Guest Post:Gregor Macdonald: What The End Of Cheap Oil Means

Tyler Durden's picture

Via Adam Taggart of Peak Prosperity,

On the heels of Chris' recent report clarifying the global net energy predicament, he and PeakProsperity.com contributing editor Gregor Macdonald sit down to talk in depth about the broken relationship between energy costs and economic growth.

For much of the twentieth century, the developed world saw a steady march upwards in wages and living standards, due primarily to huge quantities of cheap, high-yielding liquid hydrocarbon. As we find ourselves bumping along the plateau of Peak Oil's apex, suddenly we find that "growth" is a lot harder to come by.

Of course, if you follow the news today, this is not the story you are hearing. Talk of an energy bonanza and imminent energy independence (in the U.S.) are everywhere, thanks to gas fracking and tight oil production. What is missing from the headlines is the cost side of the equation and a blindness towards future demand. 

For certain, shale gas will be a boon for the U.S. and some other countries. But very little is transported these days by gas, and there are no mega-sized infrastructure projects underway to change that anytime soon. Extraction of new tight oil plays is increasing production, but not by enough to offset other field declines elsewhere in the world, and not at the prices we were used to over the past century. The era of cheap oil is over, and these higher permanent prices act as a boot on the throat of economic growth. Hence the mired global economy we have been experiencing in recent years.

Rather than fooling ourselves with fanciful "energy independence" pablum, we should be looking hard at what kind of future we want to have now that oil is no longer cheap. And we should be asking ourselves in regards to the remaining fossil fuels we're extracting: How can we put these non-renewable BTUs to their best use, before they become expensive, too?

I think the main conversation we are not having is that wages are very unlikely to ever return to a relationship to energy costs that would make the United States economy into a happy economic story once again. In other words, this whole idea that we will restore that unique relationship of high wages and low energy prices -- that is what we are not dealing with. So by telling ourselves the story that we are producing more energy, you can clearly see the cultural impulse there. The cultural impulse is there is to suggest "See? There is a chance, there is a chance we can get the energy cost down again and then there is a chance that that wages will come up again. That relationship got very skewed and kicked into a nasty bad place over the past decade. That is very much a way of thinking about what our economic story is, why we had the crisis, and why this supposed emergence from the crisis that we have been plodding our way through the past several years, why it feels so dis-satisfactory, why it feels so insufficient in many respects.

 

This goes back to the Industrial Revolution. What caused a revolution in British wages? The appearance of coal in the British economy. Why is that? Because not only did you have human workers making stuff, but also, now you had coal helping you make stuff. Coal was the slave labor that you did not have to feed or shelter or clothe or house. And you could get coal to work for you and you could work for you, and you put it all together and it becomes high wages, and you get to pocket those high wages.

 

So this is the dream that we once enjoyed, here in the States with our cheap oil and our high wages. And since oil became less cheap, the wages have stagnated, and I just do not see how we are ever going to get back to that relationship again. Maybe we will talk about this; I do have some hope that we could stabilize the relationship in a future world, which is more weighted towards the power grid in which some manufacturing returns to the United States. But I think the main thing is – you asked the question, what is the main thing we are avoiding? We are avoiding the very painful prospect  – likelihood – that we will not be able to return to high wages, low prices, cheap energy.

 

As you point out, one of the cruel things that we left in the wake of our higher rate of growth and our cheap energy era and our high wage era was the debt. We left a tremendous amount of debt. Of course there is the public debt, but I really think what has been governing the economy in the post-crisis era has been the intractable nature of the private debt. We have both done work on charting the course of the private debt and I am sure we would agree that there has been some deleveraging that has occurred, but it is not nearly the amount of deleveraging that the media either thinks or wishes has occurred.

 

When you compare private debt levels to assets in the United States, yes, we are off the peak, but we are only back to 2006 levels. Most of the people I know were worried about debt levels in 2006. So to “deleverage” back to 2006 levels is not an achievement.

 

This promise of greater energy supply is obviously dangling out the prospect that somehow that will translate into cheaper prices and that the debt can be serviced and possible extinguished or deleveraged. But as we are finding the process is grindingly slow, and that is a big reason why the economy is grindingly slow and just does not seem to make much progress.

 

These things can work for a short period in the short term, and that is what we have been doing in the last five to seven years. We have been adding either expensive or marginal sources to the liquid fuel supply, as you know. This process can be thought of as one where the older more cheap oil is continually swapped out for the more expensive, unconventional, more expensive oil, and that makes for some sort of new risks when it comes to how the global economy may slow or speed up and what it may do to oil prices.

 

Because what I think we are going to find, especially in resource plays like the tight oil resource plays: if price goes below what it is costing these companies to extract this oil, it is actually going to be quite easy for these companies to simply stop drilling; to just stop adding additional wells. Because if you look at the actual mechanics by which wells are currently being added, they are added on a highly discretionary basis. They go in, they produce a lot of oil for a short period of time, and then they go into steep decline.

 

I think what people do not understand is that the Bakken is not like a traditional oil field where you are developing the whole field at one time; you are really just sticking little pin pricks into the topography of the western Dakotas. It is not like a tar sands operation, in which you sink all of the steel in the ground first over a five- to six-year engineering project and then you try to get paid back for the steel that you sunk in the ground. This is more of an inch-by-inch incremental project in the Bakken.

 

So what it looks to me is if price goes below sufficient levels – and I currently put that if price goes below $80-$75 a barrel for any length of time – we will just lose supply much more quickly. I just do not think the market or the economy or Wall Street has gotten its head around the fact that a good chunk of our supply now is ready to go offline at the moment that price drops. And that is probably why price has been so sustainably high, because the global futures market for oil realizes that oil that you see now costs a lot more so it is not going to willing to sell you oil two years from now at $70 or $75 a barrel. It knows that the only way that $70 or $75 a barrel oil is available two years from now is if we are back into a deep recession. I mean a deep recession.

Click the play button below to listen to Chris' interview with Gregor Macdonald (48m:43s):

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FeralSerf's picture

Did you ever notice how nincompoops blame "liberals" for just about everything that's wrong with the universe, but don't even know what a "liberal" is?  Thomas Jefferson was a liberal.

ekm's picture

Bull freaking shit

 

Define cost? What is cost? Is gravity cost?

 

bullshit

ekm's picture

I have a better question.

 

Can humanity run out of .....sperm?

 

Is there such a thing as ...peak sperm?

the misanthrope's picture

if there are no measures in place to collect and store sperm, and humanity starts to reproduce, going forward, more females than males, relative to today, and it stays that way, then are we at peak sperm? or if the reproduction rate stays the same, but the killing of males increases, are we at peak sperm?

RafterManFMJ's picture

Is there such a thing as ...peak sperm?

 

Naw we'll just set a rig on your anus and pump away.

Seer's picture

So, you jump into this discussion and throw it way the fuck off and then you say it's all a joke?

Nice fucking try, troll.

SelfGov's picture

Or we can simply distill it out of his spit.

the misanthrope's picture

ok, one more reply. i'm not "hitting" on you, and I have not junked you, and even though your question below was off topic it was actually a better question than this one. Seriously, define cost? Considering you spent 19 years under communism perhaps it's not suprising you don't know how to define / measure cost.

ekm's picture

Ok. Please define cost of crude oil extraction.

Seer's picture

Here's a crude analogy:

There was this boating accident, and like all boating accidents, gold was lost.  You, in your lust for gold (it's a good thing) decide to go liberate that gold from the chilling depths.  You spend $50,000 dollars to bring up the gold, only to find that there is only $49,000 dollars worth of it (today's market price).  You then discover that many such boating accidents have occurred, but surprisingly (necessary to make this analogy simple) all accidents resulted in the drenching of $50,000 worth of gold.  You review your recovery process to find that you can only make it more efficient by $1,000.  The question then is this: what's the cost of liberating the gold from each boating accident?  Can you earn a living doing this recovery operation (given each opportunity is roughly the same)?  Oh!  And for some inexplicable reason the markets are now pricing gold lower!  Do you think that your operations will be proportionally lower, even lower lower?

MARGINS.  That's really what you should be concerned with.  Happy boating!

ekm's picture

Ah, I see. Thx a lot, margins, that's right.

 

You mean accounting, you mean balance sheets.

Now I'm freaking serious, is this a freaking joke? You mean freaking margins? Like BAC and JPM margins?

Seer's picture

You FAILED to read my analogy.

Go the fuck away you idiot/troll.

For those who can read and would like clarification: "margins" is SUPPOSED to be what's used to determine whether one is operating above or below the break-even line, HONEST tracking attempts to understand all costs/expenses and all income/revenues.  The oil industry is very aware of how much their costs/expenses are for pumping out oil; if they exert more energy to get the oil out than that oil returns (negative EROEI) then they're operating at a loss.  One can just pare it down to a pure energy equation- why would ANYONE wish to burn more oil to get oil when the oil to be gotten is LESS than that which is used to get it? (negative margin)

FeralSerf's picture

The oil industry, especially Big Oil and other owners of significant petroleum assets (e.g. Saudi Arabia), are known to have capped  or otherwise prevented the exploitation of assets to keep the price higher than it would otherwise be.   The financial industry also has methods that prevent a truly free market in oil to exist.  This prevents your analogy from being valid.  No one knows what the real, free market value of oil is, just as no one knows what the real, free market demand for that oil is.

awakening's picture

MARGINS.

Means less than jackshit, the US Fed Reserve Bank will print as many USD needed to extract oil and keep this ponzi going for their masters, all in the interests of 'national security' of course.

Readapt your analogy from USD to energy in vs energy out and the crude (I see what you did there, nice pun) analogy makes much more sense.

Matt's picture

Profit Margins and  Capital Margins are two very different things.

If the Fed prints more, sure, the price of oil goes up, but the input costs to produce the oil goes up, too. Inflation is a sword that cuts both ways.

EROI (energy returned on invested, or energy in vs energy out as you put it) is important, however, not all energy is priced the same, so an operation can be done at a less than 1.0 EROI and still be profitable.

Example: Nazi Germany needed oil, but could not get it. So they turned coal into oil at an energy return of 50%. For every 2 BTU in, 1 BTU out, but they still did it because they had a preference for diesel over coal.

Jimmy Carter tried to do the same thing, but then oil from the middle east came online, making it unprofitable.

Price, Margin and EROI all matter, but no one of them is the single deciding factor.

A Lunatic's picture

Peak inflation denial...........

orangegeek's picture

A stronger USD/weaker Euro should help drive Oil priced in US dollars down.

 

WTI Oil weekly shows lower highs and lower lows.

 

http://bullandbearmash.com/chart/wti-oil-weekly-climbs-22-breaks-channel...

disabledvet's picture

here's a chart of oil after the first Iraq war broke out:http://en.wikipedia.org/wiki/1990_oil_price_shock'if anyone remembers it was when the ground invasion began that oil prices completely collapsed...and there they would stay until 9/11 and the disaster that was Iraq Part Deaux. To answer the above "consequences of peak oil based on cost theory" presented above the answer would appear to be "rock bottom natural gas prices." are those too expensive to get out of the ground? NOT. now in addition to dirt cheap natural gas we have a revolution in the materials space that appears to be "coming of age" as this is being written...namely in "mass produced nano fiber." this material is FAST becoming dirt cheap to make...and cheap "in large quantities"....it is a HIGHLY disruptive condition as a consequence and therefor rather than spending an entire life wasting away while pondering the vicissitudes of "peak oil" i might want to take a look at "how the Revolution started in 2013" and say something meaningful in life for a change....because this stuff means "change indeed." i BELIEVE for the better...but hey, we are talking humans here.

Seer's picture

"Price" is fine and dandy if you're speculating/playing the markets.  But in the consumption world it's all about affordability.

I'd stated it years ago: if prices get too high employment will get chopped; if prices get to low they'll increase employment and jack things up via inflation.  It's a numbers game by the big time casino rollers.

NidStyles's picture

The markets play off of affordability. It annoys me how many of your idiots are running around thinking that everything is not connected.

mess nonster's picture

It's the abiotic gold bug freak show...

knukles's picture

..... brought to you by your friends at Anthropogenic Infinite Industries.

proLiberty's picture

If the US production of hydrocarbons increases, but the dollar is diluted even more, the price in the US in dollars may not change much.  

neutrinoman's picture

Oil isn't going back down to $10/barrel. But fracking, shale, and oil sands will redefine the North American energy market. Actually, it's already redefining it. Live with it.

Notarocketscientist's picture

Ya live with your 100 buck a barrel oil and water that lights on fire!!!!  Drill baby Drill!!!

massbytes's picture

You might look more closely about how many resources it takes to produce those sources of hydrocarbons...and how quickly the wells deplete.  The sucking noise you hear is all the money rushing to drill increasingly the hundreds of wells needed just to keep the overall production rates from not falling.  Volumes are increasing now...but after the sweet spots are drilled, look out below.

RafterManFMJ's picture

Oil isn't going back down to $10/barrel. But fracking, shale, and oil sands will redefine the North American energy market. Actually, it's already redefining it. Live with it.

 

Absolutely. I know in my personal experience my gasoline, heating and food bills continue to spiral downward, while my income increases...no, wait! FUCK it's just the opposite. But I guess I just have to hold on, right, to the good times roll? Just the tip, bitch, sold to you!

NidStyles's picture

It's the poor worker that doesn't understand inflation that is always hurt by it the most. Yet you keep demanding that the government does something about it, right?

Gamma735's picture

No cheap energy means smaller world, less food and ultimately less people.

Seer's picture

Cheap energy means solar, wind and hydro, though of the straight mechanical kind (passive, wind pumps and water wheels).

I don't think that current energy (fossil fuel-based) can ever become cheap with a small population base because of the economies of scale of production.  Less consumers means less volume.  It takes some pretty substantial equipment to pump oil at the depths that it's being pumped (or for digging coal; or for processing tar sands and oil shale).

Less food per capita will resolve itself (though not by waiting for the supermarket to reopen).

stacking12321's picture

peak people?

would sure be nice.

tradewithdave's picture

Davos World Economic Forum attendee list.

tradewithdave.com/?p=14948

entropy93's picture

Oil is now so expensive that its economical to scoop up and boil sand to extract tar from it. Any sane person sees that conventional oil is in serious trouble. If conventional oil production could increase, it would increase at the prices we have now.

The article is exactly correct, even if unconventional oil is highly successful there is now a price floor on oil.

We will see economic growth severely challenged as long as it depends on oil. I just saw a hybrid Fed-Ex truck the other day, they aren't going hybrid to be "green", they are doing it because expensive oil is here to stay. A bus I ride regularly runs on natural gas, again worth the investment because expensive oil is here to stay.

What will get the economy going again is high efficiency and alternatives. Plugin hybrids make great sense for delivery businesses, I've even seen a straight electric delivery truck.

 

The Second Rule's picture

"Any sane person sees that conventional oil is in serious trouble."

Yes but ze problem is that most people are quite insane.

https://www.youtube.com/watch?v=-mUCLHzWiJo

Seer's picture

You're good up until the point of cheering for the economy to be "going again."  As compared to what?  And, if you increase are you then expecting it to stabilize at zero growth or are you advocating/expecting perpetual growth?  Perpetual growth is a Ponzi.

"Plugin hybrids make great sense for delivery businesses, I've even seen a straight electric delivery truck."

Haven't seen them in my rural outback.

People ought not confuse the entire world as being like some city one lives in.  There are 7+ BILLION people on this planet, most whom have never touched a computer, let alone ordered something to be brought to them in some electric delivery truck.  Sorry, I'm just not seeing things scaling: and since everything is based on continued growth and this is a finite planet, well...

NidStyles's picture

Continued growth in your terms is not what it means in real economic terms. What you speak of of growth as being more people having more access with more dollars. When an "economist" speaks of growth he means inflation. Inflation is not increased prosperity, in fact it's the exact opposite.

entropy93's picture

The one issue I have with peak oil isn't the basic fact of peak oil.

Its the assumption by some of oil's unreplaceability. When prices stay high and are expected to stay high, people will start making the capital investments to switch off of oil. A biodiesel plugin hybrid would be one good approach. You'd rarely use the diesel engine, most trips are short, when you did use it, you'd be burning waste restaurant oil, or algie produced oils.

disabledvet's picture

13.9 billion gallons of ethanol...from pretty much zero 10 years ago. that seems pretty impressive to me. if our cars start not even using fuel but battery power that strikes me as bad for price as well. if war breaks out between Japan and China do folks really think they'll be seeing massive land armies on the move? more like "long video games" yes? i do agree "in theory war is supportive of price." you just don't know though until the shooting starts...

Notarocketscientist's picture

What I don't understand is if we can produce the much ethanol why we don't simply allocate all farmland in america to producing ethanol.  We'd never have to import another drop of oil again!!!  We've got a hell of a lot of farmland ya know :)

Seer's picture

Yes, just like in the movies where people never eat!

Fuck, the ethanol folks were screaming for bailouts when they were already massively subsidized!  If it's subsidized it means that it's NOT sustainable- WTF do we want to undertake anything that it not sustainable unless we're CERTAIN that it's only for a limited time frame (meant as some "stepping stone," which, has to be assessed as to whether the next step IS sustainable and that the unsustainable step didn't drain us completely)?

hidingfromhelis's picture

Sure is a lot of oil that goes into that ethanol.  Between fertilizer, transport, and manufacture, we're not getting much of an EROEI, and it's negative financial investment.  Subsidize research, yes!  Subsidizing ongoing production for years?  WTF?!?!  How long are we going to be stuck paying for it?  Ah yes, the power of lobbying.  Someone's making money on this horseshit.

sessinpo's picture

Perhaps because the energy used to produce ethanol actually makes ethanol more expensive compared to just growing food to eat.