Harris & Ewing Hot Air 1938
"Goodyear Blimp at Washington Air Post, Washington, D.C."
Jeff Rubin, former chief economist with Canadian bank CIBC, is very well known for his predictions of exponentially increasing oil prices (see for instance this 2009 lecture). Mr Rubin’s position was that prices would continue their rise due to a confluence of circumstances – that conventional supplies have peaked, that unconventional sources are expensive to produce and that demand would continue to grow with the energy requirement inherent in expanding global trade.
According to Mr Rubin, the assumption that transport costs would remain marginal led to the 2008 oil price spike, causing a global recession. In his opinion, high oil prices, not the sub-prime mortgage crisis, were the primary driver of financial crisis. This opinion is shared by many commentators. The simplistic approach of prediction by trend extrapolation is similarly common. In contrast, anticipation of trend changes is rare.
Mr Rubin’s price prediction was for oil first to pass $100/barrel and then reach $225/barrel by 2012, with continued growth and general price rises in an era of resource scarcity.
This was restated at the ASPO conference in November 2010, where Mr Rubin and I (both plenary speakers) ended up on opposite sides of the argument as to the prospects for growth, the trajectory for oil prices, the dynamics of the causative relationship between energy and finance, the nature of speculative bubbles, the importance of credit and debt, the probability of a major liquidity crunch, the basis for market prices, the applicability of positive versus negative feedback loops, whether or not equilibrium exists in economics, and almost every other important aspect of the way the world works.
We were, however, in agreement that resources are finite and that this will have very significant consequences in the future.
The position I espoused at the conference was that the oil price recovery from 2008/09 was close to peaking, and that, rather than the huge price spike Mr Rubin was predicting, we would see oil prices fall substantially over the next few years, as a result of financial crisis. The bursting of a thirty year financial bubble would be the primary driver of changes in the real economy, including the energy sector.
My explanation of the 2008 price spike and collapse, and also the manner in which next few years will play out, was (and continues to be) based on the context of the largest speculative bubble in human history. This has been a period of enormous inflation – a drastic increase in the supply of money and credit relative to available goods and services. Specifically we have seen a huge credit expansion, and, in the process, have accumulated a massive amount of debt on a global scale.
As we have explained many times at TAE before, credit hyper-expansions create excess claims to underlying real wealth through ever-increasing leverage. The additional purchasing power leads to the bidding up of assets prices, and, over time, to the expectation that prices can only continue to appreciate. The real economy becomes subsumed into a speculative mania.
Such periods have always resolved themselves with the extinguishing of these excess claims (deleveraging), which, being a contraction in the supply of money and credit relative to available goods and services, is deflation by definition. Investors wake up to the fact that asset price appreciation is over and that there is nowhere near enough collateral to back all the outstanding debt. The great grab for over-subscribed collateral begins. The resulting free-for-all picks up momentum as it proceeds and does not play out as a slow squeeze. The effective money supply collapses, and the impact of this is compounded by a very large fall in the velocity of money, leading into an economic seizure, or period of Great Depression. Prices follow the money supply to the downside, as speculation goes into reverse.
Naturally, such a period would be characterized by very weak demand for a long period of time. Economic activity would be greatly reduced, and a lack of purchasing power, thanks to monetary collapse, would leave money, not energy, as the limiting factor, probably for several years. While energy is the primary driver of expansion, finance is the primary driver of contraction, as the time constant for changes in finance is simply much shorter than for changes in supply or demand in the real economy. Finance is the operating system. When that crashes, resource availability becomes temporarily secondary.
One only has to look at the Great Depression of the 1930s to see the effect of a bursting credit bubble, even in the midst of plentiful resources. As the people who lived through it at the time said, they had plenty of everything except money. Our bubble will follow the same pattern, but as it is very much larger than the bubble of the Roaring Twenties, we can also expect the aftermath to be much larger. Resource limitations will bite in the end of course, but financial crisis extends the timeframe (at the price of making it worse later by sucking investment out of the sector for years, thereby setting us up for a later supply crunch).
Into 2008, increasing liquidity had been driving up asset prices across the board. A combination of liquidity and the perception of imminent scarcity led commodity prices to be bid up greatly in excess of what the fundamentals would justify at the time. The story of oil in 2008 is one of exaggerated boom leading to exaggerated bust as liquidity was rapidly evaporating, and the perception of scarcity became a perception of relative glut. The price collapse on speculative reversal (78% in five months) had very little to do with actual supply and demand, neither of which change so quickly. Financial crisis was clearly in the driving seat. At TAE we pointed out, as oil was reaching for the sky in early 2008, that the price would peak and then crash. Anticipating trend changes is a large part of what we do.
The resurgence of confidence, and therefore liquidity, from 2009 led to the beginning of the second price cycle of boom and bust. I was arguing in my 2010 ASPO talk, that oil would not regain the 2008 peak, but that price would once again overshoot the fundamentals on a perception of scarcity, and we would thereafter see prices fall again, probably to below the 2008/09 bottom – in other words to a level at or below that of the lowest price producer.
When Mr Rubin was asked his opinion of my ASPO lecture at our shared podium, his response was to call my boom and bust model “a bastardized form of monetarism that could only have been derived by a non-economist”. The audience was encouraged to laugh at the concept. I was not given an opportunity to respond at the conference, so I posted my thoughts at TAE and expressed them to Jim Puplava at Financial Sense Newshour. I posed a rhetorical question to Jim, asking if, given the generally dismal predictive abilities of economists, non-economists could possibly do any worse.
If we fast-forward to 2012, we find ourselves in the thick of a sovereign debt crisis in Europe, substantial deleveraging, spreading financial contagion, ineffective bailouts, widening credit spreads, tightening credit availability, deepening financial scandal and falling oil prices. It is absolutely clear that finance is in the driving seat once again.
Rubin acknowledges that his price forecast has not been realized, but he continues to argue, as he did in 2008, that high oil prices are causing the financial crisis.
Whatever happened to $200 oil?
If a mea culpa is in order, its roots can be found in the decision to underplay the demand side of the equation. Oil prices plunged to $40 a barrel after economic growth collapsed, taking global oil demand along for the ride. And that same movie is about to play out again. Recessions are already rolling across Europe. Economic growth in North America is lackluster, at best. Meanwhile, the spectre of sovereign debt defaults in the euro zone continues to hang over global financial markets. Added up, it spells another sharp drop for oil prices not because fuel is abundant, but because once again the world can’t afford to stay out of a recession. What happened to my forecast for $200 oil? Quite simply, the end of growth.
The inexorable build up to financial crisis has been measured in decades, with a smooth exponential rise in the money supply (i.e. inflationary credit expansion) in the post WWII period, while oil prices have been all over the map in that time. Did oil cause Europe to introduce a single currency with a highly flawed architecture for instance? Or cause a long period of negative real interest rates to bait a debt trap (leading, among other things, to huge housing bubbles)? Or allow banking to be deregulated so it could become too big to fail? I think not, at least not directly.
Energy is not the sole driver of events, at least not in the highly simplistic manner Mr Rubin suggests. Energy and human systems interact in far more complex and non-linear ways. Time constants for different kinds of change vary. Sometimes one factor is the key driver and sometimes it is another. The role of finance as a driver clearly cannot be ignored. Operating systems can take on a life of their own, in the sense that their own internal dynamics become a major factor in their own right.
Underplaying the demand side of the equation was indeed an error, but not in the sense that Mr Rubin mentions. The change in demand in 2008 was nowhere near large enough or rapid enough to trigger the price collapse at that time.
The crisis was entirely predictable to those who understand ponzi dynamics, however. Major bubbles act to bring demand forward during the expansion phase, at the expense of crashing it thereafter. In the last three decades of catabolic ponzi growth, we have probably burned our way through a century of demand. Leverage allowed us to borrow from the future, but deleveraging is now going to crash demand and asset prices.
In the case of oil, the effects of phase II of the financial crisis, and the coming demand crash, on oil prices will be exacerbated by a major shift in the perception of supply – from scarcity to glut, as a result of the unconventional oil fantasy. We covered this additional aspect in detail here at TAE not long ago in Unconventional Oil is NOT a Game Changer and in Peak Oil: A Dialogue With George Monbiot.
As we pointed out, unconventional fossil fuels and other low EROEI energy sources are caught in a paradox – they are unable to sustain a society complex enough to produce them. The additional supply will be minor and temporary, but the perception that we are suddenly swimming in oil will act to undermine oil prices further, to the point where such sources rapidly become uneconomic, which is exactly what we have already seen in natural gas.
Mr Rubin’s $225 price prediction for 2012 will be looking far more off-base in the relatively near future than it does today. If we do see that kind of price in the future, it will have to wait for the peak of the third boom and bust cycle, which likely will not even begin for several years (once massive deleveraging has run its course).
Mr Rubin’s view of the future remains at highly odds with our view here at TAE, although he has in some ways moved closer to our position. His view of energy driving finance suggests that once oil prices have fallen far enough, the economy will recover, until demand pushes up price once again and the cycle repeats. We, on the other hand, see no prospect of demand recovering for years, despite what should turn out to be historically low oil prices in nominal terms. Financial crisis is the driver, and will continue to be so for a long time.
Jeff Rubin has recently written a second book, in which he maintains that a lack of economic growth will be good for the environment, and that it will lead to a stable non-growing economy. To put it mildly, this is not our view at TAE. There is no such thing as a stable, non-growing society.
Stasis simply does not exist. It is not a mere lack of growth we are facing, but a very strong and prolonged period of economic contraction, as the demand borrowed from the future during the expansion years must be repaid. To say that this would be good for society or the environment is a bit of a stretch. True, we will emit less CO2, but financial crisis invites and entrenches escalating conflict, which is exceptionally hard on both the environment and society. Mr Rubin still appears to have little idea what we are truly facing in the coming years.
I find myself inclined to agree with the late 2010 assessment of Mr Rubin by Dan Gardner for the Ottawa Citizen:
Jeff Rubin is a guru you shouldn’t listen to
Jeff Rubin is an almost eerily perfect example of the sort of expert people should not listen to — but do anyway.
The foundation of Rubin’s fame is a correct call he made a decade ago. At the time, oil prices were low and stable. Most experts were sure they would stay that way. But Rubin became convinced the world was approaching “peak oil” — the point at which oil production would cease to grow and the price of oil would soar.
As Rubin predicted, oil prices started to climb in 2003. Up and up they went, to previously unimaginable highs. In the first half of 2008, oil topped $140 a barrel. Rubin and the few others who called the surge became media darlings.
… In November 2008, Rubin told a reporter that high oil prices killed the economy. Of course, this was well after the crash of the financial system, the global economy and the price of oil. I can find no record of him saying this beforehand.
The story he has told since then about oil prices yo-yoing the economy is — whether correct or not — an explanation he came up with only after the fact.
Not that any of this has humbled Rubin. Throughout 2009 and 2010, he forecast the return of triple-digit oil prices. It didn’t happen. But these flops, too, made no difference to Rubin’s confidence. He is as sure of himself as ever. And just as persuasive. How could he not be? He is supremely confident. He has a simple analytical story. And he is a superb communicator, in print and in person.
This is the stuff that satisfies the psychology of the audience. It is the stuff of which gurus are made.
Unfortunately, seminal research by University of California psychologist Philip Tetlock shows it is precisely this sort of expert whose predictions are most likely to fail.
Caveat emptor.
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