The Energy Perspective: Oil and the Magical 4%

The Energy Perspective: Oil and the Magical 4%

One of the major recent economic news items has been the rise of crude oil prices to an all-time high of over $55 per barrel for a few days in late October 2004. This has put pressure on both economic and financial conditions all over the world. While oil price has fallen since then below $45 per barrel, it is not likely that oil price will return to the good old days of $20 to $35 per barrel. Therefore, the feature article in this second EDL Newsletter presents an analysis of the nature and importance of the Oil Industry in the dynamic system of the Ecocosm, our name for the whole earth system. This first of two articles on the influence of oil on the world system focuses on normal economic and financial feedback controls. The second article will address controls under crisis conditions and influences on population and global life support system operations.

Introduction: Review of the Major World Feedback Control Loops

We begin with a review of the aggregate world feedback structure (Figure 1) that is systematically destroying earth’s life support system and, thereby, creating the environmental crisis. World human consumption, a conglomerate annual flow of all the renewable and nonrenewable resources that are removed or destroyed in support of the total human presence on earth, is in the center of the diagram. The earth’s existing physical, electromagnetic, thermal, chemical, and nonhuman biological substance is contained in the upper cloud from which human consumption flows. That cloud contains a massive, extremely complex feedback system that controls the earth’s many physical and chemical resources; its thermal, electromagnetic, atmospheric (weather, climate, atmospheric water circulation, air composition, mixing, and cleaning), marine (ocean water composition, recycling, and circulation), and tectonic (earth quakes, tsunamis, volcanic eruptions and lava flows) activities; the operation of the atmospheric, terrestrial, and marine ecosystems; the deflection and disintegration of cosmic radiation and debris, and the thermal insulation of earth from the near absolute zero cold of interstellar space. Thus, the upper cloud contains the Ecocosm’s life support system. In the last century, humanity’s disruptions of the feedback structure, life forms, and resources in the cloud began to compromise the cloud’s ability to maintain the global life support equilibrium.

Figure 1. Major World Feedback Control Loops Producing the Environmental Crisis

The lower cloud contains the waste and pollution in the air, in the waters, and on land that are the by-products of the operation of the human presence. This cloud also contains a complex feedback system that breaks down the waste and pollution materials, detoxifies them, and recycles them back to the life support system of the upper cloud. The speed and efficiency of this recycling is dependent upon the volume, toxicity, and composition of the waste and pollution; and on the ability of the life support system to facilitate the recycling and to assimilate the recycled materials. Since the volume of waste and pollution is growing exponentially, the materials are becoming more toxic and more resistant to natural decomposition and recycling; and the destruction of the functioning life support system reduces its ability to assimilate the recycled materials; the lower cloud’s ability to sustain and support the upper cloud’s deteriorating life support capabilities is itself deteriorating. Thus, humanity’s self-created socioeconomic system is suspended between Heaven, the miraculous planetary life support system in the cloud above, that we are systematically draining and destroying; and Hell, the mountain of toxic, slowly decomposing, disease-causing, pollution we have created in the cloud below. In a person, this process would be called cancer. On a global scale, it is species suicide.

The feedback loops shown in Figure 1 identify the major control functions associated with the human presence on earth. Annual world human consumption (WHC) is the human variable that interacts with the global life support system and with the decomposition and recycling system that are contained in the upper and lower clouds, respectively, but whose feedback processes are not diagramed therein. WHC equals world human population times annual human average per capita consumption. Both population and per capita consumption are time exponentials with estimated long-term growth rates of about 2% per year. When two exponentials are multiplied together, the exponential of the product has a growth rate that is the sum of the two contributing growth rates, hence about 4% per year. Figure 1 shows the highly-aggregated major positive feedback loops that create (right side) the population exponential and (left side) the per capita consumption exponential. The characteristics of all of the positive loops in Figure 1 are deeply ingrained in the instincts, attitudes, and collective consciousness of human beings and in the economic and financial institutions and decision policies of individuals, families, companies, banks, and governments of all kinds throughout the world. It is this persistent consumption growth that is systematically destroying the life support system and disabling the decomposition, cleansing, and recycling capabilities of planet earth, thereby creating the environmental crisis. Continuing 4% per year growth causes the growing WHC to double in 17.5 years, quadruple in 35 years, and increase by a factor of 64 in 105 years. If 4% average consumption growth continues during our new millennium, in the year 2105 WHC will be 64 times as large as it was in 2000. It is inconceivable that the earth’s finite resources, disappearing life forms, and mounting toxic burden can survive such abuse. Thus, we are all living in the last century of human life as we know it. Will this be the last century of human life? Either humanity will stop consumption growth, violently or voluntarily, well before mid-century or earth’s devastated life support, cleaning, decomposing, and recycling systems will force consumption growth to end.

Figure 2. World Gross Domestic Product from Various Sources

It should be noted that world human consumption, in the environmental sense, represents all of the renewable and nonrenewable resources recovered from the earth and its environment to be used as raw materials for making and consuming all products that humans use in any way. There are many millions of different resources and billions of different products used by humans, so WHC is a highly aggregated and complex variable. Consumption not only includes all of the resources actually used in products, but all of the resources destroyed in the recovery of resources used, all resources wasted in the recovery, transportation, refining and production phases of manufacturing and consumption, and all the resources in products that are discarded or spoiled before humans use them. Since the millions of types of resources have different units of measure that are often incommensurable, there is no accurate way to measure WHC in terms of a single number each year; and there is no data series that tries to measure it. GDP (Gross Domestic Product for the world, see the data time history from 1960-2000 in Figure 2) is a measure of human product "value added" during a year that is reported in one form of money (US dollars in the case of world GDP data).

Obviously, dollar bills are not barrels of oil or tons of fish or bushels of wheat. Furthermore, some of the GDP value added does not correspond to resources removed from the environment; and the values of the raw materials taken from the environment that are included in the GDP number do not correspond to the degree of devastation of the environment caused by their removal. This is because their values are assigned based on economic values to humans, not on their values associated with maintaining the stability of the world’s life support system (upper cloud in Figure 1). In fact, even the physical quantities of resources removed (if we knew them and could convert them into a single unit) would not fully represent the true effect on environmental degradation created by their removal because science knows little about the amount of world life support system dysfunction that does or will result from the loss of a ton of gold ore or a ton of bee pollen. Even worse, the GDP numbers are not exhaustive measurements of value added; they are statistical estimates from samples; and sometimes they are guesses. Since the GDP numbers have US dollar units, all value added estimates that are made in countries using currencies other than the US dollar introduce currency conversion problems. Since our analysis is more interested in time patterns through time than values at a point in time, changes in the economic value of the dollar itself through time and changes in the value of the dollar vs. other currencies through time can introduce errors into the patterns that the GDP numbers appear to show when viewed over a period of time. While some of errors are self-compensating, the likelihood is that consumption growth is underestimated by world GDP growth, and that effective environmental destruction growth is substantially underestimated.

World GDP is used as a surrogate for WHC because we do not have a better quantitative representation of world human consumption. Hopefully, the growth rate of recovery and disturbance of environmental resources is not greatly different from the growth rate of GDP. Some suggest that the developed world is moving away from the use of materials and moving toward the use of information. This would imply that the GDP growth rate might be greater than WHC growth rate. However, the majority of earth’s people live in developing nations whose growth rates are higher than those of developed nations, and where the use of material resources is very high now as these nations develop the material infrastructures for their cultures and as they manufacture more of the material products consumed by the developing nations.

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The Central Role of Petroleum in the World Economy

Oil is used as a raw material for many products, particularly those made of plastics; it is the world’s most used fuel; it is a major lubricant and an organic base for cosmetics and medicines. Oil’s most important use is as a fuel used in power plants to produce electricity, in heating homes and buildings, and to run engines of all kinds, especially in factories and vehicles. Since oil is the most important resource in sustaining the operation of modern life and institutions, any interruption in oil availability or even a major increase in oil price can slow or stop consumption growth. The world economy runs on oil, and stops without it. That is why so much attention is now focused on the rise of oil price to a new all-time high (see the data time history for oil price 1970-2004 in Figure 3). It is also why everyone should know how the feedback structure of the world’s economy and financial institutions depends on the oil industry. However, it should be noted that the data for oil price in U.S. dollars per barrel in the figure have not been adjusted for inflation. Thus, the oil price peak of $40 in 1980 had a greater restraint on world consumption than the $55 peak this year, 24 years later. In fact, the recent bull market in dollar denominated oil could more accurately be called a bear market in the U.S. dollar. If oil price had been quoted in Euro currency, as some of the oil producing countries want to do and Russia already does, there would not have been a record high price.

Figure 3. Oil Price History Compared with Other Financial Variables

Since there are so many aspects of the oil industry that are important, our oil analysis will be presented in two parts: one in this newsletter and the other one in a future newsletter. The present analysis will focus on the normal feedback control relationships between the oil industry, the world economy, world financial markets, and short-term (ST) and long-term (LT) growth in WHC. The later analysis will focus on the world economy and financial markets when the normal regulating mechanisms are ineffective under crisis conditions, and on the pollution, population, and environmental effects of the use of oil. To present the normal economic and financial effects, we shall focus on the variables in the center and to the left in Figure 1. New loops in color-coded groups will be added in stages, so they will be reasonably easy to follow.

Green Feedback Loops (A - F)

that Maintain the 4% Growth Channel of the World Economy

In order to understand how oil availability and price influence consumption growth, it is necessary to introduce variables into Figure 1 that represent the oil industry’s operations that influence WHC. The central flow column in Figure 1 with additional variables in the sequence of flows and accumulations that are specific to the oil industry is shown in Figure 4 (right side, top-to bottom).

Figure 4. Left Side of Figure 1 with Additional Variables Shown

Some of these accumulations and flows are implied in the clouds, but to keep Figure 1 simple, they are not shown. Loops A and B in green (Figure 4) are the highly aggregated economic positive loops in Figure 1 that drive the exponential growth of average annual world human per capita consumption. These loops are discussed in greater detail in our paper, “The Bridge to Humanity’s Future”.

In Figure 5, to the left of Loops A and B are four financial loops that regulate the economy to maintain the 4% per year growth rate of GDP without allowing it to overheat or to lapse into recession. Green Loop C is primarily controlled by the central bankers of the world who represent their governments’ interests in a world where national economic interests are greatly influenced by world economics. In this loop the growth rates of the national economies that are regulated by their respective central banks are measured by GDP. If GDP is growing at about 4% per year (for the U.S. and other developed nations), ST interest rate is left unchanged. See the data time history in Figure 3 for one version of ST interest, Eurodollar (3-month notes) nearest futures average monthly price from 1982-2004. The interest rate is measured downward from 100.00, which is 0.00 %. Thus, 97.50 on the left vertical scale would be 100.00 - 97.50 = 2.50% per year. If GDP is growing “too fast,” a judgment call for regulators, ST interest rate is raised to slow down the growth. If GDP indicates a growth rate that is “too low,” another judgment call, ST interest rate is lowered. ST interest rate is used for economic regulation, rather than the LT interest rate, because central bankers have more control over ST rates, though they do not set U.S. Treasury Bill (90-day interest bearing securities) or Eurodollar futures prices. In the

Figure 5. Financial Variable Loops C, D, E & F that maintain the 4% annual growth rate

United States, Alan Greenspan is the Chair of the Committee in the Federal Reserve System that sets the ST interest rates over which the Federal Reserve has jurisdiction. All of the developed nations have similar committees. The central bankers of the developed nations meet several times each year to coordinate their regulation efforts. The desired growth rate of 4% per year is used (Figure 6) because experience in the 20th century in regulating economic behavior indicates that there are two types of economic scenarios that are particularly destructive to national well-being and are particularly difficult to overcome once they get out of hand. These are depression and hyper-inflation. 4% is the middle between the out of control values for regulating the economy to keep growth going without risking the two economic dragons. The early stage of depression is called recession, which exists when GDP growth is negative for two consecutive quarters. By the time GDP growth has fallen to 1% per year, the regulators may have not only reduced ST interest rates considerably, but they may also be using other regulatory methods coordinated with the government’s treasury department to increase money supply and expand credit, with the tax system to reduce rates or even to give rebates, with congress to increase government spending (fiscal policy), and other methods of stimulating growth before the economy falls into recession. Similarly, by the time GDP growth rises to 7%, the regulators may have already raised interest rates several percent, credit is being restrained, taxes are being raised, et cetera. to slow down GDP growth so inflation does not get out of hand. Thus, green Loop C may be positive or negative. It will be negative when perceived GDP growth is greater than 5% per year and positive when GDP is less than 3% because it is attempting to regulate the magnitude of the rate of change of GDP, not the direction of change, which is always intended to be up.