"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Wednesday, February 9, 2011

Peak Oil and Wikileaks: Serious Concerns About Saudi Arabia's Reserves

I want to begin this post with a repost of an article I wrote last September, 2010, The Inextricable Relationship Between Energy and Money:

Modern civilization is based on the continued growth of what I call the "Trinity" of money, credit, and energy.  Credit, of course is what drives money.  Money is lent into existence, that is, one man's loan is another man's savings.  The two can not be separated.  Savings cannot be created without someone, somewhere in the system, taking on debt.  This applies to individuals, corporations, and governments.

So what of energy?  Energy is the real world, tangible engine of growth.  Energy feeds us, it transports us, it builds things, in essence, it IS the economy.  Money is what we use to measure our progress, to allocate resources, to "keep score" so to speak.

Without a constant, affordable supply of energy, balance sheets, budgets, asset valuations - all get affected.  If you think of an economy as a system of inputs and outputs, energy is the greatest input that creates wealth.  But energy is not free.  It takes energy to extract energy - i.e. coal, oil, gas, etc...

And just as a monetary system needs to grow to survive, so too does the supply of energy need to grow to allow the monetary system to grow.  And that supply of energy doesn't just have to grow, but it has to grow at best, at a constant cost.  That is, if the cost of extracting energy rises, then that impacts the ability of the money supply to grow.

Think of it this way.  I have an investment.  At first, for every dollar I sink in to that investment it yields me $1.50 - I'm doing pretty well.  But what if, over time, there is a diminishing rate of return?  What if I only receive $1.25 for each dollar of input?  Or less?

That is what is happening to industrial civilization today.  It is taking more energy to produce energy.  The easily accessible oil and natural gas is diminishing, and we are now extracting more difficult sources of energy.  And on top of that, there are billions of more people in the world today that want that industrial lifestyle, and hence, need the same energy usage.

So what does that do to a monetary system based on irredeemable currency, born of credit?  How does that impact future growth?

The US Department of Energy commissioned Scientist Robert Hirsch to produce a report that was published in 2005 titled "Peaking of World Oil Production: Impacts, Mitigation, and Risk Management."  Here is the REPORT.

Robert Hirsch was recently interviewed by Matthieu Auzanneau, Oil Man (blog), Le Monde,  to discuss his upcoming book, and how his  2005 report and conclusions have been handled by various US government officials.

Here's an excerpt:
oil man:  What should we expect, before the world is able to catch up with the ‘peak oil’ issue ?
Hirsch:  From a world standpoint, Growth Domestic Product will decline every year for over a decade, and could easily be down 20 or 30 % over this period of time. That’s what I mean when I say « catastrophic ». 
Wherever you live, somebody has to get food to you. And modern farming is run by oil, because the tractors that plow the ground and plant the seeds, and do the harvesting, run on oil. And then you have to transport the food to some kind of processor, and from there to the consumer.
From Part II of the interview:
oil man: - What happened after you published your 2005 report on ‘peak oil’ for the US Department of Energy (DoE) ?
Hirsch: The people that I was dealing with said : « No more work on peak oil, no more talk about it ».
oil man: People that were high in the administration hierarchy?
Hirsch: The people that I was dealing with were high in the laboratory level. They were getting their instructions from people on the political side of the DoE, at high levels. After the work we did on the 2005 study and the follow-up of 2006, the Department of Energy headquarters completely cut off all support for oil peaking and decline analysis. The people that I was working with at the National Energy Technology Laboratory were good people, they saw the problem, they saw how difficult the consequences would be – you know, the potential for huge damage – yet they were told : « No more work, no more discussion. »

From the article:
The US fears that Saudi Arabia, the world's largest crude oil exporter, may not have enough reserves to prevent oil prices escalating, confidential cables from its embassy in Riyadh show. 
The cables, released by WikiLeaks, urge Washington to take seriously a warning from a senior Saudi government oil executive that the kingdom's crude oil reserves may have been overstated by as much as 300bn barrels – nearly 40%. 
The revelation comes as the oil price has soared in recent weeks to more than $100 a barrel on global demand and tensions in the Middle East. Many analysts expect that the Saudis and their Opec cartel partners would pump more oil if rising prices threatened to choke off demand. 
However, Sadad al-Husseini, a geologist and former head of exploration at the Saudi oil monopoly Aramco, met the US consul general in Riyadh in November 2007 and told the US diplomat that Aramco's 12.5m barrel-a-day capacity needed to keep a lid on prices could not be reached. 
According to the cables, which date between 2007-09, Husseini said Saudi Arabia might reach an output of 12m barrels a day in 10 years but before then – possibly as early as 2012 – global oil production would have hit its highest point. This crunch point is known as "peak oil".
The article continues:
One cable said: "According to al-Husseini, the crux of the issue is twofold. First, it is possible that Saudi reserves are not as bountiful as sometimes described, and the timeline for their production not as unrestrained as Aramco and energy optimists would like to portray." 
It went on: "In a presentation, Abdallah al-Saif, current Aramco senior vice-president for exploration, reported that Aramco has 716bn barrels of total reserves, of which 51% are recoverable, and that in 20 years Aramco will have 900bn barrels of reserves. 
"Al-Husseini disagrees with this analysis, believing Aramco's reserves are overstated by as much as 300bn barrels. In his view once 50% of original proven reserves has been reached … a steady output in decline will ensue and no amount of effort will be able to stop it. He believes that what will result is a plateau in total output that will last approximately 15 years followed by decreasing output." 
The US consul then told Washington: "While al-Husseini fundamentally contradicts the Aramco company line, he is no doomsday theorist. His pedigree, experience and outlook demand that his predictions be thoughtfully considered."

So what to say of this?  Much of the Western world is bogged down in a debt or currency crisis,  and only strong economic growth can avert such crises.  If Peak Oil is indeed happening, it will become much more costly for economies to grow.  As I have said before, cheap energy is needed to sustain a certain level of economic growth.  After all, energy is a cost that affects everything, and as this cost rises, so too does the price of everything else.  If your state, or city, or country, or even business or household has a certain level of debt that needs to be serviced, any energy cost increases affect the ability to manage that debt.  It's as if the interest rate on all your loans suddenly rises.

And if you really think about it, all the balance sheets in the world, all the loans made out to all types of entities - government, corporate, individual, function under an implied assumption: that energy costs will remain stable.  A sudden rise in energy costs would have catastrophic effects on governments and economies worldwide - and ultimately, the debt based currency system we use today.

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