–Gregor

Further Reading: My recent interview with Gold Money

The chart above divides total Full Time jobs by Total Part Time jobs, in the United States. Coming into the financial crisis of 2008, the US maintained nearly 5 Full Time jobs for every Part Time job. The failure of the economy to add back those Full Time jobs, along with flat to falling wage growth in real terms, accounts for much of the country’s dissatisfaction with the “recovery.” Replacing higher paying full time jobs with lower paying part time jobs simply won’t do. As food prices continue to climb, and as oil stubbornly holds to $100 a barrel (kicking 12% of US oil consumption offline), Americans are discovering what it’s like to live without progress.

-Gregor

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An emotional, jubilant hooray! could be heard earlier this month when the Bureau of Labor Statistics (BLS) released its latest jobs numbers for January 2012, showing the addition of 243,000 net new jobs. That’s the kind of news both the financial markets and the political complex were yearning for, because it implies that growth is finally greater than the rate at which new workers enter the labor force due to US population growth alone.

But the report was not without controversy. Significant revisions to BLS sampling were introduced in this report as a result of the recent integration of the 2010 census data. Recalibrated, this altered the size of the workforce, and thus changed the number of Americans either working, looking for work, or dropped out of the workforce altogether. And so the cries of Foul! began.

Those who see politics in the numbers are perhaps overreaching. Likewise, those who see the dawn of a new era of resumed job growth are also likely premature in their celebration.

The fact remains that the United States is still at the beginning of a long journey in clearing the vast tranche of structural unemployment, sadly left in the wake of the Great Recession. A weak dollar, an emerging megatrend towards exports, and attractive business conditions should combine to enable the United States to slowly, eventually pull itself out of its current economic sinkhole.

But accurately identifying the true strength of any US recovery will be crucial, as certain portions of the economy emerge from the rubble of the past few years while other sectors languish. It’s notable, for example, that after a decade-long bear market, technology stocks and the Nasdaq 100 may now be indicating that a more sustainable recovery lies ahead. For those of us who monitor the resource scarcity story, we know that technology will not fundamentally alter actual natural limits. But on the other hand, we need to be mindful that technology still offers the promise of mitigating our resource dilemma, helping from the margin as we move through a rough energy transition.

In the wake of the jobs report, US Treasuries and gold, the two asset classes that have offered safety through the past few years, faltered. Right or wrong, global markets were jolted by what’s commonly called a “growth scare.”

The question at this juncture is how durable is such a scare as this? Does this portend a major shift in our familiar, decadal trends? Or is it just a blip, as the Great Stagnation lumbers onward?

And what will be the implication for the future price of gold?

Jobs Data Kerfuffle

The US employment data series that I have long favored is not the unemployment rate or non-farm payrolls, but simply the raw number of all those currently employed in the system. While other series are important, the Total US Employment figure has probably given the best, undiluted read on the US jobs situation.

Yes, it’s true that over the past year, government jobs have been lost while private payrolls have risen. Such trends cause many analysts to currently favor the Non-Farm Payrolls series. Also, with so many discouraged workers, the series on the Participation Rate is also important. Nevertheless, much of the contentious dispute that arose after the jobs report centered on that Total US Employment figure, as well as the big gap that opened up between the seasonally adjusted (SA) version and the non-seasonally adjusted (NSA) version.

Let’s take a look at each:

In the above chart of Total US Employment, you can see that a workforce recovery has been gathering steam for the past year. But with the January Jobs Report, employment soared by over 847,000 jobs from 140.790 to 141.637 million employed. That’s a big jump and the biggest monthly gain since the 2008 trough of 138 million.

Now let’s look at the same data series, non-seasonally adjusted (NSA):

Whoa, what’s this? In the non-seasonally adjusted (NSA) data, January actually saw total employment in the US fall by 737,000 jobs, from 140.681 to 139.944 million employed. That huge gap of nearly 1.6 million workers between the SA and the NSA data was due to the recent BLS statistical revisions and the source of the resulting disputes.

But a few comments on this issue. One, there is always a gap between the seasonally adjusted and non-adjusted time series. Eventually the conformity between the two is ironed out. Second, despite the broad scope of this series, it does not tell us the actual nature of the jobs Americans are taking. Are they full-time or part-time jobs? What supporting data can we glean from tax receipts?

Unfortunately, and unsurprisingly, the US economy is indeed adding jobs, but these are not high paying jobs, nor are they overwhelmingly full-time jobs. This is very much in accordance with the type of recovery the US economy is seeing: the permanent loss of high paying jobs in finance, advertising, and consumption, and a transition to jobs in mining, farming, and natural resource exports.

It’s also important to remind ourselves that, compared to the past ten years, the annual averages of total employed in both 2010 and 2011 — which have been heralded as “recovery years” — are still far below pre-recession peaks. 2007 saw 146.05 million of total average employment, while 2011 saw an average 139.87 million. So even the strong appearance of recovery in the monthly series needs to be tempered by the big picture: The US not only has to put the long-term unemployed back to work, it has to create enough new jobs to cover population growth, too. So far, that’s just not happening.

The New American Jobs Mix: Part-Time Work

While it’s true that the post-2008 recovery has seen a rebound in state, local, and federal tax receipts, these trends have not exactly been robust.

Again, there’s no need to argue whether the post-2008 recovery has been weak. Just about everyone now, including the perennial optimists, agree that this was neither a typical post-war recession nor a typical post-war recovery. What remains in dispute, however, is whether normalcy can ever be fully reestablished.

I would say no.

And I would say that’s not necessarily a bad thing. If the great symbiosis (hat tip: Don Coxe), in which endless American consumption of foreign goods was recycled back into our Treasury market, was sustainable, then it would still be in effect. But alas, it was not the fate of the US to claim ownership of all of the world’s full-time, highest paying jobs. Eventually the ability of the developing world to also obtain math, science, and engineering education has revealed itself. Now Americans face a more competitive world with fewer embedded advantages.

Let’s take a look at the actual mix of full-time vs. part-time jobs growth over the past five years:

America used to produce and maintain nearly five full-time jobs for every part-time job. But now that ratio has fallen nearly 15%, as part-time jobs outpace full-time job growth. This is ground zero of the weak economic recovery. Americans feel poorer because their wages are indeed lower, their benefit packages are shrinking or nonexistent, and their purchasing power is not keeping up with the rise in food, energy, and health care costs.

This structural change is reflected in Federal Tax Receipts, as reported by the US Treasury. Like the recovery itself, (withheld) receipts emerged from the lows of 2009, but are flattening once again:

The Fed’s Outlook on Jobs

Among the important shifts in policy and procedure announced in the latest Fed meeting was a renewed emphasis on jobs. And Chairman Bernanke has been explicit, in the wake of this most recent jubilant jobs report, that the US recovery has a long way to go:

Though the unemployment rate fell to 8.3 percent in January, many Americans have stopped looking for work and have therefore been pushed out of the workforce, perhaps permanently. The labor force participation rate fell in January to 63.7 percent — its lowest level since January 1982. More than 40 percent of those currently unemployed have been without work for more than six months, Bernanke noted. That’s roughly double the share during the housing boom of the early and mid-2000s, he said. That adds up to 5.5 million Americans who have been out of work for six months or more, not to mention three to five million more people who have dropped out of the labor force because they have given up looking for work. Bernanke has previously warned about the prolonged economic harm of long-term unemployment. In September the Fed chairman called long-term unemployment a “national crisis.” “This has never happened in the post-war period in the United States,” Bernanke said in September. “They are losing the skills they had, they are losing their connections, their attachment to the labor force.” — Ben Bernanke: Long-Term Unemployment Crisis Altering Job Market For the Worse.

A stubborn contingent refuses to believe that further quantitative easing (QE) from the Fed is either imminent or necessary. In an inversion of causality, some even believe that if the Fed were to withhold further QE, it would either confirm or, improbably, ensure that the “recovery” carried onward.

To believe such things, however, one would also have to believe that QE1 and QE2 did nothing stabilize the system. Likewise, that the European version of QE was also without effect. Well, the Fed as an institution no doubt suffers from extreme normalcy bias, but starting in early 2011, it clearly began to surrender its belief in a normal economic recovery. And you should, too. As the locus of contemporary economic thinking, the Fed had so much success over the decades with its stimulus policies that it would take the rough experience of 2007-2010 to break their faith with that view.

The Truer Picture of US Growth

We can think of the US now as a kind of corporate office park in which S&P 500 companies domestically maintain an executive presence only, while their operations hum along globally. A good portion of the US population has been swept aside over the past 40 years, as many jobs were lost to overseas workers, and then the 2008 crisis took out a whole additional layer of US workers when the bubble of finance, insurance, and real estate expired.

The good news is that the inflation in resources and commodities, an independent trend that started ten years ago, is providing some pricing power, and driving the growth of exports and also a fledgling renaissance in US manufacturing. As I detailed in The Price of Growth, however, this is merely the start of a long transition.

Much of the difficulty lies in precisely the issue highlighted by Fed chairman Bernanke: Much of the US workforce is wrongly skilled for the lurching, tectonic shifts that have befallen both the US and the global economy. We spent an unfortunate three decades preparing young people to play a role in what I will call the Surplus Wealth Economy: marketing, advertising, consumption, travel/leisure, and money management. These industries are fine, as industries go. But they require a continued organic growth in the “real economy.”

I recognize that such a concept, the real economy, continues to be derided as an outdated view, but I take the exact opposite position: I now think it’s appropriately contrarian to suggest that domestic manufacturing is a must-have for the US economy, principally because we now know that with new technologies — especially in greentech, from batteries to wind and solar power — much of the latest innovation is coming from the manufacturing floor.

An articulate observer of the current US dilemma in this regard is technology investor and social theorist Peter Thiel. Correctly, Thiel has noted that the US continues to be a generator of innovation, but that progress itself has become scarcer. Innovation in the digital world continues, but there is a problem in the world of atoms — the physical world. In his late 2011 essay, The End of the Future, Thiel notes the persistent belief on the part of the intelligentsia in progress and future growth that at the same time is blind to the data showing a decline in growth in real terms. As result, our top minds can delude themselves about the true state of progress.

He writes further:

Taken at face value, the economic numbers suggest that the notion of breathtaking and across-the-board progress is far from the mark. If one believes the economic data, then one must reject the optimism of the scientific establishment. Indeed, if one shares the widely held view that the U.S. government may have understated the true rate of inflation — perhaps by ignoring the runaway inflation in government itself, notably in education and health care (where much higher spending has yielded no improvement in the former and only modest improvement in the latter) — then one may be inclined to take gold prices seriously and conclude that real incomes have fared even worse than the official data indicate.

Thiel is one of the few commentators who have an interest in gold from a completely different view than is normally associated with those investing in the metal.

Indeed, this viewpoint is precisely the same one I addressed late last year, in Gold and Economic Decline, when I unpacked Paul Krugman’s view on gold as a play on stagnation. In subsequent essays, I have also cited the slowdown in the rate of productivity and other related data showing that progress has slowed. A complex system in deceleration is bullish for gold, simply because of the dearth of other investment opportunities.

I have followed Thiel’s work for years, and unsurprisingly, unlike the policy and economics establishment (which remains unjustifiably sanguine about issues related to oil depletion), Thiel — along with other notable hedge fund managers — was early to the Peak Oil story. Gold, like oil, remains very much at the center the intractable problem facing developed world economies.

What the Growth Scare Means for the Markets — and Gold

The question is, does the growth scare provided by the recent jobs report hurt the investment prospects for gold?

As I mentioned, the technology sector is flashing the possibility that investment could finally be drawn back to that area, as capital has been starved for growth opportunities for several years now. I don’t think the growth prospects of the United States and the wider OECD — Japan and Europe — are really strong enough to trounce the stagnation thesis just yet.

However, in Part II: The Case for $2,500 Gold In 2012, I am more specific than I have previously been about the likely price bands for gold as we head further into 2012. We’ll look at the impact of various economic scenarios on gold’s price and determine which one is most probable and why.

Meanwhile, I also want to address what a large selloff in US Treasuries might do to both gold and the stock market. If global markets believe strongly enough in the Return to Growth theme, then global stock markets could be pushed high enough to trigger an exit of capital out of bonds. That would create conditions that the financial markets and gold have not had to contend with in some years. If gold has indeed received a growth scare, the same effect could well likely ripple through other asset markets, with surprising outcomes.

Click here to access Part II of this report (free executive summary; enrollment required for full access).

I too used to laugh at the export prospects, of the United States. No more. A weaker dollar, a shift in policy, and a world hungry for natural resources has boosted US exports to 14% of GDP in 2011. It also helps that the US now has some of the cheapest electricity rates in the developed world, and even cheaper natural gas. Two common components, in manufacturing. Annie Lowrey at the New York Times echoes my recent writings on the subject, and also acknowledges the US has a new industrial policy: exports, and, a resurrection of manufacturing.

But many in the senior economics establishment remain skeptical. Christina Romer for example recently penned an Op-Ed that forced me to ask a question: is the Romer position on the (un)importance of manufacturing a “modern” view that’s suddenly become outdated? Discussion of the synchronous, and interactive, relationship between design and manufacturing has been flourishing for several years now. See this Alexis Madrigal piece from 2010: Key Question: Can the US Innovate Without Manufacturing? The bottom line: in new industries such as greentech, power grid development, and other technology, crucial innovation now emanates from the shop floor. That suggests any new policy to bring design and manufacturing groups back together, in closer physical proximity, is hardly a mistake.

My forecast has been as follows: at present rates, the US will see exports as a percentage of GDP climb well above 15%. At such levels, a new set of preferences will emerge. As an economy increasingly composed of exports, the US will then seek to protect that position even more. The implications for the US Dollar, on a long timeline, become rather obvious.

–Gregor

Recently released data from the US Geological Survey shows that global gold production, after falling every year between 2001 and 2008, finally rose for the past three years. In 2011, production reached 2,700 metric tons. However, in a larger context, the past decade has been quite poor for gold production and the compound annual growth (CAGR) rate has fallen well below the average of the past 110 years. The high cost of marginal supply and the poor production performance of the large cap gold miners fits in nicely to the theme. (And mirrors the experience of “Big Oil” the past decade, which has been unable to replace reserves with oil, and has increasingly turned to natural gas). Much of the new production therefore is coming from smaller plays, and from the smaller mining companies. But whether a large array of smaller deposits can make up for the decline of the larger deposits—sustainably—is unclear. What’s more certain however is that new supply is only possible with the new price range of gold, above, say, $1200 an ounce. As with oil, should price fall dramatically from here, supply too would quickly adjust downward.

–Gregor

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Growth. It’s what every economist and politician wants. If we get ‘back to growth’, servicing debts both private and sovereign become much easier. And life will return to normal (for a few more years).

There is growing evidence that a major US policy shift is underway to boost growth. Growth that will create millions of new jobs and raise real GDP.

While that’s welcome news to just about everyone, the story is much less appealing when one understands the cost at which such growth comes. Are we better off if a near-term recovery comes at the expense of our future security? The prudent among us would disagree.

Resurrecting American Export Strength

It’s easy to be skeptical that America could once again be a titan of global exports.

For a very long time, that role has mostly been relegated to countries in the developing world. America as an export economy? Somewhere along the 50-year transition from industrial manufacturer to voracious consumer, Americans have lost touch with such a remote possibility. Indeed, this phase of America’s economic history is now quite settled.

A multi-decade outsourcing wave has left US workers to concentrate in the financial sector — an over-weighting of talent we would come to regret after the crisis year, 2008.

Since 2009, though not well advertised, Washington has been pursuing a quiet policy to boost exports in nearly every sector, throwing investment capital at port and rail infrastructure, and getting the message out to regulators and state government. Now, after some very notable gains in which exports have advanced to nearly 14% of GDP, the President in his State of the Union Speech made it clear: The US would no longer cede a labor and manufacturing advantage to the rest of the world.

With that declaration, notice was served. It was perhaps not a coincidence when, the following day, the Federal Reserve articulated a zero-interest-rate policy that would be sustained for years. The US dollar reacted immediately and promptly returned to its downtrend. Has a new industrial policy now been unveiled?

(Painting: Alfred Bierstadt, 19th Century: Mt St Helens and Columbia River)

Rivers of Coal

The small city of St. Helens, Oregon sits astride the Columbia River, 25 miles closer to the Pacific Ocean than Portland. Over the past two years, a consortium of coal shippers and coal producers has been searching along the Pacific Northwest coast for a place to construct new export terminals. Coal, which is mined in the Powder River Basin of Wyoming and which often travels long distances to power stations in the American South, would also find easy rail routes to Asian markets through the ports of the West Coast. Rebuffed already by Bellingham, WA, north of Seattle, and then rebuffed again by Longview, WA, north of Portland, the industry is trying once more — this time at St. Helens.

To understand this persistence, one has to appreciate the current juncture in world coal markets. Global oil supply has been coming up against a ceiling for seven years now, since 2005. As a result, much of the world is trying to access increasingly more BTUs through natural gas and coal. Asia, which has built tremendous coal capacity, is a relentless user of coal. And US coal mines, older and with much higher extraction costs, are able to take advantage of rising world coal prices.

Moreover, as the US has been transitioning to natural gas for over 30 years to create electricity, that trend is only accelerating as its own coal plants age and retire. (see Regulation and the Decline of Coal, Smart Planet, January 2012, by Chris Nelder). The combined effect has caused a reversal in the long decline of US coal exports, which began to turn higher in 2002:

From a low of 40 million short tons at the start of the last decade, US coal exports have recovered and doubled to 80 million short tons as of 2010. One of the fastest growing subsets of our coal exports has been metallurgical coal, which has soared since 2008, climbing 60% alone in 2011, over the prior year.

More broadly, the US is already in position to become an exporter, not only of oil, but of other energy products, too. For example, much of the additional refining capacity that was added to existing infrastructure last decade now serves as spare industrial capacity to export US oil products, such as gasoline, diesel, and other fuel oil.

The deep and sustained cut that Americans have made to their own oil product consumption is thus being converted to exports. And with such high levels of structural unemployment, it does not appear Americans will account for any new call on their own energy resources anytime soon.

Unless of course, we use those energy resources — not for idle consumption, but for production.

New Energy Equations

As many are aware, the most gaping, yawning price discount found in the world today is in the comically cheap BTU found in North American natural gas. At less than $3.00 per million BTU, the energy content in natural gas can be purchased now at an 85% discount to the BTU content of oil. That is a value proposition and a pricing vacuum that — save for the typically long time frame of energy transitions — simply cannot stand.

Even if it takes 20 years to wean automobile-dependent economies off oil and back to electrified transport, someone, somehow, will find a way to perform physical tasks with natural gas that were previously completed using oil. As we know from history, it took Europe quite some time to transition from the Age of Wood to the Age of Coal, but the first country out of the gate was Britain, and the results were transformative. Something “like” this transition is happening today in the United States, because US demand for electrical power, produced from natural gas, coal, wind, and solar, is rising on a relative basis to our previous oil consumption.

For now, let’s leave aside some of the problems we will eventually run into as we hit the natural gas resource base harder. There will be environmental pressures, and constraints on water usage and water safety. And though it seems unlikely today, with natural gas trading at decade lows of $2.75/million BTU, there will eventually be a move higher in price. After all, North America is also gearing up to export natural gas, with proposed terminals in British Columbia and the US Gulf Coast.

The question is: should the US use this incredibly cheap BTU for export, to catch the much higher world price for LNG — or should the US use this cheap energy as a competitive advantage, to make cheap electricity as a manufacturing input?

It appears the US is going to do both.

Already a certain virtuous circle is developing. Increased natural gas extraction is driving the need for more drilling equipment and energy infrastructure. This has induced global companies to revive metalcraft and steel operations in the depressed American Midwest. An intriguing story in this regard is the investment Vallourec of France is making in Youngstown, Ohio, which will produce specialized steel tubing for the oil and gas industry. Surely the fact that the US has some of the lowest electricity rates in the developed world is part of the attraction.

Getting the Government on Board

Boosting the extraction of natural resources will not be without deleterious effects.

As I explained in the January 3, 2012 report A Punch to the Mouth: Food Volatility Hits the World, the massive increase in US exports of food is wonderful economic news for the US farmer. But it also means a greatly expanded use of fertilizers, and smooths the delivery of a world price for food — which American consumers must begin to pay. In food prices, and now in oil prices and coal prices, Americans must now bid for their own natural resources in a booming world market for commodities. Equally, many communities are discovering that natural gas extraction, oil and coal shipments, and the prospect of new export infrastructure are either dangerous to the environment or simply not an industry wanted by local communities.

Despite public perception, Washington is hardly antagonistic towards increased energy production, except in the most superficial, rhetorical way. Meanwhile, many of the agencies in Washington have directed their attention towards a re-industrialization of the US, and exports in particular.

The Department of Transportation (DOT) has directed a lot of its spending towards rail and port infrastructure in the past several years. A review of the DOT’s Tiger Grants since 2009 reveals wave after wave of targeted investments in the national ports of Miami, Los Angeles, Providence, Vancouver/Portland, and many others, with special attention to rail connectivity. The upsurge in port infrastructure investment is not lost on the shipping industry either, which began in early 2010 to note the rapid growth from the first round of TIGER grants from the previous year.

When President Obama originally announced the administration’s goal to double exports by 2015, it was not taken very seriously. In a New York Times piece in January 2010, a former head of the Council on Foreign Relations was quoted as saying, “How will he perform this miracle? It really is a mystery.” Indeed, if you attended university anytime since 1980, and studied economics while there, you learned that America’s industrial era was mostly over. The 1990s put a fine point on that lesson: The US would create products conceptually at home, and have the products manufactured abroad, pocketing the arbitrage of cheap labor. That equation only accelerated in the past decade as cheap coal powered foreign manufacturing centers, primarily in Shenzhen China, while oil costs rose.

But this past week, President Obama laid bare the country’s new intentions:

We can’t bring every job back that’s left our shore. But right now, it’s getting more expensive to do business in places like China. Meanwhile, America is more productive. A few weeks ago, the CEO of Master Lock told me that it now makes business sense for him to bring jobs back home. Today, for the first time in 15 years, Master Lock’s unionized plant in Milwaukee is running at full capacity. So we have a huge opportunity, at this moment, to bring manufacturing back. But we have to seize it. Tonight, my message to business leaders is simple: Ask yourselves what you can do to bring jobs back to your country, and your country will do everything we can to help you succeed. So my message is simple. It is time to stop rewarding businesses that ship jobs overseas, and start rewarding companies that create jobs right here in America. Send me these tax reforms, and I will sign them right away. We’re also making it easier for American businesses to sell products all over the world. Two years ago, I set a goal of doubling U.S. exports over five years. With the bipartisan trade agreements we signed into law, we’re on track to meet that goal ahead of schedule. And soon, there will be millions of new customers for American goods in Panama, Colombia, and South Korea. Soon, there will be new cars on the streets of Seoul imported from Detroit, and Toledo, and Chicago. I will go anywhere in the world to open new markets for American products.

No doubt a good portion of this rhetoric is election-year posturing. That said, the data shows us that exports as a percentage of GDP have soared since Obama came to office. And while part of that ratio is due to punk GDP growth, the US is stepping up its export of industrial machines, medical equipment, telecommunications and transportation equipment, civilian aircraft, and engines.

However, from its current hollowed out position, the US is still seeing its greatest growth in commodity exports. That is, in everything from grains such as corn and wheat, to cotton, and even gold. For example, by value, the petroleum products discussed earlier are now America’s largest export.

This points to a constraint: If the US is going to export mainly commodities during its long road back to the export of finished goods, then it will be even more important to cap any rise in the US dollar.

In Part II: Prepare for the Collapse of the Dollar, we discuss the growing clarity around the big changes that are afoot to create an exports-driving jobs ‘recovery’.

But it comes at the cost of drastically weakening our currency and sending increasingly strategic and depleting domestic resources overseas. Essentially, inflation and scarcity will increasingly become the themes of the future.

We address the key questions concerned readers should be asking: is this a price worth paying? What does this future look like and how should I be positioning for it?

Click here to access Part II of this report (free executive summary; enrollment required for full access).

Since 2005, European oil consumption has fallen by 1.5 million barrels a day. And, in the same period, US oil consumption has fallen by 2 million barrels a day. If oil was priced at $60 a barrel, rather than $100 a barrel, then a fair portion of that lost demand might return. Instead, since 2005, global crude oil production has been bumping up against a ceiling around 74 million barrels a day. Thus, the tremendous growth in oil demand which emanates from the developing world, in Asia primarily, has been supplied by the reduction of demand in Europe and the United States. Why doesn’t the world simply increase the production of oil to 77, or 78 million barrels a day? After all, that is precisely the history of global oil production: a continual increase in supply to capture the advantage of rising prices.

Today, in 2012, I observe that many analysts of global oil production—and the interaction between oil prices and the global economy—continue to engage in a guessing game about the future. But, frankly, the future has already arrived. And it is not a random future, but a future that was held to be improbable, if not impossible. For each extra barrel of oil produced over the past seven years from Russia, and Canada, there has been a loss of production from the North Sea, from Mexico, from Indonesia and elsewhere. And in the case of OPEC, there has been a stubborn flatlining of production growth, which, in the true spirit of argumentum ad ignorantium, has been taken as proof of OPEC’s hidden and secret supply. Thus, we are led to the newest and strangest meme of all: the failure of global oil production to grow over seven years, in the face of a phase transition in oil prices, is not even suggestive of peak oil. But rather, proof of oil’s imminent supply resurrection.

–Gregor

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photo: BP Oil Leak photo series via Boston Globe, Mark Ralston – AFP/Getty Images

Eventually the point is reached when all the energy and resources available to a society are required just to maintain its existing level of complexity.

- Joseph Tainter

The modern world depends on economic growth to function properly. And throughout the living memory of every human on earth today, technology has continually developed to extract more and more raw material from the environment to power that growth.

This has produced a faithful belief among the public that has helped to blur the lines between human innovation and limited natural resources. Technology does not create resources, though it does embody our ability to access resources. When the two are operating smoothly in tandem, society mistakes one for the other. This has created a new and very modern problem — a misplaced trust in technology to consistently fulfill our economic needs.

What happens once key resources become so dilute that technology, by itself, can no longer meet our growth needs? 

We may be about to find out.

Recent History

The twin disasters, Deepwater Horizon in the Gulf of Mexico and Fukushima in Japan, took place only nine months apart in 2010-2011, but together they have provided the world’s economy with a lesson in 21st Century un-priced risk. Our various energy systems, vastly arrayed across regions and hemispheres, have now reached a late phase of complexity. And societies, particularly in the West, have enjoyed technological progress for such a long, uninterrupted period of time that the delicate nature of this modern infrastructure has evolved to escape notice.

The BP disaster arose within the oil and gas sphere more than a century after the start of widespread oil extraction. The collective knowledge of the industry was, in one sense, a support to the operation that allowed the recovery of oil several miles below ocean and earth, using ultra deepwater drilling techniques. But a century of global oil production was also a constraint, as Deepwater Horizon illustrated the outer reaches to which a mature industry had been driven to obtain its next tranche of resources. The capital BP has set aside for cleanup stands at $40 billion. Additionally, government resources, from equipment to personnel, that were diverted to the Gulf and Gulf Coast that summer (see photo above) were reminiscent of a small military operation.

Deepwater Horizon also showed that modern energy extraction now occurs with the greatest-ever separation between human operators and their resource target(s). This physical distance is so great that, in the case of very deep offshore oil drilling, it’s no longer possible to reliably stop a blowout. Why? Because no equipment exists to easily take men and material to such depth to conduct repairs. Indeed, it was at least as much due to luck as skill that BP was able to halt the well flow several miles down. And the almost comical trial-and-error efforts (junk shots) proved what many have long asserted: In the past decade, the cost of the marginal barrel of oil has crossed a threshold to a completely new era. It now becomes possible to ask the question, Is it worth it? Is it even economic to obtain this new tranche of oil?

The Fukushima disaster, triggered by the an offshore earthquake, ripped the lid off Japan’s power grid and illustrated how the country has historically balanced its lack of domestic fossil fuel supply against its enormous manufacturing base. On a small level, the actual sequence of events at the Fukushima nuclear power plant revealed an amazing vulnerability. For it was not the passing of the tsunami that performed critical damage to the installation’s structure; rather, it was the auxiliary power that was knocked out, depriving the plant of its cooling functions. Hence the meltdown, and the subsequent issues with recriticality (resumption of fission).

Meanwhile, on a larger level, the world came to understand how dependent Japan had become on nuclear power, which provides 30% of the country’s electricity needs. Japan is also one of the largest importers of LNG (liquefied natural gas) and still has to import 80% of its overall energy mix, which includes oil and a very great quantity of coal. (Indeed, Japan is the fourth largest world consumer of coal, behind only China, the US, and India). Unsurprisingly, the country had to significantly boost imports of LNG and coal in the wake of the disaster.

What has been the cultural response to the Deepwater Horizon and Fukushima disasters? In the US, the oil spill in the Gulf, which exacted a great economic toll, echoes the aftermath of other post oil-spill environments: The moratorium on offshore drilling was quickly lifted, but in its place lies a new set of regulations and restrictions. Most of these have a single aim — that similar blowouts in deepwater be preventable or fixable. The evidence seems to suggest that deepwater drilling in the Gulf has peaked. The rig count has recovered but is still down below the highs, with many of the largest and most expensive operators having left for other parts of the world.

Meanwhile, the global response to the Japanese catastrophe rippled through several economies, especially those, such as Germany, that rely heavily on nuclear power. German chancellor Angela Merkel announced that her country had to accelerate its transition to renewables, becoming less reliant on nuclear. Other countries have increased their inspection procedures, and for the first time in many years, it seemed possible that many aging plants in the US would not see their licenses renewed. In Japan, there have been protests. And given the long lifespan of the nuclear event, which will ripple outwards for decades upon the affected portions of the northeast Japanese coast, it is not surprising:

TOKYO (AP) — Chanting “Sayonara nuclear power” and waving banners, tens of thousands of people marched in central Tokyo on Monday to call on Japan’s government to abandon atomic energy in the wake of the Fukushima nuclear accident. (Source)

Western Faith in Progress

Education in the West has, as a core feature of its curriculum, a narrative of progress. This is especially true of US history offerings and of any discipline that addresses the post-Industrial Revolution (roughly the two centuries after 1800). The examples of technological progress most available to Western cultures, as we moved from the Age of Wood to the Age of Coal and finally the Oil Age, are highly confirming of the view that humanity always finds a way. And in particular, it finds a way to grow, and even thrive.

It is particularly worth noting the symbiotic relationship between the machines that were developed to extract resources (like the steam engine that pumped water from coal mines) and the life cycle of those machines as utilizers of those resources. Coal mining triggered development of machines that would run on coal, just as oil would eventually power the latest machines that would be used to extract oil. It is this awesome ratchet effect that’s so persuasive to Western culture, and it is the story it repeatedly tells itself.

One can hardly fault the highly educated person, with an advanced position in business, communications, technology, or academia, for generally believing that innovation (and the power of prices) will obtain all of the resources we require. I believe this bias is what Daniel Kahneman would call an availability heuristic. The risk to this bias is that at some point in human development innovation and technology may very well carry forward and confirm society’s faith, but at the same time start to offer increasingly diminishing returns to progress. In my opinion, that is the lesson of Deepwater Horizon and Fukushima. And I expect it also to be the lesson of the Alberta Tar Sands.

There is a lens through which we can view events like Deepwater Horizon and Fukushima. Charles Perrow, in his important work on Normal Accident Theory (NAT) examines these accidents by type and plots them according to their complexity. See, for example, where nuclear power is located on the following grid: (Source: Accidents, Normal — opens to PDF).

What has begun to take place in global energy extraction is that the current tranche of resources obtained by more complex methods — deepwater drilling, underground fracturing, in-situ mining, and other strip mining — have begun to move towards the quadrant of Perrow’s chart that is occupied by nuclear power and chemical plants. Here, systems are both technically advanced and tightly coupled, which is to say that failures anywhere in their operations can spread easily and cause systemic failure.

Additionally, the boundaries of those failures can also be rather broad. That nuclear contamination spreads over large geographical areas has been known for some time. But Deepwater Horizon warned that contemporary oil extraction has also crossed the threshold into very wide boundaries. Despite the current euphoria over North American shale natural gas and the continuing confidence that production can be lifted in the Alberta Tar Sands, there are already indications that groundwater supply is going to become a much, much bigger issue as we try to increase access to these resources.

As Joseph Tainter explains (see the quote in the header to this essay), resources in civilization are eventually marshaled not for further growth but simply to maintain current systems, usually in their most advanced iteration. This is the terminal phase of expansion that the large, OECD regions (Japan, Europe, US) have likely reached. This is a vexing and frustrating limit that just about everyone, no matter their political orientation or economic view, will struggle to digest. For example, in an analysis of Fukushima’s impact on future energy policy, I thought this reaction from the team at the BTI Institute, was somewhat correct but perhaps a bit hasty:

Yet lost in the hyperbolic claims of nuclear opponents, the defensive reactions of the nuclear industry, and the carefully calibrated repositioning of politicians and policymakers is the reality that Fukushima is unlikely to much change the basic political economy of nuclear power. Wealthy, developed economies, with relatively flat energy growth and mature energy infrastructure haven’t built a lot of nuclear in decades and were unlikely to build much more anytime soon, even before the Fukushima accident. The nuclear renaissance, such as it is, has been occurring in the developing world, where fast growing, modernizing economies need as much new energy generation as possible and where China and India alone have constructed dozens of new plants, with many more on the drawing board.

(Source)

While it’s true that the long-forecasted nuclear renaissance in the West never took place, with little prospect now that it ever will, it’s not exactly true that the developing world is choosing nuclear power in any meaningful way. Coal remains the dominant energy source in the developing world, for obvious reasons: it’s portable, it stores well, it remains cheap, and (most of all) it is not complex.

Given that the externalities of coal use are rather brutal, it also the case that human beings place steep discount rates on the future. Society is much more fearful of accidents which take place suddenly and with little warning, than of the long term negative effects of a different set of policies on their health. It may not be logical, but that is our preference.

Tilting Away from Complexity

An emerging theme out of Silicon Valley over the past few years has been the epiphany that venture capital experienced regarding the extraordinary difficulty of greentech. “No mas” has been the conclusion. Why build expensive prototype energy boxes or invest in large vats of algae, when little apps can populate quickly across Internet devices, with no heavy lifting or messy cleanup? The difference between the two worlds has been summed up like this: In Atoms vs. Bits, it’s undeniable that “atoms are simply too difficult.” Yes, and this, too, is the lesson of Deepwater Horizon and Fukushima. If investment in complex resource extraction has either tail risk that could overwhelm returns, or externalities that overwhelm the well being of society, why do it?

Recently I spotted an insightful remark that addresses the issue, from Alan Nogee on Twitter.

In Part II: Why We Must Embrace Simplicity Now, we explore how diminishing returns have now triggered in our various complex systems. Eventually it will become clear that the cost to repair damages from their destructiveness is simply too great. Technology is practically telling us (begging us?) to place less faith in its ability to solve all problems.

It’s obvious that our elected leadership has no concept of a growth limit that could render the economy’s obligations insoluble. The Fed transcripts are yet one more piece of evidence that unless we get a better handle on the enormous, complex systems we are already operating, we will continue to suffer more frequent and painful “unexpected” economic accidents. Given our track record in this regard, the alternate route would be to step back from these complex systems and regain our footing in simplicity. Or else maintain the status quo approach until market forces pressure us to.

Click here to access Part II of this report (free executive summary, enrollment required for full access).

As you study the chart below, consider for a moment a less well advertised price spread: the disparity between North American natural gas (which remains landlocked) and the price for landed LNG in the United Kingdom. As energy market observers already know, North American natural gas will—in the next couple of years—be released through LNG export terminals in British Columbia (Kitimat) and Louisiana (Sabine Pass). That will trigger a rather momentous price convergence globally, as world LNG prices adjust to the entry of North American volumes.

–Gregor

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Perfect Storms

2011 was an abysmal year for the global insurance industry, which had to cover yet another enormous increase in damages from natural disasters. Unknown to most casual observers is the fact that during the past few decades the frequency of weather-related disasters (floods, fires, storms) has been growing at a much faster pace than geological disasters (such as earthquakes). This spread between the two types of insurable losses has moved so strongly that it prompted Munich Re to note in a late 2010 letter that weather-related disasters due to wind have doubled and flooding events have tripled in frequency since 1980. The world now has to contend with a much higher degree of risk from weather and climate volatility, and this has broad-reaching implications.

And critically, it has a particular impact on food.

Many factors seen over the past decade have produced higher food prices: population growth, urbanization, the decline of arable land per person, and the upgrading of diets for example. But more damaging than food inflation has been the pushing of global food prices out of their long, quiet envelope of stability. From the recently released UN Report on the World Food Situation:

The FAO Index (Food and Agriculture Organization of the U.N) shows that, while prices are once again down from a peak, a troublesome volatility started to affect food prices this decade. These are the very prices that caused social instability in countries like Mexico in 2007-2008 (pressure on corn prices, owing in part to US corn ethanol mandates) and more recently in northern Africa (Arab Spring).

Commodity observers will note the rough correspondence with oil prices, and of course that’s no mistake. Inputs to food production are heavily composed of fossil fuels. In the same way that both high (and highly volatile) oil prices play havoc with economies, food prices and marginal speculation in food have done the same.

2011 also saw the highest average oil prices since 2008, at $94.81 per barrel. That is not far below the average high of 2008, at $99.67. In between was a crash in oil prices — and most commodities — which unfolded at a rate almost as rapid as the original run-ups from 2006-2008. What happens next?

The USDA has just released its Food CPI readings for 2011, along with their forecast for 2012.

With 11 months of data recorded, the outlook for the 2011 Consumer Price Index (CPI) and food price inflation has become clear. The CPI for all food is projected to increase 3.25 to 3.75 percent. Food-at-home (grocery store) prices are forecast to rise 4.25 to 4.75 percent, while food-away-from-home (restaurant) prices are forecast to increase 2 to 2.5 percent. Although food price inflation was relatively weak for most of 2009 and 2010, cost pressures on wholesale and retail food prices due to higher food commodity and energy prices, along with strengthening global food demand, have pushed inflation projections upward for 2011.

For 2012, food price inflation is expected to abate from 2011 levels but is projected to be slightly above the historical average for the past two decades. The all-food CPI is projected to increase 2.5 to 3.5 percent over 2011 levels, with food-at-home prices increasing 3 to 4 percent…

With non-existent wage growth and a dearth of investment opportunities, these price advances in food costs have much more impact than it appears. What asset classes are keeping pace with the year-over-year increases in food? Certainly not stocks, as the S&P 500 has gone nowhere in a decade. Moreover, a 3.5% increase in Food CPI this year, with more to come next year, falls on top of a deeply under-utilized US economy in which tens of millions derive income from government transfer payments, most of which are not sufficiently ratcheting higher from “inflation-adjustments.” Food Stamp recipients, for example, are not seeing food inflation adjustments in their benefit checks that would compensate for the price increases. Not even close.

As you may have heard, milk was the top commodity performer in 2011, up 40% on the year in the futures market. A question: do you think milk is a central staple in American family diets? There’s more. On a year-over-year basis through November, according to USDA, beef prices are up 9.8%, egg prices are up 10.25%, and potato prices are up 12%. (This partly explains why junk-type grocery foods make up an ever-larger portion of food-stamp purchasers’ shopping carts. Sadly, people are buying caloric content, not nutrition).

Now, compare these price increases to the average individual Food Stamp benefit, which is basically flat year-over-year, moving from $133.79 in 2010 to $133.84 in 2011. And to the extent that households use Food Stamp benefits to plug overall cash flow problems, the very central and related pressure from higher gasoline prices also deflates the impact of the Food Stamp benefit.

Food Stamp Nation

The march higher in Food Stamp participation following the 2008 crisis has been relentless. The trend has paid no attention whatsoever to assertions of economic recovery or jobs growth in the US.

Yes, in the aggregate there has been moderate growth in private sector payrolls since the lows. There has also been a very big turnaround in exports, as this part of the economy has seen a veritable resurrection, growing to 15% of GDP. However, the upsurge in national Food Stamp participation (SNAP) has been stronger than them all. In December of 2007, just after the declared start of the “recession,” national participation in SNAP (Supplemental Nutritional Assistance Program) stood at 27.385 million. As of the latest data, this has ballooned to 46.268 million.

Because the national figures are so enormous and harder to comprehend, for several years I have kept track of Food Stamp (SNAP) users in Los Angeles County — alongside oil prices. Southern California illustrates well the dilemma for most of the nation: Through the force of US demand, we have lost the control we once enjoyed over oil prices, while at the same time we remain locked in to automobile-based transport. Previous recessions in the US would have knocked gasoline prices down for longer. Not so anymore. Earlier this year, it became clear to me that before year end, the number of L.A. County participants on Food Stamps would eventually cross the one million mark. That grim marker has now been achieved:

The above chart of L.A. County SNAP users echoes the FAO chart from the United Nations. Upward-moving volatility in energy is concurrent with wild swings in food prices and waves of people in need of public assistance. Wages in the US have remained flat while millions of workers remain either unemployed or underemployed. Meanwhile, urbanization in the developing world has continued apace, forcing food prices and energy prices up at the margin. The results are not complicated. When demand begins to hit a resource whose supply cannot be easily increased, then price moves to ration demand and price becomes more volatile.

That process, so obvious to many, can unfortunately digress into a series of time-wasting arguments about speculators and whether the world is running out of…(insert your preferred natural resource here). On the contrary, natural resources rarely, if ever, run out in the marketplace. The US is not running out of oil, or corn, and the world is not running out of coal, or copper. What we have seen however in the past decade is that a number of structural changes to human development, primarily industrialization in the Non-OECD, have combined to put an unexpectedly large burden of demand on world resources – at a rapid rate. Meanwhile, many natural resources, such as copper and oil in particular, had already reached a more difficult place in the arc of their own extraction history when this started to unfold.

The Decline of Arable Land

The result is that energy resources, and thus the ease of using energy resources in food production, began to converge with a long decline in the availability of arable land.

It is not for nothing that farming acreage in the US Midwest is up over several hundred percent since the lows twenty years ago. (As a personal aside, I remember those lows very well; I lived on a struggling soybean farm in Iowa during graduate school in the late 1980s). The world is in the midst of a New Great Game. But this time, the hunt is not on only for energy resources, but for agricultural resources — mostly cropland.

On my own blog, I recently did a short post on a study of urbanization in China’s Pearl River Delta and its aggregate effect on climate and precipitation. In short? Paving over the earth decreases rainfall. I also found these two photos from NASA, comparing satellite views of the Pearl River Delta over a 24-year period from 1979 to 2003.

The loss of arable farmland per capita in China has placed enormous pressure on the global food system and all of its inputs, especially fertilizer. The miracle of the food revolution, much trumpeted over the past 30 years as the latest achievement of technology and innovation, is not to be dismissed. But there are limits. We can only convert so much farmland to urbanscape while making up the difference with N, P, and K (Nitrogen, Phosphorus, and Potassium) before we lose resiliency — and redundancy — in the global food system. It did not used to be the case that a bad wheat crop in Australia or the Ukraine would hit global wheat prices so hard. Moreover, because food is a renewable resource, a level of overconfidence about our ability to respond to demand crept into policy-making and forecasting.

In Part II: Preparing for Higher Food Prices, using the most recent data, I show what’s happened to arable land around the world and talk about how we have created ever more tightly-coupled fragility in our systems of food production. I also chart the relative performance or return on various investments, compared to food, and show that despite the avoidance of the matter, stagflation has now entered the US economy. (How does one cope with flat wages and rising food prices?) Finally, I have just finished reading Julian Cribb’s The Coming Famine: The Global Food Crisis and What We Can Do to Avoid It, 2010, and found his discussion of virtual water very much on point, and relevant to our next set of challenges:

In theory, countries that lack water can import virtual water as food commodities with those with plenty. So too, countries that lack the energy to grow all their food can import surplus food from countries with highly productive oil based farming systems–provided they are rich enough to afford it. The fact, however, that a billion people starve while another billion wallow in surpluses of food so huge that they throw away half undermines this idea.

– from The Coming Famine by Julian Cribb, page 122.

As I discuss in Part II, the United States is also becoming swept up in the globalization of food production, as it remains a titan of commodities exports, on an absolute basis. But the hunger for US food exports has implications for our own population, which struggles with falling (real) wages and depressed purchasing power. Will Americans be able to afford to pay what the world can afford to pay for food?

Click here to access Part II of this report (free executive summary, enrollment required for full access).