Tuesday, September 25, 2012

On Economic Depressions and Public Policy

I think there is a demonstrated history going back to the 1930's that you do not want to try “hands-off” policies, much less austerity, during a depression, you really do want your government to spend, even if it's deficit spending. The basic concept is for the government to spend what it can, when no one else will. If no one spends, the economy grinds to a complete halt and stays depressed for several years. We saw this in the US of the 1890’s and the 1930’s. We’re seeing it again in Europe, where the banks doing the bailouts are insisting on extreme austerity, thus making bad unemployment even worse.

On the other hand, there has been plenty of evidence for centuries that in the good times, you want to run budget surpluses, so as to build up cash reserves. Such reserves allow you to spend in the bad times with much less borrowing required. Too much debt leads to an interest payment crisis just down the road. The US Congress has completely failed to run budget surpluses, dating all the way back to the good times we had in the 50's and 60's. (It is their constitutional responsibility to pass budgets.)

The third piece of that puzzle is that too-large a debt burden is unsustainable. The Europeans are now learning this lesson the hard way, and we are about to, here in the US. There is no magic to it, it's simply the math of compound interest. Unsustainable debt comes about by excessive borrowing to finance deficit spending, carried on for too long. Your only other option would seem to be printing excessive amounts of paper money, but that’s a bad thing, too.

The fourth piece of this puzzle is that you can’t finance deficits by printing excess money instead of borrowing, for that very quickly drives up inflation very dramatically, and it quickly goes completely out of control, just like 1920’s Germany, and to a lesser extent, the late 1970’s US. I remember 1979's 18.5% per year inflation with a very bad taste in my mouth.

Since neither borrowing nor printing money can “solve” the problem of chronic deficits, the only sane option is just not to run chronic deficits. Do it only during temporary emergencies like wars and depressions.

All that being said, there is a very good reason to believe that neither party's ideologies about the economy are worth a damn as public policy, or that either of them ever had much to do with the severity of what has happened to us economically in recent decades. But fuel prices did.

This country's economy was "designed" (over the last couple of centuries, mostly by the dead hand of Adam Smith, and the rest by the random action of ignorance and neglect) to run on dirt-cheap energy. Since 1973, every major economic downturn (1974, 1979, and 2001) is associated with high fuel prices.

In this context “high fuel prices” is roughly characterized as about $2.50-to-3.00/gallon for gasoline, when expressed in today's dollars, i.e., corrected for inflation. This indicator is important because our economy is much more consumer-driven, and consumer fuel demand is not very much a matter of choice: you still have to drive to work, school, and the grocery store, regardless of price.

Historically, what we remember as “good times” are associated with low fuel prices, which in today's dollars are invariably near $1.75-$2.00/gallon gasoline. Go to my earlier two articles "Oil Prices, Recessions, and the War" dated 2-4-11, and "Iran, Oil, and Economies" dated 3-8-12.

Both articles use an inflation-corrected gasoline price curve versus time from zfacts.com, as was available at each date. I modified these curves to show more current events than zfacts.com did. If you look at the 1958 price of 25-26 cents a gallon in Texas, and use factor-7.5-to-8 for inflation (pretty well-accepted) from then to now, the supply-and-demand price should be just about $1.75-$2.00/gal today. That is, they would be, if oil products really were, and are, a "market-driven" competitive commodity.

They are so very clearly not. They have not been since US oil production peaked and OPEC rose to dominate the oil market in the early 1970’s. Since then, superposed over the basic supply-and-demand pricing, there have been, and still are, frequent large, greed-driven speculator bubbles that burst, and there are huge monopoly cartel punitive pricing spikes, whenever we anger some part of OPEC.

For example, Reagan's "trickle-down" economics is still widely believed by too many to have finally ended the so-called "Carter stagflation years" just about 1986 in his second term. But that's not what really ended it. The Iran-Contra deal gave Iran the weapons they wanted. That deal ended the punitive OPEC pricing spike that started with the Iran hostage crisis in 1979 during Carter's administration. That OPEC punitive pricing spike is what really caused the "Carter stagflation years" to begin with.

My point: government economic policies are quite apparently nothing but a "fine-tuning" control that pales into insignificance when compared to the "channel-changer" that is fuel prices.

By the way, there was no fuel price spike after the 1991 Gulf War invasion of Iraq, because the rest of OPEC actually begged us to do that. Which absence proves my point.

The real trouble facing us is that OPEC production has also just about peaked, which means for the first time in history that world oil supply will begin to fall short of spiraling world oil demand. For those who disbelieve my contentions about “peak oil”, see my original article on the Bakken resource “Drill here, drill now, pay less?” dated 3-14-10. See also my follow-up article “Surprise, Surprise! Oil Boom in the Williston Basin” dated 9-5-11, that takes into account why there is an oil boom going on right now in North Dakota, but also why it is no long-term solution to our fuel demand and pricing problems.

That peak oil effect will destabilize the long constant trend of inflation-corrected supply-and-demand pricing, a constant that has underlain the various price spikes since the 1970’s. It will hence drive this underlying supply-and-demand price ever-higher, even if there were no more speculator bubbles and OPEC monopoly-pricing spikes (those just make things even worse).

Even when Afghanistan is done, and we have no armies stationed anywhere in the middle east, I predict we will never again see prices back down to $2.00/gallon, because China and India are industrializing, and there will very soon be insufficient oil to support both them and us, if it has not already happened. I think the supply shortfall relative to demand has already started. But that’s just my opinion.

According to historical precedents, it takes around 30 to 50 years for one industry to fully replace another in the free market, without some kind of government tax penalty/incentive/subsidy intervention (and all the perils and pain those typically pose). We should have started replacing oil in the 1970’s, around 40 years ago, when we first had the chance. Alas, greed for short-term profit was too strong in the halls of Congress. Now we're going to have to do it fast-and-painful.

And still, almost no one sees it coming, not even today. Because they don't want to see it. Truth can be very uncomfortable, even painful. But it does set you free. Deception, even self-deception, doesn't.

"Cassandra" has spoken.


Update 1-3-15:

The recent explosion of US “fracking” technology (hydraulic fracturing plus horizontal-turn drilling) has modified the picture of oil prices versus recessions.  Unexpectedly,  the US has become a leading producer of crude oils for the world market.  Plus,  there has been an associated massive production increase and price drop in natural gas.

OPEC has chosen to take the income “hit” and not cut back their production in response.  Their reasoning is twofold:  (1) fear of loss of market share,  and (2) hope that low oil prices will curtail US “fracking” recoveries.  We will see how that plays-out.

Oil prices are now such (at around $55/barrel) that US regular gasoline prices are nearing $2.00/gal for the first time in a very long time.  This is very close to the price one would expect for a truly competitive commodity,  based on 1958 gasoline prices in the US,  and the inflation factor since then. 

It is no coincidence that the exceedingly-weak US “Great Recession” recovery has suddenly picked up steam.  The timing of the acceleration in our economic recovery versus the precipitous drop in oil prices is quite damning.  There can be no doubt that higher-than-competitive-commodity oil prices damage economies.  Oil prices are a superposition of the competitive commodity price,  overlain by an erratic increase from speculation,  and further overlain quite often by punitive price levels when OPEC is politically unhappy with the west.  That’s been the history. 

This economic improvement we are experiencing will persist as long as oil,  gas,  and fuel prices remain low.  (Government policies have almost nothing to do with this,  from either party.)  How long that improvement continues depends in part upon US “fracking” and in part upon OPEC.  Continued US “fracking” in the short term may depend upon adequate prices.  In the long term,  we need some solutions to some rather intractable problems to continue our big-time “fracking” activities. 

The long-term problems with “fracking” have to do with (1) contamination of groundwater with combustible natural gas,  (2) induced earthquake activity,  (3) lack of suitable freshwater supply to support the demand for “fracking”,  and (4) safety problems with the transport of the volatile crude that “fracking” inherently produces. 

Groundwater Contamination

Groundwater contamination is geology-dependent.  In Texas,  the rock layers lie relatively flat,  and are relatively undistorted and unfractured.  This is because the rocks are largely old sea bottom that was never subjected to mountain-building.  We Texans haven’t seen any significant contamination of ground water by methane freed from shale.  The exceptions trace to improperly-built wells whose casings leak.

This isn’t true in the shales being tapped in the Appalachians,  or in the shales being tapped in the eastern Rockies.  There the freed gas has multiple paths to reach the surface besides the well,  no matter how well-built it might have been.  Those paths are the vast multitudes of fractures in the highly-contorted rocks that subject to mountain-building in eons past.  That mountain-building may have ceased long ago,  but those cracks last forever. 

This is why there are persistent reports of kitchen water taps bursting into flames or exploding,  from those very same regions of the country.   It’s very unwise to “frack” for gas in that kind of geology.

Induced Earthquake Activity

This does not seem to trace to the original “fracking” activity.  Instead it traces rather reliably to massive injections of “fracking” wastewater down disposal wells.  Wherever the injection quantities are large in a given well,  the frequent earthquakes cluster in that same region.  Most are pretty weak,  under Richter magnitude 3,  some have approached magnitude 4. 

There is nothing in our experience to suggest that magnitude 4 is the maximum we will see.  No one can rule out large quakes.   The risk is with us as long as there are massive amounts of “fracking” wastewater to dispose of,  in these wells.  As long as we never re-use “frack” water,  we will have this massive disposal problem,  and it will induce earthquakes. 

Lack of Freshwater Supply to Support “Fracking”

It takes immense amounts of fresh water to “frack” a single well.  None of this is ever re-used,  nor it is technologically-possible to decontaminate water used in that way.  The additives vary from company to company,  but all use either sand or glass beads,  and usually a little diesel fuel.  Used “frack” water comes back at near 10 times the salinity of sea water,  and is contaminated by heavy metals,  and by radioactive minerals,  in addition to the additives.  Only the sand or glass beads get left behind:  they hold the newly-fractured cracks in the rocks open,  so that natural gas and volatile crudes can percolate out. 

The problem is lack of enough freshwater supplies.  In most areas of interest,  there is not enough fresh water available to support both people and “fracking”,  especially with the drought in recent years.  This assessment completely excludes the demand increases due to population growth.  That’s even worse.

This problem will persist as long as fresh water is used for “fracking”,  and will be much,  much worse as long as “frack” water is not reused.  The solution is to start with sea water,  not fresh water,  and then to re-use it.  This will require some R&D to develop a new additive package that works in salty water to carry sand or glass beads,  even in brines 10 times more salty than sea water. 

Nobody wants to pay for that R&D. 

Transport Safety with Volatile “Frack” Crudes

What “fracking” frees best from shales is natural gas,  which is inherently very mobile.  Some shales (by no means all of them) contain condensed-phase hydrocarbons volatile enough to percolate out after hydraulic fracturing,  albeit more slowly than natural gas.  Typically,  these resemble a light,  runny winter diesel fuel,  or even a kerosene,  in physical properties.  More commonly,  shale contains very immobile condensed hydrocarbons resembling tar.  These cannot be recovered by “fracking” at all. 

The shales in south Texas,  and some of the shales and adjacent dolomites in the Wyoming region actually do yield light,  volatile crudes.  The problem is what to transport them in.  There are not enough pipelines to do that job.  Pipelines are safer than rail transport,  all the spills and fires notwithstanding. 

The problem is that we are transporting these relatively-volatile materials in rail tank cars intended for normal (heavy) crude oils,  specifically DOT 111 tank cars.  Normal crudes are relatively-nonvolatile and rather hard to ignite in accidents.  DOT 111 cars puncture or leak frequently in derail accidents,  but this isn’t that serious a problem as long as the contents are non-volatile.  These shale-“frack” light crude materials resemble nothing so much as No. 1 winter diesel,  which is illegal to ship in DOT 111 cars,  precisely since it is too volatile. 

The problem is that no one wants to pay for expanding the fleet of tougher-rated tank cars.  So,  many outfits routinely mis-classify “frack” light crudes as non-volatile crudes,  in order to “legally” use the abundant but inadequate DOT-111 cars.  We’ve already seen the result of this kind of bottom line-only thinking,  in a series of rather serious rail fire-and-explosion disasters,  the most deadly (so far) in Lac Megantic,  Quebec. 

Volatile shale-“fracked” crudes simply should not be shipped in vulnerable DOT 111 cars,  period.  It is demonstrably too dangerous. 


“Fracking” shales for natural gas and light crudes has had a very beneficial effect on the US economy and its export-import picture.  We should continue this activity as a reliable bridge to things in the near future that are even better. 

But,  we must address the four problem areas I just outlined.  And I also just told you what the solutions are.  The problem is,  as always,  who pays.   What is the value of a human life?  What is the value of a livable environment?  It’s not an either-or decision,  it’s striking the appropriate balance!

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