Aeldric's World Without Oil Space

 

(Or: Why I am looking for a defensive Super Fund.)

 

Well the Peak Oil game is over. It is time for me to post something serious. So I am thinking about my Superannuation and how investments are likely to do in the economic conditions ahead....

 

I am on record (in an article in The Australian newspaper, about 18 months ago) as saying we can expect a boom, followed by a severe bust. The bust will be comparable with The Great Depression, or alternately, with Russia after the collapse of the Soviet Union. My estimate for the length of the boom was 10 years, but I have since revised that down a little. There are three causes for the downwards revision: Firstly resources are tighter than I thought (a lot of proven reserves have been revised downwards recently), secondly  "above ground" political factors are moving faster than I thought and finally, but most importantly, I failed to factor in the rather obvious fact that demand destruction occurs in non-exporting countries first (exporters service their own market first, then export the excess).... and the sources of the boom (China, India, to a lesser extent the US, etc) are net resource importers, not exporters, so they are likely to suffer from this effect (at least somewhat).

 

However, as a resource exporter I think Australia is well positioned to weather the bust. 

 

My supporting argument is based on this premise:-

Resources (led by oil and gas) are becoming expensive. While there is still a lot out there, the "low hanging fruit" is gone. As a result, we are seeing the demand curve diverge slightly from the supply curve and this is driving the increase in resource prices across the board.

 

The consequences are this:-

Countries with excess resources tend to consume their own resources and only export the excess. So when the demand curve diverges from the supply curve for a given resource the need of the exporting country is met first and the countries without the given resource tend to suffer disproportionately, as they only get the leftovers. Obviously, this is a simplification, the market does tend to balance things by escalating the price, but if the local market can pay (which they probably can, since they are getting a good price for their left-over resources) then the local market will be serviced first.

 

Oil production was steady last year (at around 84+ million barrels a day), but oil exports dropped by about 1% - despite record oil prices and thus a record incentive to export.  

 

Conclusion:-

I suggest that this drop in exports was caused by the fact that oil producing nations serviced their own market first and had no capacity to service the importing nations at the level demanded (hence the huge increase in oil prices as supply and demand diverged).

 

If there is a gap between the supply and demand curves, then the drop in exports that started in January 2006 is a symptom of this problem. The slope of this graph is tiny - there is slightly more than a 3% per year difference between the historic growth trend (upwards 2%) and the export trend in 2006/2007 (down 1%) , but the implication is profound. Instead of demand being met by increased exports,  substitution must occur to supply the demand increase, and a compounding 1% destruction in demand must be found each year to cover the decline in exports.

 

The pattern seems to be that substitution is covering the increase in demand by developed countries (using ethanol, LPG, etc), while the reduction in exports is being met by demand destruction in impoverished nations.

 

The trend could be simplified by assuming that the use of ethanol and LPG will increase by 2% each year in the years to come (this is perfectly in line with George W Bush's call for "20% ethanol by 2010") and another fragile nation implodes each year to cover the 1% decline in exports. A nice, neat solution. However this simplification is unlikely to be reflected in reality.   

 

This geographic demand destruction is a complication that I did not originally consider:- despite globalisation, the world can't be treated as one discrete market.

 

As an example:- As any economist can tell you, demand destruction occurs as prices rise. This demand destruction is happening already (at least for oil), but only in some geographic areas. If you live in Australia, you get a bit miffed at paying $1.30 per litre, but it has little impact on your habits. But if you live in a country that is already marginal (due to bad government or whatever) a tripling in the price of a barrel of oil leads to complete destruction of demand. People substitute or do without. This is currently occurring in several African nations (and to a lesser extent in parts of Asia and India).

 

People in Zimbabwe in particular have gone almost completely without oil for the last few months (the government there is particularly incompetent, making their economy very marginal). This complete demand destruction will probably lead to some African nations collapsing, as industry is unable to continue in these countries without oil, and without oil for transport food is simply not making it onto the shelves in the cities. We perceive the cause of this collapse as bad government (and it is), but it is worth noting that with the tripling of the cost of a barrel of oil, complete demand destruction is starting to occur in locations made fragile by local factors. 

 

Many other resources are showing similar rises in price, and substitution is occurring for many of them. However most non-energy resources (eg copper) are qualitatively different from oil. Resources  such as copper are not consumed when they are used. So, as copper (or any similar resource) goes up in price it becomes attractive to pull it out and re-use it more profitably somewhere else. This ability to re-use the resources elsewhere makes it possible to strip resources of this type from the infrastructure of an impoverished or failed nation and add them to the infrastructure of a wealthy nation.  Resources such as this are also obvious targets for theft - It is impossible to guard a thousand kilometres of copper power line. If the price of resources goes up far enough, infrastructure is likely to be threatened, particularly in less wealthy nations. The economic implications of constant infrastructure breakdown are obvious.

 

Even in wealthy nations, if the price of these resources keeps rising, our infrastructure is likely to be subject to disruption due to theft.

 

So demand destruction occurs in a geographically staggered sequence, with the most marginal areas suffering from demand destruction first. Where the country affected is already marginal, that country collapses.

 

Each year another 1% in demand destruction needs to occur. My prediction would be that this would lead to a series of rolling collapses of the world's more seriously "failed states". Where the nation is not marginal, substitution or "making-do" will lead to a depressed economy for a while, then ingenuity will (I presume) lead to a new, robust economy based on new techniques and technologies.

 

So my prediction would be that a truly global collapse of the economy will not occur (despite the Malthusian predictions to the contrary), but that a rolling series of problems could cause a sustained economic downturn. This will culminate when the economic drivers of the boom (China, India, etc), who are net resource importers, are constrained by resource unavailability. This constraint will be obvious to net exporters, thus mitigating somewhat against the constraint, as exporters will be motivated to find ways to export to the drivers of their economy. 

 

Eventually, new drivers will emerge. The new drivers will probably not be nations, the drivers will emerge from new energy technologies.

 

This emergence may be complicated by some problematic economic precursors: the asset bubble, the US deficit, the demise of the "petrodollar" leading to the demise of the $US as a unipolar fiat currency, while simultaneously we have the demise of the US as a unipolar world superpower (and the rise of China and resurrection of Russia),  etc. These factors are significant because they can cause some economic hiccups in the near term. These hiccups are problematic because while (as you say) substitution is a possible approach when resources are constrained, there is a problem - substitution frequently requires different (or extra) infrastructure. If the economy is suffering from a series of hiccups, then investment in infrastructure is difficult. This creates another constraint to growth further down the road (as infrastructure of this type often has a 5-10 year lead time).

 

These constraints can (and will) be overcome. But if these events occur, then we can expect a very rocky road for a number of years before the solutions arrive.

 

Hence, I want to be financially insulated against this possibility. There are three final obstacles to prediction:

1. Anybody who thinks they can predict outcomes ten years from now needs to increase the dosage of their medication.

2. Other people can predict too and this changes the outcome, frequently shortening timeframes (due to the "self-fulfilling prophecy" effect).

3. Specific political responses to resource constraints appear to be emerging. The US appears to have decided that controlling some Middle East oil is a good risk-management strategy - but this may have backfired, accelerating the problem rather than solving it. Meanwhile Russia is ramping up rhetoric. Associated with the hawkish rhetoric are some internal changes in Russia that look a lot like a move to extreme Nationalism, or even overt Fascism. Both China and Russia are modernising their armed forces and equipping them with technologies that may negate the US technological advantage. Both Russia and China are extending the borders of their claimed territory to include resource-rich areas. Other nations are disputing these claims. If this trend continues and deteriorates into localised belligerence or limited war (direct or by proxy), then it is really hard to guess where this will lead. In Australia, the effects may be limited. It might even be good for Australia.

 

So, to summarise the model:

 

1. We face resource constraints due to the emergence of developing markets combined with increased difficulty in extracting resources (most of the low hanging fruit has been harvested).  This has led to a slight divergence between supply and demand, which in turn has driven prices for resources up.

2. As this divergence of supply and demand proceeds, the resource constraints are likely to disproportionately affect net resource importers.

3. Sadly, the drivers of the current economic boom are net resource importers.

4. For this reason, resource constraints represent economic constraints as the resource constraint constrains the source of the economic boom.  (However, for reasons of pure self-interest, the exporters are likely to search for ways to support exports to the nations that are drivers of the economic boom, so this problem will be somewhat mitigated.)

5. These economic constraints do not effect everywhere equally. The first impacted areas will be the most marginal economies. The next affected areas will be the nations that are net importers that do not drive the economic boom (the non-boom nations get lower priority for imports).

6. Because geographic areas are impacted sequentially, a global breakdown won't occur (despite the doomsayer's predictions), but a sustained downturn is possible as a result of economies sequentially suffering from a downturn.

 

Oh.... and the final bit of the model:

7. If resource wars become widespread, all bets are off.

 

Is the model flawed? Yes. Because I have not talked about the people that need to die as part of “demand destruction”. And I am not going to. It depresses me.

 

  

I haven’t had time to do much outside of work, but as a result of spending way too much time at work I have a piece of news.

 

I guess it would not surprise you if I told you that we have some consultants in Saudi Arabia and Iraq? (Obviously, we have consultants everywhere.)

 

The teams from Saudi Arabia and Iraq got to talking while they were at a conference in Sydney. I won’t divulge everything that was said, but here is what is rumoured to have come out of that conversation:
- Iraq’s giant oilfield in Kirkuk was damaged during the Saddam Hussein era. Unsustainable practices were used to force high flow rates. As a result, the total amount of recoverable oil from the field has been cut by a factor of 2 – or possibly even 3. Shell technicians are studying the problem. Flow rates probably cannot be increased. We have been asked to examine the economic situation. Iraqi oil was meant to pay for Iraq’s reconstruction. But this is impossible - because the flow rates that were assumed before the invasion will never be achieved.
- At the same time all is not well in Saudi Arabia. Their biggest fields have been yielding oil at high flow rates for decades. High flow rates were maintained by using enhanced extraction techniques. Using these techniques it has been possible to suck 63%-72% of the oil out of these fields at ever-increasing flow rates. But now these fields are suffering from depletion, and the flow rates are dropping.

 

So flow rates from two big fields are dropping. What does this mean I hear you ask? Well flow rates are also dropping in virtually every other major field. Saudi Arabia was the area that was meant to make up the difference. Iraq was meant to help.

If the rumours are true, it is official - oil production has peaked and the decline is going to be faster than was expected, possibly as much as 5% per year.

 

Once the analysts got together and realised what this might mean, the word got around pretty quick. A lot of position papers and white papers are being written. Nobody seems to be certain what to do next, but.. .. is it significant that a lot of the guys doing analysis are going online to buy land and shotguns?

 

Latest Actions.

In my Blog entry on Security (http://aeldric.spaces.live.com/blog/cns!A859FF3D2F2384E4!118.entry ) I mentioned that I have ended another planning cycle, and I need to act.

That was all talk; action has been difficult, because I have to fit action in around work and work is pretty full-on at the moment. This is not a good sign – I work for one of the “Big 4” accountancy firms. When other companies get in trouble, they call us. A lot of companies are finding it hard to cope with a sudden doubling of fuel prices; it looks like some will go under. I don’t deal direct with these companies, but work tends to flow on.

Anyhow, work on my Peak Oil projects has been confined to a couple of lunchtime shopping expeditions and a little work in the garden on Saturdays.

Shopping for the Peak.

I mentioned in my post on being a member of a survivor community that I wanted to develop my ability to contribute to a trade-based economy (http://aeldric.spaces.live.com/blog/cns!A859FF3D2F2384E4!118.entry ). Getting that sorted out was the goal of my shopping trips last week.

First, I wanted to buy some jars for the jams I hope to make. But I don’t want to spend much money. I’ve got two dozen jars (for $44), and another two dozen big 1 litre resealable tins cheap – at $10 for the lot).

Next, I wanted to get bottles for home-brewed alcohol (again, made from the numerous fruit trees I’ve planted). I got two dozen screw-top wine bottles, and another five dozen cheap plastic bottles for home-brew cider. That cost me more than I wanted to spend, so I’ve told my friends to save their wine bottles for me. Some good news: I’ve got a friend who is giving me a couple of 300 litre fermentation vats free!

The last thing I was thinking of getting is some extra ammunition. But there I got stuck. In Australia guns and ammunition are hard to get, and expensive. I have the necessary licenses, so buying the ammo is not a problem, but I am not sure that I want to spend so much money. Sure, work pays me well, but each pay packet seems to vanish quickly - is more ammo the best use of my money? I am considering buying some reloading equipment, so that I can reuse brass cartridge cases, rather than just throwing them away. For the moment, I just don’t have time to deal with this.

Forming a Trading Community

I have been communicating with someone that I will call "G". It may be that if the worst happens, then we will be trading partners, we will see. We seem to have a lot of things to trade, and he seems to be trustworthy, and nearby.

Off to work. Need dollars to fund my post-peak preparations.

Peak Oil Gardening 1.

 

In future posts I will talk about some of the tips and tricks for gardening in your back yard, but in this post I want to talk about the most important step: Plan your garden for the future – have a “Post Peak” strategy.

 

I started my garden a year ago, and my plan was to have crops for personal consumption, and other crops for trading. I think that I will probably be able to sell any food crop post peak, but to really maximise value it would be good if my “trade crops” are different from everybody else’s. And even better if it was something that everybody wants.

 

My theory about Peak Oil is that once people realise that things aren’t going to get better, everybody will plant a vegetable garden. If I only plant peas and beans and tomatoes and carrots in my garden, then I have exactly the same stuff as everybody else.

I talk in my blog entry on “Being a Member of a Survivor Community” (http://aeldric.spaces.live.com/blog/cns!A859FF3D2F2384E4!118.entry ) about my plan to be a contributing member of a trading community. I only have my back yard to grow things in, so I need to maximise the value of my trade goods. I needed to figure out what I can offer that everybody wants and not enough people will grow.

 

The average vegetable patch has peas, tomatoes, beans, lettuce, etc. For non gardeners - these are known as “annual” crops. You plant them, water them and then harvest them a few months later. Then you have to plant again next year. This is great if you need a quick harvest, but since everybody concentrates on these quick-yielding crops, it means that everybody has similar stuff in their vegetable patches.

 

The perennial crops, on the other hand, are pretty rare in the suburbs. This is strange, as perennial crops need much less work than annuals, because you plant them and they yield a new crop every year.  Fruit trees are an example.

 

It takes 3-5 years to get fruit from a fruit tree and almost that long to get a yield from most other perennials. When things get critical, people aren’t going to plant crops that yield in 3-5 years, they are going to plant crops that give an immediate result. So I figured that perennials aren’t just less work, they will give me crops that are different from everybody else.

 

So I went down to the nursery a year ago and bought 25 fruit trees and vines. Even discounted to $1,000 because it was a bulk purchase, that purchase hurt – but not as much as the $4,000 that I spent on water the tanks and drip irrigation system that keeps them alive!

All of the fruit trees were at least 1 year old when I bought them – you can get them older, but you will pay more. Mine are two years old now and some of them are yielding tiny amounts of fruit already. Next year will be a little better, and three years from now, I should have fruit by the bushel.

 

In addition to fruit, people like herbs and spices. So I have mint, parsley, chilli bushes, curry plants, wild ginger, and a bay tree - none of these are annuals. I also have other perennials such as an almond, perennial runner beans, artichokes, asparagus and some bell peppers.

 

Sure, I have a permaculture garden with annuals (peas, beans etc), but that is for eating, not for trade.

 

Focussing on perennials rather than annuals is not the only thing I did to ensure maximum return when I traded the crop. History shows that prior to green houses and air-freighted foodstuffs, people were always interested in two types of food:
- Food in winter, particularly tasty and varied food
- Alcohol 

 

So my strategy is to do a little value-adding as well. I will:
- Ensure that some of my crop can be fermented. I am growing apples and pears (four trees - two trees of each)  for cider - and grapes (5 vines) for wine. I have fermentation vats, yeast and some sugar to give it a little extra alcoholic kick.
- Grow food that can be dried, or turned into jam for winter.  I have a hundred kilos of sugar and a couple of packets of pectin for jam, and I have a solar drier. Any excess fruit that doesn’t end up as alcohol will end up in jam, or as dried fruit strips.

 

As I have mentioned elsewhere, I also breed fish (the big, edible kind) in an aquaponics setup (aquaponics is a system that uses the fish wastes to feed the vegetables) and I’m hoping to breed Guinea Pigs. In my youth I was pretty good at smoking meat – I could definitely smoke Guinea Pigs to produce a very nice meat. I’m not sure that I would dare smoke fish (too easy to kill someone if I make a mistake), so I might sell live fish.

 

So there it is. I have about 300 square meters of back yard (large but not uncommonly so).

In it I have:
- A vegetable patch big enough to give us all the annual vegetables we need
- A vegetable patch for perennial vegetables, herbs and spices
- 25 fruits (trees and vines)
- A 3,000 litre fish tank
- A composter and worm farm

A

nd there is still room for a BBQ, an outdoor entertainment area, and a flower garden (granted, most of the flowers are edible).

 

Some lessons I have learned:

- Have a post-peak strategy. Will you try to be entirely self-sufficient, or will you use your garden for trade?
- You will need to find ways to pack a lot of diverse plants into the smallest possible area - research permaculture and bio-intensive gardening.
- If you want to be self sufficient, you will probably need to pack a lot of calories into a small area. Check out potatoes and sweet potatoes – as they are very good in terms of calories per square meter. Also check out PeakProphet on the subject of potatoes.
- It you are aiming to trade and you want to get some fruit trees in, you can cheat by buying mature trees from the nursery – you will get your first crop soon after you buy them.
- Buy compost, manure, organic pellets, blood and bone fertilizer, and anything else you can think of now. A bag of fertilizer now is a year of rich crops later.

 

I will enlarge on all of these thoughts later, but right now it is time to go to work.

 

 

Euroa is one of the big rural communities in my state.

Euroa ran out of water yesterday. Why? Because of high oil prices.

Australia has suffered climate-change drought for 5 years now. For months Euroa has depended on water trucked in from Seymour. When the price of oil went up, the trucking company discovered that they could not afford to honour their contract and so they asked to re-negotiate the contract to accommodate the higher price of oil. The Water Authority replied that their budget for this year did not allow them room for a re-negotiated contract.

So yesterday the people of Euroa woke up and turned on their taps to find that they had no water. The trucking company has declared that it is insolvent – unable to meet contracts at the current price of oil, and unable to re-negotiate - so it has gone out of business.

Today people in Euroa are talking about leaving the town. But Euroa supports all the surrounding farming communities. What will the farmers do? Who knows? After five years of climate-change drought, a lot of the farmers are ready to walk off the land. Maybe this will be the final straw and they will walk out.

Imagine a major rural town without a drop of water. That is Euroa.

The knock-on effects of higher oil prices are already being felt.