I don’t know about you, but I’ll admit that I was completely caught off guard by the recent (and ongoing?) crash in oil prices. It’d be a stretch to say I’m embarrassed by my lack of foresight, although perhaps “dumb-ass” would be a bit deserving. For even though there were bloggers out there discussing the possible ramifications of low oil prices, its possibility still didn’t register with me. I’ll digress.
In short, the price of crude oil has crashed — falling nearly 50% in the past half a year. This has primarly been due to 4 million barrels of oil added to world production levels via fracking in the United States since 2008, and because of a slowdown of various economies around the world who have thus demanded less oil. Both of these effectively increased supply, and so have contributed to a decline in prices.
Two ways to destroy a market
First off, it’s worth noting that for the past three years or so, before oil’s recent crash, the price of crude was bouncing around the $100 mark. This was a relatively expensive range, particularly in comparison to its long-standing rate of $20-$40 per barrel for more than a decade, before its gradual then meteoric rise to $147 in 2008.
Since oil is entwined with the price of pretty much everything nowadays, its changes in price can have a significant effect on economies (as we currently [mis]understand the term). With higher and higher oil prices sapping a greater percentage of expenditures – be it of consumers or businesses – a price point is eventually reached where goods become so expensive that those who can’t afford them anymore simply stop buying them. This is what is called “demand destruction.”
When demand dries up and so fewer goods end up being bought and sold, a glut in oil supply results, which ends up crashing prices. This is simple supply and demand. Along with other factors, this is what happened after the $147 oil price spike in July of 2008, and resulted in oil tumbling down to $32 by December of that same year.
While the ensuing low oil prices get seen by some as a boon (via the expectation that consumers will have more money to spend), the opposite problem actually kicks in – namely, “offer destruction.”
Since many businesses get forced to close down due to crashing oil demand and so in effect fewer sales, and since a significant amount of people get their hours cut or even lose their jobs, there often isn’t enough money to pay for oil and other goods, regardless of how low the prices go. This is what happened in 2009. Economists called that the Great Recession. The process can be fairly described as “the beauty of the market.”
Didn’t oil peak in 2005?
To return to the first paragraph of this post, this is where I got thrown off.
The year 2005 is seen by some as when conventional supplies of oil peaked. It is because of this (and a few other factors, like speculation) that oil climbed to $147. Although prices subsequently crashed due to demand destruction, they eventually made their way back up, to the point that several unconventional forms of oil (shale oil/fracking, tar sands, and deepwater offshore oil) became somewhat profitable.
The problem with peak oil is that when (if?) growth kicks in again, and since more and more energy is getting used, soon enough the increasing levels of energy-use may very well butt up against maximum extraction levels, resulting in a shortage in supply and causing the whole demand and offer destruction cycle to kick back in again.
Furthermore, and as far as one theory goes, higher highs and higher lows will occur. That is, instead of maxing out at $147 per barrel, oil will reach, say, $200 per barrel, before crashing down to $80 or so instead of $40. And so forth.
And it is because of this notion that peak oil pulled a fast one on me. Expecting the higher high having to happen, what I didn’t clue into was that oil prices at a high enough level for a prolonged period of time would be enough to have a similar effect as a quick rise to $147.
Case in point, one can look at countries that have recently slipped into recession or simply haven’t gotten out since 2009 – Greece, Spain, Italy, Brazil and so forth. Furthermore, some of the more robust and rich countries are seeing their growth wane – Japan, China and Germany, to name just a few. For what is a slowdown in Europe leads to fewer consumer purchases from China leads to less iron ore and coal bought from Australia.
For a closer look, check out Italy. Oil and gas consumption peaked in 2004 and has been on a decline ever since. According to Ugo Bardi over at Resource Crisis, “Italy is in full collapse.” One not only sees that industries are closing down, but also that restaurants are popping up in the attempt to attract the wallets of globe-trotting, placeless tourists, along with all the chic restaurant-hoppers. What is being witnessed, says Bardi, is “unreal.”
Unfortunately, and much like the aforementioned countries, if one is looking for solid explanations about these economic collapses from mainstream news sources, then one is pretty much shit-out-of-luck. As Bardi then explains,
When the crisis is mentioned, different culprits periodically appear in the first pages of the newspapers: the Euro, the European Union, politicians, immigrants, government employees, bureaucracy, lazy workers, terrorism, femicide, Angela Merkel, Vladimir Putin, Silvio Berlusconi, and more. It is a cycle that never stops, it keeps turning, every time pointing at something – new or old – that the government will target to solve the crisis once and for all.
In turn, not only could low-priced oil usher in another Great Recession via a meltdown of the oil market, but the newly enshrined oil ventures are at serious risk of collapse, and whose bubble bursting could be akin to the recent housing bubble. (To be fair, I can’t imagine oil reaching that low if not staying there for very long, for the very simple reason that any number of unfortunate conflicts around the world could cause its price to increase overnight.)
In short, many of the unconventional sources of oil require $100 prices in order to remain financially viable (or at least give that impression). Since many of the fracking plays in the United States are owned by independents who don’t have the financial reserves to weather a prolonged period of prices below costs of production, things could get hairy.
Furthermore, since fracking is capital-intensive, drillers have borrowed ridiculous amounts of money in order to acquire leases, drill wells, as well as purchase and install processing equipment and infrastructure. And since fracked wells have both steep production increase levels and decrease levels, drillers have been forced to continually drill more and more wells to keep up the semblance of growth – and to keep the debt piling up. What’s resulted is a junk bond market possibly akin to what was witnessed a few years back with the housing fracas.
And not to let all the boosters off the hook, for it was once again an all-too-giddy media that kept itself busy cheering on the latest (fraudulent?) money-making scheme, pumping up all the debt with nary a peep about any possible consequences.
And so what’s going on now that prices have crashed? That would-be sellers panicking to unload their energy-related junk bonds and other investments in unconventional oil and related industries, and it’s anybody’s guess as to how much of a collapse will occur in these fields. And if it’s significant enough, whether they’ll even have a chance to recover.
And as mentioned earlier, a round of offer destruction is expected to kick in after a round of demand destruction. For instance, nearly 40% of the jobs created since 2009 in the United States have been in energy related fields, those being some of the higher paying jobs in the nation, a catastrophe to the U.S. economy if lost.
As John Michael Greer recently put it over at The Archdruid Report, “If I’m right, the spike in domestic U.S. oil production due to fracking was never more than an artifact of fiscal irresponsibility in the first place, and could not have been sustained no matter what.”
What we might be about to find out is how vulnerable the United States’ shale boom is to low prices, and how profitable fracking actually is.
Regardless, what happens next is anybody’s guess, and it would be a fool’s game to try and give any predictions. Nonetheless, it’s worth quoting Terry Lynn Karl from a recent conversation with Andrew Nikiforuk. “We are in a situation where oil supply limits can cause recessions and oil supply gluts can cause stock market failures.”
The reasons to get off oil seem to be piling up.
Original article appeared at From Filmers to Farmers.
— Allan Stromfeldt Christensen, Transition Voice