissions from diesel in the U.S. are likely to decrease because overall middle distillate consumption is likely to decrease due to price escalation and constrained world supply. Any carbon emissions coming from CTL are not going to replace what will be lost, which is a good thing from the climate perspective. It is a disaster if you want a functioning economy. We will require a functioning economy to fix all of our other problems, including anthropogenic climate change.

Here we are, seemingly between A Rock (climate) and A Hard Place (CTL substitutes for oil). But do these two diametrically opposed positions really form the horns of our dilemma? No. Peak oil is "the third eye" gateway to higher consciousness in this debate.

The peak oil issues will be at most a sideshow in the forthcoming debate about coal-to-liquids here in "the Saudi Arabia of Coal."  The Air Force clearly knows about peak oil, but does not frame the problem in those terms. It seems that only a few people are able to bend their minds around the idea—publicly— that we've got bigger fish to fry in the upcoming decade than either side in the debate is willing to admit. "I think the principle of 'first things first' does apply,’ said Al Gore, "and has to be followed if we are to have any chance of success." But he wasn't taking about peak oil.

Contact the author at dave.apso@gmail.com

A Response to Romm on Peak Oil

Joseph Romm's Peak Oil? Consider It Solved (Salon March 28, 2008) deserves a response. Here's his main theme.

More supply is not the answer to either our oil or our climate problem -- reducing consumption of oil is. And right now we have two feasible solutions: greatly increase our vehicle fuel economy and find alternative fuel sources that are abundant, low-carbon and affordable.

It's hard to argue that reducing our oil consumption is a good thing, bearing in mind that any oil the U.S. does not use will be consumed elsewhere (e.g. China). Perhaps by "we" he means the global community. The reason "we" in the U.S. need to reduce our oil consumption is to mitigate our vulnerability to supply shortfalls that are likely to occur within the next decade. Reducing our oil consumption will have no effect on climate change (CO2 emissions) because someone else will burn it if we don't.

Romm argues that solving the climate change problem is paramount and peak oil doesn't matter—"consider it solved"—because all we have to do is 1) not develop unconventional oil resources and 2) raise CAFE standards, buy plug-in hybrids (PHEVs) and all-electric cars. Thus we will increase efficiency and implement substitutes for fossil fuel liquids. See The Sierra Club Solution for a discussion of #2 (ASPO-USA, January 30, 2008). Here are some of the parts of Romm's article requiring a response.

To preserve the livability of the planet, we must cut liquid fossil fuel use more than 50 percent by 2050. That is a central reason that more supply is not the solution to peak oil. That is why it is crucial we don't adopt the strategy that most in the oil industry prefer for dealing with the peak in conventional oil -- ramping up unconventional oil. Most of the major forms of unconventional oil will make global warming worse -- and some would make a climate catastrophe inevitable...

Clearly we now have only two realistic strategies: increase our vehicle fuel economy and develop affordable alternative fuel sources that are low in carbon. In 2050, the planet may well have 2 billion cars on the road or more, three times the current number. To avoid dramatic climate impacts, we must use at least 60 percent less total liquid fossil fuels -- and that assumes we have essentially eliminated carbon dioxide emissions in the electric sector. The average car on the road will need to put out under one-fifth the emissions of current cars, or the equivalent of five times the "miles per gallon" of today...

And of course we'll need a very aggressive push toward efficiency and zero-carbon electricity... [emphasis added]

Where does Romm go wrong? Let's make a partial list.

1. Romm seems to be unfamiliar with the work of Pushker Kharecha and James Hansen linking the peak oil and climate problems. See Implications of “peak oil” for atmospheric CO2 and climate. Briefly, if we burn all the remaining oil and gas—undoubtedly we will—it will take us a large way toward the 450 ppm CO2 in the atmosphere target, but not all the way. (This CO2 target is usually used to define "dangerous anthropogenic interference" with the climate.) Kharecha and Hansen conclude that if we phase out coal consumption to zero by 2050, we can prevent atmospheric carbon dioxide from reaching the target 450 ppm ceiling.

   Thus, Romm's assertion that "to preserve the livability of the planet, we must cut liquid fossil fuel use more than 50 percent by 2050" is simply misguided. He's off in the weeds. We need to cut our coal consumption 100% by 2050 to prevent dangerous interference with the climate. The reason we need to cut our liquids consumption now is to stave off the worst economic effects of peak oil.
   

2. If Kharecha and Hansen are correct—this is a Big If because they use EIA ultimately recoverable reserves estimates—then we need to ask this: Where is all the electricity going to come from to power Romm's "2 billion cars or more" by 2050? It isn't going to come from natural gas. It sure isn't all going to come from solar, wind, geothermal, biomass or hydroelectric. The only conceivable sources would be nuclear or coal, but the latter is the very carbon source we need to control. (Nuclear is a separate discussion.)

   Romm asserts that "we'll need a very aggressive push toward efficiency and zero-carbon electricity." Does he seriously think there is any such thing as very-large-scale zero-carbon electricity that will support very-large-scale manufacturing processes for complex things like electric cars? And power them? Not anytime soon, most likely never. We would be fortunate indeed if 25% of our current electricity consumption is available from renewables in 2050.

   Theoretically, if renewables generated most of our energy needs, including replacement of 50% or more of all fossil fuel liquids, you could bootstrap the entire renewable energy or electric vehicle supply-chain (for materials transport, manufacture, product distribution, mining and smelting of required metals, rubber production, car seats, batteries, windmills, solar panels, you name it—no plastics from fossil fuels allowed) and thus we would have low-emissions electric cars (< 20% compared to now). Otherwise, no. Don't bet the farm on carbon capture and sequestration of CO2 emissions from coal on large scales either. Nobody's got that worked out, and we're unlikely to do so. 

   We would require lots and lots of nuclear energy, ancient biomass (coal) or current biomass (wood) to generate the electricity to build and power "2 billion or more" electric vehicles in 2050, but Romm is living in Disneyland if he thinks it's going to be possible in any case, with or without theoretical "zero-carbon electricity." Resource depletion, even for coal, will inhibit the required growth. Everything we do requires energy inputs. Everything. Carbon capture and sequestration, for example, or purifying silicon for photovoltaics or in situ bitumen production at the tar sands. Wouldn't it make more sense to plan a future in which we have only 10% (or far fewer) of the envisioned 2 billion vehicles in 2050? Why do we need to denude the planet so people can drive their cars? Easter Island anybody?

3. When Romm says "to preserve the livability of the planet, we must cut liquid fossil fuel use more than 50 percent by 2050," he doesn't understand that geopolitics, economics and geology are going to do that for us—easily. Liquid fuels from unconventional hydrocarbon sources are never going to supply more than a small fraction our needs in the most optimistic i.e. unrealistic case (graph left, from the Task Force on Strategic Unconventional Fuels). While Romm argues effectively against scaling-up unconventional oils, he neglects to mention that unconventional oils don't scale-up and have poor economics. Over time, we will have to devote more and more energy to producing energy!

Romm does not seem to appreciate the damaging effects of peak oil on economies. Hamstrung economies would need to recreate our electricity grid and vehicle fleet just as the available energy/wealth required to do so is declining. The PHEV solution (along with cellulosic ethanol) presumes we have the time to revamp our energy infrastructure. That's like closing the barn door after the horse has already left. Romm doesn't understand the depths of our oil dependency.

Suppose that by 2020, oil blew past $300 a barrel and gasoline rose to $9 dollars a gallon (still not much higher than current gasoline prices in England). You could replace your car with a plug-in hybrid, and trips less than 30 miles, which have made suburbia what it is today, would actually cut your fuel bill by a factor of more than 10, even if all the electricity were from zero-carbon sources like wind and nuclear power. The extra cost of the vehicle would be paid for in fuel savings in under five years.

Dream on, Mr. Romm. Has he looked at the oil price recently? What about the 6-year trend? What will we do if oil is over $200/barrel in 2012? (As I recall, England is a very small country. I wonder how they will fare at $18/gallon for petrol?) The U.S. economy appears to be going down the tubes now, which is partly due to the fact that the oil price has gone up over 300% since 2002. Nobody can buy a plug-in hybrid today, and few will be able to afford one in 2012, assuming Toyota or GM solve the engineering problems and start cranking them out.

Climate change is certainly a huge problem—the summer Arctic sea ice is clearly disappearing—requiring an effective longer term solution. However, the rising oil price is a disconcerting fact of life right now. Shortages are likely less than a decade away. It's high-time for climate activists to wake up and smell the coffee on peak oil. I studied the climate issues for over a decade before turning to the peak oil problems, which struck me as being immediate and inimical to our ability to solve all the other problems we have—including climate.

Many climate activists have tunnel vision that prevents them from appreciating the real oil supply problems we have to solve right now.  Everything is viewed through the lens of climate change. This view is naive—we're about to get plowed under by the oil market fundamentals. Necessity arises from near-term peak oil effects, not climate. The main effect right now is the rising oil price, but the longer term future promises to be much worse. Nobody is going to curtail their driving to curb global warming. If you want to solve the climate problem, mitigate the peak oil problem now and implement strategies for controlling longer term coal consumption.

Contact the author at dave.aspo@gmail.com

A Recipe For Disaster

Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world
      —from The Second Coming by William Butler Yeats

Signs of an economic meltdown are springing up all around us. The U.S. is almost certainly in a recession now, but the worst is yet to come. The full consumer price index has risen at a 6.8% annual rate in the last 3 months just as GDP growth has likely entered negative territory, raising the Specter of Stagflation. Americans have not faced such dire straits in 25 years.

When the New York Times feels compelled to reassure us that the chances of a full-blown 1930's-style depression are low, you know something is up. See Depression You Say? Check Those Safety Nets, March 23, 2008. The Bear Stearns debacle, a classic run on the bank, took most observers by surprise. This point was brought home to me personally when Standard & Poors downgraded National City's outlook from 'stable' to 'negative' last week, "citing risk from the shaky housing and mortgage markets." National City is my bank. Deposits are insured, of course, but that didn't make me feel any better somehow.

Paul Krugman joined the chorus, warning that we're Partying Like It's 1929. Alan "Bubbles" Greenspan, who oversaw an economy that is now unraveling, writes that "the current economic turmoil is likely to become the 'most wrenching' since World War II."  Even as the no-longer-infallible former Fed Chairman tries to squirm out of this one, Ben Bernanke is left to sort out the mess. Helicopter Ben is cutting interest rates and opening credit windows for banks to "replenish [their] depleted capital," a strategy that is further driving down the dollar's value and boosting pre-existing inflationary pressures deriving mainly from high oil prices and biofuels.

Over the next year we're going to learn a lot about global oil demand and prices. We're also going to learn whether American consumption is still the sine qua non of global economic health it once was. Regardless of the outcome, Americans are in for a tough time. Let's go through some recession scenarios.

Oil Demand and Price in a Recession

In Another Wild Ride in 2008, we noted that American oil demand growth has been slow and steady since 1990, despite two mild, short recessions in 1990-1991 and 2001 (ASPO-USA, December 19, 2008). The American economy had its longest expansion in the 1990's and continued to grow after the post-9/11 recession (graph left from the Times, cited above). This recession promises to be different.

According to the EIA's data for oil products supplied, U.S. demand actually peaked in 2005 at 20,802 million barrels per day (b/d). The data set is incomplete, but demand fell 0.6% in 2006 and was flat at the 2006 level during the last 6 months of 2007 (≅ 20,685 million b/d). This is a modest decrease, considering that the oil price has doubled over the last year.

Last week, the EIA reported that demand for petroleum products fell a whopping 3.2% in the 4-week period ending March 14th, coming in at 20,259 million b/d. Much of the decrease was in distillate fuel oils (-5.4%), which is mostly diesel fuel. Diesel prices stood at an all-time record $4.037/gallon on March 22nd according to AAA's Daily Fuel Gauge Report.

Diesel consumption fell in part because of the end of the winter heating season, in part because of the slowing economy—trucks moving fewer goods from place to place—and in part because of the price. By contrast, inelastic gasoline demand showed only an insignificant drop-off of 0.1%. Gasoline prices are also close their recent record-high.

The consumption signals are mixed. No recession U.S. oil demand trend is in place yet as we approach the "summer driving" season, which may be a bust this year as disposable income for travel becomes scarce.

The main effect of the shaky economy so far has been on the oil price, which has fluctuated wildly in the past few weeks. Traders moved their money into commodities—gold topped $1000/ounce—as a safe haven from an unregulated "shadow banking" system populated by a bestiary of exotic financial instruments in which no one knows the true value of the paper they're holding. Oil prices surpassed $111/barrel but then tumbled to values closer to $100. These actions followed another interest rate cut by the Fed.

Paul Horsnell, a commodities analyst at Barclays in London, asked the pertinent rhetorical question about the "dramatic" fall of the oil price.

“We see headlines: ‘Oil collapses to $102.’ Is that really a collapse?”

If the U.S. economy tanks and oil demand does take a swan dive, what will happen to global oil demand and the price? The answer depends on whether the American consumption still drives the global economy and its thirst for oil.

The Dangers of Decoupling

The term "decoupling" refers to the degree of economic independence of the developing economies from the American market. In Prospects For China, it was argued that 1) Chinese GDP growth, and hence their import levels for oil and other commodities, must eventually slow down to prevent overheating and tame inflation; and 2) China must function within the globalized economy, which implies that they can not push commodity prices up to levels that cripple the economies of their export markets (ASPO-USA, January 16, 2008). China has effectively underwritten debt-financed American ventures like the occupation of Iraq with their massive $1 trillion treasury bond holdings. So it would appear that the U.S. and China are locked in a mutual dependency—if the U.S. economy falters, China's will too.

This "coupling" of the two economies is rapidly losing steam. The decoupling debate, an analysis in the March 6th issue of The Economist, contains data to back up that assertion—

Sales to America will obviously weaken. The point is that [emerging economy] GDP-growth rates will slow by much less than in previous American downturns. Most enjoyed strong growth during the fourth quarter of last year, and some speeded up, even as America's economy ground to a virtual halt [0.6% growth] and its non-oil imports fell...

The four biggest emerging economies, which accounted for two-fifths of global GDP growth last year, are the least dependent on the United States: exports to America account for just 8% of China's GDP, 4% of India's, 3% of Brazil's and 1% of Russia's. Over 95% of China's growth of 11.2% in the year to the fourth quarter came from domestic demand. China's growth is widely expected to slow this year—it needs to, since even Wen Jiabao, the prime minister, warned this week of overheating—but to a still boisterous 9-10%.

Two possible outcomes follow from a substantial decoupling of the American and developing economies and neither is good news for American consumers. First, lower U.S. oil demand would have little effect on oil consumption in the emerging economies. China, Russia and others might even absorb the decrease, leaving global demand unchanged. The oil price would thus remain above $90-$100/barrel or continue to rise in a stagnant American economy, giving consumers little reprieve from higher fuel and food costs. See Would a U.S. recession lower oil prices? Not necessarily by the unfailing Jad Mouawad (International Herald Tribune, January 23, 2008).

The second, more speculative, outcome is that the Chinese may lose interest in propping up American spending when they realize that their growth can be sustained without relying heavily on the U.S. export market. Here's a quote from Prospects For China—

As [Atlantic Magazine's] James Fallows points out [in The 1.4 Trillion Dollar Question], whenever a Chinese official raises a trial balloon even hinting at the possibility that the Chinese might start unloading dollars and investing them to subsidize rapid growth in their own economy, "phrases like 'run on the dollar' and 'collapse of confidence' [show] up more and more frequently in financial newsletters." China has deliberately chosen to inhibit their own growth to keep their export customers, especially the United States, happy.

Although the Chinese are heavily invested in the U.S, they may decide to cut their losses, especially if highly leveraged American consumers are no longer buying much of their stuff in a prolonged, deep recession. Imagine the consequences for the shaky American economy should China start unloading dollars. This would give new meaning to the phrase "Cut & Run."

A Meltdown for American Consumers

As if the possibility of China abandoning its investment in the United States weren't bad enough, there is mounting evidence to suggest that American consumers are about to get seriously squeezed. It's not just the investment banks that have a liquidity crisis.

In Not Fixing To Walk, we explored the standard view of economists that rising oil prices have not affected U.S. demand because energy spending is still fairly low as a percentage of all household expenditures, and discovered that this percentage started to rise toward levels last seen in the 1970's and early 80's in 2003 after a brief spike during the post-9/11 recession (ASPO-USA, November 14, 2008). This trend is poised to get worse.

Bear in mind that wages have not nearly kept up with GDP and productivity growth throughout the Bush years, while oil prices have tripled since the beginning of 2002 (graph above left, cited by Jerome á Paris at The Oil Drum:Europe). The media was looking at this topic back in 2006. The Wall Street Journal's Wages Fail to Keep Pace With Productivity Increases, Aggravating Income Inequality was typical (March 27, 2006).

Since the end of 2000, gross domestic product per person in the U.S. has expanded 8.4%, adjusted for inflation, but the average weekly wage has edged down 0.3%...

Some factors aren't in dispute. Since the end of the recession of 2001, a lot of the growth in GDP per person -- that is, productivity -- has gone to profits, not wages...  Since 2000, labor's share of GDP, or the total value of goods and services produced in the nation, has fallen to 57% from 58% while profits' share has risen to almost 9% from 6%. (The remainder goes to interest, rent and other items.)

It's easy to overlook rising household expenditures for food or fuel when easy credit is available in the form of Visa cards or home equity loans. It was also possible to refinance and take money out of equity. Credit is now drying up for indebted consumers as housing prices plunge, which puts the bill paying burden on stagnant household income alone. Nine million households have negative equity, i.e. their mortgages exceed the market value of their homes. Mortgage defaults are up. Here are three among the many recent examples indicating distress—

1. By the end of 2007, 36 percent of consumers' disposable income went to food, energy and medical care, a bigger chunk of income than at any time since records were first kept in 1960, according to Merrill Lynch. (Associated Press)
2. Americans' percentage of equity in their homes fell below 50 percent for the first time on record since 1945, the Federal Reserve said Thursday... That marks the first time homeowners' debt on their houses exceeds their equity since the Fed started tracking the data in 1945... Economists expect this figure to drop even further as declining home prices eat into the value of most Americans' single largest asset. (Yahoo Finance)
3. The Great Unwind has begun, Citigroup warns — Avoid leveraged companies, countries and consumers, bank's strategists say... "Easy money encouraged many to buy a bigger house, a bigger car or a bigger speculative position... But now, any behavior that relied upon continued access to easy money is being dramatically reassessed," [Citigroup] added. "Leveraged banks must lend less, leveraged consumers must consume less, leveraged companies must acquire or invest less, and leveraged speculators must speculate less." (MarketWatch)

There you have it: continuing high energy and food costs, contracting credit, stagnant wages and increasing property debt. Highly leveraged or poor American consumers—this is just about everybody who isn't among the richer rich—are about to get nailed. The day of debt reckoning has arrived as the U.S. receives a long overdue margin call (Wall Street Journal, March 15, 2008).

Consumer spending makes up about 70% of GDP. The money squeeze is a recipe for disaster. Household finance will be getting more unmanageable for Americans, who have been living the high life made possible by easy credit made possible by rising house prices. The only silver linings are that American exports are up and we're getting more foreign tourists because of the shrinking value of the dollar.

On the oil front, it appears that reduced demand in a cash-strapped American economy is unlikely to lower oil prices much as the recession unfolds, but all bets are off—no one knows how much demand will be affected yet. If China and the other emerging economies truly are "decoupled' from American consumption trends, it won't matter much if U.S. demand falls off significantly in any case.

The Chinese will be partying at the Beijing Olympics while Americans be scrambling around trying pay their mortgages and make ends meet at the fuel pump. Kind of symbolic, don't you think? Here's an idea—why don't we build some light rail systems?

Contact the author at dave.aspo@gmail.com