Oil, gas, and the investment sinkhole problem

In some real sense, because of the sinkhole investment phenomenon, we are getting less and less back for every dollar invested (and every barrel of oil invested). This phenomenon as applied to energy resources is sometimes referred to as declining Energy Return on Energy Invested.

Our Finite World

Gail Tverberg, an actuary with a background in math, analyzes energy and financial matters from a perspective that the world has limited resources. For more of Gail's posts, click here.

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  Graphic: Figure 1. Comparison of 2005 to 2011 percent change in real GDP vs percent change in oil consumption, both on a per capita basis. (GDP per capita on a PPP basis from World Bank, oil consumption from BP’s 2012 Statistical Review of World Energy.)
  (BP)

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  Graphic: Figure 2. Total primary energy consumed per capita, based on BP’s 2012 Statistical Review of World Energy data and population data from EIA.
  (BP/EIA)

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  Graphic: Figure 3. World oil supply with exponential trend lines fitted by author. Oil consumption data from BP 2012 Statistical Review of World Energy.
  (BP)

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  Graphic: Figure 4. Two views of future economic growth.

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As discussed above, world oil supply in recent years is quite close to flat (Figure 3). The flat supply of oil is further reduced by the additional oil investment required by sinkhole projects, such as the ones Saudi Arabia is undertaking. Also, there is a tendency for the developing world to attract a disproportionate share of the oil supply that is available, because they can leverage its use to a greater extent. Both of these phenomena lead to a shrinking oil supply for OECD countries.

The combination of shrinking OECD oil supply, together with the need for oil for many functions necessary for economic growth, leads to a tendency for the economies of OECD nations to shrink.  It is hard to see an end to this shrinkage, because there really is no end to the limits we are reaching. No one has invented a substitute for water, or for unpolluted air.  People talk about inventing a substitute for oil, but biofuels and intermittent electricity are very poor substitutes. Often substitutes have even higher costs, adding to the investment sinkhole problem, rather than solving it.

Where we are now

When resource prices rise, the impact is felt almost immediately. Salaries don’t rise at the same time oil prices rise, so consumers have to cut back on some purchases of discretionary goods and services. The initial impact is layoffs in discretionary sectors of the economy. Within a few years, however, the layoff problems are transformed into central government debt problems. This happens because governments need to pay benefits to laid-off workers at the same time they are collecting less in taxes.

The most recent time we experienced the full impact of rising commodity prices was in 2008-2009, but we are not yet over these problems. The US government now has a severe debt problem. As the government attempts to extricate itself from the high level of debt it has gotten itself into, citizens are again likely to see their budgets squeezed because of  higher taxes, lay-offs of government workers, and reduced government benefits. As a result, consumers will have less to spend on discretionary goods and service. Layoffs will occur in discretionary sectors of the economy, eventually leading to more recession.

Over time, we can expect the investment sinkhole problem to get worse. In time, the impact is likely to look like long-term contraction, as illustrated in Scenario 2 of Figure 4.

Is there an End to the Contraction?

It is hard to see a favorable outcome to the continued contraction. Our current financial system depends on long-term growth. The impact on it is likely to be huge stress on the financial system and a large number of debt defaults. It is even possible we will see a collapse of the financial system, or of some governments.

In a way, what we are talking about is the Limits to Growth problem modeled in the 1972 book by that name. It is the fact that we are reaching limits in many ways simultaneously that is causing our problem. There are theoretical ways around individual limits, but putting them together makes the cost impossibly high for the consumer, and places huge financial stress on governments.

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