Peak Oil

This is not a peak oil blog and I do not wish it to become one. But as a finance professional educated in chemical engineering and one who worked on the design and construction of a couple of synfuel plants (way back when..), I have an appreciation for the connection between money, credit, energy, the economy and how our society's current model (Permagrowth) puts it all together into a complex whole - in my view increasingly unsustainable.

Money does not drive energy, but energy does drive money (and everything else). Thinking in terms of dollars per gallon is useful when going to the pump for a fill up, but unless we interpret price signals properly and comprehensively, it is likely that we will make profound mistakes in planning our future. When marking the price of oil in dollars we easily fall prey to notions about manipulation, political jiggery, terrorism, profiteering and a host of other "explanations", instead of hard facts.

In fact,then, the proper way to evaluate energy pricing is EROEI (Energy Returned Over Energy Invested). If the ratio is declining then energy is getting more expensive in real, BTU for BTU terms and eventually this situation finds its way into "dollar pricing", though things can get mightily muddled because money supply is artificially created and theoretically unlimited. Fiat money does not follow or depend on physical laws but "trust", a very dicey and evanescent measure of human psychology.

What do oil sands, drilling in very deep oceans, corn ethanol and resource wars (Iraq, Afghanistan..) have in common? They are very low EROEI energy sources compared to the rapidly declining high EROEI sources (e.g. Texas and Mexico). The fact that we have to increasingly depend on them to meet demand is the surest proof that "cheap" oil is rapidly becoming a thing of the past. And this, ladies and gentlemen, is as good a definition of Peak Oil as any.

In closing, you may wish to read this article from UK's The Daily Telegraph: Oil Is Expensive Because Oil Is Scarce.

For those not familiar with British politics, The Telegraph is a conservative-leaning newspaper. It has the largest circulation of any "quality" newspaper.

Unemployed Part-Time

Payrolls declined by 20.000 in April, lower than expected (-100.000). However, looking just below the surface of the headline data reveals a fast deterioration in other job measures.

The number of people employed part-time for economic reasons, i.e. those that could not find full-time jobs or had to work part-time because business was slow, swelled sharply by 306.000 in April to a total of 5.22 million. This is the highest number since 1994 (see chart below, click to enlarge).

Number of people employed part-time for economic reasons (chart: BLS)

Such part-time employment now accounts for 4.52% of all private jobs, the highest percentage in 13 years and up from 3.4% two years ago (see chart below).

The Bureau of Labor Statistics counts everyone who worked 1 to 34 hours per week as employed and includes them in the headline payroll numbers, even though such employment clearly results in fewer hours and lower pay.

Taking this analysis one step further, part-time employment for economic reasons, i.e. forced part-time, accounts for 21% of all part-time jobs. This is also the highest level since 1994.

In summary, while the headline employment numbers are not declining as fast as during previous slowdowns, the qualitative job measures are worsening and are already at multi-year points.

The most likely cause is that employers, particularly those in the service sectors, are hoping the economy will rebound soon, so instead of fully laying off people they are cutting costs by forcing employees to work less, for less pay, i.e. forcing them into part-time un-employment.

What does this mean for the economy? Let's combine the poor employment picture with sharply higher costs for necessities such as food and fuel, the zero/negative saving rate and record high debt: the result is most likely going to be a continuing curtailment of discretionary personal spending. With personal consumption accounting for nearly three quarters of GDP, I believe we are in for a prolonged period of weakness.

Looking at just the headline BLS numbers is currently pretty misleading and may cause misplaced optimism.

The Real Cost Of Black

A reader (thanks M3ANON) had this to say, by way of criticism to yesterday's post:

"To top it off you all seem to be in favor of rebuilding society on alternative energy methods that, at present, are not efficient or even self-sustaining. It might be a different matter if the alternative energy methods you all propose were actually efficient and capable or maintaining society as we know it..." (bold added).

I would like to address the two points highlited above, because I believe many people have similar concerns.

• Alternative energy methods are not self sustaining or efficient.
  

Well, obviously solar energy is self-sustaining - for several million years more, anyway. Solar energy includes direct (i.e. solar panels) but also energy derived from the wind, waves, salinity differences, marine temperature gradients and biomass (am I leaving anything out?). Geothermal and tidal energy depends on the Earth's core and the Moon respectively and is also likely to last another few million years - unless a big asteroid hits.

Efficiency is measured by EROEI and all of the above energy sources now likely exceed "black" energy, when all costs are included. For example, the cost of maintaining the enormous US and other nations' military machines and occasionally fighting wars. Or the cost of environmental change caused by greenhouse gases. And how about geopolitical cost, to account for the very real risks arising from the increasing concentration of "black" resources in a handful of nations?

• Maintaining society as we know it.

Can we actually maintain society as we know it? Society's ability to consume ever more (i.e. Permagrowth) was made possible with the enormous energy boost of fossil fuels. They are running out and are destroying our habitat, besides. So we have no choice but to change our society to better fit whatever energy is available. If we plan ahead wisely, changes will come with few major disruptions. But if we keep on pushing on the gas pedal we will just fly off the cliff.

Oh, we may maintain our society as we know it, allright. But what about our children's society? Are we willing to consume their future so we can maintain our present?

Your Votes At Work

As we move towards anointing another Defender of The (Oil) Faith (aka US President), how do the wannabes stack up in confronting the mounting energy crisis? Here are some facts on their "energy policies".

• Clinton and McCain both favor suspending the 18.4 cent per gallon federal gasoline tax for the summer driving season. This populist measure is analogous to pushing for lower cigarette taxes as tobacco prices rise. Let's all root for more cancer and emphysema, shall we?
  

• Obama and Clinton promise $150 billion over 10 years to develop alternative energy. Do a simple comparison: at today's prices the US spends $1 trillion per year on crude oil alone. Anyone that believes that $15 billion is going to make a real difference is naive, uninformed or in denial - or just throws out round numbers to palliate voters. Or all of the above.
  

• Clinton and Obama both want higher fuel economy standards from the current 25 mpg. Admirable, but Clinton wants 55 mpg by 2030 and Obama 50 mpg by 2026. Since our politicians love stargazing while whispering sweet nothings to our ear, how about 100 mpg by 2100? Perpetual motion by 2200? How about the simple fact that, should they get elected, they will be out of office by 2016 at the very latest? The problem is now and we must confront it right away. Forget McCain, he comes from another planet altogether: in 2003 he voted down a measure to increase fuel economy to 40 MPG by 2013.

• Clinton and Obama want to "investigate manipulation of oil prices". That's what I call the Darth Vader initiative: send noble knights to fight the Dark Side and liberate the Republic from the claws of the Evil Manipulator. Plays well with those who view issues in black and white and cartoons in Technicolor (IQ<100 a must).
  

To summarize, these policies are best described as follows: the "Fuel Low" warning has lit up in the middle of a flight, high above the Atlantic Ocean. Instead of altering course for the Azores or Iceland, the Captain decides to stick to his original flight plan, passes free booze to everyone - including himself and the co-pilot - and blames the ground crew for the empty tank. He also promises that after 25 years the plane will go further with less fuel.

No wonder the passengers are getting nervous...

OK then, what should be done? Well, first of all we need to land the plane without killing everyone on board. After decades of mostly forced growth (think of how foie-gras is made) we actually need a prolonged period of shallow recession to retool the national (and global) economy away from the Permagrowth model. If the rest of the world doesn't want to follow, too bad. That's what we have the Customs Service for.

Some concrete proposals:

• Start a crash campaign to honestly inform people about energy facts and choices. Updating Jimmy Carter's "moral equivalent of war" speech is not a bad place to start.

• Regulate money supply via the Greenback Model.

• Legislate a stream of steady increases in taxes for carbon-based fuels (e.g. 10 cents/gallon every six months, 5 cents/kwh of "black" energy), to raise at least $100+ billion per year and recycle the money into alternative energy sources and systems.
  

• Impose sales and annual use/registration taxes for automobiles on a sliding fuel economy scale. Those getting over 50 mpg will pay very little or nothing, whereas gas guzzlers will pay 5% of their original factory MSRP every year. Recycle the money into public transport, including high speed trains.

• Withdraw from Iraq and Afghanistan within one year and reduce the overall size of the military involved in securing fossil fuel sources and routes, at a pace commensurate to the switch to alternative energy. This will save a minimum of $150 billion/yr at once and eventually at least $300 billion/yr. (the total military expense is now $630 billion/yr).
  

• Revamp the current pensions and medical benefits scheme, since it is entirely based on the Permagrowth and serial bubble paradigms. This is key because people will not accept both present and future sacrifice. If changing energy is difficult, this is an order of magnitude harder.
  

Empty Homes

The Census Bureau announced its quarterly housing data yesterday. The homeowner vacancy rate moved to 2.9% in the first quarter of 2008, the highest reading since 1956 when records started.

Worse yet, as the number of housing units in the country increased by 2.1 million units from a year ago, vacancies also rose by a huge 1 million units, affected by rising foreclosures. For comparison, here is a chart with prior years' increases in housing units and vacancies.

Putting it into dollars, at least $200 billion in housing capital became idle in just one year. This amount likely understates reality because it reflects national median prices, whereas vacancies are higher in the West and South where houses are more expensive. For example, the homeowner vacancy rate is 2% in the Northeast, but 3.2% in the West.

Consumer Sentiment and Spending

Everyone agrees the US economy is all about consumer spending - personal consumption expenditures (PCE) make up 72% of GDP. Naturally, there is a tight relationship between how confident people feel and their spending.

Here is a chart that compares the percentage change in real, inflation adjusted PCE (red line) with the consumer sentiment index published monthly by the University of Michigan (blue line).

At 62.6, the sentiment index has now reached the lowest level in 26 years, portending further declines in spending. Headline data on sales may be muddled by sharply higher food and fuel prices and the ongoing racket of manipulating official CPI inflation*, but you can't hide the "real" reality manifesting itself on the ground.

• Starbucks just slashed its outlook. This icon of discretionary consumer spending is seeing lattes-to-go go down the drain. "It's amazing how fast business has derailed", said RBC Capital Markets analyst Larry Miller.
• People are cutting back on laser eye surgery. Elective LASIK surgery can cost thousands of dollars per eye - the other end of the discretionary spectrum from a cup of coffee. But the principle is the same: unnecessary spending is being curtailed. A 17% drop in procedures is forecast for 2008.

As we come up to stimulus time - those $600 checks borrowed abroad on behalf of the American people by the Bush administration - I expect most of the money spent will go towards basic, pressing necessities: food, gas and debt payments.

And since I mentioned gasoline, consumption has stopped growing (see chart below) and for the year to April 18 it is down 1.12% from last year.

Data: EIA

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(*) Everyone should read this damning article by Kevin Phillips in the latest issue of Harper's Magazine: Numbers Racket. Kevin used to be a mainstream Republican political strategist. I am increasingly getting the feeling that economic reality is getting swept under the carpet, an uncomfortable parallel to the late Soviet Union's "official" reality until it imploded all at once.

One Sentence, One Picture, One Story.

(A) The Sentence:

Ambac's CEO Michael Callen said his company has enough capital to keep its AAA rating.

(B) The Picture:

Ambac Share Price

(C) The Story:

Kindly combine (A) and (B).

The Greenback: Toward A New Monetary Policy

As we transit to a world of resource depletion and the reversal of the Permagrowth model, what is the proper monetary and currency regime? Clearly, not the existing fiat/credit currency, which depends entirely on financing present consumption by discounting future growth that may never occur. Just as bad would be a throwback to precious metals. It would suppress economic activity without providing incentives for developing alternative energy resources.

Instead, I believe we should implement a monetary system that uses renewable, "green" energy as a benchmark. In previous posts I have called the new currency the "Greenback", an allusion to the fact that for most people nothing would change in their daily routine. Same dollars, same bank accounts, same credit cards. The monetary institutions would also be retained: the Fed and the fractional banking system. The only change - admittedly a big one - would be the rate at which money supply is allowed to expand. Let's call this rate "M green", or M(g) for short and see how it will be calculated.

To begin with, we have the following energy consumption data from the US Energy Information Administation (EIA, see chart below). The discrepancy in percentages is in the original data, but it is very minor.

Data: EIA (2006)

We see that of the total 99.4 quadrillion BTU the US consumed in 2006, 86% was produced by "black" fossil fuels, the rest from nuclear and renewable sources. Adding the last two together gives us the percentage of "green" energy. Though I hesitate to call nuclear "green", it is an indispensable energy source in transiting away from fossil fuels.

For any given period, then, the allowed growth in money supply would be calculated by this formula:

M(g) = ΔE(g)/E(b)

where:

- ΔE(g) is the change in "green" energy consumption from the previous period, in BTU.
- E(b) is the total "black" energy consumed in the previous period, in BTU.

For example: let's say that in 2008 we consume 85 black BTU and 15 green BTU. The following year, we consume the same 85 black BTU but increase green to 17 BTU.

Therefore:

M(g) = (17 - 15)/85 = 0.0235 = 2.35%

i.e. broad Greenback money supply (the equivalent to M3 today) would be allowed to expand by 2.35%.

Putting it in simple terms, money growth would increase with "green" energy use and be constricted if "black" energy grows.

This system would broadly encourage the consumption of green energy and penalize the consumption of black energy, by controlling the money base. A monetary policy that targets money supply has not been used since the early 1980's, when the Fed switched to targeting short-term interest rates (i.e. Fed funds). Nevertheless, the tools and procedures for targeting money supply are simple and consist mostly of buying and selling Treasury securities in the open market.

There are certainly further details that will need to be worked out. Initially, at least, the formula will lead to a restrictive monetary policy and high interest rates. Left unchecked, the elevated cost of money would prevent even "green" projects from going ahead, so exceptions and subsidies should be provided. For example, the government could provide low-cost financing for alternative energy projects.

In addition, GDP growth as measured currently would be impacted negatively. To avoid a prolonged period of high unemployment resulting from sectors of the Permagrowth economy becoming obsolete, the government should implement an appropriate mix of fiscal policy initiatives. For example, increased taxes in "black" sectors could be recycled into "green" sectors, including education and retraining programs and incentives.

Notice that I have not called for a government-sponsored and financed "Greenshot" effort, a throwback to the Apollo Moonshot project. I believe that the proper mix of monetary and tax policies, balanced with liberal subsidies for green/sustainable efforts, will create more than enough opportunity for private enterprise. The prospect for attractive profits will promote vigorous technological advance and produce high value-added jobs.

The whole process will re-invigorate the American economy and society, leading to a long period of global superiority in intellectual and creative advancement. Crucially, we will no longer need to maintain a vast military-industrial complex to guard the world's oil sources and routes. America will once again become the beacon of liberty and hope, instead of fighting bloody resource wars that besmirch our national pride and give birth to sworn enemies.

Final Note: Some readers may not be familiar with actual macro-economic and monetary data and may thus be puzzled by the Greenback's ability to transform the economy. To illustrate, here is a real-life example:

Between 2005 and 2006 US "green" energy consumption grew by 0.53 quadrillion BTU, a tiny increase when fossil fuel consumption in 2005 was 86.4 quadrillion BTU. This means that broad money supply under the above Greenback system would only be allowed to grow by 0.6% for the year. By comparison, the last official reading of M3 growth, before its publication was discontinued in early 2006, was 8.0%.

I expect that the economic effects of such a large difference in money supply growth rates are obvious. If not, please refer to basic texts on monetary policy.

Heads In The (Tar) Sands

This is a follow-up post on common sense evidence that easily accessible crude oil is in depletion and its relationship to debt and central bank policies.

I just watched a TV documentary about the Alberta tar sands and the way oil is mined by Syncrude. Some facts:

• The teeth of the giant shovels that scoop up the tar sands have to be replaced every 12 hours. That's a lot of steel to chew through in half a day - it surely isn't beach sand...
  

Photo: Graig Smith

• Imagine rubbing #40 sandpaper on your skin. Now guess what happens to every pipe, vessel, pump and valve that handles the tar sand slurry. The company has two separate process trains working in parallel, switching from one to the other in order to constantly replace worn parts.

• The giant 400-ton trucks that carry the sands cost $6 million. Their 3,550 HP engines have to be replaced every two years, at $1+ million a pop. Tires cost $60,000 - each.
  

When it comes to evaluating resource depletion, deeds speak louder than words. Oil isn't available for the price of a straw stuck in the sand any more. Back when "gushers" were common, easily accessible crude had EROEI of as much as 100-to-1. Saudi crude is now extracted at 10-to-1 and tar sand oil at 5-to-1. We can argue dollar prices forever, but a kilowatt is always a kilowatt. Try this simple thought experiment: instead of thinking of oil prices in dollars per barrel, reverse the point of view and think in terms of barrels per dollar. That is, price the artificial entity (dollars) in terms of the real item (oil). Do you see the difference?

As I see it, our global human society has two choices. We can keep our heads buried in the (tar) sands, perma-consuming until all we have left to bequeath our children are dregs. Or we can stop right now and start moving towards a sustainable regime. The current debt "crisis" is not only a warning sign that we have already consumed too much of our future. It is also a golden opportunity to reverse some of the excess, to un-mortgage humanity's future by letting some of the debt go bust.

In this sense, repeated bailouts by central banks (BOE is the latest addition) are profoundly wrong, misbegotten and ultimately dangerous. Speaking in thermodynamic terms, they are trying to convince us that their kilowatt is worth more than one kilowatt. They are just drilling their heads deeper into the sand, forcing us along for the ride. Unfortunately, we will have to work that much harder to dig ourselves out - assuming we will still have some food left over.

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Note: A reader asked for a book recommendation on Thermoeconomics: Try "The Entropy Law and The Economic Process". It's now on the Amazon bar on the right.

Brave Words From A Dissenter

Two Fed presidents dissented with the previous rate cut. One of them was Charles Plosser, president of the Federal Reserve Bank of Philadelphia. Yesterday, in a speech at Drexel University, he had this to say about the limits of rate cuts:

The idea that interest-rate cuts can solve any economic ills is a misleading perception. Not only is that not true, it is a dangerous misconception and runs the risks of setting up expectations that monetary policy can achieve objectives it cannot attain.

To ensure the credibility of monetary policy, we should never ask monetary policy to do more than it can do. Lower rates, for one thing, cannot solve the problem of bad debts in the mortgage markets. Nor can they reprice the risks of securities backed by subprime loans.

Mr. Plosser, you just became my Federal Reserve resident hero.

Many think that further rate cuts can and will provide an economic boost. But with real rates already at minus 1.75% - after the fastest plunge into negative territory ever - what we are going to get is plenty of dashed hopes, if the economy does not pull out of its tailspin very soon.

Data: FRB St. Louis

The real estate bubble was created by Mr. Greenspan's spate of negative rates. We are now getting a frenzy in commodities from Mr. Bernanke's negative rates. But unlike previous bubbles that mainly involved speculators in shares and housing, the current spike in food and fuel prices is causing hunger and misery across the globe.

In a fiat currency world experiencing resource limitations there are no more "good" bubbles to blow by using negative rates. Instead, we are implementing a "beggar thy neighbour" policy by stealth, a version of the Smoot Hawley Act updated for 21st Century conditions.

A fiat currency regime, where monetary policy reigns supreme, was appropriate for an expanding world unhindered by resource depletion. An ever-expanding supply of money fit the Permagrowth model well - indeed, it was a necessary condition. However, we are now transiting to a different socio-economic model and the evidence is all around us, plain for all to see: zooming prices for low value-added necessities.

Why has the price of rice quadrupled? Does it now contain four times as much technological or knowledge value-added? Of course not. It is all about scarcity value, a concept we have not experienced in centuries, outside of war.

If I may spin Mr. Plosser's remarks to another level: We can't buy Manhattan for a bag of beads any more. There are too many buyers around and the natives are restless.