Epilogue to Oil Speculation

During recent months the world has experienced something of a roller coaster on oil prices.

Click for larger image—Note baseline is 50

I've been very skeptical of allegations that speculators are to blame for this, although in previous entries I've examined ways in which they might have (1, 2, 3).

I believe I've exhausted that subject. Since mid-June, when I last wrote about the subject, oil prices have completed a mini-spike (from a base of $122/bbl on 5 June to a peak of $147 on 11 July), and subsequently fell to levels first seen in March. At the same time, the euro has also retreated to March levels.


(The euro-denominated price of oil rose 84% as much as the price in US dollars, using 2005 as a baseline.)


However, it is probably worth noting recent disclosures about a firm called Vitol (Switzerland). Vitol's oil trades were investigated by the Commodity Futures Trading Commission (CFTC):

WP (via War & Piece): The CFTC, which learned about the nature of Vitol's activities only after making an unusual request for data from the firm, now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency. That figure may rise in coming weeks as the CFTC checks the status of other big traders.

Some lawmakers have blamed these firms for the volatility of oil prices, including the tremendous run-up that peaked earlier in the summer.

"It is now evident that speculators in the energy futures markets play a much larger role than previously thought, and it is now even harder to accept the agency's laughable assertion that excessive speculation has not contributed to rising energy prices," said Rep. John D. Dingell (D-Mich.). He added that it was "difficult to comprehend how the CFTC would allow a trader" to acquire such a large oil inventory "and not scrutinize this position any sooner."

BTW, please observe the special focus from Michigan congresspersons: oil prices have been especially devastating to Usonian car manufacturers, who have lost market share to better-engineered Japanese models.


Vitol was implicated in the UN "oil-for-food" scandal associated with the sanctions regime imposed on Iraq between June 1990 and March 2003.

IHT (20 Nov '07): Prosecutors alleged that Vitol, through an associated entity or third parties, paid $13 million in kickbacks to Iraqi officials in connection with oil purchases under the program from June 2001 through September 2002, but allowed false representations to be made to the U.N. that no kickbacks were paid.

Vitol's case is one of several that are the result of a wide-ranging criminal probe into the oil-for-food program.

Last week, Chevron Corp. agreed to pay $30 million (€20.2 million) to settle civil and criminal charges related to secret surcharges paid by third-party merchants in exchange for oil under the program.

While it's not obvious to me how the oil-for-food corruption is linked to illegal trades, it's hard to imagine how I can avoid mentioning it.
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All the same, while Vitol SA was able to briefly take a position on >11 million barrels of oil, the CFTC maintains that the real reason for the recent spike in petrol prices was supply and demand. So, while I'm aware of the Vitol story, I'm sticking to my original position.
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ADDITIONAL READING
David Cho, "A Few Speculators Dominate Vast Market for Oil Trading" Washington Post (21 Aug 2008)

Ann Davis , "'Speculator' in Oil Market Is Key Player in Real Sector" Wall Street Journal (20 Aug 2008)

Speculation and Prices

With oil prices continuing to hover around $135/barrel (or €85/barrel), the speculation hypothesis has widespread support. That's the theory that high prices of commodities generally reflects illegitimate financial market activity. I'm trying to keep an open mind but none of the arguments I've seen are convincing.

To me, the big headache is establishing a mechanism by which either (a) high futures prices drive up oil spot prices, and (b) how high flows of money into the forward markets (futures & options) influence the strike price of the commodity.

(For an introduction to this topic, see my post "Commodity Prices and Speculators.")

To some readers, these may seem like very dumb questions. If a lot of people are trying to abandon US dollars as a store of value, then they will want to buy up large tranches of oil future contracts, or perhaps options. That naturally drives up the strike price. When producers see that the strike price is rising, they naturally want to withhold stocks from the market in anticipation of still higher prices. Refiners likewise respond to the high forward prices by hoarding it. This drives prices even higher.

There are two steps to this explanation: one explains how a lot of currency flowing into commodity forward markets can drive up the strike price, and the other explains how a rising strike price can push up the spot price. Both steps are problematic. First, options can be traded at any of a wide range of strike prices.¹ At the time of this writing, Brent crude was trading at about €87 per barrel. Options must exist for €85- and €89-barrel Brent, and probable for a wide range of prices above and below that. Also, new options are written each day for spot ± €0.50/barrel, so that options are tradable from €57-89/bbl (reflecting, in other words, the range of prices over the previous six months). So it's possible for a lot of speculative money to flow into the options market at lower strike prices. Buying an option for 100 barrels of Brent that expires in 3 months with a strike price of €68/bbl means an outlay of about €1,900; should the price fall to €80/bbl, then your loss will be €700, or 36% of your initial investment. If the strike price is €89, then the option is "out of the money," and costs very little; but then you're betting that the price will rise above €90 and stay there long enough for you to cash out.

When the market for options is extremely brisk, naturally the money goes to the people writing them: in theory, suppliers of the underlying good, but also some daredevils who may write "naked options" on [say] shipments of crude they don't own. Options can absorb immense amounts of speculative money, since anyone can write them and most will expire as worthless scraps of paper. They provide no benefit to the person writing them other than the fee and favorable price movements. Basically, they are a hedge: if you are a supplier and you write a lot of call options at the current price, you are locking in the strike price as the most amount of money you will make, but if you understand the market well, then you can reap a handsome profit when your product's price falls well below the strike price. Conversely, you might be a refiner who buys a lot of crude at the current high price; you anticipate that the price will rise even more, so you write put options and sell them to suppliers in which you promise to buy crude at €90/barrel. If the price does indeed go to €100, it sucks to be you but at least you got the money from selling the options to cautious suppliers.

Nevertheless, it's hard to see how this can influence the actual price of the underlying commodity. Writing options does allow buyers and sellers to recoup a modest amount of money from unfavorable movements of the market; when money flows from the non-financial sector into options trading, the effect is to shield options "customers" from some of the consequences of unfavorable movements (giving them time to prepare for new business conditions), while partly compensating "writers" for losses incurred by unfavorable movements.

(See here for an exceptional scenario.)

Futures are a different matter. Taking crude oil (again) as our example, there's a global demand of about 83 million bbls. per day; supposing about 10 million bbls. are sold as future contracts well in advance. Normal derivatives traffic ensures minimal price risk to suppliers and refiners. Then, so to speak, Satan enters the garden in the form of hedge fund managers desperate to park $10 million per day of new money. The hedge fund buys a large number of futures, but it has no intention of taking delivery of all that oil; instead, when the futures near maturity, it sells them to a major (i.e., one of the large multinational, vertically-integrated oil companies). The problem is that the oil company can choose between buying the inflated future or a lower spot price.


David Kruse, President, CommStock Investments, wrote an editorial describing precisely this scenario:

Cash commodity markets however, run the risk of becoming the tail swung by price discovery of futures exchanges that are not based on commodity market fundamentals but on the capital investment flows in and out of the commodity sector. The connection between cash markets and respective futures markets differs between commodity markets....

When funds dominate the futures trade, a fundamental distortion can occur. We believe it has occurred in soybean prices this winter. U.S. soybean carryover was projected to reach 565 million bushels this year which eclipses the previous historical carryover record of 346 million bushels in 1998-99. Global soybean carryover is record. We could have a flat out soybean crop disaster in 2006 and not run out of soybeans next year. Why did the market call for so many more acres of soybeans when carryover was already at an all-time record? The market didn't, funds did. November new crop soybeans traded $1 above fundamental market values all winter, producing incentives for farmers to plant more soybeans which the USDA says they strongly responded to.

In this case, the mismatch produced a soybean glut (in 2006).

Over the years different Usonian commodity futures markets have adopted cash settlements. Prior to 1982, when a future expired, you either took delivery or else arranged a cash sale of the commodity to someone who wanted it. Then the Commodity Futures Trading Commission (CFTC) allowed indexed commodities and cash settlement.² While CFTC regulations are designed to prevent destructive speculation, it is worth noting that massive futures trading could easily lead to suppliers learning to anticipate the market's preferences for cash settlements rather than tangible delivery; and lead to sales of contracts for several times the actual volume of goods being sold. Note that CFTC regulations are supposed to prevent this; however, the much-discussed InterContinental Exchange (ICE) based in Atlanta, Georgia, allows one to trade virtual commodities over the web in London and Dubai.

This was extremely important because futures are very highly leveraged instruments. Typically one pays about 5% of the value of the underlying commodity (so, for 100 bbl. of WTI, $675 plus premium)³; in theory, this allows one to claim very large pools of oil for very little money. A squeeze is a situation in which a trade goes long by an amount that exceeds the actual physical capacity that can be loaded during the month. Then the trader claims delivery, knowing that the supplying parties will not have sufficient supplies to meet their obligations. This drives up the price, but the effect is of very short duration (usually a couple of weeks, at most).
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NOTES:
1 An option is similar to a future except that options are binding on only one party, while futures are binding on both buyer and seller. A [call/put] option is a tradable right to [buy/sell] a commodity at a fixed price on or before a given date in the future. For an explanation of options and how they work, see "Factors affecting Options...." For our purposes, "options" are understood to be American style, i.e., they can be exercised at any time prior to expiration.

2 Leo Chan, "Cash settlement and price discovery in futures markets," Quarterly Journal of Business and Economics (Summer 2001). The mechanism for cash settlement works like this: supposing the commodity price rose $10/unit over the period the investor held it. Rather than take delivery, the investor merely accepts a payment of $10 (minus some fee), and the supplier sells the product to another buyer for cash. Assuming the price falls by $10, the investor pays the supplier; in both cases, the transfer of money effectively cancels out the price change (as far as the supplier is concerned).

3 The premia on futures and options varies with the number of futures/options bought. Very large trades involve very small premia per contract/option. Different brokerages have very different schedules of forward premia.

Long: in finance, a "long position" in a security or commodity is a position where one benefits if the price goes up. This includes writing a naked put option, buying the underlying commodity, buying futures for delivery of that commodity, or buying call options for same commodity, are all examples of "going long" or "taking a long position."
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SOURCES & ADDITIONAL READING:

Senate Committee on Comerce, Science, & Transportation: Hearings, 3 June 2008

• Testimony of George Soros
• Testimony of Prof. Michael Greenberger, Univ. of Maryland
  

"The Role of Market Speculation in Rising Oil And Gas Prices" (PDF), Permanent Subcommittee on Investigations, United States Senate (27 June 2006)

Commodity Prices and Speculators

Figure 1 Source: International Monetary Fund WEO, Chapter 5

Figure 2

Since the summer of 2007, the world has experienced an extremely rapid increase in the price of many commodities (figure 1); the most obvious is oil, which has recently reached $135 per barrel. The recent climb in oil prices can be said to have begun in January '07 when the 12-month price change reached a cyclical trough and began to rise, becoming positive in March and began to rise (figure 2). Not only have oil prices been rising; the first derivative of oil prices (i.e., the rate at which oil prices have been increasing) has also increased, with the most recent quotes suggesting a 94% increase over the price 12 months ago.


This post will deal with the question of whether or not speculative activity has played a role in the recent run-up of the price of oil. The null hypothesis* is that recent conditions are nothing more nefarious than the adjustment of prices to increasing demand. Rejecting the null hypothesis means we need to acknowledge that speculative activity on commodities markets has led to the recent increases (or contributed somewhat to the size).


SOME THEORY

I'm going to need to introduce some technical terms for explanation.

• pools: an asset for which the total tradable supply is either permanently limited (e.g., paintings by dead artists, real estate) or represents a share of the total (e.g., equities).
  
• flows: an asset that is produced and consumed at fairly high rates, such as oil, copper, wheat, or steel.
  
• tradable streams: an exotic type of tradable that includes electricity and pressurized natural gas (PNG). Markets in tradable streams are, at best, not mature and I won't be discussing them here.
• null hypothesis: In statistics, the negation of the idea one wants to test. When statistics is used to establish a particular finding of fact, there must be an explicit statement of fact that one is seeking to prove (the test hypothesis) and an explicit contradictory hypothesis (the null hypothesis) that one seeks to prove false.
  
• inventories: US inventories of crude oil are counted in two ways: commercial and commercial plus strategic petroleum reserves (SPR). The Department of Energy usually supplies statistics on both, but it's commercial inventories that get reported. The SPR is under Congressional control; usually Congress has an incentive to add to the SPR, rather than release reserves, so it should come as no surprise that the SPR is huge: almost 650 million bbls, or twice the commercial inventory. Recently, as prices hit staggering highs, Congress took the momentous decision to desist from further expansion of the SPR.
  
  The Coleman-Levin report features a chart on p.19 that reveals the oscillation of private inventories (commercial US less SPR); inventories are shown mainly oscillating between 290 and 330 million bbl (i.e, over a range equal to 4 days worth of imports to the USA).
  
• strike price; guaranteed price of a commodity at date that futures contract matures. Hence, a future contract for 100 bbl of WTI oil at $150/bbl for 6 months in the future (23 Nov '08), which is currently $18 above the price this exact minute.
  
• spot price is the actual quoted price of the commodity
  

"Pools" and tradable "streams" can be subject to price manipulations; the one through corners, and the other through shorts and derivatives. In fact, the 2000-2001 energy crisis in California was largely the result of intentional manipulation of TS markets by Enron and Reliant Energy Systems.

Figure 3

Figure 4

But "flows" are very difficult to manipulate. Basically, you have to hoard the supply in some way; long-run price controls are really hard to do unless you're the government of a major country and can permanently interfere in the supply. At least, this is orthodox economic theory as I learned it in college. In figure 3, when the demand curve slides to the right, the equilibrium price (p* to p**) will rise, as will the equilibrium flow rate (Q* to Q**). All that that has happened is that the increase in alternate uses for each unit of each commodity (or "an increase in demand") has resulted in a new equilibrium price.

But let's now introduce financial speculators. Suppose they know the demand curve is actually concave with respect to the origin (Figure 4). If one really big investor could carry it off, he could buy a huge amount of the stuff, hoard it somewhere, and then sell it. The price would go up a lot, which would make profit α, while the loss incurred selling the inventory on the world market would be the smaller amount β.

More realistically, speculators don't buy current flows, but future ones: say, oil in six months time. Now, there's no huge tank farms with sequestered inventory, but rather, a bubble in the price of oil to be delivered in December '08. The problem, of course, is that this is always possible; and as the price gets more and more out of line, demand shrivels. But producers of either refined gasoline products, or products that require energy to produce, aren't in a position to know that. So they plan based on the forwards market rather than the spot (or current) price. When Dec '08 arrives, other commodities have gone up in price because production of them really has gone down, in response to the soaring costs of inputs. Of course, the oil producers (Kuwait, Venezuela, etc.) have to adjust production of oil downward in response to the pancaking demand.

LIMITATIONS OF THE THEORY

In theory, speculators who buy commodities future or options (the forward markets) are betting against producers on the price at the time of delivery. Gordon Gecko thinks West Texas Intermediate Crude will be $200/barrel in December; Ellis Wyatt thinks it will be $150. By agreeing to pay Wyatt $175/barrel for oil delivered then, Gecko allows Wyatt to ramp up production to where marginal cost of recovery and shipping is $175/bbl. And if Gecko is right, he walks away with an enormous profit. If he's wrong, and oil is less than $175, then he's already paid for Wyatt's capital expansion; the losses would come out of previous successful bets he's made. The speculator, in theory, absorbs the risk of major short-run fluctuations in price.

But what the speculator can't do, at least in theory, is influence the outcome. Gecko can buy all the options in the world, bidding up the forward price to something astronomical: on the actual commodities markets, the flow of commodities into port facilities all over the world has to match the flow out of them, and the flow out will stop if processors and refiners can't afford them. Several news outlets have suggested that speculators contribute to the high price of petroleum, although without offering details as to how this is possible.

(Examples include Financial Times "Commodity prices part speculative - IMF"; Los Angeles Times, "Are commodity traders bidding up food, fuel prices?")

However, I had heard references to a US Senate Report entitled "The Role of Market Speculation in Rising Oil And Gas Prices" (link below), which alleged that the most plausible price for oil was well below $60/bbl.

Since late 2004, the amount of stored oil in the United States has been increasing. Oil inventories recently reached 347 million barrels – an eight-year high and the largest U.S. inventory since 1998, when oil was $15 per barrel. Similarly, oil inventories in Organisation for Economic Co-operation and Development (OECD) countries recently reached a 20-year high. As the report explains, the traditional factors of "supply and demand" do not tell the whole story on oil and gas prices.

What is new, according to the Levin-Coleman report, is that over the past few years market speculators have poured tens of billions of dollars into the energy commodity markets. For example, the International Monetary Fund reports that over the past three years approximately $100-$120 billion has been invested in energy markets worldwide. Over this same period about $60 billion has been invested in oil futures on the NYMEX.

Bear in mind that that report was published in late 2006, when $60 billion was comparable to about one quarter's worth of US crude oil consumption. Since that report was published, crude oil inventories in the USA have declined somewhat to 320 million bbls. Inventories did indeed reach a high at the end of '06, but Department of Energy statistics show both US and OECD inventories have hovered around 2400-2700 million bbls since 1994 (EIA). And they've fallen off considerably since the late-'06 spike.

One major issue for Congressional investigators was the popularity of commodity indexed funds, which allowed small investors to buy stakes in the movements of commodities. As speculators bought futures in (say) WTI oil for delivery in December, the strike price would presumably soar (this ignores the fact that a booming futures market can include contracts with any strike price, and indeed does: complete listings include the prices for futures at many different prices, including above and below the spot price. Another consideration, though, is the impact of derivatives markets on inventories of the traded commodity: basically, if an index fund is pegged to the price of WTI oil, then the firm offering the fund is presumably obligated to own tangible inventories of the commodity equal to the amount notionally owned by investors buying into the fund.

(I am not aware that this is essential; a fund could instead invest in instruments intended to beat the judgment of amateur investors in no-load funds; in most quarters, the short-run liabilities for the fund would be smaller than quarterly net increases in asset values, and there would be no need to literally match what the investors actually did. So if I offer a fund whose value is indexed to WTI oil, then all I need to do is own financial instruments that match or exceed the growth in value of WTI oil. If there are many other funds offered by my firm, then the risk that I'll fail to do this is greatly mitigated by the fact that in quarters like this one, the losses from the WTI fund will be offset by net gains from the other funds.)

While the Senate report includes a lot of hyperventilating claims about speculation, there's surprisingly little (for a 60-page report) on actual mechanisms for "disconnecting" market equilibria and the price of petroleum. Essentially, everything is riding on a brief spike in oil inventories, and a rather smallish one at that.

There does exist a nontrivial question of volatility, in which refiners are left trying to make decisions about stocks and blends in the face of wildly oscillating futures prices. More precisely, some of the price of retail gasoline at the pump may constitute a premium for uncertainty. But even my Senate report was uncertain if commodity speculation was to blame for volatility.
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SOURCES & ADDITIONAL READING:

• "The Role of Market Speculation in Rising Oil And Gas Prices" (PDF), Permanent Subcommittee on Investigations, United States Senate (27 June 2006)
  

Jevon's Paradox Revisited

(Part 1)

Click for larger image Curved red lines represent different levels of "utility" (i.e., general well-being). Straight blue lines represent budget lines. Note: the utility curves are derived from a linear-expenditure model.

Utility functions are an extremely important part of economic analysis. When predicting the effects of fuel economy standards on overall fuel consumption, an economist is likely to reach Jevon's conclusions: increased efficiency will lead to increased marginal utility of consumption.

The effect of a change in prices or the shape of the utility function is to alter consumption. An increase in income will lead to an increase in the consumption of both x and y, and therefore of utility U. The shape of the utility curve determines by how much consumption of both goods goes up. Usually, when I explain the concept I set y equal to a particular good of interest, and set x equal to everything else. This is because (a) we are interested in the effect of changes in price, etc. on one particular good among many that people tend to need; and (b) the usual supply-demand curves use the y-axis to represent the price of one particular good.


Reverting to my original analysis in part 1, we see efficiency having the exact same effect as a reduction in gasoline prices. In the chart, petrol prices have fallen 26% so you can now buy 35% more per dollar than you could before (or, conversely, engine output per unit of fuel has increased by 35%).¹ The first thing we did was plot the new (dotted) budget line, with its steeper slope. There was an increase in liters of gasoline purchased by 37% and a 1.4% reduction in the physical amount/dollar amount of everything else. Utility has increased from the second red line to the third.


Not content with this, we are still interested in the income and substitution effects caused by this. So I plotted a "utility-equivalent budget line." This is a budget line that passes through the new (higher) utility function; but it has the exact same slope as the old budget line. If the same new level of utility had been achieved as a result of an increase in income (rather than an increase in efficiency) then gas consumption would increase by only 16%, while "everything else" would increase by 8.3%. The effect of increased efficiency was that consumers substituted gasoline for other forms of consumption: gas consumption rose another 17%, while consumption of everything else fell 9%.


The significance of the two effects is not trivial. To the extent that the concepts explained above are to be taken seriously, policymakers can use taxes and subsidies to correct for perverse substitution effects. A fairly common proposal related to peak oil and ACC concerns is to restructure tax policies to offset the substitution effects caused by (say) higher CAFE standards. In other words, it would be necessary to raise gas taxes in order to pay for reductions in other taxes.

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This illustrates a shift from one utility function (red) to another (brown) as a result of more efficient use of y.

Returning to the 2nd approach, we used another computer model to estimate what the effect of an actual increase in efficiency would be. Part of the challenge was applying the linear-expenditure model to gasoline; the first approach merely treated efficiency as a change in budget, whereas the second treated efficiency as a change in the utility function (and hence, in differently-shaped indifference curves). Mathematically, the difference between a linear-expenditure model utility function and the more commonplace Cobb-Douglass one is that the former is actually the latter minus a constant for all values of x and y.


The graph above illustrates the shift in x-y preferences caused by increased efficiency. In the scenario I depicted, the four brown curves represent (left to right) the same four successive levels of utility as the red curves. The same budget line is is tangent to a higher "brown"indifference curve than "red" indifference curve. This time, the increase in efficiency has caused gas consumption to increase by 33% (about the same as the price decline did) but since there's no "income effect," the substitution is much larger: a 20% decline in the consumption of "everything else." Now, to clarify a point I hinted at in the previous entry: this is a bit ominous because the ratio of energy expenditures to other things has increased by a lot more than if we approximated efficiency increases by slashing the "price" of gas. In the first scenario, energy efficiency had gone up, making the dollar worth more (since more energy-intensive stuff could be bought), so the economy become somewhat more energy intensive. In the second scenario, we've faithfully replicated the changed technical conditions, with the result that the economy becomes a lot more energy intensive.


As I've mentioned as often as practical, these utility functions, graphs, and inferences are mostly arbitrary. One of many problems with the utility function, for example, is that it's long been insisted by economists that the function U(x,y) only allows you to supply a rank for different values of x and y. In order to plot these numbers at all I had to create a function in which U was a specific numerical value: 20, 30, 40... The logical implication was that 3 units of gas and 6 units of everything else, say, would produce a utility of 20, whereas if gas were increased to 8, utility would be 40. This does not mean that a 2.67-fold increase of gas consumption will make one twice as happy as before, though; it only means that one is in a position that is preferred to one in which utility = 20.


This may seem like a manageable arrangement unless we consider the thorny problem of comparing different utility functions. With a new utility function we need to compare the utility furnished by old and new bundles of goods, which cannot really coexist in time for purposes of comparison.


A more sensible handling of utility is to begin with the explanation that we aren't really measuring "well-being" in a meaningful sense, anymore than average GDP per capita measures "well-being." We are actually measuring something known more properly as "welfare," which is a rational deduction of well-being based on the ability of an economic actor to exchange or arrange what she has to achieve something nearer to her heart's desire. Welfare, another subject unto itself, could be said to capture this concept.²



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Notes:

1 The attentive reader will notice that I'm actually saying fuel efficiency went up by 35%, which is exactly the same as the price of gas declining by 26%. We calculated that the actual amount of money spent on gas, or expenditure, went up 2%, while money spent on other stuff went down 1.4%. An implication of this is that people spent about 40% of their income on gas. This is really an exaggeration, even if we pretend "gasoline" refers to all forms of energy and include indirect purchases of energy, e.g., the share of a pizza's cost that goes towards the gas used in delivery, the natural gas used in baking it, the nitrates used in the cultivation of the wheat and tomatoes, and so on. Still, if we did account for costs like that, I think energy would account for a solid 7% of GDP.

By the way, if I had used a Cobb-Douglass utility function, then the expenditure on energy would remain entirely unchanged. This makes no sense to me: if something suddenly provides more satisfaction per dollar spent, and if you are free to do so, you will tend to spend more dollars on that thing than you did before.

2 See Partha Dasgupta, On Well-Being and Destitution, Oxford University Press (1993), p.70ff. Unusually for this blog, the link goes to a display of the actual page in Google Book where the explanation begins. Dasgupta, however, does not propose to measure well-being/welfare (W) as an alternative to utility, but as an enhanced version of it: freedom plus utility. I think this misses a splendid opportunity.

Jevon's Paradox

What happens to the consumption of a fuel, like coal or gasoline, when efficiency improves? The answer is that it goes up. This surprising answer was observed by William Stanley Jevons in 1865:

The number of tons of coal used in any branch of industry is the product of the number of separate works, and the average number of tons consumed in each. Now, if the quantity of coal used in a blast-furnace, for instance, be diminished in comparison with the yield, the profits of the trade will increase, new capital will be attracted, the price of pig-iron will fall, but the demand for it increase; and eventually the greater number of furnaces will more than make up for the diminished consumption of each. And if such is not always the result within a single branch, it must be remembered that the progress of any branch of manufacture excites a new activity in most other branches, and leads indirectly, if not directly, to increased inroads upon our seams of coal.
["Of the Economy of Fuel"]

This post will explain the concept of the Jevons Paradox in greater detail. The concept of the utility function is explained here; it's fairly handy for explaining the complexities of the Jevons Paradox.

Click for larger image

A paraphrase of the paradox is that, if the utility of anything is increased (e.g., the benefits to an individual of consuming a liter of gasoline), then the consumption of that thing increases as a share of total consumption. To illustrate, I created a chart with utility functions generated by the linear expenditure model of utility.


The first chart shows what happens if the price of gasoline declines. The vertical (y) axis illustrates the quantity of gasoline; the horizontal (x) axis represents everything else. The red lines indicate levels of well-being or satisfaction; any point along them is supposedly "indifferent," or equally, desirable. It is assumed that more of either x or y enhances one's well-being, but if one already has a large amount of (say) y, then one will be reluctant to give up a little x unless one receives a lot of y.


The blue line is the budget line. It is straight, and its slope represents the price of y in terms of x. It intersects the x-axis at the point where one spends 100% of one's income on x, and likewise with y. In the chart, the price of gasoline is lowered 26%, a decline so extreme it amounts to a sharp increase in real income. We can see the consumer responds by actually spending more on gasoline: she buys 37% more of it, and 1.4% less of everything else (the indicator lines on the chart were inserted manually).
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Soviet and American adaptation to Peak Oil

Hubbert Peak Oil (HPO) theory has it that the industrial world is facing a permanent and irreversible decline in supplies of oil. Specifically, the daily rate at which petroleum will be recovered in the future must necessarily decline. World oil consumption is gradually increasing; in the last ten years it's grown 1.6% annually. US oil consumption has been growing somewhat more slowly, but still accounts for about a quarter of the world total. Moreover, while US oil consumption growth is slower than the 3rd world, it is higher than the rest of the first. The world now consumes about 84 million barrels per day.

POT is unrelated to the threat of global climate change ("Global Warming"). RNL&A prefers the term "Climate Change" because the phenomenon is much more complex that that of a mere increase in the ambient temperature. My own views are that a peaking and sharp decline in world oil supply would probably have a catastrophic effect on the world economy, but would not suffice to seriously mitigate global climate change. That's because the consumption of coal is over 6 billion tons per year and rising. Coal consumption rises in response to rising energy prices, and most of that increase is in Asia. After almost 20 years of steep decline, coal is recovering as an industry in the former USSR, while China's output has shot up to a third the world total.

One of the aspects of the Soviet economy, and by extension, its system of social organization, was alleged to be its profound inefficiency. After the collapse of the USSR, there was an abundance of literature explaining why the Soviet system was fated to collapse. It was regarded as the ultimate ideological validation for the managerial cadres running the US economy. The prolonged misery that gripped post-Communist Russia revealed an immense dysfunction in the industrial system. It was hugely wasteful in execution, with machines vastly larger and more elderly than made any technical sense. The Soviet system also left a massive amount of pollution, much of it spawned by an utterly unaccountable military.

However, the case has been made that the Soviet system left intact a system of consumption and material culture that was more adaptible than the US economic system. This claim was made by Dmitry Orlov recently in a presentation made for the Energy Bulletin.

The subject of economic collapse is generally a sad one. But I am an optimistic, cheerful sort of person, and I believe that, with a bit of preparation, such events can be taken in stride. As you can probably surmise, I am actually rather keen on observing economic collapses. Perhaps when I am really old, all collapses will start looking the same to me, but I am not at that point yet.

And this next one certainly has me intrigued. From what I've seen and read, it seems that there is a fair chance that the U.S. economy will collapse sometime within the foreseeable future. It also would seem that we won't be particularly well-prepared for it. As things stand, the U.S. economy is poised to perform something like a disappearing act.

[...]

Continuing with our list of superpower similarities, many of the problems that sunk the Soviet Union are now endangering the United States as well. Such as a huge, well-equipped, very expensive military, with no clear mission, bogged down in fighting Muslim insurgents. Such as energy shortfalls linked to peaking oil production. Such as a persistently unfavorable trade balance, resulting in runaway foreign debt. Add to that a delusional self-image, an inflexible ideology, and an unresponsive political system

Orlov's article is especially interesting to me for many reasons. One is that I have a deep and abiding fascination with the USSR. I share his view that there are many strong parallels between Soviet and American society, parallels that distinguish those countries from the rest of the world. Another is that the Cold War ended when I was 23. During my formative years, I suffered from something of an obsessive dread of Communist world domination, which possibly turned me into a delusional paranoiac (If so—how would I know?). When the USSR economy collapsed, my initial relief and sense of validation was soon replaced with sadness, then horror and shame. Horror, because the reality of Russian misery was something I had never imagined. Shame, because I had once looked forward to precisely this—collapse of the military threat, as well as utter discredit of the Leninist ideology. The end of the Cold War with a mostly-peaceful institutional implosion, had seemed like the best of all possible worlds. But I had not expected that the social problems of Russia would continue to worsen as Washington pressed its advantage.

The third reason was that I began to see signs that the US economy was far from immune. The safeguards I had taken for granted—chiefly, constant adjustment to technological earthquakes—were not necessarily having the beneficial effects I had assumed they were. The liquidity of our financial markets was not constraining fiscally irresponsible governance in the USA; moreover, my assumption had once been that improving technology was reducing the volume of non-renewable resources per unit of consumption. In other words, the same or better standard of living could be furnished with diminishing inputs of fossil fuels, metals, or environmental sequestration. The opposite is true.

Orlov's article "Closing" is best augmented by reading "Soviet Lessons," which is essentially the same information in more detailed prose exposition. I found this passage captured the gist of the article (i.e., from the point of view of an economist):

It can be said that the U.S. economy is run either very well or very badly. On the plus side, companies are lean, and downsized as needed to keep them profitable, or at least in business. There are bankruptcy laws that weed out the unfit and competition to keep productivity going up. Businesses use just in time delivery to cut down on inventory and make heavy use of information technology to work out the logistics of operating in a global economy.

On the minus side, the U.S. economy runs ever larger structural deficits. It fails to provide the majority of the population with the sort of economic security that people in other developed nations take for granted. It spends more on medicine and education than many other countries, and gets less for it. Instead of a single government-owned airline it has several permanently bankrupt government-supported ones. It spends heavily on law enforcement, and has a high crime rate. It continues to export high-wage manufacturing jobs and replace them with low-wage service jobs. As I mentioned before, it is, technically, bankrupt.

It can also be said that the Soviet economy was run either very well or very badly. On the plus side, that system, for all its many failings, managed to eradicate the more extreme forms of poverty, malnutrition, many diseases, and illiteracy. It provided economic security of an extreme sort: everyone knew exactly how much they would earn, and the prices of everyday objects remained fixed. Housing, health care, education, and pensions were all guaranteed. Quality varied; education was generally excellent, housing much less so, and Soviet medicine was often called "the freest medicine in the world".

On the minus side, the centrally planned behemoth was extremely inefficient, with vast lossage and outright waste at every level. The distribution system was so inflexible that enterprises hoarded inventory. It excelled at producing capital goods, but when it came to manufacturing consumer goods, which require much more flexibility than a centrally planned system can provide, it failed. It also failed miserably at producing food, and was forced to resort to importing many basic foodstuffs. It operated a huge military and political empire, but, paradoxically, failed to derive any economic benefit from it, running the entire enterprise at a net loss.

Orlov is very tactful and gentle in his mode of expression, especially considering the melancholy message he has to convey. In short, this is that the US economy has produced a population totally incapable of coping with system failure, and a system likely to fail much more comprehensively than the Soviet one did. Sure, the USSR was no longer able to maintain a colossal state apparatus, and the sudden reduction in state services or subsidized industry was traumatic; but the pieces of the industrial system had developed adaptive methods. There was no chance of evicting the majority of the population from their homes; in the United States, it seems quite likely this could happen in the event of oil supplies peaking. In the USSR, central planners designed communities to survive and function even in the event of comprehensive industrial failure; this meant compact towns that could be easily crossed on foot, and huge common areas which could be adapted to "victory gardens." Mostly this was because central planners were trying to make it easy on the Soviet economy: cities were designed to be cheap to supply and maintain, and that mean mass transit, short roads, short mains, and traditional construction techniques.

An additional problem is that the US economic system produces an immense deficit of skills. Another is the reliance on segregation to maintain civil order—by class, race, or criminality. Corrections systems are responsible for controlling over 1% of the population, but security systems and security procedures tend to creat much larger populations of quasi-criminals: Americans not accused of a crime, but essentially roped off and assumed to be dangerous. Another is that much of the US infrastructure or commonly-used technologies, such as appliances, are virtually disposable. One does not repair an appliance anymore; one replaces it. And most of the initiatives to rectify the situation are much worse than useless. Biofuels, for example, have been a disastrous confusion sown by the new concern about "imported" oil or climate change.

Mr. Orlov is skeptical than anything useful will be done at the national level. The USA is not going to mitigate its addiction to oil. It is not going to make its cities more user-friendly or more efficient. It is not going to overcome its addiction to manufactured crises or "wars" on problems. Instead, the system will run until it collapses because political systems do not sidestep calamities. Therefore, Orlov advises complete disregard of national politics. The political system is utterly useless, and doesn't even merit mockery. His discussion of the private sector is a masterpiece of tact—he merely explains that he believes private sector solutions are highly improbable. That leaves one's own initiative. This consists of reducing one's physical needs and dependence on the integral economy. I would expect many to read his article and contemplate immigrating to Patagonia.

As with any gloomy scenario, it's made more palatable by humor. Orlov is an excellent writer and his methods of self-expression are superb. But how accurate is it?

Well....

Bear in mind Orlov's premise is not merely that US society is unprepared for the collapse, whereas Soviet society was rather more prepared. According to Orlov, Russia was able to recover (somewhat), partly because of its vast reserves of energy and the fact that it actually used less than the USA. Canadian society, for all its many superior virtues, is just as vulnerable to collapse of the same sort. Mexico, sadly, has been rendered acutely vulnerable thanks to NAFTA, although it is still head and shoulders above its northern neighbors. Still, it seems likely that the lack of a vibrant overland neighbor like the EU or China would render the US unlikely to recover at all, ever.

The other premise is that there is no favorable role for political activity.

Both premises seem a little extreme. One is the idea that peak oil is like a cliff. Orlov supposes that the entire industrial system would effectively collapse within a year at most. In the USSR, the process of collapse actually took place over 8 years, 1985-1993. One way this might happen is if the US dollar were to unilaterally lose much of its value. While I've researched this as a possible response to the terrifying indebtedness, it must be said that currencies don't behave this way. A financial collapse would be important to the narrative because it would explain how the economy suddenly lost access to much more than 60% of the crude oil it imports—within, say, six months. But economies like those of Japan and China would have to avoid collapse too, something unlikely to occur since they are so dependent on exports to the North American economy.

The other is that the political system would remain useless. There is much to be said for this view, since politics does not favor highly sophisticated response to technically complex problems. However, democratic institutions have a resiliency that is lacking in authoritarian ones. A more plausible scenario is the onset of the Great Depression, which began with a loss of over 40% of production in two years. The Depression was much more dreadful than is now imagined; a gigantic proportion of the population was reduced to destitution and homelessness. There was an entrenched ideology of virtuous prosperity and vicious failure. Yet the point was never reached where civil life disintegrated. It was a cruel time, but the US or harder-hit Canada did not regress to the Middle Ages.

Second, unlike the collapse of the USSR, the collapse of the USA would actually be more global. Some countries, like Japan, would endure relatively well, since they have reduced the significance of petroleum in their economy (the ratio of GDP to energy consumption in Japan is among the lowest in the world). But the disruption would be more diffused in space and time than Orlov suggests.

Aside from this nitpicks, I'd have to say I think it's really a very fine essay that is fun to read, and summarizes the major sustainability worries that we will face in the near future.
__________________________________________________
SOURCES & ADDITIONAL READING: Energy Information Administration and Projected International Oil Consumption to 2030 (Reference Case), Dep't of Energy (EIA-DOE); "Closing the 'Collapse Gap': the USSR was better prepared for peak oil than the US"(Dec 2006) and "Soviet Lessons" (Apr 2005), Dmitry Orlov (via James Howard Kunstler); Putin's Russia: Life in a Failing Democracy, Anna Politkovskaya, 2006

Biofuels (2)

Part 1

The person who referred me to all the glowing articles "refuting" David Pimentel's essay is an anonymous enthusiast who got his articles at a website entitled "Journey to Forever." He says the site "presents both sides of the issue," although it is actually an unabashed supporter of biofuels. However, there is an article by Jürgen Krahl and Axel Munack, "Review: Utilization of Rapeseed Oil...," originally published by the Society of Automotive Engineers (SAE). The authors tested rapeseed oil methyl ester (RME), which is saffola converted to biodiesel; they also tested unmodified rapeseed oil, which requires a different type of engine.

Now, recall from Pimentel's paper that growing an acre of corn and rendering it into ethanol yields the energy equivalent of 190 gallons (720 L) of gasoline; the process requires 140 gallons (530 L) of gasoline, for a net yield of 50 gallons (190 L). So, consuming 1 gallon of "gasoline" would require a process in which 3.8 gallons of "gasoline" are produced and consumed, 1 of which is by the end user. That, I understand, is a component of the 10-fold increase in farmland requirement Pimentel mentions. So, if ethanol were to phase out gasoline entirely, proponents of biofuels can claim that growing all that maize will absorb the carbon released in combustion. But other byproducts of combustion would actually have to be 74% less than gasoline per gasoline-equivalent burned (or, 84% less per gallon burned). According to the chart here, that is not the case with rapeseed.

I am skeptical that ethanol can be so much better than rapeseed oil in energy emissions. But let us now turn to the favorable reports on energy outputs.

Here's "How Much Energy Does It Take to Make a Gallon of Ethanol?" (Lorenz & Morris, August 1995). They include a detailed breakdown of inputs using different processes. The main difference between them is that some require small amounts of fertilizer, which is the main energy input and "process steam." This is the process under which ethanol is transformed into a liquid fuel, and it is the principle variable. According to Lorenz and Morris, the steaming process has massively reduced energy per gallon; where once (in 1980) it required as much as 157% of the ethanol's energy yield, by '95 it averaged 33% of yield. Using "State of the art" technology meant for every gallon of gasoline (equivalent), 1.39 would be produced and consumed. That would mean, of course, that instead of requiring 10.7 times the land area currently used for US food consumption, 3.9 times as much land would be required. I reviewed the rest of the article and noticed little to arouse my suspicions, except that they tended to assume industrial efficiency that is rarely achieved in practice. Also, they "award" a lot of energy output to other products besides fuel, such as cogeneration. Should ethanol be embraced on a major scale, the opportunities to exploit cogeneration would decline sharply and we would most likely trend down to Pimentel's estimates of land use.

I skimmed through the "update" (PDF) by proponents (and USDA fellows) Shapouri, Duffield, and Wang. The article has a table on page 2. I should point out that SD&W show a surprisingly narrow range of estimates from different studies, with most of the difference being in expected BTU/gallon conversions (75K/gallon for Pimentel versus 50K for SD&W; Wang, et al. claimed the figure could be as low as 40K, which is an outlier). The other big variable was nitrogen fertilizer, which SD&W claimed used only 18K BTU/lb, an astonishingly low statistic. If one believes that energy employed in the production of nitrogen has fallen so much, or that use of such energy-intensive fertilizers can be sharply reduced, then you are still stuck with a political calamity when the US begins encroaching on the farmland of 3rd world countries as it scrambles to substitute gasoline or diesel with ethanol.

The bottom line is that, while the hardcore enthusiasts and techno-optimists look forward to higher net energy yields with ethanol and rapeseed, the grim fact is that their own incentivized statistics (I expect had they reported poorer results for ethanol they would have been sacked—and probably unemployable in their fields) still stick us with consuming 3-6 times as much oil-like fluid as we actually use. The extra would be used to make the net energy value that we use. And while massive improvements might conceivably made in the ecological impact of industrial farming, it would never be enough to offset the 4-10 times as much of it we would hereafter have to do.

BOTTOM LINE: Biofuels are a biohazard.

Biofuels (1)

For several years I've heard about the industrial process of converting crops into fuel. This is called biofuel, although from the first I've been highly skeptical of the technology. The reason is that agriculture is highly energy intensive, and after burning diesel fuel in order to grow crops such as maize [corn] or oilseed rape [saffola], the product has to be chemically processed into a chemical compatible with industrial applications. This processing, or "refining," of maize/oilseed into petroleum products likewise requires more energy inputs.

So what is the balance sheet? Are biofuel programs just a singularly perverse way of wasting tax dollars and petrol, in the name of pretending to be energy efficient?

At a lively comment thread on Daily Kos, an ardent supporter of biofuels offered a list of articles offering evidence. For your reading convenience, I'll list them here:

1. "Estimating the Net Energy Balance of Corn Ethanol," by Shapouri, Duffield, & Graboski (1995); see also "The Energy Balance of Corn Ethanol: An Update" (PDF; 2002), same authors.
2. "How Much Energy Does It Take to Make a Gallon of Ethanol?" Lorenz & Morris (1995)
3. Others listed here

And as a counterpoint, here is David Pimentel's 1998 study on ethanol, "Energy & Dollar Costs of Ethanol Production with Corn" (PDF). Here's Prof. Pimentel's report:

The production of corn in the United States requires significant energy and dollar inputs. Indeed, growing corn is a major energy and dollar cost of producing ethanol ...For example, to produce an average of 120 bushels of corn per acre using conventional production technology requires more than 140 gallons of gasoline equivalents... The major energy inputs in U.S. corn production are oil, natural gas, and/or other high grade fuels. Fertilizer production and fuels for mechanization account for about two-thirds of these energy inputs for corn production...

Once corn is harvested, three additional energy expenditures contribute to the total costs in the conversion process. These include energy to transport the corn material to the ethanol plant, energy expended relating to capital equipment requirements for the plant, and energy expended in the plant operations for the fermentation and distillation processes...

The total energy input to produce one gallon of ethanol is 129,600 BTU. However, one gallon of ethanol has an energy value of only 76,000 BTU. Thus, a net energy loss of 53,600 BTU occurs for each gallon of ethanol produced. Put another way, about 71% more energy is required to produce a gallon of ethanol than the energy that is contained in a gallon of ethanol
[p.1-2]

If this is true, then the ethanol is not a competitor to gasoline and diesel; rather, the process of producing it, including such components as energy consumed in the production of agrichemicals, etc., is another demand for gasoline and diesel, or, weighted properly, coal, PNG, and hydroelectric. Additionally, ethanol is mainly used as a supplement to fuel; in several states it has been chosen as an oxidant to replace MTBE.

I could digress on ethanol versus MTBE, but I won't.

If my wife were writing this post, she would long ago have inveighed against inflicting a disastrous new scourge on the planet, in the form of tying up seven times as much land for supplying fuel, as is used now for supplying food. The amount of land required to sustain America's peculiar dietary habits, moreover, are vastly greater than those that for other national diets. That's because the US diet is dominated by meat. Beef requires about twenty pounds of grain per pound of food; so if a person replaces 11% (by weight) of her vegan diet with beef, she has doubled the land area required to feed her. Now, imagine if the US population has an energy "hiccough" when oil prices become prohibitive, then switches over to using its strong dollar to tie up the land of famine-stricken Africa for maize.

(Part 2)

Cataclysm-3

(Part 1, 2)

Some readers might wonder why I broke with my usual custom by criticizing another blog post. There are so many blog posts out there, and so many are riddled with misleading or silly arguments, that it's a disgraceful waste of time to attack them unless both the original and the response are likely to be widely read. I very much doubt that applies here. The reason is that the essay by Richard Heinberg I'm discussing actually addresses some extremely important, yet overlooked, issues:

Some techno-critics have sought to explain this recent explosion in the power and variety of our tools by tying it to developments in philosophy (Cartesian dualism) or economics (capitalism). Strangely, few of the critics have discussed at any length the role of fossil fuels in the industrial revolution. That is, they have consistently focused their attention on tools' impacts on society and nature, and on the political conditions and ideologies that enabled their adoption, rather than on the fact that most of the new tools that have appeared during the past two centuries are of a kind previously rare - ones that derived the energy for their operation not from muscle power, but from the burning of fuels.

...In assessing technology and understanding its effects on people and nature, it is at least as important to pay attention to the energy that drives tools as to the tools themselves and the surrounding political-ideological matrix.

This is getting somewhere. Likewise, E.F. Schumacher (1970's) uses this reliance on depletable fuels as the core of his argument. He uses it to illustrate the failure of the industrial system to solve, legitimately, the "problem of production." It is, and was when I first read it, the one thing that really made me sit up and take notice.

Heinberg classes tools into four groups: (1) those made and used with human effort; (2) those made with non-human energy and human energy for use; (3) those made with human effort, and using non-human energy for use; (4) those that require non-human effort for both, like electic tools. Peak oil, he reasons, will end the use of all but category (1) and (3) tools (the latter as post-oil artifacts, like hammers produced in the age of oil).

In early civilizations, agricultural workers sought to capture a surplus of solar energy on a yearly basis by plowing and reaping. It always takes energy to get energy (it takes effort to sow seeds, build a windmill, or drill an oil well). For agricultural societies, the net-energy profit was always moderate and sometimes nonexistent ...in most cases about ninety percent of the population had to work at farming in order to provide enough of a surplus so as to support the rest of the social edifice - including the warrior, priestly, and administrative classes. The extraction of coal, and especially of oil and natural gas - substances representing millions of years of accumulation of past biotic energy - has often provided a spectacular net-energy profit, sometimes on the order of 50 to 100 units obtained for every one invested. As a result, with fossil fuels and modern machinery, only two percent of the population need to farm in order to support the rest of society, enabling the flourishing of a growing middle class composed of a dizzying array of specialists.

This is a problem because when fossil fuels are no longer available (as cheaply) as they are now, then the human population heretofore sustained by industry will have to cope with tools that require neither electricity nor gas.

Heinberg is driven along by a definite hierarchy of causes: technology drives social institutions, which drive people. This is certainly a handy way of explaining economic history—it's how I would do it—but it's important to realize that it's not the only way to do it. It's important because Heinberg professes to find this chain of causality insidious. It's also supposedly ineluctable: the outcome of the Reformation, in which Europe north of the Maine River became largely Protestant, everywhere else wound up Catholic, is the result of institutions that are themselves the result of different technology-energy relationships. What about feedback? What about, for example, the organic relationship of the European congregations to their clergy? To their princes? Yet the Reformation altered the lives of everyone dramatically, well before the advent of coal. This was not a "rearrangement of deck chairs," and the relationship of human agency to events and vice versa is complex.

But it's also true that humans shape institutions. An institution that ignores its members' sexual urges, or that despises the people it proposes to lead, is doomed to failure. Moreover, some institutions work well because of individual preferences form "a tipping point," or widespread disappointment with material success, or artistic taste. Even very major changes in economic structure Heinberg dismisses as "rearranging deck chairs." This totters on the brink of tautology: only changes driven by technology matter (sic), and since this is means technology is telling humans what to do (sic), humans are "enslaved by technology."

I've encountered this line of reasoning before, and for personal usage dubbed it "the tyranny of the obvious": human will is cruelly thwarted by objective conditions. This "tyranny" is more "acute" as opportunities proliferate; add a bus service, and it imposes a schedule on commuters. Introduce checking accounts, and now people must follow the rules and guidelines on writing checks. Introduce paper money and national governments worry about inflation.

But the peak oil concern is real. While Richard Heinberg seems to believe the Hubbert Peak Oil (HPO) theory features a cliff (rather than a slope), the whole point of contention in the theory is what the industrial impact would be if output could not increased to accommodate growing demand. If the answer is, "cause a depressionary spiral" then the HPO is but one of many theories explaining the end of the fossil fuel economy. If it causes a gradual market adjustment, then the global economy will merely evolve into a new, non-fossil industrial system.




Could the outcome be a revival of the nation-state and world war three? Perhaps, but so could some other things. Too many other things.

Heinberg's scorn for human institutions is grating; it reminds one that he is a dilettante in the social sciences. The entire evolution of the industrial economy, with its stupendously complex turns and twists, its rivalries and its citizens' private pursuits, are supposedly the result of a single colossal act of stupidity: "...within the minds of society's managers and policy makers, faith in technology and markets supplanted previous religious faith in the hallucinated agricultural and herding deities that had presided over Western civilization for the previous couple of millennia."

This is disturbing because of its monumental disregard of the thoughts, efforts, planning, and problem-solving of tens of millions of people; their entire mental effort is eclipsed in merit by that used by Heinberg to compose the essay. This is a cosmic arrogance that most people outgrow in college. Moreover, it is a pretension to superior virtue to which the author is not entitled; he has no coherent alternative. Logically, an anarchist should be expected to trust the autonomous decisions of the polis or the household; if you believe society needs a philosopher-dictator with a state that can liquidate basic human impulses, you are not an anarchist.

Peak Oil will be a fundamental cultural watershed, at least as important as the industrial revolution or the development of agriculture. Yet few mainstream commentators see it that way. They discuss the likelihood of energy price spikes and try to calculate how much economic havoc will result from them.

This is dogmatic: in fact, the entire significance of HPO lies in precisely this. If the global economy can respond gradually to price spikes , then human institutions are likely to respond successfully. If not, then the outcome is war, and not some global one-child/one-bike policy. People interested in this are not silly.

But technology cannot solve the underlying dilemma we face as a result of our application of fossil fuels to every human problem or desire: we are growing our population, destroying habitat (and undermining global climatic stability), and depleting resources in ways and at rates that are incapable of being mitigated by any new tool or energy source. The only way forward that does not end with the extinction of humanity and millions of other species is a scaling back of the entire human project - in terms both of human numbers and per-capita rates of consumption.

At this point, Heinberg has completely equated "technology" with fossil-fuel based industry. He has gone far beyond past negative-predictors, who declared the impossibility of most widespread inventions. He has insisted that humans have no solution at all. Even if inventions cease entirely from here to eternity, the mere application of new state or economic institutions based on shrinking GDPs, represents a new technological endeavor.

Nor is this "mere semantics" (as if that were unimportant). Having made so many blunders about freedom by arguing in tautologies ("Tools enslave us..."), he then repudiates any organic relationship of human society to objective conditions. Only preparation for total cataclysm makes any sense, because humans are too stupid to be governed and too stupid to think for themselves.

Beware of people who argue that human history is nothing but a droll succession of stupidity. They often deceive themselves with long rants based on a single worthy fact. Everything rests on this fact (here, HPO), which they themselves don't quite understand. Faced with a hopeless, and manifestly pointless insight, they are left with the self-validation of despair. The world that neglects them does so out of folly, and will be served a bitter coin. Too bad it makes no difference.

(Part 4)

Peak Oil (2)

(Part1)

[He] shall ravin as a wolf: in the morning he shall devour the prey, and at night he shall divide the spoil...[Genesis 49:27]

I would be remiss if I did not draw the gentle reader's attention to this morning's article at Eurasianet:

Intense competition for unimpeded access to the world’s natural resources is continuing and is likely to increase, according to the April 21 edition of "Jane’s Foreign Report." The current unprecedented surge in fuel prices illustrates the growing need for a greater supply and consequently demonstrates the volatile nature of the energy market. The Caspian Sea could meet some of that demand, because it has sizeable... oil and gas reserves. The littoral states of the Caspian Sea — Russia, Kazakhstan, Turkmenistan, Iran, and Azerbaijan — collectively have an estimated 10 billion-32 billion barrels of proven and another 233 billion barrels of possible oil reserves. In comparison, Saudi Arabia has 261 billion barrels of oil, while the United States, China, and India’s proven oil reserves are respectively 22.677 billion, 18.25 billion, and 5.371 billion barrels.

[links added; several erroneous "trillions" in original corrected—JRM]

The article summarizes the conflicts over pipeline routes as well, but failed to mention a few key issues.

The first of these is that the oil reserves cited by Houchang Hassan-Yarivary dramatically; observe the extreme gap between "proven" and "probable" reserves. For over a decade the region has been alleged to have been virtually another Persian Gulf, home to hundreds of billions of untapped oil reserves. But the '90's were also tough times for oil exploration, as oil prices languished below $20/barrel.

US Dep't of Energy: Growing oil production since independence (an increase of roughly 70% since 1992) has come primarily from the north Caspian states of Kazakhstan and Azerbaijan. Development of the region's oil resources has been led by two major projects: Kazakhstan's Tengiz, and Azerbaijan's Azeri, Chirag, and deepwater Gunashli (ACG) (see Table 1.) Combined, these two projects produced about 410,000 barrels per day in 2002, one-fourth of the regional total, and are expected by the operating companies to produce 1.7 million barrels per day for world oil markets by 2010. Development of these vanguard projects, which are each roughly ten years old, has given rise to the influx of new investment and infrastructure development that constitutes the "second Caspian oil rush," the first having occured in the late 1800s.

Of course, China's daily consumption is 5.5 million barrels a day right now, a doubling since '93; as the nation's fleet of autos explodes in number, it seems reasonable to expect this growth rate to accelerate.

It's long been established that taxes on a good can, in special cases, actually reduce its equilibrium price (Edgeworth, Hotelling). In the case of petroleum, gasoline taxes or BTU taxes can reduce rates of consumption, leading to the development of more efficient devices or, as was the case in countries such as Japan and South Korea, the development of industry and consumption along far less energy-intnesive paths.

ALSO FROM EURASIANET: This review of two "recent" books on the Aral Sea caught my eye. The Aral Sea is fed by two rivers, the Amu Darya (Oxus)and the Syr Darya (Jaxartes); during Soviet times these rivers were diverted to grow cotton in Turkmenistan and Uzbekistan. The Aral Sea lost over 80% of its volume, leaving ships stranded in the desert (Aral Sea Homepage). Sadly enough, this is another case of ecological redemption gone badly wrong, but I need to post about that another time.

(Cross-posted at Hobson's Choice)

Peak Oil (1)

Peak oil theory (sometimes called Hubbert Peak Oil, after Dr. M. King Hubbert) is the proposition that there is an de facto limit at any time to the rate at which oil can be pumped from available fields; and this limit tends to follow a normal curve over time. An addition point of the proposition is that we are very close in time to this peak, after which the rate will fall off regardless of increased demand. Oil industry executives insist that there have been new reserves of oil being identified over the years, and provable reserves are greater now than they were [thought to have been] at the time of the 1973 Arab oil embargo. Peak oil theory holds that we are fast approaching the point where further increases in the volume of oil will be economically unsustainable.

For decades we've been warned of the end of cheap oil. Oil is exceptionally difficult to replace—most of the proposed substitutes are not substitutes at all. Advocates of a hydrogen-based economy, for example, tend to ignore the fact that hydrogen must be separated from other chemicals to create a gas, and that separation process requires more energy. Likewise, photovoltaic cells require large amounts of electric power to produce—they're essentially semiconductors. Biodiesel has attracted some attention in recent years, but of course biodiesel works for a small cohort of people who can gather used cooking oil and using it in their vehicles. It's an incidental use of a material which itself requires a lot of energy inputs. Ethanol is a more direct route—it's an alternative fuel made from organic products like grain or corn, but cultivation of ethanol consumes more energy than it generates. It is, however, heavily subsidized.

Electric-powered vehicles require generation of electricity to recharge batteries; much of electricity in the USA is generated by the burning of oil and natural gas (half is from coal, which contributes heavily to global warming). And atomic fission has its proponents, but created a huge environmental burden in the future as nuclear wastes pile up. As it happens, the US atomic power industry was a dismal managerial failure, and the regulatory environment is dreadful; it's just as well, because atomic fission is a faustian bargain; European nations are addicted to it, albeit less destructively than the USA is addicted to fossil fuels and coal.

Atomic fusion has enjoyed massive subsidies in multiple countries; in 1996, the US withdrew from the International Thermonuclear Experimental Reactor (ITER; BBC) project, but rejoined in Feb 2003. In addition, there is a ten-year project ($1 billion) to build a coal-powered generating plant which captures [90% of] its own emissions. This, like the freedom car and the aforementioned ITER re-entry, strike this writer as a fig leaf for otherwise blatantly shortsighted disregard for the approaching energy crisis. If ITER is to solve the world energy crisis depicted in peak oil theory, then the commitment required would be on the order of tens of billions per year; the development of an entire fusion-based economy would be required, such as power-storage and transmission, or longer-range technologies such as small fusion facilities. Needless to say, no such project was announced.

So I think it is worthwhile to return to the concepts of peak oil theory. First, I want to introduce some vocabulary (courtesy of Van Nostrand's Scientific Encyclopedia, Fifth Ed., 1976):

produced: misnomer for recovery of crude oil/natural gas; "recovery" suited to getting oil out of the ground, while "production" applicable to end-user products like aviation fuel, gasoline, kerosene, fuel oil, and diesel. provable reserves of crude oil: estimated quantities of all liquids statistically defined as crude oil, which geological and engineering data demonstrate to be recoverable from known reservoirs under existing economic and operating conditions. A major improvement in recovery technology, or favorable changes in the price structure for petroleum products, can increase proved reserves. Proved resources are calculated using conservative benchmarks; if there is no fluid contact (for example, no wellheads in a margin of the reservoir), then the lowest figure for oil content is given, based on geological structures.

The term "proved" used to apply to the above category of oil reserves. However, marginal sections of a reservoir with no fluid contact are now excluded from the definition of "proved." Readers with direct knowledge of the oil industry are requested to advise if my scientific encyclopedia is actually mistaken or merely out of date. The distinction is quite important. ExxonMobil, the biggest US oil firm, has 22bn barrels of proved reserves, but another 50bn barrels of "provable" (BBC).

probable reserves: same as above, except that mean probable estimate (rather than structural minimum) of recoverable reserves are used. By definition, a reservoir's "probable reserves" will be greater than its "provable reserves," and both will be greater than "proved" reserves.
oil in place: includes all oil estimated to exist in a reservoir, regardless of technological constraints.

crude oil: a mixture of carbon-based molecules, mostly of comparatively high molecular weight. Organic compounds like methane (CH4), ethane (C2H6),..., propane (C5H16) are gases at ordinary temperatures and pressures, and are a separate product; natural gas is about 95% methane, 1% ethane, and 4% nitrogen. In contrast to NG, crude is extremely complex chemically, and its place of origin can be determined based on its chemical composition. Crude oil, when recovered, can be dark, clear, golden, or greenish.

gravity, degrees API: API stands for "American Petroleum Institute"; the designation works backwards. "Specific gravity" is a general term representing the unit density of a substance, so water at ordinary heat and temperature has a specific gravity of about one gram per cubic centimeter. For high quality grades of crude, this is typically about 0.7 g/cm3. API assigns 10.0 to water, and moves upward as the fluid gets lighter. Since the most commercially desired products, like aviation fuel and gasoline, are very light (60% as heavy as water), the highest grades of crude are 35-40° API. The poorest grades are found in Wyoming and California, and reaches as low as 13° API. Typically, higher degree crudes are recovered first; the API rating declines as a field is drained.

Another attribute of oil is the sulfur content. Sulfur must be refined out of oil; if there is very little, as in West Texas or Iran, then it is called "sweet"; high levels of sulfur and other undesirable chemicals are "sour."

oil reservoir: more precisely, a proven oil reservoir includes area delineated by drilling, plus neighboring areas deduced from geological analysis, from which oil can be recovered economically.

refining crude: the main part of this procedure is boiling the crude at different levels. East Texas light crude, for example, boils at 125° F (51° C), an unusually low temperature; 5% boils off before 191° (88.3°) is reached. By volume, 29% of this grade is gasoline; 10% is kerosene; 18% is diesel. What is left behind boils at temperatures of almost 800° (426°), and forms asphalt. In addition, there are trace compounds of salt and sulfur, nickle and vanadium. This process is called "distilling." The middle distillates (gasoline, diesel) are then subjected to cracking (which breaks large hydrocarbon molecules into smaller ones), alkylation, catalytic reforming, polymerization, isomerization, and other processes. Then they are blended. About now, the oil companies are required to add ethanol as an oxidizer; because ethanol blended with gasoline is not stable, it must be blended in the tanker trucks before being delivered to the service station.

Refineries and the capitalization of their costs account for about half the cost of gasoline at the pump in most US states. Motorists share that cost with airline passengers, homeowners and utilities customers, and users of products like plastics, fertilizers, and other petrochemicals.

When researchers attempt to calculate proved oil reserves, they lump all grades together although the utility of those grades vary as well.

For example, recently estimates of Canada's reserves were drastically increased, pushing Canada from well below the USA in terms of total proved reserves to far above it. The reason is that 175 billion barrels of bitumen held in the oil sands of Alberta, Canada, were suddenly included in the total. Suddenly Canada is believed to have more oil than Iran and Venezuela combined. Yet bitumen requires extraordinary processing before it can be refined. I was surprised to learn that Alberta already produces massive volumes of gasoline and diesel from oil sands (a third of Canada's total output is from oil sands).

Conventional economic analysis of oil reserves would lead one to believe that, as the commercial value of productive reserves declines, the cost of products (like gasoline) will go up. If the price of gasoline rises to $4/gallon all the time, then marginal oil fields will go online. Refineries will become more sophisticated; new procedures will be introduced. Airlines will shift to airplanes with 100-250 passengers rather than the gas-guzzling jumbos (which burn more fuel per passenger), then to turboprop airliners (which are the most efficient planes of all). SUVs, created by massive government subsidies, will disappear as prices climb above $6/gallon, while new industrial processes phase out petrochemicals. Eventually the pressures gradually push the developed world into developing post-petroleum energy systems, and the problem goes away.

Under peak oil theory (POT), this doesn't happen because, when oil rises above $80 a barrel and stays there, the world economy implodes. Refineries may require twenty years before the bulk of capacity incorporates major new equipment optimized for $80-crude, simply because of the risks associated. In the meantime, economies like that of China require massive new infusions of petroleum. Exactly what happens then is a matter of intense debate. Here is a casual listing of speculative analyses by extreme pessimists. The listing is handy because it gives names, titles, and summaries.


While it's true that there is a physical limit to the volume of oil that can be pumped per day—it's about 80 million barrels per day, of which 20 million is consumed in the USA—it seems likely that we would simply revisit 1978. That was the year that the real price of oil was driven to a record high by a shortfall, then created by OPEC. The effect of '78 was to send a huge lump of global income to the banking system of the West, as petrodollars flowed into OPEC coffers, then back to New York and London. The dollar soared relative to the rupee (Indian and Pakistani) and other non-OPEC third world nations. Then latter had a debt crisis and capital flows to those countries dried up. When they revived, the damage was done; countries like India or Brazil had permanently exploitive terms of trade with OECD countries. This damaged the bargaining position of American workers relative to management, and soon after 1980, the real outsourcing revolution began. The maquiladoras opened up along the border with Mexico, median wages stagnated, and the lines of debate in the USA moved relentlessly to the right. Certain liberal measures like legal abortion and civil rights survived because they benefited many income categories; and Europe was spared the decline in wages because of a sound industrial policy.

A repetition of '78 could simply make everything more extreme. American society could fall apart, placing extreme pressures on European society, then on Japan. China could suffer a depression, while Latin America explodes into revolution. Or it could cause the reverse: it could create a crisis felt disproportionately by American elites, reversing the decades-long growth in inequality. Or, of course, I could be in denial, and the POT could explain why the world will end and we will be plunged into the stone ages.

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Additional Reading:

Oil Depletion Analysis Centre (ODAC), London, UK;

Inventory of US & global reserves of oil and energy situation overview for all countries (Department of Energy);

Exxon Mobile report on energy trends : an analysis of growth in demand for various types of energy. According to the report, global oil consumption is expected to double by 2020; 80% will be in developing countries.

Chevron’s Pascagoula Refinery Home Page: guided tour of a modern facility with simple explanations of processes involved

(Part 2)