Oil Supply Limits and the Continuing Financial Crisis

Oil Supply Limits and the Continuing Financial Crisis – Unofficial Version

By Gail Tverberg

Published in Energy Volume 37, Issue 1, January 2012, Pages 27-34. Official version available at Science Direct.

Abstract

Since 2005, (1) world oil supply has not increased, and (2) the world has undergone its most severe economic crisis since the Depression. In this paper, logical arguments and direct evidence are presented suggesting that a reduction in oil supply can be expected to reduce the ability of economies to use debt for leverage. The expected impact of reduced oil supply combined with this reduced leverage is similar to the actual impact of the 2008–2009 recession in OECD countries. If world oil supply should continue to remain generally flat, there appears to be a significant possibility that oil consumption in OECD countries will continue to decline, as emerging markets consume a greater share of the total oil that is available. If this should happen, based on these findings we can expect a continuing financial crisis similar to the 2008–2009 recession including significant debt defaults. The financial crisis may eventually worsen, to resemble a collapse situation as described by Joseph Tainter in The Collapse of Complex Societies (1990) or an adverse decline situation similar to adverse scenarios foreseen by Donella Meadows in Limits to Growth (1972).

Highlights

► Reduced oil consumption leads to lower economic growth and less capacity for debt.

► Lower capacity for debt leads to debt defaults, reduced credit, falling home prices.

► Oil supply limits appear to be a primary cause of the 2008–09 recession.

► If world oil supply remains level, more recession can be expected in OECD countries.

► Inadequate demand for high-priced oil is likely to cause much oil to be left in place.

National Geographic - End of Oil

1. Introduction

The future of the world’s oil supply is at this point uncertain. Some observers are concerned about the possibility of peak oil, while others believe that some combination of new technology and improved efficiency will prevent any potential problem. While this latter view is widely held by the public, there is no certainty that such a scenario will come to pass. In this paper, we consider the possibility that world oil supply will not grow significantly above the level that it has maintained since approximately 2005.

Furthermore, we consider the possibility that if world oil supply fails to increase, the growth of the emerging economies will create a shortage of oil that will act as a bottleneck for Organization for Economic Cooperation and Development (OECD) economic growth in the next several years. This hypothesis seems reasonable since Smil shows that moving away from a fossil fuel civilization in less than 20 or 30 years is very unlikely, because of the very long time required for transition from one type of fuel infrastructure to another [1]. Biophysical constraints arising from the loss of fossil fuel energy could also be expected to negatively affect the economic process over the long-term [2]. Given our built infrastructure, oil is one input that is currently needed for economic growth. While there are other requirements, such as appropriate social institutions, technology, and ingenuity that are necessary for growth, lack of oil would seem to act as a bottleneck, even if other necessary factors are present.

While substantial work has been done outlining the connection of energy supply or oil supply with the economy, little work has been done laying out how, in practice, a reduction in oil supply might affect the credit system and the economic leverage it provides. It is the purpose of this paper to make a first step toward setting forth some of these connections. When this is done, there are striking similarities between the attributes of the 2008-2009 recession and the expected impacts of reduced oil supply on economies.

We show that increasing oil supply tends to give rise to economic growth and to conditions that foster the expansion of credit. Economic growth tends to be associated with many other favorable outcomes, including rising home prices, rising stock market prices, and adequate supply of capital. These outcomes play a crucial role in enhancing the positive effects that credit has on the functioning of modern economies. Decreasing oil supply tends to have an opposite effect, leading to economic stagnation or decline and credit restriction, and unfavorable follow-on outcomes, including falling home prices, declining stock market prices, and inadequate supply of capital.

Financial Crisis - WSJ

Because declining oil supply tends to be associated with credit restrictions and economic stagnation or decline, the common belief that oil prices will rise to a very high level in the face of inadequate supply appears to be untrue. Instead, our research shows that the limiting factor with respect to oil supply is likely to be inadequate demand for high-priced oil. Oil prices are likely to rise to a point where they cause recession and credit contraction, and then decline. After a time, they may rise again with economic recovery, only to fall again when they reach the point when the high prices lead to recession. At times, there may appear to be a glut of oil on the market. Oil prices may never reach a high enough level to stimulate extraction from sources that require very expensive extraction techniques or to encourage widespread use of renewable sources of energy.

We show that since 2005, oil consumption of the OECD countries has been declining at the same time that oil consumption of many emerging market countries has been increasing. The effects of reduced oil supply in the period 2005 to 2010 would therefore be expected primarily in OECD countries, and, in fact, this seems to be where recession has been the greatest issue.

2. Reduced oil supply is likely to result in reduced or negative economic growth

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