Sunday, September 08, 2019

Oil prices and the coming financial 'Ice Age'

Albert Edwards turned bearish on stocks back in 1996—well, not exactly bearish, but cautious. He recommended to clients that they overweight long-term, high-quality bonds and therefore underweight stocks in their portfolios. It turns out that clients who followed his advice fared not quite as well as those 100 percent invested in stocks but also took far less risk. Edwards believes that events that are currently unfolding will actually vindicate his approach.

Although Edwards never mentions energy as central to his thinking, I believe that energy and oil, in particular, are related to his views. I'll develop this later, but first more on Edwards.

Edwards is a long-time financial strategist for the French investment bank and financial services giant Société Générale. He has an investment thesis that arose from the experience of Japan in the 1980s. He calls it the "Ice Age" thesis. It amounts to this: Gigantic debts that built up during Japan's boom in the 1980s led to exceptionally sluggish economic growth after the Japanese stock market bust and finally to deflation and ultra-low interest rates.

Edwards expected the same thing to happen to Europe and the United States for the same reason. He got some of what he expected after the market crash of 2008/2009: ultra-low interest rates and sluggish growth. What didn't show up was deflation.

But Edwards kept expecting his Ice Age thesis to play out in a subsequent recession that he felt couldn't be more than four or five years away. At regular intervals he gloomily predicted a stock market crash resulting from a deflationary shock. But the recession and crash kept getting postponed—until now, he thinks.

Edwards was one of the very few who correctly predicted the drop in bond yields this year and he believes the world is about to enter the long-awaited terminal phase of the "Ice Age" he outlined back in 1996. In this terminal phase, he expects U.S. interest rates to turn decidedly negative and U.S. stocks to decline by more than 80 percent—that is, unless the Federal Reserve decides to interrupt the decline by buying stocks directly to bolster the market or to hand out free money to the populace in a sort of quantitative-easing-for-all strategy.

Edwards writes: "The key for me is whether QE2 [that is, another round of forced credit and money infusions into the economy by central banks] can revive the economic cycle, not equity prices temporarily." He believes QE2 cannot revive economic activity at this point. And, that implies a bust that will rival if not exceed the crash of 2008, he says—and a prolonged malaise of slow or no growth afterward as part of a financial hangover from bingeing on too much credit.

Edwards hints that "unprecedented monetary measures" might be taken to forestall outright deflation which, of course, implies entirely different investment advice than he is giving now.

So, how does all this relate to energy and, in particular, oil. When reading Edwards' latest pronouncements, I couldn't help thinking about Gail Tverberg's almost parallel thesis that what will doom oil supplies is prices that are too low for producers to make a profit. That is just what has been happening this decade along with the slowly creeping financial Ice Age described by Edwards. Could the two be related?

Tverberg answers the question indirectly in a second piece entitled "Why stimulus can’t fix our energy problems." For Tverberg affordability is the problem. Widening wealth inequality leads to stagnant and even lower incomes for a greater and greater number of people who are then unable to afford not only direct energy purchases as easily as they have in the past, but are also faced with affordability issues for practically everything else. That's because energy is embedded as a cost of production, distribution and sale in everything we buy.

So, a sluggish economy—made sluggish by excessive debt (Edwards)—combined with widening wealth inequality (Tverberg)—leads to generally lower employment and depressed wages than otherwise would have been the case—which leads to prices that are too low for energy producers, in particular, oil producers to make a profits sufficient to replace oil reserves that have been depleted or, in the case of oil exporting nations, pay for social welfare costs. According to Tverberg, this inability to make much profit among oil producers—shale producers have had negative free cash flow for years—feeds back into the economy, especially in the United States where the previously broadly booming oil and gas industry has been a major source of employment and business activity. (The boom now seems confined to the Permian Basin in Texas.)

A low oil price also leads to lower investment and social welfare payments in major oil exporting nations which reduces employment and incomes below what they otherwise would have been. The overall sluggishness of the world economy (compared to previous expansions) reinforces the effect of low oil prices.

The sweet spot in the oil industry is a price which insures healthy profits for the industry (with which they can invest in new wells) and at the same time does not tip the world into recession because the price is unaffordable to consumers. There is a supposition in Tverberg's work that these two price bands no longer overlap. Prices low enough for the world's consumers to afford are too low for producers. Prices high enough for producers to make a decent profit are too high for consumers to afford over the long term.

Now, here's how Tverberg's thinking hooks up most directly with Edwards'. Tverberg writes: "It looks as though growing debt at ever-lower interest rates is becoming a less effective workaround for the economy's real need, which is a need for a rapidly growing supply of under $40 per barrel oil and other low-priced energy products." Edwards sees debt creation as becoming a less and less potent way to create economic growth in a debt-saturated economy. Tverberg goes to what she believes is the heart of the matter claiming that added debt cannot seem to provide oil and other energy sources at cheap enough prices for the economy to flourish. The financial Ice Age seems central to the views of both.

And, both Edwards' and Tverberg's outlook lead to the same result, a crash in the world economy that will be difficult to turn around. For Edwards there is the possibility that after a long retrenchment period, economic conditions could return to what passes for normal. For Tverberg, however, her thesis suggests a permanent alteration of conditions for modern societies in which energy insufficiency becomes a feature that limits and even stops economic growth.

If either one is correct, look for an economic tsunami in the not-to-distant future.

Kurt Cobb is a freelance writer and communications consultant who writes frequently about energy and environment. His work has appeared in The Christian Science Monitor, Resilience, Common Dreams, Le Monde Diplomatique,, OilVoice, TalkMarkets,, Business Insider and many other places. He is the author of an oil-themed novel entitled Prelude and has a widely followed blog called Resource Insights. He is currently a fellow of the Arthur Morgan Institute for Community Solutions. He can be contacted at


Joe Clarkson said...

Both Tverberg and Edwards are describing factors that will limit growth, Tverberg from the resource depletion angle and Edwards from the aspect of the burdens of excessive economic complexity.

It has been obvious at least since "Limits to Growth", published in 1972, that economic growth would peak and then rapidly retreat, taking the human population of the earth down with it. The only question is, "When"? The "standard run" from "Limits" projects economic decline in the 2020s and population decline in the 2030s.

Based on current evidence, I think it prudent to prepare for the "economic tsunami" as soon as possible. The best metric for preparation is the ability to subsist without money. If people can do that, they are as prepared as they can possibly be.

Shawn said...

Thanks Kurt as always for your interesting and insightful synthesis of ideas.

Several other bloggers have worked to quantify the rising cost of fossil fuel energy extraction, processing and delivery, and therefore the decreasing surplus energy to the non-energy economy. And how that relates to MONEY. Their conclusion also is that we are close to the tipping point in the global economy and the value of fiat currencies.

I agree with the commenter above, broadly speaking, we seem to be approaching limits to growth as well outlined in 1972. In addition to energy, we are rapidly depleting the easy to extract non-energy natural resources. Untapped arable land in developed countries at least is very limited. Water is becoming limited in some places. The waste products of industrial civilization are beginning to overflow the waste sinks and negatively impact economic growth. The drag from these wastes will grow. Human population growth that might have previously additive to GDP growth now appears to have negative consequences. Economic and climate migration are beginning to destabilize political structures.

Does the current social and economic model end when fossil fuel production and GDP growth turns permanently negative? Permabear financial analysts in the mainstream institutions don’t venture that far in their forecasts.

Gail the Actuary said...

Thanks, Kurt. I think you did an excellent job with this article. I hadn't been aware of Albert Edwards forecasts.

A finite world works differently than what a person might, on first analysis, expect. There are many different interconnections. The naive view is that we will run out of oil and because of this, prices will rise. It is hard to see that the real result close to the opposite of this: there will be a glut of oil and other energy products, at very low prices. Debt defaults will be a huge problem. Derivative defaults will be likely. Stock prices will fall.

Robin Datta said...

SRSroccoReport Interview with Louis Arnoux (October 20, 2016) YouTube:

A more extensive description:
Louis Arnoux

It all hinges on net energy:
Resource Insights: The net energy cliff

ChemEng said...

As always, Kurt, thanks for an interesting post.

As I was reading it, I received an email asking me to speak at one of the Thunberg-inspired climate change rallies. It struck me that a debt/oil related recession of the type you talk about could have a greater effect on slowing down climate change than all the rallies and speeches.

Kurt Cobb said...

Thanks for all the thoughtful comments. Gail, you already know that I follow your work closely and find it very compelling. I am glad to have a chance to feature it here and marry it with a long-running financial analysis that seems to be very much aligned with your analysis.

Diaconu Radu Ionut said...

Mr. Cobb, your article and Gail Tverberg's is an inspiration. My country of Romania, where the oil age was born - first country to record a oil production, first refinery in the world and I could go on with the inventions of our engineers, which patents, stolen by Big Oil, are now object of major litigation in the US - is in a dire situation.
We are hit now by a severe drought. For 3 years now the Social Democrats have imposed a Wage-led growth model, based on borrowing large sum of money from lenders abroad in order to give bigger paychecks to all government bureaucrats. This wage increases have translated so far inta a spiralling commercial deficit and inflation. The reckoning is near and if that financial tsunami hits us, we are in a very bad spot.
Back in 1989, when communism felt, Romania was an independent country with a self relient economy, no imports, but almost a failed economy, cause nobody cared to have relations with a dictatorship. Today we are a democracy, but a dependent state on EU and NATO, and our economy is an export oriented economy, barely producing for the internal market. If those buying from us stop buying, we are toast, since we cannot turn our economy overnight to became self reliant and to produce for the internal market - we depend vastly on imports, much like all economies around us and around the world.
Virtually, the today interconnected world economy has created not only a wide gap in income between people, but also between nations and states.
There is a codependency - we send to you whatever you need, resources, manufactured goods, even people, either as workforce or sex slaves, and you the West pay for that. And the West sends back expensive goods - processed food, cars etc. And waste products, until recently.
This simbiotic relationship was possible because of cheap fossil fuels, cheap energy, cheap labor and huge logistic chains. And cheap money to delocalize everything. And a lot of corruption.
If those things that in the past were cheap become expensive, the relationship gets murky or, possibly, ends. And yes, cheap money no longer have the bang they used to have.
I sincerely wonder how entire nations will survive, since megatons of whatever those societies need to function are imported and no longer locally produced.
I don't see any serious attempt to wean world of fossil fuels, long supply lines and supermarkets on the corner, from wich a cornucopia of mainly chinese goods get consumed every day.
I cannot imagine what will go down if this state of play existing today implodes. Forget financial tsunami, Armaggedon is more likely...and dont count on cops, soldiers etc...those are human too, and the Maslow pyramid is very much alive and kicking.

Diaconu Radu Ionut said...

Apologies for this, but I could not help myself. A bit of oil history
The industrial start of Romania’s oil industry is considered to be 1857 because of
three world firsts that year.
The first country in the world to officially record petroleum production.
Romania was the first country in the world to officially record an oil production of 275
tonnes in the international statistics. Romania was followed by official oil production
from the United States in 1859, Italy in 1860, Canada in 1862 and Russia in 1863.
The world’s first refinery
Romania‘s first oil processing refinery in the 1840’s was a simple handmade
equipment using rudimentary methods similar distilling alcohol in a rustic boiler.
Distillation on industrial scale started in 1857 with the building of the Mehedinteanu
Brothers refinery. The refinery installations were primitive, with all the equipment and
cylindrical vessels were made from wrought iron and heated with wood fire.
Bucharest, the world’s first city illuminated with kerosene
Bucharest was illuminated with 1000 street lamps. On 1st April 1857 everything was
ready and working. The oil offered by Mehedinteanu brothers for public illumination
had incontestable properties: colourless and with no smell, burning with a light flame
with a constant intensity and shape, without smoke, ash or resin.
Romanian scientists and inventors have made lasting contributions to the worldwide
oil industry. These include:
Blowout Protector By Ing. Virgiliu Tacit and Ing. Valeriu Puscariu
Refining oil based with sulphur dioxide by Lazar Edeleanu. separation from the oil
of some hydrocarbon groups, without their chemical alteration
Additional important dates:
1861 – 1st well drilled using wooden rods and auger type bits to a depth of 150m
1882 – Establishment of the Geological Bureau
1904 – Establishment of the School for Drilling and Refining Foremen in Campina
1906 - The founding of the Romanian Geologic Institute
1907 - The Romanian-American Company drilled the first well with a rotary bit
1907 - The testing of the first air-system extraction
1908 - First manufacture of oil equipment , installations and the start of repair
1913 - The first natural gas production
1914 - The start of the Petroleum and Mines Section within the Roads and Bridges
Construction School
1921 - The testing of the gas-lift extraction system, by ASTRA ROMANA
1927 - First mechanical core and the first gun casing perforation
1931 - The execution of the first electrical well logging
1936 - The first gas injection, on an industrial scale by ASTRA ROMANA, at the
Meotian Boldesti oil field, at a 1800 m depth
1951 - The first water injection operation on an industrial scale at Sarmatian
Boldesti oil field, at a 2600 m depth
1984 - 7000 Baicoi well reaches a depth of 7025 m.
Petrol and gas prices at the pump are pretty big, almost 1,50 usd per liter, due, of course, to high taxes and tariffs. And since Europe imports oil, any uptick in prices translates in bigger prices at the pump. With incomes so low, no wonder that people in France exploded when Macron tried to pass the cost of green taxes onto them
The european consumers are getting squeezed by high prices and high taxes on everything, plus a huge bureucratic superstructure. If the economy tanks and european consumers reduce their overall spending, as low as it is today, to nothing but food, medicine, bills...the economy goes down in flames aka deflation, which will translate not only in low consumption of oil products by the population, but also by ALL, since fossil energy resources permet ALL level of our economy and our society.
I dont know how oil companies can survive on low price of oil and gas without another round of QE to boost spending...since those who have trillins in the banks now dont want to spend a dime.
Yes, trillions are sitting idly in the banks world wide...until states probably will conficated them to escape the debt almost happended in Cyprus.
Have a good day, sir!

Unknown said...

For a non-academic but easy to read ecological perspective on the economy read my book.