The secret cause of the Financial Crisis
Oil's hidden influence on world events
The idea that mortgage-backed securities triggered the Global Financial Crisis has become folk wisdom. But the root cause of the GFC is far more fundamental, yet virtually never discussed.
Financial products may have sparked the flame, but a structural change in the oil market served as the foundational kindling for the greatest recession since the Great Depression.
I graduated college in May 2007, entering an economy that was in the early stages of a Wile E. Coyote running-off-a-cliff routine. Lehman Brothers went bust less than 18 months later. I remember speaking to a friend as he left their offices, cardboard box in hand, more vividly than what I ate for dinner last night.
In the subsequent months and years, I grew obsessed with understanding what happened. I was ravenous. Devouring any GFC post-mortem I could find. Most people were content watching Too Big To Fail, I read the official Financial Crisis Inquiry Commission report. (Actually not as dull as it sounds.) It consumed me.
But it wasn’t until October 2022 that I really came to understand. I stumbled across the work of Simon Michaux, an Associate Professor with the Geological Survey of Finland. Despite its prosaic title, his December 2019 report on “Oil from a Critical Raw Material Perspective” provided me with answers I didn’t even know I was looking for.
In reading it I felt as though I was seeing the world for the first time. Was this what Newton felt like when the apple fell on his head? Simon’s magnum opus is the skeleton key to understanding not only the financial crisis, but the way of the world at large.
Energy is so fundamental as to render it invisible, like gravity to a skydiver. We all autopay a monthly bill to some nebulous power company. But do we really think about what they do? What once seemed like a miracle is now an afterthought every time we flip a light switch. Nearly all modern conveniences and the functioning of the economy are made possible because of our ability to harness energy. Especially oil.
Without a steady flow, these things we take for granted simply wouldn’t work. And despite ongoing efforts to transition, oil remains the dominant resource that powers the global economy. Simon breaks this down so comprehensively, it beggars belief.
Three highlights from the report follow below:
70% of our daily oil supply comes from fields discovered prior to 1970
And the majority of it comes from 10 - 20 giant oil fields. The largest of which is Saudi Arabia’s so-called Ghawar “elephant” field. Despite what Saudi Aramco’s public filings may say, there’s evidence that the elephant is growing long in the tusk. Which is to say it’s nearing its final years of peak production before beginning to taper off.
World economic growth is directly tied to energy consumption
More specifically, it’s tied to growth in energy consumption. Oil is, by far, the largest source of energy powering the global economy. This fact is so fundamental, but almost entirely unappreciated.
Without energy growth, there is no way to grow the real economy. Any supposed growth in this sort of environment is financial in nature and likely to be illusory in the long run.
What happens if energy consumption simply stops being able to grow?
In January 2005, nearly four years before the collapse of Lehman Brothers, global oil production plateaued. From 2006 through 2008, global demand for oil outpaced supply. This led to a spike in oil prices that had a ripple effect across the global economy.
This oil shock, as Simon aptly calls it, put the world industrial ecosystem under unprecedented stress. Economies were driven to a breaking point. The financial sector, which had spent years issuing trillions of dollars of increasingly questionable mortgage-backed securities, served as the weakest link in the economic chain.
With oil production stuck at 2005 levels, the chain broke. The result was the Global Financial Crisis.
Global oil production didn’t start growing again until the US began its shale revolution in 2009.
Simon’s report makes the overwhelming case that oil and our financial system are inextricably linked. When the wells flow freely, your economy grows and the world continues to work. But when supply gets tight, the effects can be profound.
If a plateau in production led to the GFC, what might happen in a decline?
Perhaps the one thing more amazing than the insights of the report is the fact that it was created at all. In a time where attention spans are approaching the zero bound, this man wrote the literal book on the key role that oil plays in the world. And it’s actually fun! The last time 500 pages kept my attention this well, I was reading Dune.
Its only real flaw is that its name, “Oil from a Critical Raw Material Perspective” sounds like an engineering textbook. A tome this compelling needs a title fitting of the best seller table at Barnes & Noble. I propose “The Spice Must Flow: Oil’s Hidden Influence on World Events.”
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