The threat of an Oil Pearl Harbor

Part 2 of Looking down the barrel—The Tooth Fairy & the Dragon-King

This is our fourth GB post on the global demand for “something else”. In our previous post we cast light on two “thermodynamic elephants” roaming in the “globalised industrial world room”, the GIW — the loss of access to bioenergy and the loss of access to oil. Both constitute major existential threats and are key to figuring out how to address the demand for something else. We also outlined the former, the loss of access to bioenergy. We are now going to look further down the barrel in order to focus on the latter, access to oil.

Something ominous happened in late 2014

Figure 1 — The unseen signal

Ever since the beginning of the oil price crash in late 2014, countless pundits and journalists have earned good money pontificating about why the crash and how much and when prices would recover. Initially there were abundant talks of the crash having to be short lived — obviously prices would bounce back to their former highs, above $100/bbl. There were talks of a W recovery, one that would take longer. Then came articles divining that the recovery would be long term. Then appeared talks of “peak demand” because of the rise of electric vehicles (EVs) and/or of efforts to combat climate change, with the risk of stranded oil reserve assets, and thus some suggestions that prices around $50/bbl was the “new normal”.

Throughout, articles remained firmly grounded in the supply and demand dogma that as oil became scarce, whatever the supply or demand reason, prices would unavoidably finally rise back to well over $100/bbl when the “oil glut” was finally over. A few voices could be heard to the effect that the triumphant rise of EVs, from their present 0.1% of total on-road light duty vehicles, would obviously destroy the oil industry over the next couple of decades (really?).[1]

Meanwhile, one could glance at thousands of articles with titles like “Oil price rise on X” or “Oil price falls on Y”, with X and Y having to do with countless minor events concerning shale oil in the US, rig counts, squabbles around the Persian Gulf, OPEC, NOPEC, individual more or less failing oil states, the “oil glut” and many more, including endless “technical analyses” of oil price charts amounting to no more than some weird form of numerology, astrology or divination — the ancients observe the flight paths of birds or the entrails of chicken; speculators “technically analyse charts”…

So, over the last nearly three years, GB is not aware of even one party who would have enquired into the appropriateness of the question and challenged an obviously failing dogma. Instead in December 2014 and January 2015 GB saw in the oil prices suddenly going South something akin to a signal on a radar screen, a signal warning of an imminent Oil Pearl Harbor (Figure 1).

Figure 2 — The wisdom of maybe avoiding another Pearl Harbor?

Based on decades of experience in energy matters, it was instantly obvious that this was not like other crashes. It was also obvious to us that avoiding something that would be far worse than actual Pearl Harbor would be an intelligent thing to do (Figure 2). However, almost none of the many parties GB talked to could even remotely see the point. Those who did are now part of the GB Task Force, busily working to address “the demand for something else” that these GB posts are about.

What GB saw buried in the price statistics for both WTI and Brent benchmark prices was a signal of prices on their way to the floor (Figure 3). Obviously, at the time, this was something taboo to voice except in very restricted and small circles of engineers who were also considering the same scenario. It still is. However, so far events have amply corroborated our analyses.

Figure 3 — Another way to look at the price crash

To date, probably not many more than a dozen engineers, scientists and entrepreneurs, internationally are aware of and understand the global, immediate threat that the 2014 oil price crash signalled and that nearly all decision-makers still remain blind to. This is the ultimate “elephant-in-the-room.” It began rampaging around in 2012. It is now powerful enough to create much more damage than the 2008 financial crisis and than all the other elephants that we have identified so far.

To put it bluntly, we are living through the last 10 years of the Oil Age. Losing access to energy from oil (and as we have seen it in GB’s previous post, also losing access to bioenergy) is catalysing an avalanche of world-changing consequences.

No doubt, this sounds highly improbable. Presently, all media talk of a persisting oil glut while global food production has been increasing steadily at about 2.2%/year since the 1960s and global wood production has surged since 2009 (FAO). How could it be that the GIW is losing access to all its sources of energy in short order? However, the evidence is solid. Concerning bioenergy, the analysis by Schramski et al., 2015, presented in our previous post, leaves little room for doubt. Concerning oil, the above conclusion is based on research initially developed in the 2010–2013 period that enabled anticipating the oil price crash of late 2014 some six months ahead of time.

Introducing the Oil Fizzle Dragon-King

The “elephant-in-the-room” that we refer to above and that threatens something far worse than the historical Pearl Harbor, is in fact not an “elephant” but a “Dragon-King”. We call it the Oil Fizzle Dragon-King (OFDK). The emergence of OFDK in 2012 is an unprecedented global situation; one that humankind has never had to face since the end of the last Ice Age and the advent of agriculture some 10,000 years ago.

What is a “Dragon-King”?

A “Dragon-King” (DK) is a statistical concept developed by Prof. Didier Sornette, Chair of Entrepreneurial Risks at the Swiss Federal Institute of Technology Zurich and a few others, in order to differentiate clearly certain events and processes that cause major economic and financial impacts from another class of major events, known as Black Swans, also causing major impacts (Figure 4).

Figure 4 — Strange beasts

Black Swans are low probability of occurrence, high impact events located at the tail end of known probability distributions, e.g. stock exchange crashes or oil price spikes. They do not occur often. They are hard to anticipate. But when they strike the damage is usually very big.

Dragon-Kings are high probability of occurrence, very high impact events or processes located on unknown or ignored probability distributions. They are called Dragons to signal that they are “another kind of beast” than Black Swans. For example, in medieval times the wealth of Kings often resulted from very different processes than that of Bourgeois. The wealth of Kings often stuck out away from the distribution curve of bourgeois wealth — hence the Dragon-King label, which has a nice Chinese lore ring to it.

Like Black Swans, DKs do not occur often and have very big impacts. But differently from Black Swans, if one knows what to look for, it is possible to anticipate them, in which case the rewards for addressing them can be very substantial. From the perspective of whoever has anticipated them and found out how to not only survive them but also leverage their power, DKs eliminate competition at little or no cost to the anticipator and open up substantial, highly rewarding opportunities.

Why “Oil Fizzle”?

Figure 5 — Vanishing net energy from oil

It takes energy to get energy. We have already noted that, presently, oil is the most primary of all energy sources because energy from oil is required to get energy from all the other sources (coal, gas, nuclear, biomass and food, wind, and direct solar, such as photovoltaics).

As Figure 5 shows, the problem is that, due to the advanced stage of the oil resources depletion process, the energy cost of getting energy from oil is now increasing very rapidly (yellow arrows). The consequence is that the net amount of energy actually available for global GDP growth per average barrel will be nil by about 2022 (red arrows). This is the key finding from pioneering, independent research that GB has been involved in over the last ten years.[2] Very few parties are yet aware of this threat.

In short, since 2012, net energy per average barrel is rapidly “fizzling out”. This is a Dragon-King because, although the tail end of the Oil Age was highly predictable, it was and remains wholly unexpected by world elites, and its impact on the globalised industrial world (GIW) is going to be huge.

A stressed earlier, all forms of transport (land, sea and air based) are about 95% dependent on net energy from oil, in the form of transport fuels (gasoline, diesel, jet fuels, bunker fuels, etc.). Accessing other forms of energy is also dependent on net energy from oil and all economic activities globally are also thoroughly dependent on supplies of net energy from oil — hence the fizzling out of net energy per average barrel is bound to have major impacts on the GIW. This is also why our emphasis on a new class of means of accessing and transacting energy and related value (cryptocurrency wise) is so central in our set of something else specs.

The Oil Fizzle Dragon-King (OFDK) is already having a big impact. It is the fundamental reason for the lack of sustained global economic growth since 2008 and for the oil price crash of 2014. As we get closer to 2022, OFDK will have an ever-growing impact to the point of dwarfing the 2008 crisis. It actually threatens to bring the GIW down to its knees. Besides drastically disrupting all economic activities, it will also affect all currencies, modes of payment and the very viability of the current global financial system — all core issues of our times are affected, unemployment, ever growing debt, globalisation impacts, “energy and/or ecological transitions” presently focused on combating climate change, Internet and so-called artificial intelligence related technological disruptions, and of course, all forms of transport. Almost none of the key players in the energy world, in industry or in the finance world have seen this coming. None understands it. None is equipped to address it. The same applies to all governments around the world.

Understanding OFDK is crucial to addressing the global demand for something else.

Supply and demand have to abide by thermodynamics

The above considerations enable us to begin to understand the present oil price situation. As depicted on Figure 5, we estimate that in 1900, per average barrel, some 61% net energy (ED) reached the GIW. In 2016 it was only 7%. It should be obvious that it is not possible to generate the same amount of economic activity on 7% now as it was in 1900 on 61%.

To understand the “supply and demand” implications of this hefty drop in ED we must keep firmly in mind the structure of the oil world. There is no such thing as a simple “supply and demand” for oil that would operate within the GIW nor an oil market between oil industry businesses and GIW ones. The sole tangible markets for oil are within the oil industry, between the producers of oil and the transformers of oil (refiners) who deliver transport fuels (TFs) and petrochemicals to the GIW. In addition there are also speculators who attempt to make money by taking advantage of fluctuations between producers’ and transformers’ operations.

What people variously refer to as “oil price” are only benchmarks for conventional crude only, e.g. from West Texas (WTI) or the North Sea (Brent), that is, specifically, such benchmark prices do not encompass shale oil, tar sands oil or heavy oils. Furthermore, in practice, within the oil industry, there is no such thing as a single “oil market”. Instead, producer and transformer parties are trading a bewildering range of hydrocarbons of widely varying qualities at a wide array of locations and at many differing prices.[3]

It ensues that so-called “oil supply” concerns markets internal to the oil industry while, within the GIW, end-users’ so-called “demand” concerns only TFs. Between the two are zillions of transactions along the complex production chains. This means that parties trading crudes within the oil industry do so in a kind of “fog”, constantly attempting to guess what might happen along such chains months later, all the way to the sales of TF end-products to end-users. Mostly they get it wrong and they have to constantly correct their rather blind guesses, pushed this way and that, with substantial lags, by various “bottom lines” of the wrong colour.

Eventually this erratic trial and error process ends up by abiding with thermodynamics’ dictates and those who stray away from them for too long end up bankrupt. This is what has been at play in late 2014 and ever since, as we are now going to see.

As shown on Figure 6, up until 2012, the main driver for oil prices was ETP, the energy cost of delivering TFs to the GIW (resulting in the SOC price blue curve shown on the diagram). That is, up to this point in time, the amount of economic activity that the GIW could generate per barrel out of the net energy delivered to it, ED, was way above the ETP-based oil price, which meant that businesses within the GIW could cope with the impacts of ever increasing prices (except for the odd price flares). Both the oil world and GIW could function “normally” and keep growing.

However, from 2012 onwards, the amount of economic activity derived from ED, per barrel, became less than the oil price based on ETP and this completely changed the “game”. It took a lag of about 2 years for this situation to filter through from end-users within the GIW all the way back to where oil traders operate within the oil world.

Figure 6 — A still taboo insight

We have seen that a Dragon-King is an event or an abrupt process that is bound to happen but that people are blind to. Here, there is an OFDK because all players do “fly blind”. They evaluate oil reserves in terms of “barrel counting” (e.g. reserves to annual production ratios, measured in million barrels per day) or “bean counting”, that is, financial analyses. Both approaches ignore thermodynamic fundamentals and blind decision-makers to what is actually going on, within the oil world and the GIW alike. In the 2000 to 2012 period, had industry players paid attention to the thermodynamics of oil as we are outlining it here, it should have been obvious to them that the GIW could not operate for very long on the basis of costs that were in the process of becoming higher than the economic activity that the GIW could generate per barrel on the basis of residual ED. In which case they could have taken action to change course. Flying blind, they did not.

From 2012 onwards the overriding oil price driver of was no longer ETP but the rapidly declining ED, resulting in the MASOP red curve on Figure 6, that is, the maximum value that is viable for the GIW, based on the declining amount of economic activity derived from residual, rapidly declining ED. This is why, bar the odd price flares due to speculative moves or geopolitical events, oil prices are now on a relentless downwards trend towards the floor regardless of mythical so-called “supply and demand” notions that have nothing much to do with how the oil world actually functions. The oil world has already suffered a great deal from the price crash. GB considers that much worse is still to come over the next few years. Oil prices are now confined within the space between MASOP and zero on Figure 6, and thus trend towards $10/bbl in the 2017–20 period, with drastic consequences not only for the oil industry but also the GIW and the global financial system. This is also why our something else specs are so crucial.

Figure 7 — What next?

In fact some elements in the Oil and “Planet Finance” worlds have begun to realise that all is not well down the barrel and even that may well be at the wrong end of it. Figure 7 illustrates summarily how some parties are slowly becoming aware of the OFDK challenges.

Yearly oil discoveries have been declining for decades. In 2016 they were at their lowest level since 1947 — far below annual depletion levels. This is not just due to the recent curtailing of capital expenditure (CapEx) in response to the oil price crash of 2014. The trend has been ongoing since the mid 1960s.

Increasingly, industry analysts read further ominous signs. For example, in its 2017 Outlook for Energy, page 38, Exxon Mobil Corporation, considers that over the 25 years between 2015 and 2040, conventional crude supply levels will unavoidably drop from approximately 85Mbbl/day to about 18 Mbbl/day only, by 2040.

In order to fully understand the significance of the fall in conventional oil supplies expected by the likes of ExxonMobil and/or the IEA, it is necessary to know that only conventional crude (about 40% only of the entire spectrum of hydrocarbons) enables producing net energy in the form of fuels (which is not the case for heavy oils or shale oils). Exxon estimates that an investment level of $ 11.25 trillion would be needed over this period to offset this drop — an estimate that ignores the physical impossibility of achieving this goal (see subsequent posts on this). Even assuming that this could be feasible, we must also consider that presently the oil industry operates at an overall deficit of $2 to $3 trillion/year, in a context where the GIW’s total debt is in the order of $225 trillion and increasing (according to the IMF and others). The probability that the oil industry may find more than $11 trillion of “debt-that-cannot-be-repaid” is therefore low in a context where net energy is fizzling out of the average barrel. Also, were such debt levels to be generated, it would only give more momentum and impact to OFDK.

In short, although OFDK remains largely unseen by most decision-makers, an increasing number of key “players” sense major challenges ahead, albeit in very foggy ways, without ever understanding the fundamental issues.

The problem is that sensing challenges without understanding them and without enquiring into the appropriateness of the question usually results in making matters far worse.

GB’s next post will look further into the oil dynamics that triggered OFDK. Subsequent posts will focus on OFDK itself, its causes, its consequences and how to address them, further detailing the demand for something else with at its core the demand for new means of access, new class of networking and new means of transacting value.

GB’s previous posts in the demand for something else series are:

Post 1: Hello, this is GB…

Post 2: Elephants in the cryptocurrency room — current fiat currencies have no future; however, cryptocurrencies can’t scale to the global demand for something else; in particular they require far too much energy and are overlaid on top of an Internet also requiring far too much energy; and, like fiat currencies, they are disconnected from the sole reliable and necessary anchor of value into the thermodynamics of any social activity.

Post 3: Looking down the barrel — the Tooth Fairy and the Dragon-King; Part 1: Loss of access — humankind is rapidly losing access to all the sources of energy it depends on; the threats are dual, loss of access to bioenergy and loss of access to net energy from oil; those losses translate into loss of access to all other energy forms; Post 3 focuses on the loss of access to bioenergy; this loss will be complete by about 2030; this loss frames in stringent ways how to address the demand for something else, not just concerning energy but also all economic activity and all the way to finance and all currency matters.

[1] Wikipedia. Electric car use by country. Available from: https://en.wikipedia.org/wiki/Electric_car_use_by_country.

[2] GB anticipated the present OFDK situation some 20 years ago. In late 2014 GB identified the pioneering work by Mr Bedford Hill and his team from The Hill’s Group LLC (THG) as being probably the most advanced towards producing a sound thermodynamics-based evaluation of the status of oil reserves (Hill, Bedford. W., Depletion: A determination for the world’s petroleum reserve — An exergy analysis employing the ETP model, The Hill’s Group, Reserve Status Report # HC3–433, version 2, 1 March, 2015 http://www.thehillsgroup.org). In 2016, GB worked with Mr Hill and others to update and progress THG’s pioneering research. This lead to the production of a scientific paper aimed at publicising the updated THG-based findings in a peer reviewed journal, hopefully in 2017: A Global Transport Fuels Gauge — determining the status of global transport fuels supplies and prospects, an exergy analysis employing the ETP Model. The global oil industry is very complex. Few parties can claim a thorough understanding of its intricacies. Also in GB’s view, the initial THG report was not very didactic nor accurate in presenting the thermodynamic approach followed by THG. While a number of high profile academics have sought to critique THG and point at alleged mistakes, it transpired that most had not actually studied their work in any detail nor understood it and none had an actual in depth knowledge of the oil industry. THG’s approach is not a full, all encompassing thermodynamic analysis of the whole of the global oil industry, a near impossible task. Instead, it enables building a robust index, akin to a fuel gauge in a car, of where the GIW stands in terms of oil resource depletion. GB and others have found that the outcomes of this approach fit remarkably well with historical empirical data, and thus adopted it. Hopefully, the Global Transport Fuels Gauge paper will serve to eventually clarify THG’s work. Meanwhile, it provides an extremely robust pointer to what has triggered OFDK.

[3] Hydrocarbons are organic compounds containing only carbon and hydrogen and often occurring in petroleum, natural gas, coal, and bitumens.