Sunday, May 2, 2010

Why Your World Is About to Get a Whole Lot Smaller: Oil and the End of Globalization by Jeff Rubin

Rubin argues that the world faces an unavoidable decline in petroleum production, which, coupled with increased demand from rapidly growing economies, will drive the price of oil ever higher and produce a situation where our economy, as currently structured, is unsustainable.

"Once the dust settles from the various crises rocking financial markets, we are looking at the same basic demand-supply imbalance that we were looking at before the recession began. That imbalance took us to nearly $150 per barrel before the recession set in. In the next cycle, the same imbalance will probably take us to $200 per barrel before another recession temporarily knocks back prices and demand."

The author has written a compelling and very readable account of what he believes we face. The first part of the book contains his arguments about declining production and our seeming inability to do anything about it. The second part of the book discusses the implications for our economy and for our lives of this coming stage of oil/energy scarcity. Rubin provides a good discussion of a number of energy related issues including transportation, agriculture and global warming. This second part of his book is actually a good bit more optimistic than the first. It is replete with suggestions for becoming more energy intelligent and energy efficient. One of his more interesting ideas is to impose a carbon tax on ourselves to minimize greenhouse gas production and then to impose a carbon tax on the goods we import. The latter move would in effect be a tariff that would fall most heavily on those countries that continue to produce the most greenhouse gases (read China). In promoting mass transit infrastructure investments he provides an interesting perspective on the role of the auto industry in ensuring that we ended up the greatest gas guzzling nation of all. The author’s chapter "Going Local" makes for interesting reading as he gives us a view of life in an energy/oil limited world. Increases in the cost of oil will increase the cost of transportation enough to curtail the current "globalization" of the economy. This will in turn generate a host of "good" and "bad’ effects on our lives. People will have to depend on their local economies more for food and manufacturing, travel at all levels will become less frequent. Countries that depend most on the global economy will have numerous fundamental problems to overcome.

However, before we plow under our lawns to make space for the gardens that will sustain us perhaps we should ask the question "Is he correct?" The author’s contention that this cycle is inevitable seems to rest on two foundations: the notion of peak oil having been reached and the belief that economic growth demands a certain quantity of energy/oil and therefore increased growth necessarily results in increased demand for oil. The author admits that he is on the wrong side of conventional wisdom with respect to his assumption of peak oil. His discussion of energy/oil usage is laden with suggestions for how greater efficiency is possible but he ends up assuming these efforts will fail, presumably because they failed in the past (at least in our country).

"While we routinely pat ourselves on the back for reducing the amount of oil we burn to produce a dollar of GDP, our economies nevertheless continue to ever more efficiently consume more and more oil, making them even more vulnerable to oil prices.

The fact that we can support a larger economy today for a given level of oil consumption than we could have thirty or forty years ago should be of limited solace to us. The same efficiency paradox that has prevented the average car owner from cutting his fuel bill or the average home owner from reducing her power bill plays the same role in the economy as a whole. Oil per unit of GDP in the US has fallen over 50% since the first OPEC oil shock, but total oil consumption has risen by 20% nevertheless.

The OPEC shocks didn’t wean us off oil. They just prompted technical change that has made us even more leveraged to the stuff. And when we can no longer expand supply, we risk living in a stagnant world economy that may no longer be able to grow. That world, which could be right around the corner, is going to feature a lot fewer drive-thrus, a lot more bicycles and, no doubt, less Atlantic salmon on our dinner plates. In short, it is going to be a whole lot smaller."


The real issue is one of timescale. If supply and demand for oil leads to a controlled and modest increase in price then there could be a few decades before any of the effects that Rubin warns of come into play. The more time you have the more likely it is that technology and changes in lifestyle can come to the rescue, perhaps in ways that cannot be envisaged today.

He argues that spikes in oil prices cause recessions. He implies that the current recession is a result of oil prices rising from $40 to $140 per barrel. His conclusion seems to be that as soon as the global economy recovers the price will go back up to that range again triggering another recession. What has happened thus far is that the price of oil fell to around $40 per barrel and then rose to about $70-85 and has stabilized there—so far. No one seems to be particularly worried about maintaining economic growth at this price, and the prospects for expanding oil production are much better.

Some of Rubin’s assumptions are admittedly counter to conventional wisdom and may be proven incorrect. He implies that the OPEC countries are incapable of manipulating price by increasing output; others assert that the Saudis are growing their output capacity to maintain that capability. Iraq is reputed to have undeveloped oil reserves that could be comparable to those of Saudi Arabia. The author makes no mention of that. Rubin asserts that the Gulf of Mexico will never meet expectations as a source, not because the oil is not there, but because of the difficult environment. DOE and others disagree. Rubin implies that production from oil sands will never be significant and that producers are backing out of the business. Apparently new technology now allows these companies to operate at a profit with oil as low as $60 a barrel and they have renewed their activities in this area. The output from Russian fields is described as falling. More recent data indicates it may in fact be rising.

The DOE has an entity called the Energy Information Administration which provides data and projections of energy supply and demand ( They have a draft report posted that predicts relatively slow growths in oil price and oil consumption out to the year 2035. This is the conventional wisdom that Rubin disparages. One should at least hear both sides of the story.

A useful and readable description of the "conventional wisdom" can be found in an article by Edward L. Morse in the journal "Foreign Affairs" (September/October 2009) "Low and Behold: Making the Most of Cheap Oil." The article discusses petroleum-related politics in general. Some of the discussion related to oil supply is reproduced here.

"Energy Intelligence, a leading market analyst, estimates that the world’s surplus oil-production capacity peaked at around 12 million barrels per day in 1985, was eliminated soon after Iraq invaded Kuwait in 1990 and the United Nations embargoed oil from Iraq, and climbed back up to over five million barrels a day in mid 2002. Until about 2002, the conventional wisdom held that the world was mired in a permanent oil glut and with so much oil around investments to find and develop more of it were too risky."

"Then, in 2002-3 the overhang in production capacity evaporated rapidly and unexpectedly. Some analysts invoked the so-called peak oil theory and blamed the situation on an unprecedented acceleration in the decline of oil production caused by the gradual exhaustion of underground resources. But there are more reasonable explanations for what put pressure on oil supplies. Even those countries with plenty of oil resources suffered political impediments to production that could not easily be removed. Venezuela’s state oil company went on strike in protest against President Hugo Chavez, civil disorder over living conditions in the Niger Delta crippled Nigeria’s oil sector, Iran failed to put in place an investment regime to attract foreign capital, the United States launched a war to oust Saddam Hussein and resource nationalism in Russia and other non-OPEC countries reduced production growth."

"In short order, the virtual disappearance of surplus oil-production capacity jolted the market. The loss of that cushion, which had seemed a fixture for decades, surprised both consumers and producers, not least Saudi Arabia, whose commitment to readily supply the world market is the basis of its political clout both within OPEC and globally. The tightness in supplies exposed the complacency or, rather, the failure of Saudi Arabia and other producers to adequately invest in exploration and the production of crude."

"By 2003-4 Saudi Arabia was concerned. It responded by raising production: from 7.5 million barrels per day in 2002 to 9.2 million barrels per day in 2003. After a dip in 2004, it produced close to 10 million barrels per day in 2008....Huge production expansions, including a new field that opened in June and can yield one million barrels a day, have raised capacity to 12.5 million barrels per day. Another one million barrels per day of potential capacity is on standby, meaning that it could be developed in 12-18 months. And because of Saudi Arabia’s efforts to increase its production capacity, OPEC’s total production capacity could exceed 37 million barrels per day in 2010. This would be a record level: five million barrels per day more than in 2002 (before the strike in Venezuela) and more than ten million barrels per day above today’s level."

"In fact, there are plenty of deep-water resources waiting to be tapped—in the Gulf of Mexico; off the coast of Brazil; in the eastern Mediterranean; in the gulf of Guinea; in the Caspian Sea; off the shores of India, China, Indonesia, and Australia; and along the shores of Arctic-bordering states (the United States, Canada, the United Kingdom, Denmark, Norway and Russia)—and oil companies spent increasing sums to do so.....If there was an obstacle, it was not a lack of hydrocarbon reserves—deep-water resources appear to be even more abundant than was thought a decade ago—but a lack of equipment to discover and produce them. Fewer than two dozen drilling vessels (each costing $1 billion) were available in 2000. But as contracts were put in place at the time of very high oil prices, the fleet of vessels started to expand. By 2012 there should be close to 150 such units available for finding and developing deep-water resources."

"But by mid-2009 non-OPEC output was surprisingly robust. At midyear, the International Energy Agency was projecting growth in the output of non-OPEC countries, and the Department of Energy was also projecting an increase. Russia’s output could rise by 200,000 barrels a day this year rather than falling by 600,000-700,000 barrels a day, as many had forecast at the end of last year."

"Executives at the U.S. energy company ExxonMobil and the Canadian firm Suncor Energy say that the costs of developing oil sands have dropped so much that their companies are going ahead with large projects they had postponed until now—projects that, combined, should provide 300,000 barrels per day of new output by 2012. Last year, these projects would not have been viable with the price of oil at less than $90 a barrel. Today they make sense with oil at $60 per barrel."

Morse also has some interesting comments on the demand side in future years. Not surprisingly, he is more optimistic than Rubin in anticipating reductions in demand.

"Countries with historically high demand growth, especially, have experienced unexpected and sharp drops in demand. For example, Japan’s oil appetite was growing at a sustained rate of ten percent a year before 1973, when global oil prices spiked, and South Korea’s demand growth was at double-digit levels before 1998, when the effects of the 1997-98 Asian financial crisis began to be felt. Japan has never again exceeded its pre-1973 oil needs, nor South Korea its demand of pre-1998."

Morse presumably had other motives for his article, but he ends up providing an alternate and contrary take on all of Rubin’s assertions concerning near-term oil supply and long-term demand. It will be interesting to see who is more correct. Hopefully global economies will come roaring back and one will know in a year or so.

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