A year and a bit has passed since Godzilla rampaged down Wall Street and Beaker cowered in the ruins of the City of London. At the time it seemed like the most significant event to have happened in our lifetimes since 9/11. For a few weeks in the autumn of 2008 capitalism seemed to hang in the balance. Serious people talk about the abyss. The FSA monitored cash machine withdrawals on an hourly basis, so fearful was it of a run on RBS. Nothing would be the same again.
And yet, here we are a year on and the most remarkable thing is how little has changed. Bankers are still paid big bonuses. Crappy plastic toys are still shipped from China to a Burger King near you. Amazingly, the almost certain next government of the UK blamed the whole thing on an over-mighty state meddling in the market, which is like blaming the ditch a car drives into instead of the drunk driver sawing at the wheel.
I’m going to have a crack at taking the lid off this in some detail. Was it that the predictions of apocalypse were too strong or have we just mistaken Godzilla for the Bug Blatter beast of Traal and assumed that if we can’t see it it can’t see us, so the fact that the City is not literally on fire means all is well? What was it that caused the crisis? Was it all hocus-pocus securitisation or was something deeper and far nastier at work?
First, some honest to goodness facts.
- in the first quarter of this year the UK economy contracted more than at anytime since the great depression
- the bank bail out has cost the equivalent of £5000 for every man, woman and child in the country
- US unemployment has risen not a kick in the arse off 10% and some people worry the real figure might be nearer to 20%
- A recovery of sorts appears to be underway, but as all the people claiming that also claimed that there was nothing to worry about in August last year I am inclined to take that with a pinch of salt
All this is what us seasoned and sober people like to call Bad Shit.
Now we are a year on, its time to ask the question again: what the fuck happened?
The choke chain and the volcano
In my post last year I tried to explain the factors that went into the near collapse of the financial system. I was absolutely right and absolutely wrong. I was right because all the factors I mentioned, investment banks with far-too-smart-for-our-good people slicing and dicing debt into weapons of financial destruction, their greedy grasping rotten culture, low interest rates caused by increasing Chinese productivity, the sudden loss of faith in the system, they were all there. Together they made a perfect bonfire and last year it burnt viciously. Its still burning.
I was absolutely wrong because I didn’t see that the bonfire was built on top of a volcano and the little flames we’ve seen are caused by its first stirrings.
The volcano is called Mount Peak Oil and if you don’t know about Peak Oil now, relax and take it easy, because you soon will. In my seasoned and sober analysis it gets a special category all of its own: Motherfucking Bad Shit. It one thing I really really hope I am utterly 180 degrees wrong about. Peak Oil theory starts with a simple premise: oil is a finite, fossil fuel and one day it will run out. Like, duh. It gets interesting when it starts to describe how its going to run out and what that will feel like.
The guy who first figured all this out was a geologist in the employ of the Shell Oil Company called M. King Hubbert. Hubbert realised that every oil well follows a curve in its production.
With a classic ‘gusher’ oil well - the kind that still provides most of the oil we use everyday, the first sip of the milkshake is by far the easiest one. Hell, mother nature was actually kind enough to bury the stuff under pressure so it actually squirts out of the ground as soon as we drill down to it. After about half has been pumped out through its own pressure though it starts to get tricky. What’s left is under no pressure at all, so for the pumps to work pressure has to be introduced. The easiest way to do that is to pump sea water into the well, boosting the pressure and forcing the oil out. The more sea water you pump in though the worse it gets because the water and the oil mix and the mixture has what’s called a water-cut - a percentage of the liquid that comes out the top that is just sea water and not oil at all. The emptier and emptier the well gets the bigger and bigger the water cut gets, until what coming out is so diluted that it no longer makes economic sense to continue, basically it costs more than a barrel of oil is worth to force one out of the dirt and the well is abandoned. This process follows a curve. For half of the well’s life production grows and grows, until it hits a peak and then production declines until the well stops pumping altogether. This is true of every well that has ever been found.
This pattern was first predicted by a Shell geologist called M. King Hubbert in 1956. To a chorus of catcalls and boos he claimed that the world’s pre-eminent oil producer, the United States of America, would peak between 1965 and 1970. He didn't factor in the Arabs turning the taps off over Israel, so the US actually peak at the end of his estimate in 1970. The North Sea peaked in 1999. Saudi Arabia? They aren’t saying.
Oil discoveries peak too. The top year for finding new fields was 1965. New fields that we hear about now are both tiny in comparison to existing fields and horrifically difficult to get the oil out of. At the first gusher, at Spindletop in Texas, the oil was buried under a thousand feet of sand. Not exactly easy to get out, but the new field off the coast of Brazil that is getting everyone excited is under 2 kilometres of water, 4 kilometres of rock and 6km of salt. Getting at it is the equivalent of trying to drill through the sidewalk from the top of the Empire State Building using a strand of spaghetti. And after all that effort, at current rates of consumption all the oil in the new Brazilian field will last the world three months. Three months.
What is true for one field is true for them all. If the US peaked, Saudi will peak, Russia will peak, Mexico will peak. The world's production will peak. And of course demand keeps going up and up and up.
What this all means of course is that we’re not going to run out of oil anytime soon, but we are going to run out of cheap oil. In fact, we’ve probably run out of cheap oil. Hell, here we are in the teeth of the worst economic crisis since the second world war and its still seventy bucks a barrel, which was apocalypse money not so long ago.
Here are some more facts:
- the price of a barrel of US crude oil in January 1999 was $16
- nine years later it was $147
Each little incremental increased was explained away; it was speculation, it was some Mexican bandits blowing up a pipe, it was the Iraq war, it was speculation again by those nasty hedge funds. All true. However, the price kept going up and up and up. The real reason is that we’ve run out of cheap oil. The world oil supply has peaked. From now on demand keeps going up but supply will start to fall. The price will go through the roof.
Which brings us back to the credit crunch, great recession, call it what you will. The real cause for the problems we’ve now got is the price of oil. The credit bit was a perfect little bonfire we built which lit when people couldn't afford their subprime mortgages because they were spending too much on oil related stuff - petrol by and large so all the securised debt went up like the fourth of July.
Cheap oil is the reason our civilisation works
The reason this is important is that everything in our modern society with possible exception of the rules of cricket is utterly dependent on oil. Everything we do, everything we consume, everything is in some way a measure of energy. If that energy is cheap, cheaper by miles than it has ever been in history, we’ll can do loads of stuff, stuff that we are going to find harder and harder when the energy price goes up.
Let’s take an example of a city. Let’s take Edinburgh in fact, because I live there and that’s the kind of effort free research this blog is all about. And let’s start in the middle of the city.
The oldest part of Edinburgh is the medieval core - the long rocky ridge that runs from the castle to the Palace of Holyrood house called The Royal Mile by tourists and the High Street by people that get pissed off during the festival. This was all Edinburgh was for a few hundred years; people built towering tenements, burnt witches, got their asses handed to them by the English on a regular basis and threw their shit out of windows. Happy times. They also got their energy from brute muscle power, (their own and their animals) and by burning wood. Not a great deal happened.
In the mid eighteenth century Edinburgh Got Civilisation in a spectacular way. They built the New Town, still perhaps the finest example of the enlightenment applied to building and then invented the modern world. David Hume changed how we think about religion and the nature of reality, Adam Smith invented modern capitalism though he’d do his fucking nut if he saw what people did in the name of the invisible hand now, James Hutton invented geology and worked out the earth was really, really old and so on and so on. These people also relied by and large on muscles and wood and a bit of coal. They made it go a really long way though. The thing to remember here is that most of the food they ate came from down the road and was brought in on horses and carts. The stone for the New Town was also local and was also lugged by a (presumably very over-worked) nag. The glass in the windows was hand rolled. The lead smelted in tiny furnaces. There were exotic things from half a world away, tea and opium and bottles and bottles and bottles of booze, but this stuff came in to Leth docks on sailing ships. Their energy profile was low, the only thing that had changed since medieval times was their minds and their plumbing.
That changed in the nineteenth century though. Thomas Newcomen and James Watt (another local boy) figured steam engines out, used them to pump water out of mines that would otherwise flood and suddenly coal mining was possible on a major scale. Shazam - the industrial revolution. Now, a few other things happened as well to make that possible, I’ll give you that, but the key was the sudden massive increase in the availability of energy and drop in its price.
This made industrialisation possible. Factories made sense. Edinburgh grew another ring, a Victorian, industrial one of tenements for the workers and villas for the middle classes. This was a coal age. The jobs, industrial scale brewing for example in Edinburgh, were made possible by coal, the food came in on coal powered trains, the ships in the harbour were faster and carried goods cheaper and burnt coal in their boilers, the building materials were mined and quarried using coal and occasionally young men got on coal powered ships and sailed off to be blown to bits by coal forged heavy artillery.
Coal is better than wood because it is much more energy dense. Energy density is a simple measure of how much of an energy wallop a set amount of a thing provides. Wood is about 6 Mega Joules per kilo, bituminous coal (the kind used in steam engines) is about 24 MV/kilo and oil, crude oil, is 46.3 MV/kilo.
In the early 20th century we shifted from coal to oil and even-bigger-shazam, things changed again. Energy was so cheap and so easy to move around that it transformed the city.
Look at the modern bits of Edinburgh, or any city for that matter. The most modern parts are utterly, utterly dependent on oil. The houses have parking for two cars and without them no one could get to their work in their out of town business parks or shop at their out of town big box retailers where they can buy an apple for 34p that has been flown in from Chile. Chile! The twentieth century buildings in between the big boxes and executive homes and the Victorian ring are oil dependent too, but it was built for oil in buses, not cars. The cars line the streets, but the housing materials came in on trucks from all over the world.
In other words, you can walk across the part of the city that isn’t built by oil in about 45 minutes. The rest of it, all 400,000 people worth, is a creature of the oil age. That’s what’s at stake when the cheap oil runs out.
My point simply is this. Economic activity is dependent on cheap energy. There is no cheap energy left.
The oil price will go up and down because its very sensitive to fluctuating demand and small supply problems can cause it to spike. The trend is clear though and its up up up. This means that the oil price will act like a choke chain on the economy. The economy grows, so the oil price sky rockets because the cheap stuff has run out, which means people can’t afford oil based stuff, e.g. everything, so the economy collapses and so does the oil price. But it collapses to a higher level than it did the last time. The economy staggers back to its feet and takes another run, the oil price spikes, the choke chain snaps tight and the economy collapses again. This is the pattern I fear we will see over the next few years.
The Tibetan name for Mount Everest is Chomolunga, or Goddess Mother of the World. Our Goddess Mother is Ghawar, the Saudi oil field that is the source and wellspring of most middle eastern oil, and therefore most oil point blank. Its likely that one barrel in twelve is Ghawar oil. Here is Paul Roberts, an energy journalist, writing in 2004:
"On a whim I asked my hosts (Saudi oilmen) about another , older oilfield called Ghawar. It is the largest field ever discovered, its deep sandstone reservoir at one time had held perhaps one-seventh of the world's known oil reserves, and its well produced roughly one of every 12 barrels of crude consumed on earth. In the iconography of oi, Ghawar is the mythical giant that makes most other fields look puny and mortal. . . .
"At Ghawar,' he said, 'they have to inject water into the field to force the oil out,' by contrast, he continued, Shayba's (a newer, smaller, field) oil contained only trace amounts of water. At Ghawar, the engineer said, the 'water cut' was 30%."
"The hairs on the back of my neck stood up. Ghawar's water injections were hardly news, but a 30% water cut, if true, was startling. Most new oilfields produce almost pure oil or oil mixed with natural gas--with little water. Over time, however, as the oil is drawn out, operators must replace it with water to keep the oil flowing --until eventually what flows is almost pure water and the field is no longer worth operating."
Ghawar is at, or near, its peak. The economic crisis that we in the midst of now is likely to be the first of a series of profound shocks that may well end up shattering our economy. The worst thing in my mind is that it may already be too late to do anything about this, but our response right now - attempting somehow to stick the toy back together and carry on as business as usual and that will make it okay - is perhaps the worst thing we could do. This, and some of the things we might be able to do to soften the blows as they continue to come will be the subjects of my next posts.
