Below is the transcript for Nate Hagens: We’re Not Facing A Shortage of Energy, But A Longage of Expectations
Chris Martenson: Welcome to another PeakProsperity.com podcast. I am, of course, your host, Chris Martenson, and today we have the distinct pleasure of talking with Nate Hagens, a well-known authority on global resource depletion. Until recently, he was lead editor of The Oil Drum, one of the most popular and still highly respected websites for the analysis and discussion and global energy supplies, and the future implications of the energy decline that we are facing. Nate’s presentations address the opportunities and constraints that we face in the transition away from fossil fuels. He’s appeared on PBS, BBC, and NPR, and lectured around the world. He holds a Master’s Degree in Finance from the University of Chicago and recently completed his PhD in Natural Resources at the University of Vermont. Previously, he was President of Sanctuary Asset Management and a Vice-President at the investment firm Solomon Brothers and Lehman Brothers. I happen to know Nate from our connections through the Association for the Study of Peak Oil and Gas, or ASPO, where we’ve both been featured presenters and active participants. So, Nate, welcome, and glad you could be with us today.
Nate Hagens: Thanks, Chris, glad to be here.
Chris Martenson: You know, I want to start with a little bit about Peak Oil, the idea that someday there’s going to be incrementally less oil flowing from the ground to use as we wish. In your estimation and experience, where are we in the Peak Oil story?
Nate Hagens: Well, there are a lot of details that people will argue about. The bottom line is that we’ve reached a level where supply cannot continue to keep up with demand increase. We’ve been on a plateau for five or six years now, where oil supply has become inelastic: more demand, higher prices will not bring out more supply. And there are interesting sub-stories to that. For example, the EIA and the IEA, the data that they report show that we just recently hit an all-time high in oil production. If you include tar sand, biofuels, natural gas, plant liquids, etc., we’re around 88 million barrels a day. But if you look at some other data sources, like the JODI, the Joint Oil Database Initiative, that is a compilation of national governments reporting their own oil production, there’s about a three to four million dollar difference in total production. So we don’t really know the source of EIA and IEA. We assume it’s IHS CERA data, but there’s a big gap there. And if you look at the JODI data, we’ve still peaked in 2006 and have not regained that peak. Now if you’re just talking oil, both data sources agree that 2006 is still the peak of global oil production.
Chris Martenson: Is that where you are? So in your estimation, conventional oil has peaked? I think that’s in the rearview mirror, but you’re now going out and saying all liquids that we would call oil; forget about the funny stuff out there, the ethanol and whatnot, but in terms of stuff that comes out of the ground we would call oil, we’ve peaked?
Nate Hagens: Well, I’ve stopped paying attention to that, Chris, because I don’t think it really matters. I think Peak Oil is a constraint going forward, but it’s not the real driver on the energy side. It’s that our marginal cost keeps going up for liquid fuels, which are basically the hemoglobin of global trade and global commerce, so that’s relevant. But whether we have another million, or two million, or two million less, isn’t the real story. We’re not going to be able to meaningfully grow something that the entire world depends on, and so I think all this bickering about which month or which year is the highest is missing the point. And then I’m sure, we’ll probably touch on it later, the greater threat right now is not Peak Oil, but Peak Debt or Peak Credit, and that’s the much more clear and present danger. But you mentioned ethanol, and there was a stat that came up today, I just wanted to point it out. As of now, corn for food is the number two use of corn in this country. We now use more corn to create ethanol than we do for food. And we produce about a million barrels of ethanol a year. Each of those barrels, of course, has, because of the BTU content, a lot less energy than a barrel of oil, around 70%. So we’re using half of our corn supply to produce one million barrels of ethanol, when we use nineteen million barrels a day of oil. So it’s kind of a conversion of corn, water, soil, natural gas, and coal into liquid fuels in order to become less dependent. But it’s only a drop in the bucket relative to our total consumption.
Chris Martenson: Right. So here we have this magic substance, it’s the hemoglobin of global trade, as you said, meaning it’s the carrier that’s providing the oxygen, as it were, to have the global economy function. We will get to that Peak Debt connection in just a second. But this is a really important point to me, the idea that what we need is we need more oil or liquid fuels if we want to broaden it on a daily, yearly, monthly, whatever basis we want, than we did last year, day, month or whatever, because we want our economy to keep growing, and that’s what we understand and know and love. In your estimation, though, we are now facing physical constraints that are going to prevent us from growing the supply of oil at the higher level. And on a more granular level, you used marginal cost of production, but that itself might be a proxy for increasing energy costs to go out and get energy. However we look at it, money [is] a great proxy for energy, so let’s use that. Energy’s going to become more expensive going forward and there’s going to be slightly less of it. Those are two pieces of the story, in your mind, from now stretching into the future.
Nate Hagens: Yeah, that’s right. And, you know, the main reason that’s a problem is because our entire system is based on the incorrect assumption that energy, which underpins every single physical service transaction we have in this economy, is substitutable. You can substitute capital or labor for it. And in reality, that’s not true. If you don’t have energy, you don’t have an economic transaction.
So if it becomes either more expensive or unavailable, both of those have deleterious impacts to economic growth. And we’re kind of in what I call the “biophysical gauntlet” right now, which is that oil, we’ve found all the Beverly Hillbilly Oil 60 to 70 years ago that was bubbling right under the surface, and now we have to drill deeper, drill further offshore; create things that aren’t really oil and process them into oil, like tar sands and oil shale. And all these things cost a lot more for the energy companies to produce. And society is reaching the point of being insolvent because of our claims and liabilities. And eventually we get to a point where the oil companies need higher and higher oil price in order to make a profit, but society can afford less and less. And at some point those two prices of oil cross and we have a real problem. You know, right now, the marginal barrel of oil costs between $70 and $90, so there’s a little bit of a cushion in there now. But a lot of people say above a hundred dollar oil, it has significant economic headwinds. So at some point there, dollars don’t become an accurate measure of our real natural resource balance sheet.
And as you know, part of the tenets of biophysical economics is measuring our natural resource endowments in natural resource terms, themselves. For example, Energy Return On Investment (EROI) is how much energy it takes to get one unit of energy in our society. And 70, 80 years ago, we would invest one barrel of energy to get out a hundred barrels of oil, and that 100:1 ratio declined to 30:1 in the 1970’s, and it was around 10:1 in the year 2000, and the EIA stopped producing data on how much energy it takes to get energy. So we can kind of interpolate it now, but it’s clearly under ten in single digits.
And you eventually get to a point, even if oil is $100,000 dollars a barrel, or $1 million dollars a barrel, if it takes one barrel of oil to get out barrel of oil, you’re kind of out of gas at that point.
Chris Martenson: So the energy return on energy invested, or EROI, has been declining steadily. I want to just back up for a second. So here we are, if we scan the papers this morning, you know, we’ve got a debt-ceiling sort of mini-drama going on in D.C. We’ve got Italy’s bond spreads blowing out. Greece is clearly in trouble. Everybody’s familiar with the whole Portugal/Ireland story. Japan is in a pickle. China looks like it’s getting there. And as we scan across the landscape, we can’t really find any corner of the globe at this point, at least in all the advanced economies, where things look like they’re working as they used to. So if we just have our economic hats on, I believe this is a very, very confusing period of time. I know our economic high priests and priestesses are waiving their magic money wands wondering, I bet, why isn’t this working? You know, where is unemployment? Why is it stuck there? Whereas, if we step over here into the energy world and put our EROI hats on and we say look, this is perfectly predictable, I think. When you have less available net energy, these are the sorts of problems you might experience and expect. Does that make sense to you, or is that even remotely how you see it?
Nate Hagens: It makes absolute sense. We need energy to create our physical realities and create our economic growth and trade for transport, everything. If the energy sector requires a greater and greater chunk of that energy, we have less available for the rest of discretionary society. And once that constraint exists and even accelerates, you need to respond to that. And the way we responded to that was increasing our debt, which, of course, as you know, is pretty much created by a pen stroke. So that can temporarily offset energy shortages at a cost of a steeper decline, because debt actually functions as a spacial and temporal reallocater of resources, away from the periphery towards the center and away from the future towards the present. So there’s a very subtle but important relationship between debt and energy. And the problem is, is that most of, as you term, economic priests and priestesses, don’t have training in the biophysical economic world, and they treat everything in monetary terms. And we just throw more money at the problem, and it’ll go away. Well, our energy, and especially our net energy story, is getting worse. So we’re increasing our money supply while our energy supply is declining, and, yeah, that’s not a good situation.
Chris Martenson: All right, so biophysical ignorance is one way that maybe the classical economists and economy theory got it wrong. Are there other ways?
Nate Hagens: Well, there’s a lot of ways, there’s a lot of problems with mainstream economic theory. On the micro side, there’s not a real good differentiation between needs and wants. If you look at the evolved architecture of the human brain, you know, we evolved in a period of scarcity. And the things that give us pleasure, happiness may not be the right word, but pleasure, satisfaction, etc., those things are highjacked in the modern era. And utility — which is what economists measure as something that’s good or positive or desirable — the utility of a five hundred pound guy eating another pizza is equivalent to a starving child getting some rice. So there’s something kind of messed up in that space.
I think regular economic theory also gets the debt side wrong. They assume that debt is a neutral transfer between Party A and Party B, it’s just Party A’s deferring consumption to the future and Party B will one day be able to consume. But in reality, if you look at energy as being non-substitutable and it being impossible to grow our economies forever, then that relationship in debt breaks down. And it turns out that debt is not a neutral transfer.
I know that you are also a student of E.F. Schumacher. In Small is Beautiful, he talks about what real wealth is: Wealth is our primary capital; our trees and our rivers. And secondary capital is what we do with that; turn things into lumber and tractors, etc. And then tertiary capital is stocks and bonds and derivatives of that. So I think we have focused too much on the tertiary measures of our wealth, when they’re really just markers. And these financial markers have far outpaced our real capital. And that is kind of the elephant in the room, in our conversations about the economy in the future, that people are ignoring. They just assume that the dollars are the real markers.
Chris Martenson: Right. I noticed, too, that you know, our money is also. It’s an agreement between ourselves. We have an agreement: I have lots of paper in this room, but you and I might agree that only the stuff in my wallet has this utility, right? And here’s one of the things that I think is really sort of a characteristic of our time. I certainly pick this up in my work: I notice that a lot of people are very nervous.
You wouldn’t think people would be this nervous with the GDP allegedly growing at 2.8% or whatever they’re claiming at this point. This nervousness, I think, comes from the idea that this contract is breaking down. There is something really fundamentally wrong with this story that most people are picking up and that politicians, bless their hearts, and monetary authorities, bless their hearts, are missing almost entirely at this point in time, which that there is something with the model. And the old model was, we’re going to grow, grow, grow. If you look at Bernanke’s recent testimony to Congress and to the Senate, if you look at the most recent statements from Obama or out of the EU, all of them are talking about, we want to get to a resumption of growth right away, as fast as possible. We want jobs to grow. Who can be against that? We want trade to grow. We want consumption to grow. We want all these things to grow. And more and more people, I found, have started to look at that story and say wait a minute, there’s something broken in that story. And you don’t have to think about it all that long, I don’t believe, these days, to really understand the flaw in that particular model. And we have now lots of evidence that there are flaws in this model.
First: A, do you see it that way? B, if that’s true, why is it that people like you and I are talking about it, and thousands, if not millions, of other people are talking about it, and we can’t even get to square zero in terms of public acknowledgment at what we would call the highest levels?
Nate Hagens: Well, first of all, yes, I do agree that that is the case. I think we have peaked globally in growth. Certainly, in real terms. It’s possible that in 2013 or such we see a nominal increase in global output, but I doubt it. I think the problem – well there’s a lot of problems – but one of the main ones is if it was a 5% or 10% belt-tightening or switch that needed to happen, you would see more politicians go in that direction. But it’s such a huge change, the implications of the end of growth and what that means for our institutions and the way that our society is organized. The politicians now would be thrown out of office because people, the average American is not educated to understand these things, so it’s a very threatening story. I mean, it’s very difficult to grasp that the biggest threat to the American way of life is the American way of life. And that’s kind of a profound crossroads that we’re at. While the world is advocating that Chinese and Pakistanis should aspire to an American footprint, it probably makes more sense for Americans to aspire to a Chinese or Pakistani footprint – but try selling that. So I think the politicians and the average person — and there are evolutionary, well-understood reasons for this — we are not going to respond to this crisis until the crisis is truly upon us. And then, given the lead time and the ten or twenty years we need to really rejigger the infrastructure, it’s not going to be enough time.
Chris Martenson: Not going to be enough time to make a smooth, disruption-free –
Nate Hagens: Not a smooth transition, correct.
Chris Martenson: Right. So to me it really looks like a catch-22 at this point in time. We can’t really acknowledge the problem until it’s a problem. By the time we do that, it might be too late to really undertake a smooth transition.
So I really want to drive home this point, though, about the connection between energy and, let’s say, finance. So let’s imagine for the moment, Nate, that you owned all the bonds in the world. Somehow they all came to you, and you understand that growth is no longer possible. What do you think the value of your bond portfolio would be, before that moment of recognition, and after?
Nate Hagens: Well, I think there would be three timeframes. There would be before, and they would be worth a hundred, or par. And immediately after, the end of growth means that we’re going to have a deflationary spiral, because things are going to unravel. So in deflation, bond prices go up, because interest rates are going to go down. But ultimately, they’re going to be worth zero, because people aren’t going to be able to pay them back. There’s two issues: We have a huge amount of aggregate claims on the future. My research estimates, you add up all of the aggregate debt in the OECD, it’s around $250 trillion, and that’s not including financial derivatives where J.P. Morgan owes Goldman-Sach some hundred billion dollar swap on currencies. Excluding that, it’s around two hundred and fifty trillion. We are transitioning from a period of understanding we will never be able to pay that back – I think a lot of people understand that – to a period where we will not even be able to service that debt. So that’s the theater that’s going on right now.
As far as what is the value of all the bonds in the world if I owned them? It’s hard to answer that without knowing what the objective is and what trajectory the world goes on. I could give you multiple answers, but ultimately they’re going to be worth less. We’ve got a giant haircut coming our way. It could be as little as 50%, as much as a 100%, and I would say between 70% and 90% percent in the next decade.
Chris Martenson: So it’s sort of like Templeton’s view on housing from a few years back. It sounded crazy at the time, but the trajectory is still good for him to be potentially right on the housing side. How about for stocks, then? How much of say the total stock index fund? How much of that value is growth a component of?
Nate Hagens: Well, growth is a component of everything in our system. So I’m not necessarily calling for a stock-market crash in the next decade, but I am calling for within the decade we probably won’t have a stock market. That’s a scary thing to contemplate, but this entire system is based on more every year, and we’ve extended the system by a decade or more by little bells and whistles and allowing people to buy houses with no money down and the repeal of Glass-Steagall. And since 2008, the crash in private and household credit has been made up by government stepping in and providing 11% of our GDP just from deficit spending. And that bullet has now been spent. So the whole thing starts to unravel once they’ve spent all the bullets they have. And I don’t know that it really matters, really; stocks go down 10% or 50% or 100%, we have to restructure the way that we think about society. Competing for nominal, digital wealth is going to go away as the main cultural objective.
Chris Martenson: And would that conspicuous consumption, does that get rethought, or do we just keep that up to the bitter end? Is that a biological function?
Nate Hagens: Conspicuous consumption is part of nature. There are displays in the wild of ornate horns and plumage, etc., because those confer special advantages in mating, via sexual selection, etc., so some elements, some level of conspicuous consumption, will always be part of our species, our culture. But the way it’s promoted now, where we just are on this consumption treadmill, where we buy more and more things and don’t feel satisfied from the marginal purchase, I think that will go away. When the amount of novelty and extraneous products in the shelves kind of go away and people are more concerned about how their community and their friends and family are going to have more basic needs going forward than frivolous things. I think that’ll happen naturally.
Chris Martenson: And this is going to be part of why I think the transition is going to be difficult for a lot of people. Even though personally I cut my standard of living in half and I have a higher quality of life, and I did that very consciously over time, and I’m thrilled with it. I know other people, if it’s forced upon them, however – our living standards fall, and they fall because there’s a debt problem or an energy problem, or the combination of both, whatever, some confluence of events – that they’ll feel and experience this as a loss. And I was talking with Dan Ariely and he explained that loss is something is something that we are wired, biologically wired, to avoid. So when I summarize all this and I put it into a spot, I say okay, so we have this physical constraint that’s coming because of Peak Oil. There’s nothing we’re going to do about it. We can’t out-clever that. It’s just a constraint, it’s a limitation, there it is. We could manage it well or we can manage it poorly, but it’s there. We have a political system that’s not really geared for the magnitude of the change that we’re seeing, so the most likely outcome is that we’re going to wait, we as a culture are going to wait until we’re forced to deal with this. That’s probably going to come with disruptions. So my question here is, given all of that: What do you see as the most likely outcome, and then what do people do, what do communities do to prepare before we get to things like maybe, you know, big picture, what should the world or our country do? If we could start at the sort of the individual level, you’ve been facing this for a long time, you’ve learned a lot of things. How are you facing this?
Nate Hagens: Well one of the things that, you know, as you know I was very active in The Oil Drum for many years, because I just wanted the average person to be educated that look, our situation is based on physical stuff, and that picture is changing now. And I thought if more people would understand that, they would change on their own, because they had some “ah ha!” moments. I now think that trying to teach against the destruction of the planet, you know, for example, Lester Brown or Al Gore, is actually teaching against the drive for status, given our current environmental cues of ‘more is better.’ So it’s like trying to teach teenage girls to dress as ugly as possible. It just doesn’t work, and it’s been a waste of trillions of dollars.
Chris Martenson: Uh-huh.
Nate Hagens: I think what you just said about yourself, knowing that austerity is coming, whether it’s imposed by the markets in some sort of disruptive currency trade event or imposed by increased nationalization and the loss of freedoms – austerity is coming. So one thing, and this sounds radical, but one thing that you can do as an individual is kind of self-impose austerity. And that doesn’t mean turn into a monk or anything like that, but do things lower on the footprint meter and, you know, bike instead of take your car, walk instead of drive, eat local, don’t use as much technology, be more psychologically resilient to lower consumption. And it’s actually kind of fun, and I’ve done it myself. But you and I have advantages that a lot of people don’t have. We have money in the bank and have had successful careers, and not everyone can do that. But I do think that really, and this is kind of counter-intuitive to what we talked about earlier, but we’re not really facing a shortage of energy, we’re facing a longage of expectations. And the sooner that we as individuals or a nation recognize that the future is going to be much lower consumption than today and prepare for that, that psychological resilience is going to be really important, because if no one is psychologically prepared, people are going to freak out when some of these freedoms start to go away.
Chris Martenson: Hmm. Not facing a shortage of energy, a longage of expectations; an expectation that the future will look just like the present, only more?
Nate Hagens: Well, yeah, well, not only that. Well, look, we consume, the average American, around 230,000 kilocalories a day of energy. The body itself consumes about 2,500 to 3,000 of those, endosmotically, within the body. So exosmotically, outside of the body, we consume 99% of our energy footprint. So if Peak Oil is upon us, or any issue with coal or natural gas, or the main fossil pixie dust that has subsidized our lifestyle for the last century, if that stuff declines twenty or thirty or even forty percent, it’s not like we’re literally out of calorie availability. It’s just that our system is built on all this decadence and industry and trade and cross border transfers; it has all been built on a model that can’t continue. What’s going to break first is people’s expectations of what they own, the digits in the bank, and all of the financial claims. But those are just digits, they’re abstract digits. The day that a financial system would be disrupted, nothing happens physically.
So I think if we drop our energy consumption quite a bit, nothing has to change other than our supply chains and the way that goods and medicine and water and sanitation and all that get to the cities and towns and states. That has to be deeply thought about on a national level. But I’m optimistic – if we were sitting here and the average American used 10,000 calories a day of total energy, and we needed 3,000 for our bodily functions to continue, that would be a real problem, because there wasn’t much extra. But we have a huge amount of energy relative to what we need.
So I think there are two main things that need to happen – and of course, individuals can play a role in this – but one is we need to design some sort of future system that is an accurate barometer of what we really have on our natural capital balance sheets, relative to what we really need on our human behavior balance sheets. People are working on both sides of that.
Number two is we need some sort of bridge, some sort of mitigation towards a financial currency trade disruption, which very few people are working on. The fact is that a large percentage of our economic output globally is traded: If there’s some problem with the euro or the yen or the pound or the dollar, how does that stuff continue to get shipped every day, along with all the components and everything else that we need? In my discussions, very few people are looking at that. And so on a macro level, people need to start focusing on how supply chains look and what are ways around our current system so that we can guarantee at least basic necessity-type things to continue to reach our shores and be processed, etc.
I actually think Washington, among other mistakes, in pursuing the import substitution and Washington consensus policies of the last couple of decades, they actually were promoting to other countries like Ecuador and Africa to have imported substitutions where they actually were dependant on international trade. So these local regional models aren’t really in existence; they don’t exist. So I think yes, it’s healthier for us to eat local food, local and regionally sourced, but it’s actually the resiliency and redundancy that comes from a local and regionally sourced model that is going to play a big role in the future, because it’s a lot easier to get parts and tools in Massachusetts from New York than it is from Korea.
Chris Martenson: You know, I’ve long noted that there’s a, there’s almost like a slider, you can push it back and forth. And on one side is resiliency and on the other side is cost effectiveness. So, you know, we don’t have a lot of redundancy in our inventories, which is lean and mean and that’s great and, you know, our food is really cheap right now. At the same time, there’s very little resiliency or redundancy built into that, let alone leave sustainability and whether it’s a thousand-year plan or not aside.
Nate Hagens: We haven’t needed resilience or redundancy; we’ve needed efficiency and profit.
Chris Martenson: Uh-huh
Nate Hagens: And so that’s why this whole, what is the carrot? What are we driving for? What is the goal of a society and a goal of a culture? And it has been, for quite a while, profit that is supposed to trickle down. Once the assumption of growth goes away, then you have to start looking at different objectives, and that’s the gorilla in the room that people are afraid to voice. And I think if they understood the energy-economic link better, they might start to come to that conclusion.
Chris Martenson: That’s very well said. And that’s exactly where I am on this story, is big transformation, big shift is happening. But ultimately, you know, it comes down to, let me pin it on money, our money system. There are a lot of forms of money out there. We happen to have a debt-based money system, and by we, I mean the whole world. So when you have a debt based money system, it’s not true to say that fiat money is not backed by anything; it’s backed by debt. And it’s backed by the debt that is attached to the people of the nation. So in our case, you and I, our dollar bills physically are backed by the full faith and credit of the U.S. Government, which really means the ability of the U.S. taxpayer to pay back the outstanding debts, which are Treasury obligations. That’s the little loop that gives our money value, because ultimately you and I have productive output and that can be attached. So this is our distribution system.
The problem is, is that, of course, that with debt-based money systems, you know, they are exponential by design. And I understand the theories that say they don’t have to be, technically. There can be immaculate flows of interest and stuff like that. But in truth, when you look at a five- or a six-decade-long graph of either debt or money and you put a curve fit on it, it’s perfectly exponential, it’s just got an awesome .99 coefficient of determination, it looks great, right? So we have this exponential money system and it’s careening headlong into a physical limitation. So here we have this system where we clearly can see we have an exponential money system, those claims on the future. All of that is what we’re just desperately trying to sustain – the status quo, sustain the unsustainable; I get it. But I have personally lost any faith in the idea that we’re going to be able to do that for a whole lot longer. If my daughter lives to be the same age as my grandfather, she will die in the year 2094. Think of the number of things that will have been past peak by 2094: everything that I can possibly chart or look at at this point in time. So it’s a, we’re really facing a really profound moment in not just U.S. history, but I think human history, which is pretty extraordinary. How do we navigate that? What, at the highest level, what do we need to change to get our minds around the fact that there’s a new narrative on the table?
Nate Hagens: Well, this may not sound so cheery, but I really don’t think we’re going to change any people’s minds before the crisis happens. I just think the political drive and the people in power now are so linked to the current system. So that leaves us with, we have to build lifeboats of some sort, either by country or institution or region or individual, and I’ve changed my mind on that thinking a little bit. I think it’s