DECEMBER 7 2014
THIS WAS THE WEEK THAT WAS- DECEMBER 7 2014
OIL IS NOT WELL
A lot happened this past week. There is a glimmering of good news: Oil is not well. Its price has dropped close to 40 percent. That means that ‘fracking’ may suffer. Fracking is the forceful ‘fractioning’ of rock to release the oil there. It is an expensive process that takes a lot of water, a lot of sand and chemicals, and causes a lot of dangerous pollution. Recent reports state that fracking is as poisonous as tobacco and excess alcohol use for people who work in it and the people who live around these wells, and by the latest count that is some 12 million breathing human beings, not counting at least an equal number of animals, also God’s creatures.
This is just another example of the lethal damage we do to our precious planet. It also is an expensive process, just as the Canadian Tar Sand Enterprise where also billions have been invested. All these operations are based on $100 + per barrel oil in perpetuity. Banks have given loans to these operators based on that projection: nobody counted on a 40 percent drop. This means that suddenly the collateral for these loans have also decreased by that same amount.
Oil companies are committing $1.1 trillion over the next decade to projects that require prices above $95 to break even. The Canadian tar sands mostly need $80-$100 to pay for themselves. Arctic and deep water projects require $120, some even $150 oil. The biggest European oil groups (BP, Shell, Total, Statoil and Eni) spent $161 billion on operations and dividends last year, but generated only $121 billion in cash flow, which means that they faced a $40 billion deficit when oil sold for $100 per barrel. Now it trades just over $60. Go figure.
Why is gasoline so cheap now?
There is all sorts of speculation why ‘gas’ is suddenly so much cheaper. Politics? Trying to get at Putin whose country needs expensive oil to continue? Or is it aimed at Iran, which needs $140 oil to keep its population happy?
Actually the reason is quite simple: China is experiencing an industrial malaise. Over the last decade or so China’s economy has been firing on all cylinders to go —- nowhere. Yes, you read it correctly. It built bridges to nowhere, highways to nowhere, entire cities where nobody lives, office towers completely empty. By its own estimate China has built improvements to the tune of close to $7 Trillion that is more than the GDP – the Gross Domestic Product – of France and Great Britain combined. All these empty structures and useless infrastructure boosted the Chinese economy and, in turn, the entire world’s economy. Now the chickens come home to roost: everybody is gearing down, because the second largest economy in the world, after the USA, is in deep trouble.
And the rest of the world?
Not much better. Europe is in deflation. The USA has increased its National debt by some $8 Trillion on the Obama watch, now totally $17 Trillion, or close to $60,000 for every American from 0-100 years. That in addition to other debt, such as mortgages, car loans, credit card balances, which easily adds another $40,000.
Another somber note came from different field altogether. Prof Stephen Hawking, one of Britain’s pre-eminent scientists, has said that efforts to create thinking machines pose a threat to our very existence. He told the BBC: ”The development of full AI- artificial intelligence – could spell the end of the human race.” His warning came in response to a question about a revamp of the technology he uses to communicate, which involves a basic form of Artificial Intelligence, which is, of course, programmed in English. It reminds me of the Tower of Babel. There God expressed his misgivings: “If as one people speaking the same language they have begun to do this, then nothing they plan to do this is impossible for them.” (Genesis 11: 7). AI already is able to do many of the tasks we human do routinely, and more labor saving possibilities are invented every day. We are in this world to serve each other, not to destroy our own employment and that of our neighbors. Once we are useless, then our reason for existence is gone as well. Already in Southern Europe youth unemployed has reached 50 percent. Idleness is the source of all evil. No wonder suicide rates are growing rapidly.
Ban Ki-Moon came calling
On the eve of another UN sponsored Environmental Conference, this time in South America, another warning, which, given past history, will also go unheeded. In spite of many of such world gatherings, the last 20 years GHG- Green House Gases, carbon dioxide emissions (CO2) – is up 60 percent. Global temperature: up six-tenths of a degree Celsius. Population: up 1.7 billion people. Sea level: up 3 inches or 7.5 cm; U.S. extreme weather: up 30 percent. Ice sheets in Greenland and Antarctica: down 4.9 trillion tons of ice. Just like the G20 meeting, these global conferences do perhaps more harm than good.
But we have to try. That’s why Ban Ki-Moon came calling on the Western world’s greatest polluter: Canada. The highest diplomatic official, the head of the United Nations, visited Ottawa ahead of the Lima, Peru conference on Climate Change. I am sure that Stephen Harper did not like Ban Ki- Moon’s harping on Canada’s P.M.’s pet project: The Tar Sand Oil, which makes Canada the world’s villain as the country doing the least to combat Green House Gases. To Harper’s great chagrin, the current low prices of international oil will make much of the Alberta’s oil uneconomical, and will make his balanced budget plans for 2015 impossible.
We all know by now that oil and its products is the main source of Climate Change. All nations are busy reducing their carbon foot prints. Better insulation, solar power, more small cars with much higher mileage all have accomplished that, and also has reduced the need for oil. With China no longer able to afford to build the immense ghost towns, cutting down on oil consumption is a world-wide endeavor. So, yes, what is at work is the simple law of supply and demand: the world has produced too much of that lethal liquid and now there is a surplus. In order to avoid the worst of Climate Change, the world simply has to leave much of what is called oil reserves in the ground. It is now estimated that under a global climate deal consistent with a two degrees centigrade world, the fossil fuel industry would stand to lose $28 trillion of gross revenues over the next two decades, compared with business as usual. The oil industry alone would face stranded assets of $19 trillion, concentrated in deep water fields, tar sands and shale. Many Canadians have objected to Alberta’s tar sand operations. Well, it could quite well be that in the next few years we will see a drastic reduction here. Watch for dominoes to fall everywhere in banking, in the stock market – your future pension is in danger – in the oil fields and in government revenue, which for a good portion depends on oil royalties. No royalties means either higher taxes for all or cutbacks in social services. Either way it will hurt you and me in our pocket books.
Cheap oil is actually a curse. It promotes increased use of carbon fuels at a time when we should be investing massively in substitutes, but now the apparent plenty of oil and gas takes the spine out of most politicians.
We have entered a new phase in Human History.
There have been several periods in human history, all periods of millions of years where life was determined by natural events: the ice age comes to mind, one of the shortest of environmental periods. We now have entered the final stage which people have been calling The Anthropocene Age. You may recognize the ‘anthropo’ part, referring to us humans.
Today we humans dominate the earth, hence that label. Here are some basic facts:
- Somewhere between 40-50 percent of every living or dead organism is dominated by us humans. Scientists call that Primary Productivity, which was nil when the humans roamed the earth as hunter-gatherers, eating renewable fruits and animals on a sustaining basis.
- Today our domination is evident in the rivers, most of which we have either been diverted or dammed.
- We use so much fertilizer that we exceed the nitrogen naturally occurring in nature.
- The fish we catch far exceeds its natural growth, with total depletion slated in a few decades. We use more than 50 percent of the water run-off and are rapidly depleting the world’s aquifers.
- CO2 has risen by 40 percent – the Green House Gases – while the even more lethal methane has doubled.
Why is this happening? The fact is that markets price all matters wrong. They price oil and gas, for instance, based on current demand and supply, while not calculating the costs to the planet in pollution, global climate change, sea level rise, and more. This is, as Lord Nicholas Stern famously put it, history’s greatest case of market failure. What the world needs is a radical new approach to pricing the products, but, unfortunately business as usual is just too convenient, too easy, and incremental change will not save the planet. The only conclusion is that what cannot last, will not last.
The 40% drop in the price of oil looks like the first domino. All the supposedly safe, low-risk loans and bets placed on oil, made with the supreme confidence that oil would continue to trade in a band around $100/barrel, are now revealed as high-risk.
In the heyday of home mortgage financing – a mere 7 years ago – exotic mortgages were bundled into securities, and sold with the implicit understanding that they were low-risk because the housing market would continue to expand. However, once home prices fell and the collateral collapsed and borrowers started to default, the result was that banks were on the hook for trillions of dollars, and the US government bailed them out, by borrowing trillions.
Now the same is true of oil, except that all borrowing power has disappeared. Just as the belief was that house prices would only go up, so banks today have assumed the oil would never go down, and used that assumption as collateral. Now they have to bite the bullet or go under.
Now that the first domino in the oil sector has fallen a long line of financial dominoes is next in line. Everyone who bought a supposedly low-risk bond, loan or derivative based on oil in the ground is about to discover the low risk was illusory. All those who hedged the risk with a counterparty bet are about to discover that a counterparty failure ten dominoes down the line has destroyed their hedge, and the loss is theirs to absorb.
The next link is jobs. Of all new American jobs since the recession, 93 percent were in the fracking field, all related to the oil and gas industry, which if oil prices stay where they are or fall more, will all vanish just as flared gas disappears into nowhere. However the fall-out in welfare and unemployment payments, reducing deficits even more, will be felt by all. Add to this the losses to investors, the restructurings and bankruptcies more bailouts, and more dominoes are destined to topple.
Don’t for a minute think that these bankers, who take home millions of dollars in bonuses, have a clue what’s going on. They all live by the herd instinct. Every one of them knows the risks, but they all are afraid to be the first to bail out, to be the first one to call the entire financial system a hoax.
When, in Lima, the world’s climate experts will gather, the only result will be more words, words, words. Nothing will change because as long as there still is a dollar to be made from exploiting the earth, this will continue, even though the odds are getting longer and longer.