AGE OF PETROLEUM ENDS IN SYSTEMIC IMBROGLIO

8/9/2019 AGE OF PETROLEUM ENDS IN SYSTEMIC IMBROGLIO

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If you are puzzled by the debate over the future of oil and, like most of us, have no access

to primary data to form an independent opinion based on physical facts, there is still help

available to see through the fog of information and disinformation. Consider thefollowing:

Conservative estimates published by U.S. Government sources indicate that the world isfast approaching the point where half of its oil endowment will be gone; consumption

outpaces new discoveries of conventionally accessible reserves by a wide margin; loud

and clear market signals for increased supplies during the past decade remainedunanswered; and the current flow of capital into expanding production to levels

commensurate with the planets economic ambitions is wholly inadequate.

These four seemingly unrelated observations in toto lead to the conclusion that themaximum rate of global oil output cannot be far. If we could complete the graph of

historical production with 20 more annual entries, and calculated a 10-year moving

average for the century of 1930-2030, a smooth, Hubbert-like curve rising, peaking, and

descending without recourse would appear on the screen.

Contrast the apparent, cost-dictated difficulties a sustained increase of oil productionfaces with forecasts of further growth in the worlds already precarious dependence on

this paleo-biological substance, and the picture becomes even clearer: The peak is not a

knife edge-like turning point. It is a time zone, a temporal force field. Its effects are felt

long before and after it shows up as a statistic. We are already living cheek by jowl withits consequences, but the perplexingly contradictory expert opinion on reserves, tainted

with brazen claims of superabundance, and resistance against parting with routine

economic and political motivations prevent their recognition.

While it is generally acknowledged that the world economy needs to reconfigure itsenergy base so as to rely primarily on renewable sources, it is rarely admitted that therequisite process of transition cannot be smooth. Putting it as succinctly as possible, here

is the reason why.

There is conflict between economic growth objectives and the structural

transformation of the energy base.

Our techno-economic civilizations dependence on fossil sources is so overwhelming thatthe expansion of the renewable energy sector is inconceivable without heavy reliance on

them. An economist might say that the coefficient of renewable-energy supply elasticity

for fossil-fuel demand is a positive number (hopefully less than 1.0).

Even if a solar panel and cell manufacturing plant is able to produce the energy it needs,

its total material (metals and minerals), off-plant energy demands involved inwarehousing, marketing, transportation (personnel and goods), and administration are

built into the economys input-output grid. Renewable energy generation is entangled in

the flow of inputs into the sectors and the transaction of outputs among them. A drastic

change in the scheme implies an epochal development in technology as well as in the

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ways value added is generated and distributed; that is, income and employment, living

standards and socioeconomic institutions are maintained.

John Donnes No man is an island . . . applies to every heroic effort aimed at carving

out a local sanctuary of green energy.

Fumbling on the margin of transition is possible without transforming the economic

structure; which, given the past threescore years advances in trade liberalization, has

acquired a distinctly transnational character. However, prohibitive obstacles wouldemerge before the scale and tempo of the process could reach its tipping point.

Transitions unsolved problems

A tradeoff exists between using resources (including energy and material inputs of fossil

origin) to feed the growth of material production (industry and agriculture) and to support

the economys structural transformation.

Hearing this, conventional economics comes out swinging with the old one-two:

Economic growth is not confined to such a zero-sum game (resources constantly expand);and the desired transformation has always been envisaged as gradual. Then the knock-out

blow: Knowledge, efficiency, and organization have reduced the human economys

dependence on natural resources.

To show how ineffectual and off target this entire argumentation is, let us begin with the

intended knock-out. It is true that material resources and energy carriers together

account for less than ten percent of the GDP in developed economies, but so does theweight of blood supply in the average human body. Restricting that small percentage in

either case spells calamity. Vulgar (un-ecological) economics has turned the economy-

natural resource relationship on its head and tries to keep it that way.

The old one-two also misses the target for reasons that are at once physical and

systemic.

The scale of a primarily renewable-energy-based world economy may be smaller than the

one already in existence; a circumstance that long-term official growth targets, certainly

justified by the abject poverty of at least one billion people and the legitimate aspirationof billions of others to raise their levels of living to developed country standards,

completely ignore.

As the substitution of renewable for nonrenewable (primarily fossil) energy continues,

nature exerts resistance at some point; the scale limit begins to bind. Either economic

growth or transition must halt. Both alternatives lead to severe disequilibrium. The firstbecause increased pauperization and the apparent irreducibility of income differentials

would endanger social peace. Also, since an economic order built on competition among

private firms cannot exist without expansion, the free enterprise system would flounder.

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The second alternative is equally untenable because the depletion of nonrenewable

resources, proceeding along a rising marginal cost curve or, equivalently, along a

descending Energy Return on Energy Invested (EROI) schedule, increases productioncosts across the entire spectrum of activities. Supply curves shift upwards.

The problem that substitution tries avoid -- running out of affordable nonrenewableresources -- becomes more acute as time passes.

The prevalent incentive system, which is naturally aligned with traditional consumercapitalism, rejects a large-scale substitution of nonrenewable resources. It does not jibe

with its endless long-term growth perspective and it reflexively repels the requisite

transformation in the short run.

This is the mechanism through which the systems complex defense network

unconsciously immunizes poisonous greening: When energy prices are low, energy

carriers flow into expanding the production of consumer goods. But when as a result of

the systems inability to maintain the abundance of cheap energy, the exchange value ofcarriers begins to increase faster than the general price level, aggregate demand receives a

shock. The resultant threat of recession closes the door on private incentives. Theeconomys currently unchangeable dependence on oil seals it.

The obvious requirement for substituting away from oil is that its price should exceed the

price of the substitute by a significant margin. However, given the importance of oil inevery single cell of the body economic, the price of solar and wind energy, for example,

would tend to rise with the barrel.

The incentive that worked (and still works) in substituting consumer and manmade

capital goods for one another will not lead to a sustainable energy base.

The currently experienced will-o-the-wisp reprieve from the oil constraint only

reinforces this ever more obvious conclusion. Goldilockean, not too low and not too

high oil prices neither spur the private sector to green the worlds energy base nor is itmore than a strictly temporary phenomenon. It is tied to persistent unemployment in the

United States, the worlds largest consumer and importer of crude. Once demand begins

to press against supply as a result of India and China, the price of oil will go up to

disruptive levels once again with or without resumption of U.S. growth.

The micro-foundations of the mixed economy are such that the elasticity of substitution

between nonrenewable and renewable energy sources is too low in the desired direction.Even when the price of oil rises above its renewable-source substitutes -- sluggishly for

the reasons cited; the global input ratio, quantity of nonexhaustible substitutes for oil

consumed per a given period divided by the quantity of oil consumed during the sameperiod will not increase to an extent that would be needed to accomplish transition to a

significantly more sustainable world economy.

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To summarize, the physical constraint facing the global economy invalidates the

expansion of resources argument, and the one that claims that transition will be

accomplished with gradual smoothness falters on the systems micro-level resistance.There is trouble also with the macro-foundations.

Public authority in the mixed economy is insufficient to clear the logjam.

Apetit tourof recent macrohistory in support of this proposition follows.

The Great Depression turned the United States of the 1930s into an experimental

laboratory in which democratic institutions and traditions allowed society to seek a new

equilibrium between labor and capital and develop modalities appropriate for guiding the

growth of mass production and consumption. The resultant mixed economy (solidifiedlegally, ideologically, and psychologically by the Employment Act of 1946) was cloned

with incredible speed and matter-of-fact naturalness by the rest of the industrialized

world immediately after the war.

Based on the principle of multilateralism, the United Nations, with its panoply of

chartered organizations, provided the framework of international cooperation. Sincesupranational institutions remained subordinate to nation states; i.e., they cannot be

regarded as a World Government, the current global system may best be described asmixed economy/weak multilateralism. (Until the end of the Cold War, it seemed that there

were two competing global systems vying for domination. In retrospect, this view isincorrect. During its peak years, the Soviet Bloc represented less than five percent of

world trade and, to avoid ruinous isolation la Kim Jong-ils North Korea, countries

under communist control had to conduct their international relations within the industrial-democracy-dominated UN framework.)

Multilateral institutions -- especially the WTO/GATT, the IMF, and The World

Bank -- are the guardians of the world orders mixed economy character.

Only pariah regimes remain outside these agencies, but once inside, they arecontractually obligated to abide by the fundamental principle of the mixed economy:

Laissez fair, with governments role restricted to using mainly indirect tools of

governance; i.e., fiscal and monetary measures.

The system tolerates state-led industrial policies within limits, particularly when it comes

to developing countries. But the pressure against the idea and practice of government

support extended to specific economic sectors or industries is relentless. Using itsvirtually apostolic authority, neoclassical academe has come close to turning the claim

that government interference does more harm than good into an edict. It has injected into

public policy analysis mathematical models that treat tax and tariff reductions asautomatically growth-spurring, job-creating achievements of enlightened societies.

The substantial public role in Asias economic progress over the past decades has been

smeared and rubbed to innocuousness through definitions and by imparting more clout to

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econometric work in support than in opposition to the principle that privatization and

liberalization is the quickest, surest, and least-expensive way to high living standards.

Time relentlessly tests the appropriateness of economic organization for its ability to

fulfill social objectives.

No matter how successful the system ofmixed economy/weak multilateralism has been in

increasing and spreading prosperity over half a century, it is no exception. If it becomes

widely recognized that it cannot harmonize the planets activities with its physicallimitations, it will have to go too. This may indeed be the case.

The curve depicting the marginal social cost of oil production faces an abrupt acclivity,

the introduction of substitutes is mired in demanding oil as a complement, and the entireprocess seems helpless without enlarging the role of the state beyond the mixed

economys legal-institutional parameters.

This new reality, which differs so profoundly from what postwar generations came toregard as permanent, does not announce itself clearly. But nor is it hidden beyond any

hope of grasping it. A little unorthodox eyeballing suffices to show that, given the rolethat oil now plays in global welfare, the system is out of whack; the stasis built around it

has been punctuated. Specifically, one of the mixed economys canonical principles, the

independence of the market rate of interest from any given industry, no longer applies.

Checking out from Hotelling

The Hotelling Rule, dating to 1931, retains a considerable influence on the wayeconomists think about nonrenewable resources. It has been stated in many different

ways, but the bottom line is simple enough: The market rate of interest (i), characterizing

general economic conditions, plays a key role in deciding how fast to draw downreserves.

If owners of a scarce resource expect return on investments they could make in the rest ofthe economy to exceed the appreciation of their reserves, increasing extraction makes

good sense. The appreciation of reserves is measured by dividing next years expected

rent (profits to be obtained exclusively as a result of possessing the scarce resource) --

denoted as (t + 1) -- by this years rent, (t ). When (t + 1) / (t) is smaller thanoverall return in the economy -- (i +1) -- there will be more of the scarce resource on the

market since (1 + i) > (t + 1) / (t) makes it rational for the owners to step up the

liquidation of reserves and invest the proceeds elsewhere in the economy.

When the inequality sign points in the opposite direction, i.e., interest rates are relatively

low, the incentive goes into reverse: Scale back and wait until the opportunity cost ofsitting on the reserves -- (1 + i) -- rises.

The Hotelling Rule proposes that competition among the owners of nonrenewable

resources will tend to equate the opportunity cost of production now and production later

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via the market rate of interest. That is, the condition (1 + i) = (t + 1) / (t) will pave the

optimal path to emptying reservoirs.

To appreciate this theory, it is important to note that economists like to equate high real

(inflation adjusted) interest rates with prosperous times. Productive capacity and

purchasing power are growing. The world produces and earns more; capital continues toflow into new machinery, equipment, buildings, infrastructure, and intangible productive

assets. Growth calculus even equates a summary, symbolic rate of real interest with the

steady state tempo of global expansion, determined by the combined increase ofpopulation and productivity.

Beautiful minds conceived all this, but after the insatiable Leviathan has gone through a

trillion barrels of oil and, in close relationship with this devastating throughput, anunsalvageable international monetary-credit system begot astronomic quantities of

worthless payment obligations, winds blow differently.

Peak Oil renders Hotelling obsolete.

Since both theories predict a decline in the rate of oil output over the long run, they seemto be compatible. But this is mere appearance.

The Hotelling Rule has practical relevance only if the low and diminishing supply of

the nonrenewable resource in question does not constrain economic growth and if strongcompetition prevails among suppliers. Short of allowing oneself to remain hypnotized be

the internal consistency of neoclassic algebra -- along with sound-bites attesting to the

titanic lore of markets and mans unlimited engineering genius -- one can see that theseconditions are absent from the contemporary economic scene.

The actual and prospective supply of oil does act as a growth constraint and the pastdecade has revealed that OPEC can act more in a concerted fashion than previously

believed.

The absence of conditions required for the Hotelling Rule has shrunk the mixed

economys policy space. Keynes, the systems philosophical sire, considered the rate of

interest an independent variable in the hands of central banks. But if the state of the

economy can worsen as a result of reduced flows of oil, central banks have no choice butto reduce interest rates through increasing the money supply in order to stimulate

recovery. There goes the independence of the independent variable and the

meaningfulness of the real rate of interest as a long-term growth indicator. High real ratesare as likely to imply expansion as contraction, good news or bad news.

To repeat, the mixed economy and the global system based on it presume that firm- orindustry-level investment decisions do not alter general economic conditions. All

particular judgments about investing in real capital (machinery, equipment, etc.) are

guided by what the same amount of money would expect to yield if it were invested

elsewhere, including the financial sector. That is, economic agents depend on

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comparative (present value) calculations in which the prevailing or expected market rate

of interest is independent from their actions.

Things have become very different in our brave new, post-Hotelling, post-Keynesian

world. Decisions made in the boardrooms of OPEC forcefully affect both the global

economys critical resource and the market rate of interest, nominal and real.

Oil is king but, as Hemingway mused, how happy are kings?

Monopoly power means an ability to influence the price. But in the sunset phase of the

petroleum age this simple one-step has turned into a roundelay. The price will have an

impact on the rate of interest that will loop back to the price. In theory, major oil

producing nations could control this interwoven dance, but in practice they cannot. Evenif monopoly power can be preserved as oil depletion proceeds, the chain of causalities

along the price-interest rate-price circle is too uncertain both in terms of time and

effect.

Prices set too high could catalyze post-peak-characteristic structural transformation in

the worlds energy base, devaluing reserves. And while sovereignty over how high theceiling can go has been reduced, the floor is rising. The inevitable increase in the

marginal cost of production tends either to reduce the rent (price minus marginal cost)

or lead to the error of setting prices cripplingly high.

To recap the same dilemma in an alternative way, if the oil monopoly over-boosts the

rent it destroys opportunities to invest profitably in the rest of the world. If it wants to

feed global prosperity in order to maintain and expand opportunities for investing exportrevenues, it would hasten the end of the bonanza, reducing the time budget available for

transiting to an economic structure no longer dependent on oil export revenues.

In this all-around dangerous Odyssey, the monopoly tries to navigate the whirlpool

between the Scylla of overcharging (and harming itself indirectly through damage caused

to the global economic environment) and the Charybdis of undercharging (sufferingdirect harm through forgone revenues). The thickening fog of uncertainty may require

modifying the tactic daily, but the overall strategy has constant components. Exhaust

natures one-time gift as slowly as possible and forestall net oil importers momentum

toward greening their energy base.

Consequently, the oil monopoly must lull the rest of us into believing that the Earth, in

general, and itself, in particular, have enormous riches of untapped reserves -- much morethan claimed to be the case by independent (i.e. not oil money supported) expertise.

Such self-regarding course of action is logical and judicious from the monopolysstandpoint. Yet it defies imagination how widespread, unfounded expectations for

affordable long-run oil supplies will not lead to an all-engulfing catharsis, a Wagnerian

finale to our reckless materialistic disposition and correspondingly deficient economic

and social structures.

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The specter of segmented rationality haunts the world just when it needs collective vision

more than ever.

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AGE OF PETROLEUM ENDS IN SYSTEMIC IMBROGLIO

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