Energy and the Financial System

The financial system acts as a time machine, pulling perceptions of the future into the present through such mechanisms as stock price/earnings multiples and assumptions about borrowers ability to pay back loans. The functioning of these mechanisms is critically dependent upon the perception of continued and perhaps limitless, economic growth. However, this growth has been and will continue to be, critically dependent upon abundant supplies of cheap energy. The era of such abundance is coming to an end, with much more expensive and lower production rate energy sources replacing the cheap and high production rate depleting ones. As an example, the Energy Return on Investment (EROI) for oil production has fallen from 30:1 in the 1970s to under 10:1 today, leaving less net energy and higher energy costs for all sectors of the economy. In the past few years the rapid growth of China and India has been possible only with the rapid exploitation of their coal reserves. The energy dependence of the financial system is also shown in the drop in oil demand in recession-impacted OECD countries. For reasons from relatively low EROI to the need for massive amounts of path dependent energy infrastructure, no other energy source can seamlessly substitute for the 87% of global energy supplies now provided by fossil fuels. Without sufficient energy-fueled growth, financial assets will crash, not in the future but when a future of no growth becomes accepted by a significant number of financial players. Pension funds, insurance companies, banks and personal portfolios will be decimated in a short period as this acceptance takes hold, just the same way that the acceptance of falling U.S. house prices and failing sub-prime loans quickly crashed the financial system in 2008. There will be no full recovery now or in the future, as the problem is one of physical geology and thermodynamics rather than just a malfunctioning financial or political system. This book addresses what these circumstances mean for the financial system, wealth and in a negative feedback loop, the constraints that a broken financial system will place upon investments in new sources of energy. Written by a senior manager with a quarter century of experience in the banking industry, the book also describes how this crisis will affect countries and regions differently and the career and investment choices which may provide a relative safe harbor.