On "Perfect Storms"

Today, I came across a news article explaining elevated oil prices as being due to a "Perfect Storm" in the oil markets:

"Supply-side issues, particularly the problems around Iran, and demand-side issues, especially very strong Asian and Chinese demand, will help take prices higher.  A weak U.S. dollar adds a final drop"  

It got me thinking back to an economist cover from around this time last year:

News at the time described a "Perfect Storm" as well:

"Tensions in the Middle East and Libya show no signs of abating. Japan is dealing with post-earthquake rebuilding and major nuclear issues. And the U.S. is entering prime driving season."
"It is truly the perfect storm right now," said James Cordier, president at Liberty Trading Group. "I've never seen anything like it -- the news just isn't stopping."

In 2008, there was another "Perfect Storm", this time blaming:

"The forces behind the meteoric price rise this spring are slowly receding. Nigeria has boosted output by 200,000 barrels a day (BPD) this month, making up most of the shortfall caused by rebel attacks on pipelines in April."
"Like the rest of Opec, the Saudis blame "speculators" for running amok, pushing paper contracts into the stratosphere."

In 2005, the Harvard International Review described the "Perfect Storm" as the result of, among other things:

"OPEC lost control of oil prices in 2004. In the first three quarters of 2004, the OPEC basket price remained above US$40 per barrel, although it fell slightly below US$40 per barrel in September. A series of factors contributed to these developments, which have been characterized by observers such as Edgard Habib, chief economist at Chevron Texaco, as a "perfect storm." Factors included a largely unanticipated surge in oil demand spurred by high economic growth in China and the United States (estimated at 13 percent and 4.5 percent respectively in 2004 by Deutsche Bank), low oil inventories, deepening violence and instability in Iraq, declining OPEC spare capacity, and bottlenecks in the gasoline market due, in part, to stretched refineries."

I would argue that "Perfect Storm" is the wrong term for what the oil markets are experiencing.


   perfect storm

1. A particularly violent storm arising from a rare combination of adverse meteorological factors.
2. A particularly bad or critical state of affairs, arising from a number of negative and unpredictable factors.

The fundamental problem is that there is very little wiggle room in the global supply of oil.  Production has stagnated and could very well be in global decline.  In the face of rising demand in the developing world and inelastic demand in the United States, prices are going to remain elevated and should be expected to grow relatively steeply well into the foreseeable future (with periodic crashes as the economy stumbles under the weight of the burden).  There is nothing coincidental or unpredictable about this.

The unpredictable bits, attacks on oil pipelines, instability in the middle east, growing demand in the developing world, have always happened.  But their effects were never characterized as a "Perfect Storm" until their effects were felt in the context of perpetually constrained supply.  And that macro-economic trend, growing demand in the face of constrained supply, is here to stay.

The CNU's Live/Work/Walk Initiative

This week, I became a member of the Congress for the New Urbanism and attended the kickoff of the Live/Work/Walk Initiative :)

The basic problem being addressed by the initiative is that current Federal lending standards dictate that new development cannot include more than ~15% commercial space. This has distorted the market by diverting new development towards single family homes and high-rises. In a small urban area, such as Mt. Clemens or Royal Oak, MI, it is prohibitively difficult to secure financing build new 2-3 story mixed-use (Apartments on top, shops on the bottom) buildings along the commercial corridors. This is tragic because it essentially forces people to spend money on gas and time in traffic, when they could walk downstairs to work.

Prior to the involvement of the federal government in real estate lending, banks preferred mixed-use development as it allowed them to hedge the risk of a downturn in either the commercial or residential property markets. Banking followed the path of least-personal-risk and bent their lending standards to those of the Gov't-backed entities. Single-use is still the more risky option, just not to the bank whose loan is now backed by the American taxpayer. The CNU wants to modify the restriction to relax the restrictions on commercial space. This requires no government funds and would clear the way for private investment in our historic, walkable urban centers.

This is a Forbes summary

Daily Show: An energy independent future

The Daily Show
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Expectations of Indefinite Growth

I often find myself speaking with people who believe that technological progress and growth are simple facts of life.  The sun rises in the east, birds fly south for the winter, new iPhones are announced in July.  Most people are not technical, so this is not such an unreasonable belief.  The pace of technological growth has been picking up for several generations now.  Nobody has ever known anything different.

I believe that forward progress is anything but certain.  Most economic growth is underpinned by ever-increasing volumes of energy, while our debt-based economic system is predicated on steady, reliable, exponential growth.  Between population growth and resource exhaustion, we are now facing a steady squeeze in the energy supply.  This will necessarily put the brakes on growth as more capital is diverted to energy procurement and away from consumption of goods and services.

I was recently sent an article by Dr. Tom Murphy, a physicist at UCSD, who has a great blog about energy and growth.  He makes some great points about the ultimate physical limits facing our economic system.

Galactic Scale Energy
Timelines to Physical limits for modest levels of growth.

Can Economic Growth Last
(Sequel to Galactic Scale Energy)  He talks about the infeasibility of maintaining growth without increasing energy inputs

What if Malthus was right?

Jeremy Grantham is a British investor and Co-founder and Chief Investment Strategist of Grantham Mayo Van Otterloo (GMO), a Boston-based asset management firm. GMO is one of the largest managers of such funds in the world, having more than US $107 billion in assets under management as of December 2010. Grantham is regarded as a highly knowledgeable investor in various stock, bond, and commodity markets, and is particularly noted for his prediction of various bubbles.

His past couple of quarterly newsletters have focused on resource limitations and I believe that they are spot-on.  The emphasis added to specific bullet points is my own.

(The april link to the GMO site was broken, so I uploaded my copy of the pdf as a google document)

April 2011 - Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever

July 2011 - Resource Limitations 2: Separating the Dangerous from the Merely Serious

Summary from the April 2011 newsletter:

The world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value.  We all need to adjust our behavior to this new environment. It would help if we did it quickly.

Summary

• Until about 1800, our species had no safety margin and lived, like other animals, up to the limit of the food supply, ebbing and flowing in population.
• From about 1800 on the use of hydrocarbons allowed for an explosion in energy use, in food supply, and, through the creation of surpluses, a dramatic increase in wealth and scientific progress.
• Since 1800, the population has surged from 800 million to 7 billion, on its way to an estimated 8 billion, at minimum.
• The rise in population, the ten-fold increase in wealth in developed countries, and the current explosive growth in developing countries have eaten rapidly into our finite resources of hydrocarbons and metals, fertilizer, available land, and water.
• Now, despite a massive increase in fertilizer use, the growth in crop yields per acre has declined from 3.5% in the 1960s to 1.2% today. There is little productive new land to bring on and, as people get richer, they eat more grain-intensive meat. Because the population continues to grow at over 1%, there is little safety margin.
• The problems of compounding growth in the face of finite resources are not easily understood by optimistic, short-term-oriented, and relatively innumerate humans (especially the political variety).
• The fact is that no compound growth is sustainable. If we maintain our desperate focus on growth, we will run out of everything and crash. We must substitute qualitative growth for quantitative growth.
• But Mrs. Market is helping, and right now she is sending us the Mother of all price signals. The prices of all important commodities except oil declined for 100 years until 2002, by an average of 70%. From 2002 until now, this entire decline was erased by a bigger price surge than occurred during World War II.
• Statistically, most commodities are now so far away from their former downward trend that it makes it very probable that the old trend has changed – that there is in fact a Paradigm Shift – perhaps the most important economic event since the Industrial Revolution.
• Climate change is associated with weather instability, but the last year was exceptionally bad. Near term it will surely get less bad.
• Excellent long-term investment opportunities in resources and resource efficiency are compromised by the high chance of an improvement in weather next year and by the possibility that China may stumble.
• From now on, price pressure and shortages of resources will be a permanent feature of our lives. This will increasingly slow down the growth rate of the developed and developing world and put a severe burden on poor countries.
• We all need to develop serious resource plans, particularly energy policies. There is little time to waste.

Summary from the July 2011 newsletter:

• We humans have the brains and the means to reach real planetary sustainability. The problem is with us and our focus on short-term growth and profits, which is likely to cause suffering on a vast scale. With foresight and thoughtful planning, this suffering is completely avoidable.
• Although we will have energy problems with peak oil, this is probably an area where human ingenuity will indeed eventually triumph and in 50 years we will have muddled through well enough, despite price problems along the way.
• Shortages of metals and fresh water will each cause severe problems, but in the end we will adjust our behavior enough to be merely irritated rather than threatened, although in the case of metals, the pressure from shortages and higher prices will slowly increase forever.
• Running out completely of potassium (potash) and phosphorus (phosphates) and eroding our soils are the real long-term problems we face. Their total or nearly total depletion would make it impossible to feed the 10 billion people expected 50 years from now.
• Potassium and phosphorus are necessary for all life; they cannot be manufactured and cannot be substituted for. We depend on finite mined resources that are very unevenly scattered around the world.
• Globally, soil is eroding at a rate that is several times that of the natural replacement rate. It is probable, although not certain, that the U.S. is still losing ground. The world as a whole certainly is.
• The one piece of unequivocal good news can be found in the growth of no-till farming. In no-till, the residue of the previous crop is left on the ground and new seeds are planted without plowing. This technique reduces erosion by around 80%, reduces fertilizer run-off, preserves moisture, improves the soil (and, quite possibly, the quality of the food), and reduces the emissions of heat trapping gasses.
• The growth of no-till has been very rapid in South America, rapid in the U.S. (which is now at 35%), and moderate in many other developed countries. But it is used on only about 5% of farms globally.
• Overall, the best farms will have no erosion problems but, on average, soil will continue to be lost across the globe. Together with increased weather extremes and higher input prices (perhaps much higher), there will be increasing problems in feeding the world’s growing population.
• In particular, a significant number of poor countries found mostly in Africa and Asia will almost certainly suffer from increasing malnutrition and starvation. The possibility of foreign assistance on the scale required seems remote.
• The many stresses on agriculture will be exacerbated at least slightly by increasing temperatures, and severely by increased weather instability, especially more frequent and severe droughts and floods.
• These types of slow-burning problems that creep up on us over decades and are surrounded by a lack of scientific precision hit both our capitalist system and our human nature where it hurts.
• Capitalism, despite its magnificent virtues in the short term – above all, its ability to adjust to changing conditions – has several weaknesses that affect this issue.
• It cannot deal with the tragedy of the commons, e.g., overfishing, collective soil erosion, and air contamination.
• The finiteness of natural resources is simply ignored, and pricing is based entirely on short-term supply and demand.
• More generally, because of the use of very high discount rates, modern capitalism attributes no material cost to damage that occurs far into the future. Our grandchildren and the problems they will face because of a warming planet with increasing weather instability and, particularly, with resource shortages, have, to the standard capitalist approach, no material present value. 4

4 An expanded discussion on the failings of capitalism will be in next quarter’s letter. In addition, a discussion on the current market, including any investment implications from this piece, will be posted in two weeks.

Airlines cut markets in face of high fuel prices

Assuming that fuel prices continue to steadily climb into the indefinite future, what will the airline industry look like in 50 years?  I don't think that we're going to see an electric airplane in the near future.  I could see it steadily ratcheting down to the point where it is an intercontinental transportation option for the rich, with rail shouldering the domestic needs of the masses.

Lady gets charged with a Misdemeanor for her front yard vegetable garden

This prioritization of aesthetics over practical utility really bothers me. All that land goes to waste just so that people can enjoy an uninterrupted green view. She should be applauded for supplementing the local food supply and reducing the amount that has to be trucked in from elsewhere.