Wednesday, July 21, 2010

Oil Production During Deleveraging

I've been musing on the interaction between a) an extended period of economic stagnation/contraction due to deleveraging, and b) peak oil.

Let's start with the above graph, which shows the global history of oil production as year-over-year percentage changes (taken from this 2006 Oil Drum post of mine), along with an orange box that highlights the years of the Great Depression.   The Great Depression is the most recent analogy we have to a global deleveraging event.  You can see that, overall, growth in oil production was lower during the depression than it was before (or after) but that it did grow except during the first few years of particularly sharp contraction.  For comparison, here's the level of US GDP during the years 1920-1940 (from here):

You can see that the main setback to US GDP coincides with the main setback of global oil production.  Overall, the growth rate during major eras of global oil production was as follows:
  1860-1891     13.9%  
  1891-1929     7.9%  
  1929-1942     3.9%  
  1942-1973     7.4%  
  1973-1979     2.1%  
  1979-1983     -4.0%  
  1983-2004     1.5%  

Again, the depression years had the lowest growth until the 1970s oil-shock era.

So one approach would to be assume that the current deleveraging episode will have similar effects to the great depression (a few years of mild contraction of global oil production, followed by renewed but slower growth). There are a number of problems with that analogy, however:
  • The policy response has been different this time around, with rapid injection of government fiscal stimulus in the early stages of the deleveraging (although it seems that political support for that might have run out of steam, at least for now)
  • The global economy is very different than it was in 1930. In particular, the leading countries of 1930 were what we would now call developing economies in earlier stages of their adoption curve for oil powered machinery and oil products.
The first point may matter less than some people currently think.  It appears we now have a political swing towards government fiscal austerity.  I expect that will produce another round of global economic contraction.  That will scare political elites back to more stimulus after a year or three (and indeed automatic stabilizers alone will tend to do that).  However, a number of economies are probably running out of room for much more government indebtedness, and others will over time, and so the sovereign defaults will begin.  Overall, I'm not sure how much more expansionary policy is really going to be, on a full-cycle basis, than it was during the 1930s, though the time course will certainly be different.

The second point, however, is pretty significant.  In particular, let's remind ourselves of the automobile adoption curve in the US, as a rough proxy for oil usage generally (see this post):

At the outset of the Great Depression, the auto had penetrated 60% of US households.  This is probably higher than auto penetration on the global scale today (there are about 1 billion cars, but most of them are in multi-car households in the developed world).  So we can probably think of oil usage today as made up of two components: the developed countries with substantially complete adoption of oil (which is going to have to get slowly unrolled in response to supply restrictions), and the developing countries, particularly the BRIC countries, which are in a much earlier stage of adoption and will probably continue to rapidly increase their oil usage as long as the price of oil is not completely prohibitive and the global economy is not completely in the tank.

So, recognizing there is a high degree of uncertainty here, overall I would expect global oil production to continue to grow over the next decade, supply permitting, but more slowly and interrupted by periods of contraction as the global economy falls into recession repeatedly due to the ongoing deleveraging process.

Under the circumstances, the general course of oil prices seems almost completely unknowable.  One can imagine periods of relatively healthy recovery (a la 1934-1936) coinciding with supply restrictions and causing prices to shoot through the roof.  One can also imagine the al-Shahristani plan bringing on a flood of new oil unluckily timed with a contractionary episode and depressing prices quite a bit below recent levels.

Not the best environment for good decision-making about moving beyond oil...


rks said...

"At the outset of the Great Depression, the auto had penetrated 60% of US households". Wow, that's amazing. It shows that the depression was occurring in parallel with a huge infrastructure change (think of all those blacksmiths going out of work and the shortage of motor mechanics, quite apart from the pressure on oil supply). This is a tick for folk like me that think that serious economic problems are mostly about some real change in the real economy. Financial ponzi schemes transfer real wealth around, but it isn't obvious that this should bring the world to its knees unless there is some decline in real wealth. [And yes I realize that ponzi schemes do a fair bit of misallocation of resources].

Ralph said...

Wait, at the beginning of the depression (1929?), 60% of households had a car, but only 35% had a stove? That can't be right. Every household needs some way to cook. What would that be, other than a stove?

KLR said...

EIA data goes back to 1920 - perhaps it didn't when you made the chart? I see a lot more instances of occasional YOY contraction by just eyeballing, don't have time right now to run numbers. said...

Stuart, given that global oil production has not grown in nearly six years, and that any relationship between higher prices and increased supply appeared to break down as far back as 2004, I don't agree there's much prospect at all that oil production will grow over the next decade. Indeed, as it appears we agree on a suppressed economic outlook that oscillates below a ceiling, this only serves to draw down from current production while inhibiting development of the new barrel. We just keep plugging along here chewing up slightly less than 30 Gb per year, without really doing enough to fight decline.

I suppose we can increase bbls of NGLs, with their 35% less BTU, and no doubt we can create small energy-margin liquids from other laborious methods--but surely this will not produce an increasing quantity of net BTU to the global economy.

Sadly, where the potential for a real increase in BTU supply lies is in coal. This also may not increase in supply much longer--but I think long enough to both do further environmental damage, and to fund growth.

My view is as follows: oil is no longer able to fund world growth. It's available to operate current systems as they are.



Stuart Staniford said...


You don't say why you discount the possibility of Iraqi oil expansion. (Maybe you've addressed this elsewhere and I've just missed it).

I'm not saying the al-Shahristani plan is assured of success, far from it. But it certainly seems amongst the universe of plausible possibilities and has the potential to raise global production. said...

Glad you asked. :-) My view is that the fields of Iraq have been damaged enough over 2-3 decades that raising production from them will extend out over a much longer timeline, thus blunting their effect on global daily production. In addition, I don't expect stability to be the defining condition in Iraq, and therefore the very thin profit margins the Western Oil Cos have agreed to will come under pressure. From a corporate standpoint, therefore, Western Oil Cos are set up just as they have been so often in the past: to find that cost escalation forms part of a squeeze between their ability to operate, and, the ability to explain such changing conditions to the national government. I therefore see an eventual slowing, dialing back, and eventual retreat for these companies as the years go on. That's my general view.

BTW, I thought it was useful that you put the uber-optimist Iraqi forecast to paper a while back, because the chart became a handy portrait of a very unlikely case.

I don't see Iraqi oil production going down from here, and I also would favor it to go higher. But my view is that it will be a gentle, upward drift higher as the various limits I see act together over time. I think we'll see lots of coverage at least through 2015 asking why Iraq has not been able to increase production more.

G said...

As a counterpoint (sort of) to my view on Iraq: what impact would we see on the current cost spread between OPEC and Non-OPEC should even 50-70% of the high production case come to pass, in Iraq? What happens to Non-OPEC supply if a super robust supply surge comes on from Iraq and sends oil to a price band between 40 and 60 for 36 months? Kinda fun to ponder that, yes?


Stuart Staniford said...


Yes, I definitely don't have a clear sense of how well designed the mechanisms are for Iraq to ramp back production to control prices, and given how well the rest of the political apparatus works, caution would seem to be in order.

BTW, I am not, and have never been, sure that Iraq will substantially succeed in getting close to 12mbd. I just think it's in the universe of reasonable possibilities. So is another complete meltdown of Iraq. This is why it's become extremely difficult to say much with any confidence about the level or timing of peak oil...