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Low Oil Prices Lead to Economic Peak Oil

High oil prices make countries that use large amounts of oil less competitive with countries that use less fuel in general, and less oil in particular.
If we look at the 2008 situation, oil limits were very much behind the overall problem, even though most people do not recognize this connection.
It was the fact that oil limits eventually led to credit limits that caused the system (including oil prices) to crash as it did. 
High oil prices led to debt defaults and bank write offs, and eventually led to a huge credit contraction in economies of the developed world.
This credit contraction affected not just oil demand, but demand for other energy products as well.

The problems of the 2008 period were never really solved:
the lack of growth in world oil supply remains, and this lack of growth in world oil supply ( MHIP : the higher price like minimum 3 times higher ) continues to hold back world economic growth, particularly in developed countries.
We recently have not been feeling the effects as much, because with deficit spending ( MHIP : deficit spending = spending more than your income ), the problems have largely moved from the private sector to the government sector.

The situation remains a tinderbox, however.

The financial situation is propped up by ultra-low interest rates, continued government deficit spending, and Quantitative Easing.
In a finite world, debt growth cannot continue indefinitely ( MHIP : because you will never be able to pay her back and it becomes a drag ).
But if debt growth permanently stops, and switches to contraction, we would end up in an even worse financial mess than in 2008.

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Figure 2. World crude oil production and Brent oil prices, based on monthly EIA data, with different scale for oil production.

If we look at world oil production and price between January 1998 and July 2008, we see that as long as oil demand stayed below 71 million barrels a day, oil price stayed low ( MHIP : mostly aournd 20 USD ).

But once demand started to push above that level, oil price started to rise rapidly, with little increase in production ( the little rise is the problem and points to peak oil wether it is peak cheap oil, peak conventional oil or economic peak oil ).
It was as if a brick wall on oil supply had been hit.
No matter how much the oil price rose, virtually no more production was available.

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Figure 3. X-Y graph of world of monthly world oil production and price data, based on the EIA data shown in Figures 1 and 2.

If we look at an X-Y graph of the non-OPEC portion of oil supply, we see that the situation was even worse for the non-OPEC portion (Figure 4, below).
The amount of oil that could be produced at a given price had actually begun to fall back.
While in 2003 and 2004, non-OPEC had been able to produce 42 million barrels a day for only $30 barrel, by 2008, non-OPEC could not reach 42 million barrels a day, no matter how high the price.
It looked as though non-OPEC had hit “peak oil” production.
Geological limits appeared to have the upper hand.

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Figure 4. X-Y graph of world of non-OPEC world oil production and price data, based on EIA data.

Fortunately, during this period OPEC was able to raise its production somewhat, in response to higher prices, as illustrated in Figure 5, below.
Between July 2007 and July 2008, it was able to raise oil production by 2.1 million barrels a day, in response to a $56 dollar a barrel increase in price in a one-year time-period.
( The small increase in response to a huge price rise suggests that OPEC’s spare capacity was not nearly as great as claimed, however. )

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Figure 5. X-Y Graph of OPEC oil production and price, based on EIA data.

What brought about the collapse in oil prices in July 2008?
I believe it was ultimately a financial limit that was reached that eventually worked its way to the credit markets.
Once the credit markets were affected, individuals and businesses were not able to borrow as much, and it was this lack of credit that cut back demand for many types of products, including oil.

The way this cutback in credit came about was as follows:
Oil prices had been rising for a very long time–since about 2003, affecting the inflation rate in food and fuel prices.
The Federal Reserve Open Market Committee tried (unsuccessfully) to get oil prices down by raising target interest rates.
I describe this in an article published in the journal Energy called, “Oil Supply Limits and the Continuing Financial Crisis,” available here ( or here (  
The combination of high oil prices and higher interest rates led to falling housing prices starting in 2006 (big oops for the Federal Reserve), and debt defaults, particularly among the most vulnerable ( those with sub-price mortgages ).
As early as 2007, large banks had large debt write-offs, lowering their appetite for more debt of questionable quality.

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Figure 6. US Mortgage Debt Outstanding, based on Federal Reserve Z1 Report.

By July 2008, the financial problems of consumers in response to high oil prices and falling housing prices had transferred to other credit markets as well.
Revolving credit outstanding (mostly credit card debt), hit a maximum in July 2008, and has not recovered (Figure 7 below).
(July 2008 is exactly the same month as oil prices began to fall!)
Non-revolving credit, such as auto loans, hit a maximum in the same month.

The Federal Government tried to fix the situation by running larger deficits (Figure 8)
( starting the very next quarter after oil prices hit a peak and started declining ).

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Figure 8. US Federal Debt, from Federal Reserve Z-1 Report. (Excludes debt owed to Social Security and other Federal programs.)

Oil prices rose again starting in 2009 as demand outside the US, Europe, and Japan continued to grow.
By 2011, high oil prices were back.

The economies of US, Europe and Japan did not bounce back to the kind of economic growth most expected, because at high oil prices, their products were not competitive in a world marketplace that relied on an energy mix that was slanted more toward coal (which is cheaper), and also offered lower wages

In 2013, world oil supply is still constrained.

It is easy to get the idea from news reports that everything is rosy, but the story presented to us is painted to look much better than it really is.
Production from existing sites is constantly depleting.
In order to replace declining production, huge investment must be made in new productive capacity.
It is as if oil producers must keep running, just to stay in place.

Part of the problem is that the cost of new capacity keeps escalating.
I have called this the Investment Sinkhole Problem
The Financial Times describes the problem as .

Cash flow has historically financed much investment.
Now we read, Energy Industry Struggling to Generate Free Cash Flow (


Figure 11. US Debt by Sector, based on Federal Reserve Z.1 data. (Amounts shown exclude government debt that is not publicly held.)

Government debt helps take the place of “missing” debt from other sectors (at least in theory).
Now government debt is above acceptable levels.
US debt is around 100% of GDP, and growing each quarter.

Without rapid economic growth, only a small portion of the debt that remains can be repaid.
If increases in taxes/cutback in benefits leave more without work,  a new round of debt defaults can be expected.

Student loans are particularly at risk.
Business loans maybe a problem as well, especially in discretionary industries.
Government debt is likely to be a problem, especially for states and municipalities.
Banks may again have financial problems, especially if they have exposure to debt from other countries, or student loans.

I am not certain what will happen to the huge amount of US government debt, if Quantitative Easing ( ever stops.
The same might be said of the debt of all of the other countries doing quantitative easing.
Who will buy the debt? And at what interest rate?
If the interest rate rises, there will be a huge problem, because suddenly loans of all types will have higher interest rates.
Governments will need higher taxes yet, to pay their debts.
It will be hard to sell cars with higher interest rates on debt.
Home prices will likely drop, because fewer people can afford to buy homes with higher interest rates.

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Figure 12. Per capita wages (excluding government wages) similar to Figure 5. Also, the sum of per capita wages and the increase in household debt, also on a per-capita basis, and also increased to 2012$ level using the CPI-Urban. Amounts from US BEA Table 2.1 and Federal Reserve Z1 Report.

I showed in Reaching Debt Limits ( what a big difference increases in household debt can make to per capita income (Figure 12).
What is Ahead?
Lower oil prices indicate that demand is declining. (The cost of extraction is not lower!)
Lower oil demand seems to be related to poorer earnings reports for the first quarter of 2013
, which in turn is at least partly related to the increase in US Social Security taxes withheld, starting January 1, 2013.  
Nothing will necessarily happen quickly, but by next quarter’s earnings reports, some of the “sequester” cuts will be added to the cuts.
Businesses with poor earnings are likely to lay off workers, and those workers will file for unemployment benefits.
Gradually, we will see increasing evidence of recession.

It is not clear that this time will necessarily lead to the “all time” switch to long-term debt contraction, but it will bring us one step closer, at least in US, and probably in Europe and Japan as well.
Oil supply may not drop very much, very quickly ( MHIP : as a result of the declining in demand caused by recession ).
If we are lucky, demand will bounce back and bring prices back up, as in 2009-2010.
But with all of the debt problems around the world, it is possible that a contagion will begin, and defaults in one country will spread to other countries.
This is what is truly frightening.

Authored by Gail Tverberg
Beach Villa Brazil
Gail Tverberg is a casualty actuary whose prior work involved forecasting and modeling in the insurance industry.
Starting in 2005-2006, she decided to apply her skills to the question of how oil and other limits would affect the world.
Besides writing on her own blog, Our Finite World, she is also an editor at The Oil Drum.

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