Why is oil production peak the problem and not when the oil runs out?

First, a little history

The exponential growth of population from 1 billion to 7 billion in less than 200 years was fueled by fossil fuels, especially oil, which does the actual work of a society and is as necessary as food itself: oil grows, cooks, distributes, and refrigerates our food, and is the basis of 97% of all transportation.

Our financial system has also become dependent on oil.  It is entirely structured around credit being lent out and debt paid back.  But debt can only be paid back if the business or salary of the borrower grows, and for the past two centuries that has been true because we have exponentially extracted oil, coal, and natural gas to make billions of combustion engines, roads, bridges, sewage systems, dams, medicine, plastic, ships, trucks, cars and everything else you see around you.  We industrialized agriculture to mine topsoil to grow enough crops to feed 7 billion people to the point where the soil will be exhausted within 200 years.  Previous civilizations without enormously destructive tractors were physically incapable of doing that, but even they depleted their soil over an average of 1,500 years by using the so-called waste as feed for their animals, to burn to cook with, and thatch for their roofs.

We’ve grown so used to that we forget that for the previous two million years homo sapiens lived in a steady state economy.  If you ate all the fish, shot all the game with arrows or spears, drank the last fresh water from a pool in the desert, your tribe died. When agriculture arrived, there wasn’t a single region that didn’t periodically suffer famines from one or more years of bad crops.  People had no choice but to live within the boundaries the natural world had set for them.

Okay, so it’s peaked, we’ll just drive a bit less  

Half the oil is left after all.

But it’s expensive.  If the financial system fails, how will the super-expensive projects to get at oil under miles of ocean be financed?   There are many reasons the financial system could fail.  A high-speed trading flash crash, the corruption and greed, 1 quadrillion in derivatives unwinding, a natural disaster like an earthquake in Tokyo or Los Angeles, cyber warfare taking out part or all of our electric grid for a year or two, and so on.

The remaining oil is remote and inaccessible.

We’re consuming more oil than we’re finding.  The few discoveries are few and very small compared to the giant fields that have provided 80% of our oil for decades.

The remaining oil is nasty, gunky, sour, full of impurities and comes out slowly like tar instead of quickly like the sweet light oil we’ve been pumping so far.   Before you could get $500 a day out of your checking account at the ATM.  But from now on you can get less every day, eventually not enough to pay the rent, pay for the utilities, and buy food.  The money is there, but you can’t get it out…

Nicole Foss on the intersection of oil and the financial system, December 7, 2008

“One might imagine that as an essential resource becomes scarcer, it’s price would move in one direction only – up – and for a while it appeared that would be the case. However, our energy supply system is set in the context of our existing economic and financial structures. The extreme and increasing stress that these structures are under will interact with future energy scarcity with devastating effect, effectively placing a hard limit on any eventual recovery. Energy is the master resource without which no activity, economic or otherwise, is possible.

The effect of easy credit was to flood commodity exchanges with liquidity, as liquidity fleeing risky securitized assets searched for a safe haven. This pushed up the prices of all commodities beyond what could be justified, sending premature signals of scarcity that attracted even more speculative investment. In this way a bubble was formed, but bubbles always burst, and when they do, the speculative money disappears very quickly, taking price support with it. The price collapse we have seen since is partly a result of speculation in reverse, as speculators go short, and partly a result of falling demand, and that fall in demand has only just begun.

The consequence of that price plunge is a severe impact on the viability of continued fossil fuel exploration and development, and also a similarly significant impact on the viability of energy alternatives such as renewables and efficiency investments. Ilargi has long referred to this as the Law of Receding Horizons, meaning that each time alternatives appear to be reaching the threshold of viability, the combination of the price of conventional energy and the cost structure for the alternative is such that the threshold is never quite reached. Once again, energy prices are falling as costs for alternative have remained high, so that the hoped for developments will again be put on hold.

We are seeing the beginning of a global demand collapse, as the credit crunch takes an ever increasing toll on global economic activity and international trade. Already we are seeing the dire effects on shipping in the Baltic Dry index, thanks to the difficulty in obtaining letters of credit for shipments. Consumers in developed countries are tapped out and trying to repair their tattered balance sheets by cutting back, as are companies and banks. Consumption is therefore falling, which will hit exporting economies very hard indeed. They have spent vast sums, and used huge amounts of raw materials, to build what will now be shown to be an enormous excess of productive capacity. Their demand for raw materials will not recover any time soon, as there will be no demand for their products for a very long time.

For the time being, the on-going demand collapse, which has very much further to go, is causing the price of commodities, and particularly energy, to drop like a stone. This may well continue for a period of time, but the danger is that the demand collapse will lead to a supply collapse, and at that point prices will find a floor and begin to climb again. This price bottom could happen earlier in the coming Depression than would be the case for other goods and services.  Exactly when we might see the impact on supply is not clear. Already there are many projects with high cost structures which are no longer viable. These are the projects that could have cushioned the down slope of Hubbert’s curve (the decline from peak production of oil), but will not now come on line. Although they could in theory be developed at a later date, increasing capital constraints will make financing almost impossible, hence development will be unlikely for a very long time. We will therefore continue to make do with the fields already in production, but many of those are depleting very quickly – Ghawar in Saudi Arabia, Cantarell in Mexico, Burgan in Kuwait and many others.

For a while it will be enough to sustain the much lower level of economic activity that we are headed for, but not for all that much longer, especially since there will be many other ‘above ground factors’ to consider. For instance, production infrastructure requires expensive maintenance that will be increasingly difficult to perform, separatist movements in producing countries will seek to control resources for their own benefit, productive capacity being fought over will be damaged or destroyed, sabotage by the disaffected with nothing left to lose will increasingly become a factor, and piracy will make delivery much more challenging. Living off our fossil fuel legacy will therefore become progressively more difficult.

Many governments around the world, including those of all the major powers, are well aware of peak oil. In a very real sense in a modern world, oil IS power, as there is no comparable source of concentrated, transportable and flexible fuel. Securing access to it is therefore of the utmost strategic importance. Some governments, like the Anglo-Saxon economies, have so far appeared to place their trust in the global markets and their own perceived ability to outbid the competition. Others, notably China, have been quietly arranging long term bilateral supply contracts directly with producers, thereby taking production off the market.

China’s strategy is likely to prove far superior in difficult times when international trade is drying up, the fungibility of oil comes under threat and no one can be sure of being able to outbid the competition. By the time others realize that trusting the market to provide is essentially a modern day cargo cult, they may have been completely out maneuvered. In my opinion, this will be the foundation of the coming shift in hegemonic power towards the Far East, but it will not be a peaceful transition. Resource wars are a given under these circumstances.”

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