2022: Energy limits are likely to push the world economy into recession

In my view, there are three ways a growing economy can be sustained:

1. With a growing supply of cheap-to-produce energy products, matched to the economy’s energy needs.
2. With growing debt and other indirect promises of future goods and services, such as rising asset prices.
3. With growing complexity, such as greater mechanization of processes and supply lines that extend around the world.

All three of these approaches are reaching limits. The empty shelves some of us have been seeing recently are testimony to the fact that complexity is reaching a limit. And the growth in debt looks increasingly like a bubble that can easily be popped, perhaps by rising interest rates.

In my view, the first item listed is critical at this time: Is the supply of cheap-to-produce energy products growing fast enough to keep the world economy operating and the debt bubble inflated? My analysis suggests that it is not. There are two parts to this problem:

[a] The cost of producing fossil fuels and delivering them to where they are needed is rising rapidly because of the effects of depletion. This higher cost cannot be passed on to customers, without causing recession. Politicians will act to keep prices low for the benefit of consumers. Ultimately, these low prices will lead to falling production because of inadequate reinvestment to offset depletion.

[b] Non-fossil fuel energy products are not living up to the expectations of their developers. They are not available when they are needed, where they are needed, at a low enough cost for customers. Electricity prices don’t rise high enough to cover their true cost of production. Subsidies for wind and solar tend to drive nuclear electricity out of business, leaving an electricity situation that is worse, rather than better. Rolling blackouts can be expected to become an increasing problem.

In this post, I will explore the energy-related issues that are contributing to the recessionary trends that the world economy is facing, starting later in 2022.

[1] World oil supplies are unlikely to rise very rapidly in 2022 because of depletion and inadequate reinvestment. Even if oil prices rise higher in the first part of 2022, this action cannot offset years of underinvestment.

The IEA, in its Oil Market Report, December 2021, forecasts a 6.4-million-barrel increase in world oil production in 2022 over 2021. Indications through September of 2021 strongly suggest that there was only a small rebound (about 1 million bpd) in the world’s oil production in 2021 compared to 2020. In my view, IEA’s view that liquids production will increase by a huge 6.4 million barrels a day between 2021 and 2022 defies common sense.

The basic reason why oil production is low is because oil prices have been too low for producers since about 2012. Companies have had to cut back on developing new fields in higher cost areas because oil prices have not been high enough to justify such investments. For example, producers from shale formations could add new wells outside the rapidly depleting “core” regions if the oil price were much higher, perhaps $120 to $150 per barrel. But US WTI oil prices averaged only $57 per barrel in 2019, $39 per barrel in 2020, and $68 per barrel in 2021, so this new investment has not been started.

Recently, oil prices have been over $80 per barrel, but even this is considered too high by politicians. For example, countries are releasing oil from their strategic oil reserves to try to force oil prices down. The reason why politicians are interested in low oil prices is because if the price of oil rises, both the price of food and the cost of commuting are likely to rise, since oil is used in farming and in commuting. Inflation is likely to become a problem, making citizens unhappy. Wages will go less far, and politicians who allow high oil prices will be voted out of office.

[2] Natural gas production can be expected to rise by 1.6% in 2022, but this small increase will not be enough to meet the needs of the world economy.

With natural gas production growing at a little less than 2% per year, a major issue is that there is not enough natural gas to “go around.” Natural gas is the smallest of the fossil fuels in quantity. We are depending on its growth to solve many problems, simultaneously:

• To increase natural gas imports for countries whose own production is declining
• To provide quick relief from inadequate production by wind turbines and solar panels, whenever such relief is needed
• To offset declining coal consumption related to a combination of issues (depletion, high pollution, climate change concerns)
• To help increase world electricity supply, as transportation and other processes are gradually electrified

Furthermore, the rate at which natural gas supply increases cannot easily be speeded up because (a) the development of new fields, (b) the development of transportation structures (pipeline or Liquefied Natural Gas (LNG) ships), and (c) the development of storage facilities all require major upfront expenditures. All of these must be planned years in advance. They require huge amounts of resources of many kinds. The selling price of natural gas must be high enough to cover all of the resource and labor costs. For those familiar with the concept of Energy Returned on Energy Invested (EROEI), the basic problem is that the delivered EROEI falls too low when all of the many parts of the system are considered.

Storage is extremely important for natural gas because fluctuations tend to occur in the quantity of natural gas the overall system requires. For example, if stored natural gas is available, it can be used when wind turbines are not producing enough electricity. Also, a huge amount of energy is needed in winter to keep homes warm and to keep the lights on. If sufficient natural gas can be stored for months at a time, it can help provide this additional energy.

As a gas, natural gas is difficult to store. In practice, underground caverns are used for storage, assuming caverns of the right type are available. Trying to build storage, if such caverns are not available, is almost certainly an expensive undertaking. In theory, importing natural gas by pipeline or LNG can transfer the storage problem to LNG producers. This is not a satisfactory solution, however. Without adequate storage available to sellers, this means that natural gas can be extracted for only part of the year and LNG ships can only be used for part of the year. As a result, return on investment is likely to be poor.

Now, in 2022, we are hitting the issue of very slowly rising natural gas production head-on in many parts of the world. Countries that import natural gas without long-term contracts are facing spiking prices. Countries in Europe and Asia are especially affected. The United States has mostly been isolated from the spiking prices thanks to producing its own natural gas. Also, only a small portion of the natural gas produced by the US is exported (9% in 2020).

The reason for the small export percentage is because shipping natural gas as LNG tends to be very expensive. Long-distance LNG shipping only makes economic sense if there is a several dollar (or more) price differential between the buyer’s price and the seller’s costs that can be used to cover the high transport costs.

We now seem to be reaching a period of spiking natural gas prices, especially for counties importing natural gas without long-term contracts. If natural gas prices rise, this will tend to make electricity prices rise because natural gas is often burned to produce electricity. Products made with high-priced electricity will be less competitive in a world market. Individual citizens will become unhappy with their high cost of heat and light.

High natural gas prices can have very adverse consequences. In areas with high prices, products made using natural gas as a raw material will tend to be squeezed out. One such product is urea, used as a nitrogen fertilizer. With less nitrogen fertilizer available, food production is likely to fall. If food prices rise in response to short supply, consumers will tend to reduce discretionary spending to ensure that there are sufficient funds for food. A reduction in discretionary spending is one way recession starts.

Inadequate growth in world natural gas production can be expected to hit poor countries especially hard. For example, a recent article mentions LNG suppliers backing out of planned deliveries of LNG to Pakistan, given the high prices available elsewhere. Another article indicates that Kosovo, a poor country in Europe, is experiencing rolling blackouts. Eventually, if natural gas available for export remains limited in supply, electricity blackouts can be expected to spread more widely, to less poor parts of Europe and around the world.

[3] World coal production can be expected to decline, further pushing the world economy toward recession.

Figure 3 shows my estimate for world coal production, next to a recent IEA forecast.

The general shape that economic growth is likely to take is that of a “Seneca Curve” or “Seneca Cliff.” In the words of Lucius Annaeus Seneca in the first century CE, “Increases are of sluggish growth, but the way to ruin is rapid.” If we think of the amount graphed as the total quantity of goods and services received by citizens, the amount tends to rise slowly, gradually plateaus and then falls.

We now seem to be encountering lower energy supply while population continues to rise. It takes energy for any activity that we think of as contributing to GDP to occur. We should not be surprised if we are at the edge of a recession. If we cannot get our energy problems solved, the downturn could be very long-lasting.