2006: The Year of Oil Collapse?

By James Howard Kunstler, Kunstler.com. Posted January 11, 2006.

Editor's note: This is one of three perspectives AlterNet has assembled on the prospect of peak oil and its implications for modern society and the global economy. The other two are from World Watch: Christopher Flavin writes that while we can't know exactly when oil production will start declining, we must focus on alternatives to petroleum now; and Robert K. Kaufman describes the role the market and government should play in helping to make the transition from a petroleum-dependent society.

The sheer weight and inertia of American life kept our systems on their feet through 2005, despite a worsening economic climate and some harsh body blows, like the hurricanes that pounded oil and gas production in the Gulf of Mexico. In a way, some perverse law of sociopolitical physics seemed to concentrate all the year's destructive potential in the devastation of New Orleans, Biloxi and other Gulf Coast towns -- while the mighty din of motoring and cheeseburger sales roared on elsewhere without pause from Cape Cod to Catalina.

First, a little background briefing on where we are at -- to use some of the bad grammar now normative in American life -- before I make predictions (i.e., guesses) about the year ahead.

You can only introduce so much perversity into an economic system before distortions cripple it. From 2001 through 2005, consumer spending and residential construction had together accounted for 90 percent of the total growth in GDP, while over two-fifths of all private sector jobs created since 2001 were in housing-related sectors, such as construction, real estate and mortgage brokering. Much of the money spent did not really exist except as credit -- incomes as yet unearned, hallucinated liquidity, wished-for wealth, all based on the expectation that house values would continue to rise at 10 percent to 20 percent a year, forever. It became a reckless racket, all predicated on sustaining an economy that had lost its other means for generating wealth -- foremost its infrastructure for making things besides suburban houses.

This housing bubble economy represented, holistically speaking, the wish to maintain a sense of normality in American life under conditions of disintegrating normality, and it is no symbolic accident that it centered on the images of hearth and home, because fundamental comforts were what many Americans actually stand to lose in a reality-based future. The decay of standards and norms in banking behavior applied to housing started, as in the case of the proverbial rotting dead fish, at the head, the Federal Reserve, and infected every lowly loan officer through the body until, in effect, lending standards ceased to exist.

The suburban housing bubble and its related activities were predicated on the idea that we could continue building out a living arrangement dependent on cheap oil and methane gas, and that all the subdivisions and strip malls would retain value for decades to come. Of course, this was the central delusion of the suburban sprawl economy, because it was obvious to anyone who gave the situation more than a cursory glance that cheap oil and gas were the things we were least likely to have in the decades to come.

This reality had begun to penetrate the American collective consciousness and will be represented in 2006 by millions of individual choices to not buy a new suburban house, either because the individuals fear the expense of long commutes, or they fear the cost of heating a 4,000-square-foot house occupied by only a few people (or both). As the inventory of unsold new houses mounts up, the prices of all houses, new and old, will start to go down. There will be enormous psychological resistance to this reality, expressed in a lag of correct pricing, as the owners of these value-shedding "investments" wait for the bubble behavior (anticipated 10 percent to 20 percent asset appreciation) to return. Eventually they will get the picture.

The velocity of change in the housing bubble (and the psychology involved) will be greatly affected by oil and gas prices. It seemed to many of us watching the energy markets that the world may indeed have passed through its all-time oil production peak in 2005. Production in 2005 was nearly flat over 2004. The world was producing and also using roughly 82 million barrels of oil a day. Oil coming into new production was not making up for signs of depletion showing among virtually all the world's major producers. Iran, Russia, Mexico, Venezuela, the North Sea and, of course, the United States, were all past peak.

The big mystery was Saudi Arabia, but its inability to boost production from the 50-year-old fields that comprised its main reserves suggested that it was topping out, too. Which left an energy-hungry world with the need to either (a) make other arrangements for powering industrial economies or (b) contest for control of the remaining oil reserves, which were substantially concentrated in the Middle East and Central Asia.

Here, I hasten to remind the reader that peak is peak, meaning right now we are all operating on the basis of a lot of oil flowing around the world. The comfort level is still high. The factories are still humming in China, and the six-lane commuting corridors are still full of big cars around Atlanta, Dallas, Denver and Minneapolis. The problem is that the oil supply will soon steadily diminish at a rate of at least 3 percent a year, and that necking down of supply is likely to be expressed in greater geopolitical friction and turmoil between the great nations who crave oil.

The United States entered into the military phase of this turbulence before any other nation. We used our superpower status to set up a centrally located Middle East garrison in Iraq, under the idealistic cover story that we were removing a dangerous head-of-state and helping to set up a model democracy that would invite us to stick around the vicinity indefinitely and thus retain some control over the deportment of other oil-rich states in the region.

The foregoing is the background of my predictions for 2006, which will be the year that the hardships and difficulties I lump together as "The Long Emergency" get some serious traction.

The world’s oil-allocation system is now so fragile that any disturbance in one producing region can send damaging shock waves around the planet. There is no more "swing producer." The United States squeaked through the huge loss of oil production capacity this fall by taking oil from our own strategic petroleum reserves and from Europe's. These actions kept oil prices in the high $50 range through the holidays, giving Americans a false sense of festive security. Those withdrawals are now over. Global demand for oil is still increasing. The strategic reserves will now have to be refilled (they're called strategic reserves for a reason). This will start oil prices moving upward again -- they already have moved above $61 as of Jan. 2.

I can't predict whether some maniac will drive a Zodiac boat into a tanker in the straits of Hormuz or fire a shoulder-launched missile at an Arabian refinery. If nothing like that happens, the first year of post-peak will express itself in turbulent oil markets. Fear of not getting enough will rule. Futures will be overbought and then dumped or shorted, and then overbought again. This will at least increase the violence of the ratcheting effect in the markets. Overall, I expect to see $100-a-barrel oil at some point this year. Last year I made a bet with a friend that oil would end 2005 at $75. I lost the bet. But it is a fact that the price of oil altogether ended the year 40 percent higher than 2004, so it is not as if the markets did not show extraordinary stress.

New laws regulating gasoline mixtures will also contribute substantially to higher gasoline prices (perhaps as much as 40 cents a gallon). So I will predict gasoline breaking through the $4-a-gallon mark sometime this year.

Our natural gas situation is pretty dire. Prices shot up for a while above $17 (per one million BTUs), but that was the energy equivalent of $100-a-barrel oil and was based at the time on the enormous damage in the Gulf of Mexico prior to the start of the heating season. The heating season so far as been abnormally mild in the northern United States, and prices have slumped back to the $11 range -- which is still a lot higher than the $7 range in 2004. Unlike oil, we will get no quick relief from international gas sources if the rest of winter turns sharply colder. We're short of terminals to receive significant quantities of imported liquefied natural gas, and they cannot be built quickly (or cheaply). The natural gas markets in the United States respond very sharply to current conditions. A warm week and the prices sink. A cold one and the price shoots up. Our gas storage for the year is slightly below 2004 levels. Even if we have a mild winter overall, there will be spikes of cold. Our production is still crippled in the Gulf. Therefore, I'll predict that methane gas prices will spike above $20 sometime before May.

High gasoline, heating oil and methane gas prices will absolutely kill the housing bubble for reasons I've already outlined. The production home builders will be idle, stuck with huge inventories in places that never should have been suburbanized in the first place. A lot of Americans holding "creative" mortgages -- no money down, interest only, adjustable rate, what-have-you -- will be crushed by the expense of their obligations. Many of them will go bankrupt under new bankruptcy laws that leave no wiggle room for escaping partial repayment. Their houses will flood the real estate markets in an orgy of distress selling. "Greater fools" will snap up these "bargains," failing to realize that many of the logistical liabilities will remain -- namely remote locations and huge heating costs of enormous McHouses -- even if the ownership terms are less hazardous than the previous owner's. At some point in the future, after several flippings perhaps, all those 4,000-square-foot houses 44 miles outside Denver (or Cleveland, or Seattle) will be seen as the mistakes that they are, and their cash value will reflect that.

With the cratering of the housing bubble, the U.S. economy has to fall on its ass. The global economy is likely to fall on its ass, too, since so much of it depends on the decisions of Americans to take out exotic loans for buying houses they can't afford. Large numbers of jobs will vanish in construction, remodeling, real estate sales, and the various mortgage rackets -- those things precisely related to the recent gains in GDP.

The sheer falloff in new mortgages will send a tsunami through financial markets addicted to continuous supplies of new "money" to preserve the illusion of expansion. I'd called for a Dow-4000 late in 2005. I think that was just an error in timing, and I still call for the Dow to sink into that range, or worse, in 2006. This will represent a moment of painful clarity for market professionals, as they realize that an industrial economy and the finance that serves it must be based on the expectation of generating real future wealth, not on zero-sum rackets, games of monetery musical chairs, or casino legerdemain. Hedge funds, which depend on predictable stability, will be especially vulnerable. They will certainly take some large banks down with them when they go. I'll call for the so-called government sponsored entities of Fannie Mae and Freddie Mac to groan under and then drown in a sea of nonperforming loans, probably with overtones of criminal irresponsibility.

If these things occur, ugly things would happen to the dollar. I would predict an episode something short of hyperinflation -- say a rapid 30 percent drop in dollar value -- with a later deflation in the price of things like houses, paintings by Childe Hassam and many consumer goods. Which means that standards of living will fall across the board as incomes vanish with jobs, and food and energy prices rise -- while Americans try to shed their houses at the same time that consumer products sit unsold on the shelves of WalMart, Target and Best Buy. This will spell the beginning of the end for the chain store universe.

The commercial airline industry is already whirling around the drain. 2006 will send it decisively down that drain. Since we cannot do without aviation in a nation as large as the United States (with train service on the level with Bolivia), the government may have to take over the crippled air routes. If that happens, then service will certainly be greatly diminished. Fewer people will be flying under the circumstances, anyway, but there is no reason to believe that this will all occur smoothly. Among other things, huge pension obligations would remain to be worked out.

By similar reasoning, I see an excellent chance for General Motors and Ford to go out of business in 2006. Sales of their stupid SUVs were already tailing off in the second half of last year, and they are not positioned to offer much of anything else. Anyway, a middle class groaning under insupportable debt and bankruptcy is not likely to be assuming new time payments for exactly the kinds of vehicles they would be insane to depend on.

As America roils in economic pain, factory workers in China will be thrown out of work. They will be extremely pissed off, and as their appeals go unappeased, they might start making political trouble in their country. That could easily stimulate Chinese leaders to divert their nation's attention with a compelling military project -- say some moves into the oil-rich former Soviet lands to China's west. Sooner or later, China eventually will go cuckoo from a shortage of fossil fuels. It only remains to be seen how this will express itself. So far it has only done so in terms of an aggressive outreach in oil contracts with producers like Venezuela and Canada. But those arrangements were based on a peaceful world and a peaceful China.

I have no idea what will happen with Iran. Their leader Mr. Mahmoud Ahmadinejad, is clearly a maniac -- calling for Israel to be removed to Alaska, for instance. But here I invoke my allergy to conspiracy theories by saying I do not necessarily expect any U.S. or Israeli strikes against that country. One could argue that Iran could comfortably kick back and watch America get tortured by the insurgency next door in Iraq, and I think it will do just that through 2006. The nuclear card is wild, however, and anything could happen if they keep slapping it on the table.

Which brings us to the extremely sore subject of Iraq. I maintain that our reasons for being there have not changed one bit, namely to make sure that we don't lose access to Middle East oil in any shape or form. Now my stating that does not mean I think we will necessarily succeed. The creation of a constitution in Iraq and holding elections based on it amounted to an admirable stunt, but I tend to think this experiment will dissolve into sectarian violence and civil war, probably in 2006, no matter what else we do. I predict that circumstances will impel us to withdraw from the Iraqi cities, but that we will not give up large bases near the oil production areas of the north and south, and that we will continue to control the air space over Baghdad. Our position in that country would then devolve to a sort of Fort Apache situation. I imagine the vast emptiness of the desert combined with air cover will afford us some protection. But our presence there will only inspire more turmoil, hatred and jihad elsewhere.

King Abdullah seems to be in pretty good health, but he is going on 82. I predict that there will be fissures in the kingdom and continued confusion about its oil production capacity. But by the end of the year, it ought to be clear that they have not increased their output. Peak for Saudi Arabia may be the beginning of the end of the Saud kingdom -- since peak itself is highly destabilizing.

In Europe, we are beginning to see some of the first tectonic heavings over energy as Russia jerks poor Ukraine around on its natural gas shipments. England has managed to piss away all the former advantage of its North Sea oil bonanza, and it now faces a future of dependence on Russian gas, plus the bankruptcy of its remaining industrial base. France enters 2006 somewhat more energy self-sufficient, at least as far electricity is concerned, since 70 percent of it comes from nuclear reactors. The other nations of Europe are apt to get restive this year and may more actively join the worldwide contest for access to fossil fuels. At the same time, they will be struggling to contain large Muslim immigrant populations, and I would be surprised if there were fewer problems in 2006 than last year, with the riots in France and the London subway bombings. We tend to write off Europe as a region of sclerotic cafe layabouts, but for the time being, many of these nations can still mobilize potent military forces if they have to defend vital interests. Generally, I predict 2006 will see a shift in power to the big energy bear, Russia. It's industrial infrastructure is otherwise decrepit. Its armed forces are bankrupt. But it has at least enough nuclear arms to blow up the world a few times over, so that, combined with its oil and gas assets, require us to take it very seriously.

Japan has nearly been forgotten. It now imports 95 percent of the fossil fuel it needs to run itself. God knows what they will do if geopolitical turmoil shuts down the shipping lanes that bring a steady stream of oil tankers to the islands. They are capable of mobilizing to defend their vital interests. We just haven't seen them do it since the 1940s. What role Japan will play in the Pacific remains a mystery, especially in relation to the growing power of China. Perhaps some of this oriental mystery will be revealed in 2006. Perhaps Japan will enter into some kind of Asian coprosperity sphere alliance. Japan's economy will otherwise be subject to the severe economic strains emanating out of America.

South America is going loco on us. It will probably never amount to a united front, but one by one, its nations will become more hostile to us, in the manner of Venezuela's Hugo Chavez and the newly elected Evo Morales of Bolivia, a former coca farmer who aims not to allow America any more say in what crops his people can grow. Chavez can jerk America around on oil imports if he wants to, but probably not without risking his health and position. Mexico's economy is dependent on ours, only Mexico will suffer by another order of magnitude if the U.S. economy turns down in a big way. In 2006 I think we'll see the first signs of overt hostility between our two nations as the United States desperately tries to come to grips with the flow of illegal immigrants, and Mexico attempts to divert its suffering peoples' attention by making threats of incursion and reviving claims to lands along the border. We could see the first shots of what could turn into a huge ongoing border nuisance, perhaps even a quasi-war. Meanwhile, Mexico's premier oil field, Canterall, has entered depletion. Mexico depends on imports of natural gas from us, and under the rather insane terms of NAFTA, we in the United States depend on gas imports from Canada to make up for the stuff we have to sell to Mexico. Those relationships may be subject to review.

Karl Rove will probably join Lewis "Scooter" Libby in the indictment pen for the Valerie Plame incident. Tom DeLay is going to have a very ugly trial in Texas, and Senate Majority Leader Bill Frist may end up being prosecuted for stock sale irregularities. These shows may so successfully entertain the public -- and the cable news impresarios -- that we will fail to notice the rising predicament of oil and gas prices and the cratering of the suburban sprawl economy (just as Watergate -- a very satisfying melodrama for those of us who were young reporters in 1973-4 -- diverted the United States from the first throes of the oil crisis). All this activity will tend to degrade the standing of the Republican Party to "junk" status. But there is no sign that the Democrats offer an alternative world-view to the "non-negotiable American way of life."

Political circuses will not completely divert the middle class from its own suffering, as mortgages devour what is left of Americans’ financial lives. But as they sink in fortune and hope, I predict we will see a turning of all the recent celebrity envy -- and the infotainment value spun off it -- into a vicious hatred of the rich and famous, and a new desire not to emulate them, but to punish them. Look out, Nicole Ritchie and the Donald Trump. The grandchildren of Ozzie and Harriet will be looking to eat you for dinner starting in 2006.

James Howard Kunstler is a regular contributor to Orion magazine, Mother Jones and the Atlantic Monthly, and is the author of "The Long Emergency" (Atlantic Monthly Press).

Liked this story? Get top stories in your inbox each week from AlterNet! Sign up now »