I have been having a long- distance  dialog with Peak Oil analyst Michael Lynch. He is a notable establishment figure who maintains there is no effective shortage of fossil fuels.

The first installment was not really Lynch’s but the ‘Whistleblower’ article in the Guardian UK:

HIM:

The Peak Oil Secret is Revealed!

by Michael Lynch
November 11, 2009

The latest peak oil news is simply astounding: a whistleblower inside the International Energy Agency (IEA) claiming that “the US has played an influential role in encouraging the watchdog to underplay the rate of decline from existing oil fields while overplaying the chances of finding new reserves.”

The fact that this report appeared in the Guardian, which has published questionable articles on peak oil, is suggestive.

First and foremost, one is tempted to conclude that this story represents poor reporting, bringing to mind an earlier Guardian story claiming that Fatih Birol, the IEA official in charge of the World Energy Outlook, acknowledged peak oil. It turns out that Fatih was misquoted. And while I might be biased, considering Fatih a friend, the nature of the present story is close to ridiculous, rather than misleading. (Sadly for him, Birol is often a lightning rod for any disagreement about energy forecasts.)

This is a long-standing problem with peak oil advocates, many of whom misrepresent comments as agreeing with them.Colin Campbell often refers to those who ‘acknowlege’ peak oil, and Robert Hirsch mistook concerns about the end of so-called ‘easy’ oil as admitting to looming peak.

In a similar vein, Jeremy Leggett (mistakenly) crowed when asked whether he had expected to win a debate vote on the motion that Peak Oil Is No Longer a Concern. “No way! I thought I’d be lucky to get 10% of the vote,” he said. Of course, what he doesn’t explain is why peak oil’s being a “concern” equates to the idea that peak oil is near or a serious danger. (Someone buy that man a dictionary!)

ME:

Peak oil took place in 1998. Don’t believe me, look at any price chart. Since 1999, prices have risen over 600%.

Don’t blame this rise on speculators, speculators arbitrage between markets, they do not destroy them.

Forget geology, follow the money. Oil has never been as available as it was in December, 1998. Since then, the world’s economy has been unwinding. Some businesses can thrive on oil priced higher than $35, most US businesses cannot.

The macro- strategy for coping with uncertain availability and increasing prices has been to inflate asset bubbles to hedge against the higher (oil) prices. Unfortunately, support for the asset prices depended more on low input costs than the architects of the hedges assumed.

Oil is not simply a commodity. It is a platform which includes all the infrastructure that is required to consume it. The productivity of the entire platform cannot generate returns at high prices as it is designed and built for and around oil inputs at pre- 1999 price levels.

The costs of the platform are stranded as a result. Additional platform costs are stranded as oil prices increase. Unproductive infrastructure and stranded costs are why businesses are failing and have been failing all across the country. The economy is being eroded from the bottom up.

For the same reason reason, consumers in 3d world countries are able to outbid the US and other developed countries for for oil. Developing countries do not have to support the costs of massive consumption infrastructure that does not exist.

As more countries develop further and add platform infrastructure, their costs rise and more of their platform becomes stranded, too. This is beginning to happen in China, which is building consumption infrastructure – roads, bridges, shopping centers, suburbs – as fast as possible.

The 500,000+ US highway bridges – one quarter of which are dilapidated – can be supported by $20 oil but not $50 oil. @ $80 the entire economy begins to collapse. At less than this price the entire economy collapses more slowly.

Don’t believe me, walk outside.

What is happening is the free market in action. Establishment efforts to maintain oil price hedges in real estate and finance derivatives simply add to consumption pressures increasing price. The actions of the Establishment are eloquent testimony to the fact of peak oil, even as they deny it with words.

Price movements and the lack of effect on production – less production @ increasing investment inputs – also indicates peak oil has taken place. In fact a definition of peak oil is the period when production becomes unresponsive to investment stimulus.

Peak oil can also be described when market equilibrium shifts from a balance between consumers and producers … to favoring producers. This shift took place with the decline in North Sea production beginning in 1999. Since then, price- setting power has fallen to OPEC, away from independent producers (and consumers).

Another indicator of peak oil is when the aggregate value of the oil commodity is greater to the producer than the value to the producer of the commerce derived from oil use. This reflects the shift from industrialized countries adding value by trade and manufacture toward non- industrial producers who do not engage in commerce and consequently cannot receive value from it.

The solution to this permanent oil shortage and its effects on the current iteration of socialized crony capitalism is a free- market one. However, you will not like this free market solution one bit! Your oil use will be rationed by price and availability; it will be effectively zero. All US production not slated for agricultural- and emergency services use will be sold overseas to developing countries for hard currency.

My market call is to invest in some comfortable shoes. Welcome to walking.

HIM:

mlynch { 11.14.09 at 7:24 am }

Dear Steve, well, I guess I have to plead guilty to your ignorance of my work. I have published lots of empirical analysis, and have been more successful in my conclusions than the peak oil advocates.
Al Bartlett finds exponential growth scary. This represents a very naive, simplistic view, which is not of any great value.

Hubbert was right about lower 48 US production, but that does not validate his theory. Many peak oil advocates mention that, but don’t remark on the poor track record of others (Simmons, Campbell, etc.)–what a coincidence.

And when you point to Cantarell production falling off a cliff, what does that mean? That the decline in one field will cause global production to drop? That all fields will behave like Cantarell (at some point, but when?). That you find this event unique and alarming? Or could it be something hit you on the head and you think the sky is falling?

Your comments suggest that you have picked up points and anecdotes (not always true or relevant) from peak oil writers, and assumed them valuable. A little more critical thinking is in order.

ME:

Hmmm … I didn’t make a depletion argument.

I didn’t mention Colin Campbell or exponential growth or Cantarell, they are irrelevant to my argument which is strictly about oil price and effects of price on the economy. Your discussion about Cantarell is not relevant to my observation.

I have never seen or read any claim by any other analyst that peak oil took place in 1998. It’s hard to replay a concept – anecdotal or otherwise – that isn’t in circulation, The conventional peak oil argument is built around the period of peak physical production. Your depletion counter- argument belongs with these peak oil analysts, not with me..

At issue is whereabouts of the $15 – 20 oil? Much of our nation’s infrastructure was financed and built assuming sub- $20 oil cost to operate, ad- infinitum.. As oil prices rise, both the fuel itself and associated infrastructure becomes increasingly unaffordable. Our infrastructure is designed to leverage expanding oil consumption. Investment returns on this consumption are meager, returns derive from the direct sales of the infrastructure components themselves; cars, houses, roads, bridges, schools, waste and water treatment plants and grids, utilities, state- and municipal government services, various consumer goods, transports, etc.

Whatever returns derive from the development of new supply. This appears to be diminishing relative to the rate of investment. This trend is well documented and includes all forms of energy return on oil- investment.

Because there is little investment return, small increases in component prices tend to strand proportionately larger amounts of consumption infrastructure expenditures. If the average price of a car were to rise to $100,000, the number of cars would diminish and the roads would become underutilized. The trillions spent on the roads would be unrecoverable through use/returns. Funds would nevertheless be required to repair the roads otherwise large sections would become unusable. At the same time fewer persons could afford $100,000 cars and the manufacturers would have problems staying in business.

At low oil prices, money returns of commerce are distributed to increasing numbers of market participants – including those that do not directly trade in oil or oil products. Market participants ‘play the spread’ between the low input cost of oil and the profits/returns gained by their trade. Oil producers gain new customers with the expansion of markets. Here, the value of commerce is greater than the commodity value of the oil.

Currently, consumption has become too expensive. Diamonds will burn in the presence of air as they are carbon. You can heat your house for a little while by burning your wife’s wedding ring. The return on burning the diamond is insignificant. Diamonds are too valuable to burn because the investment in time, money and effort required to bring them to market is greater than any possible gain in heat. Oil since 1998 has fallen within the same dynamic. Oil has become too valuable to simply consume, it represents the increased investment in time, money and effort required to bring it to the market! The returns of oil- enabled commerce are shrinking relative to the intrinsic value of oil traded as a commodity.

The power of this dynamic is illustrated by the observation that oil that is still cheap to produce is sold for a high price. The returns offered by commerce have little value to producers which do not manufacture or trade in goods other than oil. The marginal producer in this environment sets the price for all other producers; Saudi oil costs $5 a barrel to produce, there is no incentive for them to sell for less than $75; a price deemed necessary by higher- cost producers but acceptable to buyers as well as providential to the Saudis.

The Saudis could dump some of their ‘spare capacity’ and drive prices to $25 a barrel. They would stand to lose $50 on each barrel in the commodity markets. This amount could not be gained elsewhere by commerce as the value of commerce is set by the returns ‘baked into’ the consumption infrastructure. The intrinsic worth competes against the consumption ‘worth’ of each barrel of oil.

Consumption must now to provide a return greater than $78 a barrel. It cannot because all returns now flow to the producers marooning the many business participants who would generate profits/returns at lower prices. This failure is reflected in the erosion of the businesses that depends on consumption. Anecdotal or not, the trials of retailers, commercial real estate, home builders, and the rest of the list are well documented. Consumption makes up a large part of the developed world’s economy, by extension that part of the world’s economy is now going out of business.

As it goes out of business, more infrastructure costs are stranded. Commerce’s ability to generate returns diminishes. Consumers are locked into a strong feedback cycle. The only means to make consumption competitive long- term is for commercial nations to bring sufficient oil to the markets to drive prices lower. That these nations have failed to do so over a ten year period of mostly high oil prices is noteworthy.

Ironically, consumers have no choice but to bid prices higher, raising commodity values at the same time. Refusing to bid means nothing is available for the non- bidder to consume.

Currently, cheap oil can only be provided by destroying demand by a credit malfunction or money panic.

Would an alternative to ‘cheap oil by demand destruction’ be available it certainly would be made use of.

Whether this dynamic is a result of above- ground or geologic or otherwise causes is immaterial. The ‘cheap oil’ peaked ten years ago, this is the kind of oil that our economy needs to show profits. The fact of this dynamic is far more important than its cause. It is likely the cause is the lack of returns against the scale of consumption ‘investment’.

More evidence for the intransigence of this dynamic is illustrated by the tactics of the Establishment to counter it. In general, businesses’ expensive labor component has been exported to low wage countries. Lower wages plus higher transport costs (with capital and management costs remaining the same) allows a ‘brand’ to offset higher energy costs and salvage a profit for a short period. Unfortunately, the businesses’ high- paying customers are exported along with the jobs. A second and enduring tactic has seen the inflation of asset price bubbles created as hedges against higher costs and uncertain energy availability. Participants would see increased ‘wealth’ and collateral values that could be loaned against to fund both fuel and stranded infrastructure costs. Unfortunately, the costs of inflating the asset bubbles turned out to excessive. Post- 2008 crash, the government and Wall Street seek to maintain the hedges intact, the fact of the hedges themselves is eloquent. Outside of offsetting energy costs, there are few other reasons to maintain them.

So it goes …