Crashing Oil Prices Aren't Due to an Oil Glut But to Demand Destruction and Peaking Credit

Since money is a proxy for energy, energy's limits are putting a damper on credit creation. Could this be the cause for plunging stock markets & oil prices? [part 2/3]

As I began to mention at the end of the first part of this three-parter, I've only just recently come to the conclusion that oil prices aren't going to have a tendency to rise due to the tightening of supply imposed by peak oil, but to depreciate. This of course flies in the face of the common logic of supply and demand, but when factoring in the method by which the majority of our money is created, a deflationary effect can be seen to come into play. This has taken me an absurdly long time to clue into, for although I'd steadfastly amassed a bunch of pieces (various information), I hadn't realized they were actually all part of the same puzzle.

With peak oil and fractional-reserve banking being the first two pieces of this puzzle, the third piece that I needed to factor in (which oddly enough I'd already written about) is the fact that money is a proxy for energy. As I wrote in a previous post, Money: The People's Proxy,

Simply put,... the core function of money is that it enables us to command energy – the energy used to move our bodies with, to power our machines, to feed to domesticated animals whose energy we then use to do work (which nowadays generally means entertaining us), etc. In other words, it might be tough and/or inconvenient, but one can get by without money. You can't get by without energy.

In other words, at their core, our economies don't run on money, they run on energy. Moreover, it doesn't even really matter what you use as your form of currency – coins, pieces of paper, gold, zero and one digibits, conch shells, whatever – because if you don't have the energy to perform the work and/or create the products your society expects, the money is virtually useless and worthless.

Although it would be far too extreme to say that all our economic problems have always had energy issues as their core problem, peak oil (and peaking fossil fuels in general) combined with the fact that money is a proxy for energy, imply, in reverse, a kind of peak to money. In other words, this therefore implies a limit to credit creation. As a result, since private banks create money as debt via the fractional-reserve system and must continually create new loans so that the interest can be created to service previous loans (so that the system doesn't implode in on itself), well, the system is in a bit of a pickle. Furthermore, with oil prices and worldwide stock markets taking a recent hammering, and the situation in Greece and similar countries still a thorny issue, this fermented cucumber seems to be taking shape.

Regardless, none of these core issues and problems are readily recognized (or at least mentioned) by the mainstream media. As Business Insider aptly, yet perhaps a bit daftly, put it (in regards to the current market confusion),

And this is really the crux of the current confusion in markets right now: there is nothing to point a finger at. There is no tech bubble bursting or subprime mortgage market imploding... And so what the media — like, for example, Business Insider — and actual market participants have to go on is to simply say what has happened without being able to say why.

So far, all that's really been stated by mainstream media sources is that we're in the middle of an oil glut, the reasoning ranging from the US's massive increase of fracked oil production the past few years, OPEC's increased output over the past year, and more, to go along with Iran's possible addition to oil markets upon lifting of sanctions. However, this notion of an oil glut is rather dubious for a variety of reasons. First off, global coal consumption is growing at its slowest rate since the Asian crisis of 1998. On top of that, earlier this year the Baltic Dry Index (an index which measures the price of shipping freight rates) hit a 28-year low. Meanwhile, export orders from Chinese factories just fell for an eleventh straight month, with August's activity shrinking at its fastest rate in three years, and which in turn has led to an increased rate of layoffs.

What was once the seemingly endless supply of Chinese plastic toys and electronic gizmos (photo by David Grant)

Those kinds of things don't occur because there's too much oil – the supposed glut – they happen because people are buying less. It is those and other factors then that have some people thinking that perhaps the problem isn't so much an oil glut as much as a lack of demand — otherwise known as demand destruction.

In the past, dips in the price of oil eventually led to their own recovery since demand became enlivened by the new-found cheap prices. However, those were often after geopolitically induced oil-price shocks, while the current situation is more of a geologically induced oil-price shock. That is, for several years now oil has been selling in the rather high-priced $100 range, due to most of the easier-to-access and so cheaper oil having been extracted and produced first. This has therefore left us with the pricier to get at and produce tar sands, deep sea oil, and fracked oil, all requiring higher prices in order for oil extractors to turn a profit. In effect, while oil at $100 enabled drillers and such to turn a profit, it was costly enough for a long enough period of time to price a significant amount of people out of the market, or at least out of a substantial enough part of the market. In fact, it was just announced a couple of weeks ago by the National Employment Labor Project that "average pay in real terms slumped 4 percent from 2009-14."

In turn, the curtailment on demand has contributed to a depression on oil prices, which has then led to massive layoffs of high paying ("It's easy to earn at least $100,000 a year") oil patch jobs – a loss of 100,000 in the US so far, another 900 more in Canada just last week, and so forth.

What looks like an oil glut, acts like an oil glut, but isn't an oil glut? (photo by Joris Louwes)

As a result, this increasing number of consumers on the margins has ended up with less money to spend via loss of access to the more conventional form of credit – jobs – while others are no longer seeking out and/or accepting as much of the credit that banks are desperately trying to dish out — either because people are trying to pay off the debts they've already got, or are waking up to the risks of taking on even more. As the Toronto Star conveys (italics mine),

economic troubles could start to weigh on their [the big Canadian banks] results — if not directly, through higher loan losses, then indirectly, by hurting loan growth and other sources of revenue.

If you're anything like me, then you've probably been receiving boatloads of 0% interest rate credit card offers (with an initial fee of 1% or so on said transfers) from all sorts of banks. In other words, banks are increasingly desperate to get consumers to spend credit so that the debt-spiral doesn't come to a halt and the system ultimately seizes up. Similarly, this is why governments are practicing quantitative easing (QE), to increase "liquidity."

In the meantime, while credit problems on the consumer end of things are posing a problem, the credit situation for the energy extraction and production industries isn't doing all that great either. The Canadian tar sands provides as good of a stand-in for explaining this as any.

Never minding the massive ecological destruction left in the wake of tar sands projects, but because of the massive industrial operation entailed, to earn back enough funds so as to turn a profit they require a relatively high oil price (that is, the high prices that contributed to the insolvency of many of their customers in the first place). With oil prices currently so low, only 450,000 of the 2.2 million barrels of synthetic crude currently being produced are in the black. This has then placed many tar sands companies between a rock and a hard place. For as the Toronto Star also quotes,

The problem is these companies just can’t stop producing. They still need to produce, they need to pay their bills, and they need to ensure their bond covenants are not breached.
One doesn't stop a juggernaut on a dime (photos by Shell)

In other words, with so much money having been sunk in their operations, and with so many bonds having been sold (to go along with all the junk bonds sold by fracking operations, especially in the US), money-losing oil projects must continue extracting to get their bare minimum daily revenues, lest they renege on their payments and go bankrupt.

That being said, some oil producers have hedged their bets through 2015 with a median price of $87.51, and so are making do for now. Nonetheless, with these hedges expiring and debt repayments coming due, producers need to come up with more than half a trillion dollars within the next five years. What happens between then and now is anybody's guess. Are oil drillers and other companies going to be able to restructure their loans and/or access fresh credit if they're bleeding money? Are they going to go bankrupt en masse and get sold off for pennies on the dollar, quite possibly throwing the world economy into yet another bubble-induced recession? Are derivative-exposed banks going to get bailed out yet again after inflating and seeing their second bubble burst in less than a decade?

On the other hand, with low prices being such a problem, it is not possible that some kind of government intervention and/or policies can somehow induce an oil price recovery and save the markets (and, uh, industrial civilization)? Well, as it happens to be, governments did actually do two things last week that made the price of oil increase by 27% in three days. First off, Saudi Arabia announced that it was willing to talk about oil prices. This got the market happy, and so helped prices increase. However, this was essentially just talking up the market since Saudi Arabia was actually saying nothing new, as it had long ago stated that it was willing to engage in a dialogue (for the purpose of curtailing production in line with others, not unilaterally). Secondly, New York's branch president of the Federal Reserve came out hinting that the upcoming interest rate hike that many had expected was likely to be delayed. In effect, the stock markets got another dopamine rush and regained most of their losses, while oil's price concurrently rebounded. However, you can only talk up the markets so much, and for so long.

Similarly, any number of circumstances could cause oil's price to rise, from a well-placed hurricane to an outbreak of war in some relevant part of the world. In reality, guessing oil's prices and movements is ultimately a fool's game, the fools nonetheless getting paid rather handsomely.

Regardless of how this all turns out though, all things being equal, the tendency is now for oil prices to continue decreasing. No longer are we in a cycle of higher highs and higher troughs followed by ever higher highs and troughs, but one of lower highs and lower troughs, bouncing their way down in the opposite direction from the simpleton economics that papers like the New York Times profess: "it boils down to the simple economics of supply and demand."

To close this all off, and to point out a fair enough — and quite relevant — question, does this mean that oil will crash all the way down to $0 and be free? In short, no, and present circumstances can explain. Sure, if governments and bankers decided to just Let The System Be, then yes, the Ponzi scheme would likely go kablooie and implode in on itself, and oil would be $0 — or rather, $N/A. That of course won't be allowed to happen. For as it is, since the credit system is a proxy for the energetic system that industrial civilization maintains, this means that triaging people and nations from the industrial credit machine effectively triages them from the supply of fossil fuels. Supposing that "we" can even afford it, that means that there is less fossil fuels for "them" and more left over for "us" to maintain the operation of our industrial economies and continue living the 21st century fossil-fuelled lives we've become accustomed to (until the triaging hits closer to home, which it already has for some). And the methodology by which all that triaging is enacted is via what we all now know as austerity on the micro scale and Grexits and such on the macro scale.

It's pickling time! (photo by Jacki Gallagher)

As ambiguous as it/they may be, there is however a third option that can be strived for, which I'll get to in part 3.

A former filmmaker, now jawboning on the collapse of industrial civili­s­a­tion and the renewal of culture. .