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Energy politics at the piano bar

Reframing the transportation debate

The narrow ledge of oil prices

Have we reached an inflection point in economics history?

Coal is fading as the power generation fuel of choice in the U.S., but it’s not just because of the EPA.

Coal-burning utilities and their industry partners have mightily protested new EPA regulations, due to go into effect last weekend, that would curb emissions of mercury, sulfur dioxides, nitrogen oxides, and other metallic toxics such as arsenic from power plants. A federal appeals court delayed enforcement of the regulations on December 30 after hearing a challenge brought by power-plant operators and utilities, six states, the National Mining Association and the IBEW electrical union. Their arguments hardly need recitation: The regulations are expensive and “draconian.” They’re job-killing. They’ll raise the price of grid power. The EPA is overstepping its authority. Yadda yadda yadda.

Having had a long look at the data, however, I think the industry doth protest too much.

Price

There is no doubt that several decades ago, clean air regulations caused power generation to begin shifting away from coal and toward natural gas. But in recent years, the most significant pressure by far is price.

The chief reason for this was the explosion of shale gas production, which created a gas glut and drove the price of gas to under $3 per million BTU — an insanely low price, as my friend Gregor Macdonald showed this week. Natural gas now sells for 83 percent less than oil for the same amount of energy, an historically unheard-of discount. Even more remarkably, it’s now actually cheaper than low-sulfur bituminous coal from Central Appalachia. Only coal from the low-sulfur Powder River Basin of Wyoming is cheaper, at $0.71 per million BTU. Its price advantage has gradually pushed coals from the East Coast out of the market.

A detailed 2010 report on Central Applachian coal by researchers Rory McIlmoil and Evan Hansen showed that PRB coal began offsetting high-sulfur coals in the 1980s as clean air regulations favored lower sulfur dioxide emissions, but then began to offset low-sulfur coal from Central Appalachia as well by virtue of price:

Source: “The Decline of Central Appalachian Coal and the Need for Economic Diversification,” McIlmoil, Hansen, 2010

Central Appalachian coal has ceased to be competitive on price largely because those mining operations are much older. As with oil, we burned the best, cheapest, and most abundant coal deposits first, and the Appalachian mountains have simply become mined-out. The best coal reserves are depleted, and producers now must move on to thinner, less productive, more geologically challenging deposits with lower energy content. Overall, domestic U.S. coal now has 20 percent less energy per kilogram than it did in 1949, and the quality is still declining.

Shifting from underground mining to surface mining (mountaintop removal) improved productivity through the 1990s, the researchers note, until it maxed out in 2000. At that point, labor productivity fell by 25 percent, and the price of Central Appalachian coal began to rise. By 2008 it had doubled and lost its price competitiveness:

Source: ibid

Central Appalachian coal production peaked in 1997 at 290 million tons, then fell 20 percent to 235 million tons by 2008. On current trends, the researchers estimate, coal production from the region will fall another 58 percent by 2035 to 99 million tons.

Source: ibid

One coal industry response to this long decline was to optimize its supply chain, reducing inventories and moving to just-in-time shipping. But as we discovered in 2008, that came with a hidden price: The spare production capacity of coal fell to a thin enough margin that it couldn’t respond adequately to sharply rising demand from Asia, and invited opportunistic speculators. Now we have entered a new era of structurally higher prices for Central Appalachian coal.

Source: EIA

This has added some upward pressure on the average price that utilities have to pay for coal, which rose from $1.25 per million BTU in 1998 to $2.41 in 2011. At the same time, the utility price for natural gas exploded from $2.38 in 1998 to $8.32 per million BTU in 2005 as the depletion of conventional resources began to cut into supply. Then the arrival of significant volumes of shale gas around 2006 started to bring prices back down again. The explosion of commodity prices in 2008 interrupted the new trend, but then it resumed, taking gas prices gradually down to a 2011 average of $5.14 per million BTU through September (the latest month the EIA included in its 2011 average calculation), then sharply lower after that.

[Important note: Although the Henry Hub spot price of natural gas is lower than the price paid for by gas by utility operators, I have added the monthly spot data to the end of the operator price series offered by the EIA here simply to illustrate how quickly the price of gas has fallen over the past four months, because the EIA doesn't offer monthly operator price data for those months. The daily spot price of gas fell from $4.18 on September 1, 2011 to $2.96 on January 4, 2012 — an astonishing 29 percent decline. The EIA's 2011 average $5.14 cost to operators from January through September compares to a daily Henry Hub average of $4.22 over the same period.]

Now let’s think about the two fuels like a utility operator would. In 1998, the cost of gas for electric utilities was 1.9 times higher than coal. That ratio rose to 5.4 in 2005. It now stands at a mere 1.2, making gas just slightly more expensive than coal for power generation.

That calculus is precisely why Michigan’s Consumers Energy cancelled its plans for a $2 billion, 830-megawatt coal plant in December. It made the decision, a company spokesman said, because the economics didn’t pencil out — not because it was cowering in fear before regulatory uncertainty.

Regulatory uncertainty

To meet the requirements of the new EPA regulations, operators of legacy coal-fired plants would either have to retrofit them with scrubbers, or to switch to natural gas. (Burning natural gas in a power plant generates less than a third as much nitrogen oxide emissions, and about half the carbon dioxide emissions, as burning coal. Sulfur dioxide and mercury compound emissions from natural gas are negligible.) The estimated $11 billion price tag and three-year deadline to retrofit the nation’s coal-fired plants with scrubbers, while not hugely burdensome, might just be enough to persuade some operators to throw in the towel on coal.

Coal plants also face retrofit or replacement due to the need for storage and handling of coal ash, which fell under tighter restrictions after the catastrophic collapse of the Tennessee Valley Authority Kingston Fossil Plant’s coal ash pond in December 2008, a disaster with a cleanup cost of over $1 billion.

Yet another factor against coal plants is a potential requirement to switch to closed-loop systems for cooling water, to reduce their consumption of fresh water and their discharge of heated water into the environment. The states of New York and California have already issued rules requiring all power plants to switch to closed-loop systems, and the EPA is considering a similar national regulation. The Electric Power Research Institute estimates that 252 gigawatts (GW) of existing fossil fuel power generation capacity would be affected by such a rule, of which I surmise at least half would be coal plants.

Age

The age of our coal-fired power plants is a final, key factor.

Over half of the nation’s generating capacity comes from plants that are at least 30 years old. Nearly three-quarters of our coal-fired capacity, contributing 46 percent of our electricity supply, is at least 30 years old. Many of the plants are using outdated, inefficient technology. Some need to be retired immediately, and within 20 years nearly all of them will need to be replaced.

Source: EIA

For plants that are close to retirement age, the decision is easy. The investment horizon of a new power plant is at least 35 years. In its Annual Energy Outlook 2011 report, the EIA estimated that the capital costs of building new coal and nuclear power plants had risen 25 to 37 percent from 2010, while the capital cost of combined-cycle natural gas plants had remained steady. Who would build a new coal plant in an environment of ever-tightening emissions limits, rising capital costs, rising coal prices, falling coal supply, rapidly falling gas prices and rapidly increasing gas supply? Particularly when carbon capture and sequestration technology has still not been proved to be commercially viable?

Transition already under way

The fact is that the transition from coal- to gas-fired plants been under way for decades, and has accelerated since coal prices started rising in 2004:

And for at least the next several years, gas will continue to be a preferred fuel for new plants:

[Note: The EIA's most recent available data for planned capacity changes is from the Electric Power Annual 2010 report, in which the 2011 data is "planned."]

In its AEO 2011, the EIA offered multiple scenarios for how electricity generation might evolve over time, depending on the price of gas, various potential regulations, and how quickly plant owners might expect to recover their capital investment. Without belaboring the details of these scenarios, I’ll just present one of those charts with the comment that in my view, the last column in this chart is the more likely of these scenarios. Under that scenario 72 GW, or 23 percent of the nation’s 313 GW of coal-fired plant capacity, will be retired.

Source: EIA

Various industry organizations have recently weighed in with their own estimates of coal plant retirements, and evidence of the transition to gas.

The Edison Electric Institute, an association of public electric companies, estimates that 48 GW of coal-fired capacity will be retired from 2010 to 2022.

A 559-page report issued in November 2011 by the North American Electricity Reliability Corporation (NERC), an independent, non-profit regulatory authority charged with evaluating and monitoring the reliability of the North American grid, suggests that net coal capacity will decline over at least the next 10 years. They cite 326 GW of total coal generation capacity in 2011, but project only 8 GW of it to be retired by 2021. In the same report, however, they identify 89 GW of coal-fired capacity that will need to install flue gas desulfurization units by 2015 to comply with the new EPA rules, and note that 29 GW of it is already designated for retirement, leaving 60 GW of coal capacity with an undecided fate. By 2021, they see 45 GW of planned new gas capacity, plus an additional 48 GW of “conceptual” capacity (which they define as “resources with less certainty,” according to a “confidence factor”). Noting that their last four assessments successively reduced their expectations for coal generation while increasing their outlooks for gas, they observed that “the evolution from coal to gas is evident,” and offered a chart showing gas and renewables dominating future capacity additions with net declines in coal capacity every year:

Source: NERC

While the news is almost universally bad for the coal-fired sector, the outlook for gas is excellent. Gas producers, manufacturers of modern, high-efficiency gas turbines, and gas pipeline providers are all looking at a decade of substantial growth. NERC reckons that replacing the 60 GW of coal-fired capacity whose fate is yet to be decided with equivalent gas-fired capacity would require an additional 1,200 miles of gas pipelines.

So in reply to the coal-fired power sector’s bleating about regulatory uncertainty, I say: The only uncertainty is how quickly, and how much, the noose tightens around your neck. While I have questioned both the economics of shale gas production and the claims about its reserves, there is no arguing about price. As long as the shale gas phenomenon can bring gas to market for under $4 per million BTU, the economics are tilting in its favor. The cost of renewables will continue to drop, while the cost of coal will continue to rise. That’s the hard reality of price, and it has nothing to do with regulatory uncertainty.

And even though regulatory uncertainty does pose a problem for coal plant owners, those regulations can only be good news for the health of the public and the environment. It’s cynical and shameful to pretend to a principled stand against overweening federal regulation when you’re really just trying to squeeze a little more life out of filthy old plants that are destined for retirement anyway. The public has gotten wise to your game, and your onslaught of glossy prime-time ads isn’t convincing anybody that you’re clean or green. Concerns about killing acid rains, billions of dollars in health destruction, and general environmental contamination have begun to weigh more heavily than adding a fraction of a penny to the cost of a kilowatt-hour. The public now knows that the price of power from renewables and gas is on the verge of being competitive with coal, and that if no externalities (like carbon emissions) are allowed into the calculation, coal is already a hands-down loser. Your “jobs, jobs, jobs” mantra is wearing thin. We don’t just need any old jobs, but the right jobs, in order to become a more healthy, safe and sustainable society.

Photo: The George Washington Bridge in heavy smog, May 1973 (from The National Archives) . . . before the EPA began its fascist reign of terror (hat tip @bradplumer)

Three deformations of the apocalypse

In response to my 2012 outlook last week, a reader requested a five-year outlook that’s long on opinion and short on data. As SmartPlanet’s resident energy futurist, how could I decline? As that reader suggested, I will offer three scenarios: the bad, the good, and the likely.

The bad: Evil drift

Tough times call for tough men. But at this crucial turning point in history, they are nowhere to be found. The entitled class of pantywaist leeches who command our political and economic institutions spend their time slap-fighting over picayune issues and debating points of style like 18th Century French courtesans, accomplishing nothing, utterly tone-deaf to the cries of the people. (Overheard in the Bastille in the spring of 1789: “These protestors are so disorganized and filthy. What do they want? Can’t somebody just clear them from the square?”) As it always has in the past, this toxic brew spawns revolution.

The Fed remains committed to pushing printed dollars onto a world already awash liquidity, in hopes that growth will return. But it doesn’t. The captains of the financial industry refuse to mark their hallucinated assets to hard assets, because the former exceed the latter, and the people are unable to force a reckoning that would put the economy back on terra firma. The great tide of the global currency wars sucks the sand out from under our feet as it recedes, and we gradually sink deeper into the mire of debt and deflation. Slowly, bit by bit, the Great Contraction tightens around the world.

Rick Santorum is elected president in 2012 on the back of a massive evangelical campaign. The Tea Party retains its hold on the House, and the Democrats retain control of the Senate, ensuring four more years of legislative gridlock. Grover Norquist is appointed to Santorum’s cabinet, and embarks on a relentless campaign to shrink the federal government, browbeating the House leadership into radical cuts to social services. These new austerity measures squeeze the economy dry.

Spot shortages of gasoline and food begin to appear, along with ever more frequent failures of infrastructure. Transformers blow up and water mains break once a week in major metropolitan areas. Road transportation becomes increasingly difficult as roads and bridges fall into disrepair, but mass transportation systems are unable to compensate due to power outages and fuel shortages. The veneer of civilization wears thinner, and finally crumbles as complex delivery systems begin to fail.

In the aftermath of the 2012 election, Americans lose their last vestiges of faith in the corrupt, immobile knot of their so-called democratic institutions. Realizing that there are only passengers on this ship, and that no strong hand will take the till to keep us from drifting into the teeth of disaster, they live up to their self-image as anti-government, rugged individualists and take matters into their own hands.

There simply aren’t enough National Guard and police to keep the peace, and our military troops remain committed to securing our globalized corporate interests on the far-flung reaches of the American empire. Tax revolts deprive state and local governments of enough revenue to maintain, let alone increase, their police and fire services. Civil order begins to break down.

By 2013, protestors are occupying public spaces permanently. Retail shopping becomes next to impossible, sucking the remaining wind out of economy. Inner-city neighborhoods in poor areas fall under the control of local gangs. Wealthy areas hire private security and throw up fences. Street gun battles become commonplace as local thugs vie for turf. Vigorous black markets in food and fuel bloom like toxic red mushrooms in an early winter rain.

Armed mobs take over Wall Street, and go hunting in the Hamptons. The national banks collapse as it becomes impossible for them to function, leaving only small regional banks. Lloyd Blankfein meets a gory end, hanging by his thumbs from the Brooklyn Bridge. The dollar becomes worthless and gold and silver become the only accepted currencies.

Global oil supply begins to decline in 2014 as the depletion of non-OPEC producers entwines with the collapse of governments across OPEC, keeping prices high even as the global economy contracts and demand falls. Consumers in the West are continually outbid for rapidly falling available net exports by the five billion people of the East. New geopolitical alliances are formed along the shortest energy supply routes, binding Asia to Russia, and India and Pakistan to the Middle East.

By the general election of 2016, the remaining vestiges of American civil society, now desperate for order and stability, elect a hardcore right-wing fascist who promises to “kick ass on those ragheads and make ‘em give us their oil.” He launches military strikes against Iran and Syria, and re-occupies Iraq. He imposes a harsh domestic police state in an attempt to restore domestic order, imprisoning all dissidents without due process under the legal framework that Barack Obama signed into law on the last day of 2011. Millions of destitute citizens are conscripted to serve in a massively expanded military- prison complex. The governments of Canada, Mexico, and all of Central and Latin America fall under the new authoritarian government of the U.S. in all but name, as it installs friendly puppet regimes.

Global resource wars break out in 2017. The people revolt against the increasing taxes needed to fund the wars and the domestic police state, and Texas secedes from the union, followed by the states of the Pacific Northwest. (Think it can’t happen? It already did, in 1941.)

Five years from now revolution, and the dissolution of the American republic, are under way.

The good: Seizing the future

President Obama, having been reelected in 2012, abandons his previous ineffectual tactics of appeasement and finally finds his sac. At the head of a new Democratic majority in both houses of Congress, in which labor threw out the stultified party leadership and brought in a new crop of reformers, he leads the country on a breathtakingly ambitious infrastructure rebuilding program, riding roughshod over all opposition. Over $1 trillion dollars per year are committed via public-private partnerships to transition transportation to rail, rebuild our water and sewage systems, and transition grid power to renewables. Only essential local roads are maintained, and lanes of interstate highway are converted to rail corridors. The power grid is nationalized and upgraded with smart-grid technology. A high-voltage long distance DC transmission grid is built to redistribute wind power from the Plains, solar power from the South and Southwest, geothermal power from the Rockies, and marine power from the coasts. Solar PV becomes the cheapest form of power generation by 2016.

The program reunites the country politically, restoring full employment and national pride. The principled opposition to federal spending is swept away by a new fervor to retake the high ground of the global economy. The American Restoration Act of 2012 imposes harsh penalties on profits made from foreign operations, while rewarding the repatriation of profits and manufacturing with generous tax breaks. “Made in America” becomes a national slogan again, and is proudly stamped into every nut and bolt.

The surge of domestic rebuilding tilts the global balance of power back toward America, as companies scramble to rebuild manufacturing capacity at home and withdraw from their outposts in Asia. The dollar becomes stronger, and the return of growth allows the Fed to begin withdrawing the trillions of dollars it injected after the crisis of 2008.

Sweeping financial reform legislation is forced through Congress, including a massive transfer of private sector assets to the federal balance sheet. Bondholders are forced to take a 50 percent haircut. New incentives allow all Americans to refinance their homes and personal debt under federal programs at 2 percent interest for 30 years, with the stipulation that they can no longer use credit cards. Banks are once again relegated to the boring historical norm of making loans earning no more than 2 to 3 percent interest, and are forbidden to use leverage or take positions in equities or commodities. The finance sector is forced to shrink from over 8 percent of GDP today to just 2 percent, as it was in the 19th Century, and millions of its workers are forced to find something useful to do.

The “Victory Garden” initiatives of WWII are revived, and everyone plants vegetables in their yards. Those without yards are given plots to farm in public parks. Overbuilt and disused suburbs are demolished, and the land converted to agriculture. Tariffs are imposed on imported food in proportion to how far it traveled to get to the U.S., and agriculture is slowly relocalized across the country, resulting in a two-million-barrel-per-day cut in domestic oil consumption by 2017.

Five years from now, America is on course to be a new economic powerhouse with domestic demand replacing the falling consumption of Asia. The decline of global oil supply pinches the economy, but does not break the skin, as demand is shifted from liquid fuels to domestic renewables. Realizing that she can get by on North American oil supply once the transportation and power transitions are complete, America begins to withdraw its military forces across the globe, ending the drains of military adventures and foreign oil expenditures simultaneously. By the time the global resource wars ensue in 2017, she will stand once again as a prosperous, peaceful, more insular, “shining city on a hill.”

The likely: Decline by default

Barack Obama is reelected by default in 2012, since none of the GOP’s insane clown posse are deemed both electable, and acceptable to the Tea Party. A broad anti-incumbent electoral revolt completely transforms the leadership of both parties and creates a balance of power in both houses of Congress, creating a brief window of opportunity for real change.

Unfortunately, that opportunity is squandered for a lack of effective vision and leadership. As in all other scenarios, oil still declines starting in 2014, squeezing the economy and stifling growth. The Fed keep printing, but in vain. America is sucked into the deflationary vortex by default.

Oil prices remain just above the pain threshold of ordinary Americans. In response they move to small apartments in converted downtown office buildings. Empty suburbs are abandoned and James Howard Kunstler does a victory dance in the dust of the geography of nowhere, to the applause of no one. Roads and bridges fall into disrepair, forcing the working class to crowd into slow, meandering buses and decrepit light rail systems when they aren’t traveling on foot or bicycle. Things work until they don’t, and then they are abandoned.

America is drawn by default into the global resource wars starting in 2017, but fails to secure any significant new supply of foreign oil. Available imports from the Middle East begin to fall, prompting a massive drilling and mining campaign across every last inch of America where hydrocarbons may be found, with attendant soaring environmental damage. But solar PV still becomes cheaper than regular grid power, and millions of small rooftop solar systems with battery backup are installed by individuals in self-defense, creating little islands of light in a country plagued by sporadic blackouts.

Unemployment continues to rise until Americans are willing to work for less than the Chinese. Farming is the hot sector for young people entering the workforce, as the finance, insurance and real estate sectors shrink. Millions of Americans move to Canada in search of a better life and a stronger currency. The dollar survives, but it doesn’t buy much.

Five years from now, America is crumbling, mumbling and bumbling its way to a smaller, leaner, and more agrarian economy. Its superpower days are fading into history. The republic holds together in name only. The inability of the economy to generate excess revenue starves the federal government of receipts and a gradual, decades-long shift to more regional governance and culture begins.

Postcript

I have offered these fanciful, extreme, and hopefully mildly humorous scenarios to provoke thought, not to draw a map. And if I seem hard on the GOP, it’s because of their staunch opposition to energy and transportation transition, which I believe are absolutely necessary to avoid collapse. In reality, the next five years will be replete with surprises—including natural disasters, unprecedented political upheaval, and unimaginable financial hijinks—that may incorporate elements of all these scenarios.

So. . . What’s your scenario?

Illustration: “Enchantment’s End” (gideon_wright/Flickr)

In conversation with Dr. Colin Campbell, Ballydehob, West Cork, Ireland

Campbell was also featured on the ‘Eco Eye’ program on Irish Television last night. If you’re in the UK you can probably see it, but sadly, they don’t allow it to be viewed from here in the US. Here is the link: http://www.rte.ie/player/#!v=1129353

That was originally part of my recent post, The questionable economics of shale gas

I’d also point your attention to a new piece by Reuters, who did some good investigative journalism on top shale gas operator Chesapeake Energy, and accused them of conducting a stealth “land grab” operation by using a series of shell companies: Energy giant hid behind shells in “land grab”

This kind of work is vitally important, because the majority of press about shale gas still consists of wild-eyed optimism and verbatim repetition of industry propaganda. For example, this new piece in the Wall Street Journal.

There is still plenty of energy-illiterate press going around, such as the recent rash of articles that misinterpreted the US becoming a net exporter of refined products as being a net exporter of oil, when we are still the world’s top importer of oil. It’s pathetic. The data are freely and publicly available, so why are these egregious errors still being propagated in high-profile publications? I hope my recent pieces help to clear things up just a little.

Postscript: Al Gore blogged on my story January 8, 2012

Corrections: Most regrettably, I discovered two typos in the story some weeks after it was published:

1) “At the 2010 rate of American consumption—about 24 tcf per year—that would be a 95-year supply of gas, which apparently has been rounded up to 100 years.” should have been “At the 2009 rate of American consumption—about 22.8 tcf per year—that would be a 95-year supply of gas, which apparently has been rounded up to 100 years.” At the 2010 consumption rate of 24.089 tcf/yr, the 2,170,000 bcf estimate would last 90.082 years. (Therefore, one could say that one year’s increase in US gas consumption shaved five years off the claimed supply.)

2) “It offered a range of estimates, from 43 tcf at 95 percent probability, to 84 tcf at 50 percent probability, to 114 tcf at 5 percent probability.” The high end USGS estimate was 144.1 tcf, not 114.

Read it here: 2012: Terra incognita

Predicting the future is never easy, but as I contemplate what 2012 might bring, I confess that it’s never been harder.

In 2005, it was fairly easy to see that commodity prices would rise in the coming years, and that the purveyors of petro-Prozac who dominated the press were wrong. It was evident in the data, particularly on oil. My outlook was generously validated up through the first half of 2008. While I expected a significant correction in housing prices and equities, I underestimated the magnitude of the late-2008 crash in the financial markets. Only a few observers who paid close attention to arcane derivatives markets got that one right.

In the fall of 2009, I made some outlier calls for 2010 on oil, equities, the US dollar, and China, all of which proved correct. I attribute that in part to luck, but mostly it was the result of having done my homework and developing a fine-tuned contrarian view.

Then it got more difficult.

In the fall of 2010, I was having a long email discussion with some fellow peak oil analysts about our outlooks for oil supply, trying to identify when the next big oil price spike might occur. After working over several detailed models of OPEC and non-OPEC supply, I snipped irritably that oil prices would likely be affected far more by above-ground factors in the next few years than below-ground factors. Geopolitics would soon trump geology, I ventured, and we would do well to pay attention to the news overseas. One well-placed bomb, another big hurricane in the Gulf of Mexico, a civil war in the Middle East, or any number of other events could blow our carefully constructed mathematical models out of the water.

But even I did not anticipate how radical the upsets of 2011 would be. No one could have predicted the earthquake and devastating tsunami that struck Japan on March 11, or foreseen how wide-ranging its effects would be: from shutting down automobile manufacturing plants, to record grid power prices in Hawaii, to several of the world’s most advanced economies turning their backs on nuclear power. We had plenty of advanced warning that weather would become more erratic due to climate change, but a record 12 natural disasters in the U.S. costing $1 billion or more, each, was an eye-opener. And I don’t think anyone expected the Arab Spring. It was a tough year for dictators.

Geopolitical challenges for fossil fuels

Above all, what jumps out of my crystal ball about 2012 is geopolitical instability. The popular unrest we saw worldwide this year feels like a mere prelude to a very chaotic period.

As an example, consider the slew of threats that currently imperil the global oil market:

• On December 16, a months-long peaceful protest by striking oil workers in Kazakhstan exploded into violence. Somewhere between 14 and 64 people were killed by police over the following weekend (depending on whether you believe the official count or a report from the morgue) in a harsh government clampdown which included shutting off all Internet and telephone access, and cordoning off the city. (Steve LeVine has been doing some terrific coverage of the events there for Foreign Policy.) The echoes of the Arab Spring are unmistakable. With about 1.6 million barrels per day (mbpd) of oil production, Kazakhstan is the world’s 18th-largest oil producer, on par with Libya’s output before the uprising there added about $10 to the global price of oil.
• Fresh waves of unrest in Syria could lead to civil war and seriously destabilize the already-tenuous oil trade in the Middle East. Oil production there has fallen from over 400,000 barrels per day in 2010 to 260,000 bpd now, in part due to EU sanctions. And Egypt is still very much in play in the region.
• Sanctions are likewise behind heightened tensions with Iran, as the US and EU forbid domestic and foreign partners from doing any business with the country in continuing efforts to stymie its nuclear ambitions. Iran conducted naval war game exercises near the Straits of Hormuz last week in retaliation, an implicit warning that it would attempt to shut down the critical Persian Gulf oil trade chokepoint if hostilities increase. And yesterday, they made that warning explicit, as Vice-President Rahimi said, “If Iran oil is banned not a single drop of oil will pass through Hormuz Strait.” Iran’s primary oil buyers, including China, Japan, Korea, and India appear to be seeking alternate supplies, but that will support oil prices globally as competition increases for oil from OPEC producers, notably Saudi Arabia.
• The situation in Iraq deteriorated almost immediately upon the exit of US military forces, with fighting between Sunni and Shiite leaders within the fledgling central government threatening its dissolution. A barrage of attacks in Baghdad over the last week portend continuing violence and instability, and do not bode well for the future of oil supply in the region.
• Tens of thousands of protestors jammed the streets of Moscow on Christmas Eve, jeering the Kremlin over widely alleged fraud in the recent election which retained Prime Minister Vladimir Putin’s grip on power. Russia was the largest oil producer in the world at the beginning of 2010, and now stands just below Saudi Arabia with 10.3 mbpd of production. Were it not for Russia, non-OPEC oil production would have been in steep decline for the last several years, and as such it remains a critical pillar of stability for world oil markets. . . a pillar which may now be eroding.

Though little reported in the American press, popular protests are on the rise in China as well. With a major turnover in leadership scheduled for 2012, there is at least the potential for significant reforms favorable to the country’s burgeoning middle class, who are growing increasingly restive under the suppression of its central government. But there is also the potential for renewed attempts to reinforce authoritarian rule. In the province of Guangdong in the south of China last week, tens of thousands of residents participated in two separate protests against the local governments over land policy and a planned expansion of a coal-fired power plant in the smog-choked town of Haimen. With the largest GDP of any province in China due to its heavy manufacturing base, Guangdong may be considered a leading indicator of China’s direction, more oriented to its trading partners to the west than to Beijing. Local authorities capitulated to the demands of the Haimen protestors, but only after police used tear gas to quell the demonstration. In short, China looks like an interesting wild card in 2012 where popular unrest could explode, particularly if its economic growth slows significantly, as some observers expect, and/or if the protests in Russia become more strident.

Another interesting wrinkle with potentially far-reaching implications emerged on Christmas Day, as China and Japan announced that they would begin direct bilateral trading of their currencies. About 60 percent of the trade between the two nations is currently settled in US dollars, according to Japan’s Finance Ministry. Coming from the two largest holders of foreign-currency reserves in the world, the accord constitutes a potentially serious threat to the hegemony of the US dollar, which has conferred an enormous economic advantage to America for many decades. The pact is considered largely symbolic for now, but could signal the ascendancy of the renminbi, and will likely lead to continued weakening of the dollar against it. More broadly, the move could presage an entirely new era of geopolitical alliances.

Economic outlook

The economic front looks perilous indeed. It is certainly possible that 2012 will be another year of aimless bouncing around in a narrow channel while the world’s central banks keep trying to extend and pretend. With just three trading sessions left in a brutally difficult year that ruined many a seasoned hedge fund manager, the S&P 500 stands up a lousy 0.6 percent on the year. That could happen again. But I would put greater odds on a real reckoning. The long series of attempts to save the Eurozone in the final months of 2011 staved off collapse, but they fixed nothing. The enormous overhang of leveraged debt and the impossibility of restoring economic growth in the West are still with us, and every month that passes without an honest strategy to bring obligations in line with hard asset values only increases the threat. Faith in the markets, the dollar, and the euro has all but evaporated, and our economies now hang by a string dangling from the hand of Ben Bernanke. If that string doesn’t break in 2012, it will in 2013, or 2014 at the latest. The key question is how long the world’s central bankers can skate on the thin rim of the deflationary vortex.

Should the global financial regime fail, there will be blood in the markets. Bank runs are not out of the question. Commodity and equity prices could fall to the tune of 40 percent or more, but without destroying enough demand in Asia to restore a comfortable cushion of supply in oil and agricultural commodities. Here, it is useful to reflect on 2008. From 2005 on, the data suggested that 2012 would be the turning point when oil supply began its long, inevitable, terminal decline. But the crash of 2008 bought us a few more years of adequate oil supply at a moderately uncomfortable price, and pushed that point off, at least theoretically, to around 2014. If there is a similar crash in 2012, the turning point could be delayed another year or two, but only if supply from all of the highly unstable sources mentioned above remains firm. I would put 50-50 odds that it does not, in which case prices will remain uncomfortably high even as deflation takes a firmer grip on Western economies. The world will be hard-pressed to increase liquid fuel supply from current levels.

Certain uncertainty

The one thing I can say with certainty about 2012 is that it will be fraught with uncertainty. 2011 could look tame by comparison.

More natural disasters are almost certainly on the menu, which will disrupt supply chains and exact a painful toll of blood and treasure the world over.

Regional skirmishes over resources, particularly in developing oil-rich areas like the Caspian and Africa, are likely.

Authoritarian governments, along with their corporate sponsors, will continue to be challenged by the people, and will resort to heavy-handed crackdowns in response. The Arab Spring and the Occupy movement are merely the beginning of popular revolts that will ultimately transform the political and economic order of the world. Unrest in previously pacific areas should be expected.

Intelligence agencies will find it difficult to keep up with multiplying threats. Attacks by the hacker group Anonymous on powerful vested interests, like the Christmas weekend attack on the US-based security think-tank Stratfor, will become more commonplace and focused on high-value targets like government and military organizations. The potential disruptions to business as usual are hard to overestimate. Banks, public services, utility grid operators, and communications systems could suffer extended outages. Electronic systems of exchange could be compromised. Faith in our large, complex systems will wane.

In the face of all this uncertainty, then, what is one to do?

The answer is simple: Do what you can.

Minimize your expenses, and pay down debt as rapidly as possible.

Grow some of your own food, whether you have a big backyard or just a little balcony with room for a couple of small pots. Millions of people have begun doing so since the crash of 2008, and they have found it a universally rewarding and fun experience. It helps to ground one in reality, and brings a little peace of mind. Before you know it, you’ll be expanding your garden and maybe keeping a few chickens.

Reduce your consumption of fossil fuels any way you can, by focusing on efficiency. Then (and only then), if you can, think about installing some solar hot water, solar PV, and battery backup on your house or business. I expect the distributed solar market to be a rare and surprising bright spot in 2012.

Keep a little “rainy day” cash on hand. To really hedge your exposure to financial collapse, physical gold and silver bars and coins are your best insurance.

Renew your relationships with friends, family and neighbors. Nothing is worse than feeling alone when the world is going crazy around you, and they will help you keep your head on straight.

Most importantly: Try to keep your mind in the present. Don’t let the uncertain future frighten you into immobility, and don’t let the past keep you from doing the best you can today. It’s surprisingly hard to do, but it gets easier with practice. The Buddhist approach is to simply be mindful of what you’re doing, seeing, hearing, and feeling right now, be it walking down the street or cleaning the cat box. Or, in the Biblical verse of Matthew 6:34, “So do not worry about tomorrow; for tomorrow will care for itself. Each day has enough trouble of its own.”

I wish all of us luck, wisdom, fortitude, and peace of mind in what will undoubtedly be a very challenging year. We will soldier on, somehow.

Photo: marcobellucci/Flickr