Explaining The WTI-Brent Spread Divergence

Something totally bizarre has happened in the last three years. Oil in America has become much, much cheaper than oil in Europe. Oil in America is now almost $30 cheaper than oil in Europe.

This graph is the elephant in the room:

3 year brent spread

And this graph shows how truly historic a move this has been:



The ostensible reason for this is oversupply in America. That’s right — American oil companies have supposedly been producing much, much more than they can sell:

This is hilarious if prices weren`t so damn high, but despite a robust export market for finished products, crude oil is backing up all the way to Cushing, Oklahoma, and is only going to get worse in 2013.

Now that Enterprise Products Partners LLP has let the cat out of the bag that less than a month after expanding the Seaway pipeline capacity to 400,000 barrels per day, The Jones Creek terminal has storage capacity of 2.6 million barrels, and it is basically maxed out in available storage.

But there’s something fishy about this explanation. I don’t know for sure about the underlying causality — and it is not impossible that the oil companies are acting incompetently — but are we really supposed to believe that today’s oil conglomerates in America are so bad at managing their supply chain that they will oversupply the market to such an extent that oil sells at a 25% discount on the price in Europe? Even at an expanded capacity, is it really so hard for oil producers to shut down the pipeline, and clear inventories until the price rises so that they are at least not haemorrhaging such a huge chunk of potential profit on every barrel of oil they are selling? I mean, that’s what corporations do (or at least, what they’re supposed to do) — they manage the supply chain to maximise profit.

To me, this huge disparity seems like funny business. What could possibly be making US oil producers behave so ridiculously, massively non-competitively?

The answer could be government intervention. Let’s not forget that the National Resource Defence Preparedness Order gives the President and the Department of Homeland Security the authority to:

(c)  be prepared, in the event of a potential threat to the security of the United States, to take actions necessary to ensure the availability of adequate resources and production capability, including services and critical technology, for national defense requirements;

(d)  improve the efficiency and responsiveness of the domestic industrial base to support national defense requirements; and

(e)  foster cooperation between the defense and commercial sectors for research and development and for acquisition of materials, services, components, and equipment to enhance industrial base efficiency and responsiveness.

And the ability to:

(e)  The Secretary of each resource department, when necessary, shall make the finding required under section 101(b) of the Act, 50 U.S.C. App. 2071(b).  This finding shall be submitted for the President’s approval through the Assistant to the President and National Security Advisor and the Assistant to the President for Homeland Security and Counterterrorism.  Upon such approval, the Secretary of the resource department that made the finding may use the authority of section 101(a) of the Act, 50 U.S.C. App. 2071(a), to control the general distribution of any material (including applicable services) in the civilian market.

My intuition is that it is possible that oil companies may have been advised (or ordered) under the NDRP (or under the 1950 Defense Production Act) to keep some slack in the supply chain in case of a war, or other national or global emergency. This would provide a capacity buffer in addition to the Strategic Petroleum Reserve.

If that’s the case, the question we need to ask is what does the US government know that other governments don’t? Is this just a prudent measure to reduce the danger of a resource or energy shock, or does the US government have some specific information of a specific threat?

The other possible explanation, of course, is ridiculous incompetence on the part of US oil producers. Which, I suppose, is almost believable in the wake of Deepwater Horizon…


Why China is Holding All That Debt

What does it mean that China are making a lot of noise about the Federal Reserve’s loose monetary policy?

 Via Reuters:

A senior Chinese official said on Friday that the United States should cut back on printing money to stimulate its economy if the world is to have confidence in the dollar.

Asked whether he was worried about the dollar, the chairman of China’s sovereign wealth fund, the China Investment Corporation, Jin Liqun, told the World Economic Forum in Davos: “I am a little bit worried.”

“There will be no winners in currency wars. But it is important for a central bank that the money goes to the right place,” Li said.

At first glance, this seems like pretty absurd stuff. Are we really expected to believe that China didn’t know that the Federal Reserve could just print up a shit-tonne of money for whatever reason it likes? Are we really expected to believe that China didn’t know that given a severe economic recession that Ben Bernanke would throw trillions and trillions of dollars new money at the problem? On the surface, it would seem like the Chinese government has shot itself in the foot by holding trillions and trillions of dollars and debt instruments denominated in a currency that can be easily depreciated. If they wanted hard assets, they should have bought hard assets.

As John Maynard Keynes famously said:

The old saying holds. Owe your banker £1000 and you are at his mercy; owe him £1 million and the position is reversed.

But I think Keynes is wrong. I don’t think China’s goal in the international currency game was ever to accumulate a Scrooge McDuck-style hoard of American currency. I think that that was a side-effect of their bigger Mercantilist geopolitical strategy. So China’s big pile of cash is not really the issue.


It is often said that China is a currency manipulator. But it is too often assumed that China’s sole goal in its currency operations is to create growth and employment for China’s huge population. There is a greater phenomenon — by becoming the key global manufacturing hub for a huge array of resources, components and finished goods, China has really rendered the rest of the world that dependent on the flow of goods out of China. If for any reason any nation decided to attack China, they would in effect be attacking themselves, as they would be cutting off the free flow of goods and components essential to the function of a modern economy. China as a global trade hub — now producing 20% of global manufacturing output, and having a monopoly in key resources and components — has become, in a way, too big to fail. This means that at least in the near future China has a lot of leverage.

So we must correct Keynes’ statement. Owe your banker £1000 and you are at his mercy; owe him £1 million and the position is reversed; owe him £1 trillion, and become dependent on his manufacturing output, and the position is reversed again.

The currency war, of course, started a long time ago, and the trajectory for the Asian economies and particularly China is now diversifying out of holding predominantly dollar-denominated assets. The BRICs and particularly China have gone to great length to set up the basis of a new reserve currency system.

But getting out of the old reserve currency system and setting up a new one is really a side story to China’s real goal, which appears to have always been that of becoming a global trade hub, and gaining a monopoly on critical resources and components.

Whether China can successfully consolidate its newfound power base, or whether the Chinese system will soon collapse due to overcentralisation and mismanagement remains to be seen.

When Solar Becomes Cheaper Than Fossil Fuels

Solar power has been getting cheaper and cheaper:


Current estimates suggest that solar might be as cheap as coal by the end of the decade, and half the cost of coal by the end of the next decade:

If the trend continues for another 8-10 years, which seems increasingly likely, solar will be as cheap as coal with the added benefit of zero carbon emissions. If the cost continues to fall over the next 20 years, solar costs will be half that of coal. These predictions may in fact be too conservative given that First Solar have reported internal production costs of 75 cents (46 pence) per watt with an expectation of 50 cents (31 pence) per watt by 2016.

When applied to electricity prices this predicts that solar generated electricity in the US will descend to a level of 12 cents (7 pence) per kilowatt hour by 2020, possibly even 2015 for the sunniest parts of America.

What does that mean? Cheap, decentralised, plentiful, sustainable energy production. This would be a massive relief to global markets that have been squeezed in recent years by the rising cost of oil extraction, which has been passed onto consumers. Falling energy prices — all else being equal — mean more disposable income to save and invest, or to spend.

Some will say that solar is inherently unviable due to the difficulty of storing energy. But huge advances have been made on that front in recent years, and improvements continue.

This — if it comes to pass — would be a basis for a period of strong growth. Independence from foreign oil. Independence from falling EROEI yields on conventional energy. A robust decentralised grid. A new sustainable energy supercycle — and new growth in other industries that benefit from falling energy costs. This has the potential to reverse so many of the negative trends we have seen emerge in recent years, and prove wrong the Malthusians who claim that humanity has over-extended itself and that the era of growth is over.

In the long term, this makes me pretty bullish. But unfortunately this is all still years away. Maybe five, maybe ten, maybe twenty years. We’re not out of the woods yet. Not for a long time.

Explaining Wage Stagnation


Well, my intuition says one thing — the change in trajectory correlates very precisely with the end of the Bretton Woods system. My intuition says that that event was a seismic shift for wages, for gold, for oil, for trade. The data seems to support that — the end of the Bretton Woods system correlates beautifully to a rise in income inequality, a downward shift in total factor productivity, a huge upward swing in credit creation, the beginning of financialisation, the beginning of a new stage in globalisation, and a myriad of other things.

Some, including Peter Thiel and James Hamilton, have suggested that there is data to suggest that an oil shock may have been the catalyst that put us into a new trajectory.

Oil prices:

And that this spike may be related to a fall in oil prices discoveries:

I certainly think that the drop-off in oil discoveries was a huge psychological factor in the huge oil price spike we saw in 1980. But the reality is that although production did fall, it has recovered:

The point becomes clearer when we take the dollar out of the equation and just look at oil priced in wages:

Oil prices in terms of US wages ended up lower than they had been before the oil shock.

What happened in the late 70s and early 80s was a blip caused by the (very real) drop-off in American reserves, and the (in my view, psychological — considering that global proven oil reserves continue to rise to the present day) drop-off in global production.

But while oil production recovered and prices fell, wages continued to stagnate. This suggests very strongly to me that the long-term issue was not an oil shock, but the fundamental change in the nature of the global trade system and the nature of money that took place in 1971 when Richard Nixon ended Bretton Woods.

UPDATE: Commenters are pointing out that I should probably have concentrated a bit more on the trade and globalisation dimension, which I did mention in passing. However, I see this as an outgrowth of the end Bretton Woods, because it began just after Bretton Woods was ended and there is no way that America could afford to run the kind of trade balance it runs today with the world had America stayed in the Bretton Woods system.

I have covered this issue in quite some depth in the past.


Free Market Ecology

These gargantuan global conferences where the emissaries of governments meet in hallowed halls to thrash out a global planning agenda — dressed in the clothes of ecology, or sustainable development, or whatever the buzzword of the day — are a waste of time.

They are a waste of time for the taxpayer, who has to stump up to pay for such efforts. They are a waste of time for the protestors who swarm to such events holding placards and shouting slogans. They are a waste of time for the ecologists who — whether right or wrong — believe that the present shape of human civilisation is unsustainable. Possibly the only group that really benefits are the self-perpetuating bureaucratic classes, who often take home huge salaries they could never earn in the private sector.

And the Malthusian targets of the bureaucracy have a history of missing.

The Guardian notes:

Rio+20 was intended as a follow up on the 1992 Earth Summit, which put in place landmark conventions on climate change and biodiversity, as well as commitments on poverty eradication and social justice. Since then, however, global emissions have risen by 48%, 300m hectares of forest have been cleared and the population has increased by 1.6bn people. Despite a reduction in poverty, one in six people are malnourished.

If these bureaucratic classes knew the first thing about economics or markets, they would begin to question whether such conferences — and all the promises, intergovernmental commissions, and regulatory pledges they spawn — are necessary. The more I question, the more I come to believe that all that is needed to halt any man-made ecological crises are free markets and free speech.

The history of human civilisation has been one of triumph over the limits of nature. While we have had our ups and downs, recent projections of imminent ecological ruin — such as those in the 1970s produced by Ehrlich and Holdren and the Club of Rome, or earlier by Keynes, Malthus and Galton (etc) — have all failed to materialise. But the trend goes back much further, into the distant past. Throughout our history our species has done what has been necessary to survive. Humanity has lived on this planet for upwards of 500,000 years, and through that time, we have survived a myriad of climate changes — solar variation, atmospheric variation, cycles of glaciation, supervolcanoes, gamma ray bursts, and a host of other phenomena.

It will be no different this time. We are dependent on our environment for our life and for our future. That is widespread knowledge, and so as the capable and creative species that we are, we have already developed a wide array of technological solutions to potential future environmental problems. This is a natural impulse; humanity as individuals and as a species hungers for survival, for opportunities to pass on our genes.

As I wrote last month:

If we are emitting excessive quantities of CO2 we don’t have to resort to authoritarian centralist solutions. It’s far easier to develop and market technologies (that already exist today) like carbon scrubbing trees that can literally strip CO2 out of the air than it is to try and develop and enforce top-down controlling rules and regulations on individual carbon output. Or (even more simply), plant lots of trees and other such foliage (e.g. algae).

If the dangers of non-biodegradable plastic threaten our oceans, then develop and market processes (that already exist today) to clean up these plastics.

Worried about resource depletion? Asteroid mining can give us access to thousands of tonnes of metals, water, and even hydrocarbons (methane, etc). For more bountiful energy, synthetic oil technology exists today. And of course, more capturable solar energy hits the Earth in sunlight in a single day than we use in a year.

The only reason why these technologies are not widespread is that at present the older technologies are more economically viable. Is that market failure? Are markets failing to reflect our real needs and wants?

No; those who so quickly cry “market failure!” fail to grasp markets. Certainly, I think GDP is a bad measure of economic growth. But throwing out the concept of money altogether as a measure of society’s needs and wants is completely foolish. Markets are merely an aggregation of society’s preferences. Capital and labour is allocated as the market — in other words, as society — sees fit. As Hayek showed in the 1930s, the market gives society the ability to decide how a good or service should be distributed based on individuals willingness to give money for it. The market gives feedback to producers and consumers through the price mechanism about the allocation of resources and capital, which in turn allows on the basis of individual consensual decisions corrections that prevent shortages and surpluses. Under a planned system there is no such mechanism.

The fact that greener technologies have not yet been widely adopted by the market is merely a symptom of the fact that society itself is not yet ready to make a widespread transition. But the fact that research and development and investment continues to pour into green technologies shows that the market is developing toward such an end.

Solar consumption has gone parabolic:

And so it will continue; as society evolves and progresses, the free market — so long as there is a free market — will naturally reallocate resources and labour based on society’s preferences. Without a free market — and since 2008 when the banks were bailed out and markets became junkiefied intervention-loving zombies, it is highly dubious that there is such a thing as a free market in the West — planners will just end up guessing at how to allocate resources, labour and capital, and producing monstrous misallocations of capital.

The political nature of such reallocation is irrelevant; whether the centralists call themselves communists or socialists or environmentalists, their modus operandi is always the same: ignore society’s true economic preferences, and reallocate resources based on their own ideological imperatives (often for their own enrichment).

My view is that the greatest threat to the planet’s ecology is from the centralists who wish to remove or pervert the market mechanism in order to achieve ideological goals. It is not just true that removing the market mechanism retard society’s ability to evolve into new forms of production, resource-allocation, and capital-allocation based on society’s true preferences. The command economies of the 20th Century — particularly Maoist China and Soviet Russia — produced much greater pollution than the free markets. Under a free market, polluters who damage citizens or their property can be held to account in the market place, and through the court system.There is no such mechanism through the kind of command of economy that the centralists seem to wish to implement.

The answer is not central planning and government control. The answer is the free market. 

What Peak Oil?

Is peak oil imminent? Lots of people seem to think so.

The data (released by BP a company who have a vested interest in oil scarcity) don’t agree. Proved reserves keep increasing:

The oil in the ground will run out some day. But as the discovery of proven reserves continues to significantly outpace the rate of extraction, the claims that we’re facing immediate shortages looks trashy.

Some may try to cast doubt on these figures, saying that BP are counting inaccessible reserves, and that we must accept that while there are huge quantities of shale oil in the ground, the era of cheap and readily accessible oil is over. They might cite the idea that oil prices are much higher than they were ten years ago. Yet this is mostly a monetary phenomenon resulting from excessive money creation beyond the economy’s productive capacity. Priced in gold, oil is still very cheap — almost as cheap as it has ever been:

The argument that the vast majority of counted reserves are economically inaccessible is fundamentally flawed. In the long run there is only one equation that really matters in determining whether oil is extractable, and that is whether there is a net energy gain; whether energy-in exceeds energy-out. If there’s a net energy gain, it’s feasible. Certainly, we are moving toward a higher cost of energy extraction. Shale oil (for example) has a lower net energy gain than conventional oil, but still typically produces five times as much energy as is consumed in extraction.

But the Earth’s extractable hydrocarbons will eventually dry up, whether that’s in 500 years or 200 years. If we want humanity to have a long-term future on Earth, we need to move to renewables; solar, hydroelectric, thorium, synthetic hydrocarbons. And the market will ensure that, eventually — as the cost of renewable energy continues to fall, more and more of us will adopt it. I don’t buy the myth that markets are stupid — if humanity needs renewable energy (I believe we do) the market will see to it (I believe that is slowly happening). Markets are just the sum of human preferences.

According to the International Renewable Energy Institute:

Power from renewable energy sources is getting cheaper every year, according to a study released Wednesday, challenging long-standing myths that clean energy technology is too expensive to adopt. The costs associated with extracting power from solar panels has fallen as much as 60 percent in just the past few years.The price of  from other renewables, including wind, , concentrating solar power and biomass, was also falling.

So no. I’m not lying awake at night worrying about imminent peak oil. There’s plenty of extractable oil, and renewable energy will eventually supplement and replace it. But will politics get in the way of energy extraction? The United States has huge hydrocarbon reserves, yet regulation is preventing drilling and shipment, leaving America dependent on foreign oil. And the oil companies themselves are largely to blame — after Deepwater Horizon, should anyone be surprised that politicians and the public want to strangle the oil industry?

If there’s an imminent energy crisis, it will be man-made. It will come out of the United States’ dependency on foreign oil. Or out of an environmental catastrophe caused by mismanagement and graft (protected cartels like the energy industry always lead to mismanagement). Or out of excessive red tape. Or war.

Keynesianism & Eugenics

The theory of output as a whole, which is what The General Theory of Employment, Interest and Money purports to provide, is much more easily adapted to the conditions of a totalitarian state.

John Maynard Keynes

In looking at and assessing the economic paradigm of John Maynard Keynes — a man himself fixated on aggregates — we must look at the aggregate of his thought, and the aggregate of his ideology.

Keynes was not just an economist. Between 1937 and 1944 he served as the head of the Eugenics Society and once called eugenics “the most important, significant and, I would add, genuine branch of sociology which exists.” And Keynes, we should add, understood that economics was a branch of sociology. So let’s be clear: Keynes thought eugenics was more important, more significant, and more genuine than economics.

Eugenics — or the control of reproduction — is a very old idea.

In The Republic, Plato advocated that the state should covertly control human reproduction:

You have in your house hunting-dogs and a number of pedigree cocks. Do not some prove better than the rest? Do you then breed from all indiscriminately, or are you careful to breed from the best? And, again, do you breed from the youngest or the oldest, or, so far as may be, from those in their prime? And if they are not thus bred, you expect, do you not, that your birds and hounds will greatly degenerate?  And what of horses and other animals? Is it otherwise with them? How imperative, then, is our need of the highest skill in our rulers, if the principle holds also for mankind? The best men must cohabit with the best women in as many cases as possible and the worst with the worst in the fewest,  and that the offspring of the one must be reared and that of the other not, if the flock is to be as perfect as possible. And the way in which all this is brought to pass must be unknown to any but the rulers, if, again, the herd of guardians is to be as free as possible from dissension.  Certain ingenious lots, then, I suppose, must be devised so that the inferior man at each conjugation may blame chance and not the rulers and on the young men, surely, who excel in war and other pursuits we must bestow honors and prizes, and, in particular, the opportunity of more frequent intercourse with the women, which will at the same time be a plausible pretext for having them beget as many of the children as possible. And the children thus born will be taken over by the officials appointed for this.

Additionally, Plato advocated “disposing” with the offspring of the inferior:

The offspring of the inferior, and any of those of the other sort who are born defective, they will properly dispose of in secret, so that no one will know what has become of them. That is the condition of preserving the purity of the guardians’ breed.

In modernity, the idea appears to have reappeared in the work first of Thomas Malthus, and later that of Francis Galton.

Malthus noted:

It does not, however, seem impossible that by an attention to breed, a certain degree of improvement, similar to that among animals, might take place among men. Whether intellect could be communicated may be a matter of doubt: but size, strength, beauty, complexion, and perhaps even longevity are in a degree transmissible. As the human race could not be improved in this way, without condemning all the bad specimens to celibacy, it is not probable, that an attention to breed should ever become general.

Galton extended Malthus’ thoughts:

What nature does blindly, slowly and ruthlessly, man may do providently, quickly, and kindly. As it lies within his power, so it becomes his duty to work in that direction.

Margaret Sanger — the founder of Planned Parenthood — went even further, claiming that the state should prevent the “undeniably feeble-minded” from reproducing,  and advocated “exterminating the Negro population”.

And these ideas — very simply, that the state should determine who should live, and who should die, and who should be allowed to reproduce — came to a head in the devastating eugenics policies of Hitler’s Reich, which removed around eleven million people — mostly Jews, gypsies, dissidents, homosexuals, and anyone who did not fit with the notion of an Aryan future — from the face of the Earth.

Of course, the biggest problem with eugenics is that human planning cannot really control nature. Mutation and randomness throw salt over the idea. No agency — even today in the era of genetics — has the ability to effectively determine who should and should not breed, and what kind of children they will have.

As Hayek noted:

The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society – a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.

Keynes’ interest in this topic appears to have descended from his contempt for the individual, and individual liberty. He once wrote:

Nor is it true that self-interest generally is enlightened; more often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these.

The common denominator in all of these examples — and in my view, the thing that brought Keynes toward eugenics — is the belief that the common individual is too stupid to be the captain of his own destiny. Instead, the state — supposedly equipped with the best minds and the best data — should centrally plan. Eugenicists believe that the state should centrally plan human reproduction, while Keynesians believe that the state should centrally engineer recovery from economic malaise through elevated spending. Although it would be unwise to accuse modern Keynesians of having sympathy for eugenics, the factor linking both of these camps together is John Maynard Keynes himself.

Keynes’ description of an economic depression — that a depression is a fall in the total economic output — is technically correct. And many modern Keynesian economists have made worthwhile contributions — Hyman Minsky, Steve Keen, Michael Hudson, and Joe Stiglitz are four examples . Even the polemicist Paul Krugman’s descriptive work on trade patterns and economic agglomeration is interesting and accurate.

The trouble seems to begin with prescriptions. Keynesianism dictates that the answer to an economic depression is an increase in state spending. And on the surface of it, an increase in state spending will lift the numbers. But will momentarily lifting the numbers genuinely help the economy? Not necessarily; the state could spend millions of dollars on subsidies for things that nobody wants, wasting time, effort, labour and taxes and thus destroying wealth. And the state can push a market into euphoria — just as Alan Greenspan did to the housing market — creating the next bubble and the next bust, requiring an even bigger bailout. State spending creates additional dependency on the state, and perverts the empirical market mechanism — the genuine underlying state of demand in a market economy — which signals to producers what to produce and not produce. Worst of all, centralist policies almost always have knock-on side-effects that no planner could foresee (causality is complicated).

So Hayek’s view on the insuperable limits to knowledge applies as much to the economic planner as it does to the central planner of human reproduction.

While eugenicists and Keynesians make correct descriptive observations — like the fact that certain qualities and traits are inheritable, or more simply that children are like their parents — their attempts to use the state as a mechanism to control these natural systems often turns out to be drastically worse than the natural systems that they seek to replace.

As Keynes seems to admit when — in the German language edition of his General Theory — he noted that the conditions of a totalitarian state may be more amenable to his economic theory, the desire for control may be the real story here.

Keynesianism brings more of the economy under the control of the state. It is a slow and creeping descent into dependency on the state. As we are seeing in Europe today, cuts in state spending in a state-dependent economy can cause deep economic contraction, providing the Keynesian more confirmation for his idea that the state should tax more, and spend more.

That is, until nature intervenes. Just as a state-controlled eugenics program might well spawn an inbred elite suffering hereditary illnesses as a result of a lack of genetic diversity (as seems to have happened with the inbred elite Darwin-Galton-Wedgwood clan), so a state-controlled economy may well grind itself into the dirt as it runs out of innovation as a result of a lack of economic diversity. Such a situation is unsustainable — no planner is smarter than nature.