Tuesday, November 4, 2014

The Oil Crash: it is happening now!

James Schlesinger said once that humans have only two modes of operation: complacency and panic. This bimodal kind of functioning seems to be applied also to the oil market, where everything is judged on the base of a simple binary rule: high prices: bad; low prices: good. So, with oil prices falling rapidly during the past few days, the general attitude seems to be mostly of rejoicing. All worries about peak oil are being swept under the carpet and SUV owners seem to be happily expecting the fall of gas prices that will allow them to fill up their tanks on the cheap.

Unfortunately, the bimodal perception of the world makes people blind to the fact that nothing happens in isolation in the world. It is the basic law of complex systems: you can't do just one thing. If something changes in a complex system, it is because something else has made it change. And if something changes, then something else will have to change. Complex systems work in this way. And changes are unavoidable and not always for the good of those experiencing them.

That's true also for the crude oil producing system, which is not an isolated system. Changing some of its features reverberates all over the world. So, bringing down oil prices has an effect on other parameters. Look at this figure (from an article by Hall and Murphy on The Oil Drum)

Of course, these data are to be taken with some caution - they are only estimates. But there are other, similar, estimates, including a 2012 report by Goldman and Sachs where you can read that most recent developments need at least 120 $/barrel to be profitable. So, you see what is the problem? Prices under 80 $/barrel destroy the profitability of about 10% of the oil presently produced. If prices were to go back to values considered "normal" just 10 years ago, around 40 $/barrels, then we would lose around half of the world's production. Anyone saying "peak oil"? Well, yes, this is the mechanism that generates peak oil: an irreversible decline of the world's oil production. But it is not just a question of reduced oil production: if oil demand collapses, then the whole world plunges into deep recession, as it happened already in 2009, when prices briefly collapsed down to about 40 $/barrel.

Maybe this is just a temporary fluctuation; maybe things will go back to "normal" in a few months. After all, the market worked some magic during the past 4-5 years that kept oil prices high enough to generate profits high enough to make the industry able to keep producing at the usual levels (and even increase them a little). And these prices seemed to be not so high to destroy demand (not too much, anyway). But, in the long run, it is a no-win game. Depletion makes extraction progressively more expensive and not even the mighty market can work the magic needed to keep selling something that customers can't afford to buy. The oil crash takes time to unfold, but it is happening, and it is happening now.

Ugo Bardi teaches at the University of Florence, Italy. He is a member of the Club of Rome and the author of "Extracted, how the quest for mineral wealth is plundering the planet" (Chelsea Green 2014)


Ugo Bardi is a member of the Club of Rome, faculty member of the University of Florence, and the author of "Extracted" (Chelsea Green 2014), "The Seneca Effect" (Springer 2017), and Before the Collapse (Springer 2019)