Watching the peak unfold – small jets become non-viable economically

Posted: September 8th, 2010 by: h2

Sometimes it’s useful to stop thinking abstractly, and to stop guessing on a future we can as of yet only faintly make the outlines of in our daily lives, and to just see what’s going on here, now, today.

I like as a news site, because it aims at capitalists, and the USA is a capitalist country, so news pointed at them tends to be more accurate than most standard corporate mass media. This doesn’t mean you can turn off your critical thinking, but the news there is often real, and points to larger trends, since such trends are exactly what businessmen need to have a solid understanding of in order to hope to make good decisions.

So it struck me when I read Airline Era Ends as Carriers Cull 50-Seat Jets ‘Nobody Wants’ .

The 50-seat jets once prized by carriers such as Delta Air Lines Inc. are being culled from U.S. fleets as higher fuel and maintenance bills make them too expensive to fly.

By 2015, U.S. airlines will have about 200 jets with 50 or fewer seats, down from about 1,200, said Michael Boyd, president of consultant Boyd Group International Inc. in Evergreen, Colorado. More than 80 have been scrapped in 2010, he said.

Got that? I don’t know if you followed the airline industry when oil went to $147 a barrel, in 2008, but one prominent airline CEO stated that the global airline industry becomes non-viable at oil prices over $100 per barrel. This is because of economies of scale certain pricing models enable. In other words, airlines have basically three fixed costs: 1. the physical airplane, 2. fuel, and 3. labor/corporate. Debt costs would mainly be centered around the cost of the aircraft.

The cost of the physical airplanes don’t change much, the cost of labor has been cut about as far as it can be cut, as you should be able to notice if you fly routinely. So that leaves only one variable, fuel costs.

The airline industry is in precipitous decline – across all regions and categories, from the low-cost carriers to the legacy giants. Even the success stories are doing little more than treading water.

Particularly if fuel prices continue to climb while demand remains weak, Neidl believes one or two U.S. carriers could disappear or be taken over in the next few years. While previously it has “seemed that airlines never die,” tight credit markets could make it difficult for them to find the financing they would need to operate through Chapter 11 bankruptcy protection.

The primary premise of peak oil is not that we will run out, but rather that oil, being a fundamental component of our economy, will become increasingly unaffordable as drilling costs go up and up to try to maintain a plateau of global oil production, currently hovering at around 82 million barrels per day, total liquids, about 72 million petroleum.

We are deep inside this cycle (GAO 2007 Report to Congress: pdf) now, most solid estimates, based on reality, not wishful thinking, put the actual peak in oil production somewhere between 2005 and 2008. If you factor in how much energy is now required to bring new oil production to the market, ie, deep sea drilling rigs drilling down some 25k feet or more in the ocean, or oil sands that require massive amounts of natural gas to melt the bitumen enough to make it flow so you can extract it, some analysts say that the peak actually occurred some years earlier in terms of the actually available energy being added to the supply total.

My working hypotheses, which I evolved some time ago during a fairly unrewarding discussion with a somewhat prominent proponent of the ‘doomer’ position, is that you have two extremely reliable metrics of systemic failures: 1. global air travel, and 2. the global internet. Both systems are extremely complex, both require that basically the entire global system is working in order to function.

I came to this conclusion because there’s an annoying tendency to proclaim the end of all things, a few times per year, while the system continues to not end, but to grind slowly downhill, disappointing prominent prognosticators who are foolish enough to confuse their (I believe) flawed understanding of what money, finance, and the economy, actually are with reality. This mistake creates constant bad predictions.

I like, and read routinely, a lot of these bloggers/writers, but the fact remains, they are constantly wrong when they make concrete predictions, and they are consistently wrong. This doesn’t mean they are wrong on the overall direction, ie, down, but they are most certainly wrong on the fundamentals of what makes our modern societies tick. Here I’m referring to the Automatic Earth, from which I regret not having collected the roughly bi-annual proclamations of full and total economic collapse, or James Howard Kunstler, who confuses his well founded loathing for the status quo and its aesthetic outrage against all that is good and decent (thoough he too is largely on target with his longer term views, found in for example The Long Emergency) with the actual state of this world in terms of specific predictions of collapse/economic ruin and so on.

There’s a few other less prominent people not really worth mentioning unless you are really into doomer porn (aptly named term for such gleeful anticipations of total collapse), so I’m going to leave them to the side, where various people who find such reading amusing can pick at those bones. Hint: if you want to go off and farm, just do it, but do it because you love the soil, growing things, nature, and the entire cycle of life, not out of some absurd notion that you will magically be able to ride out whatever storm you believe is coming down the pike in your rural hideaway.

So I have come to prefer a much more solid set of standards to gauge the overall health of both global and national systems. The airline industry and the internet are the two strongest contenders, because they both track with fair accuracy the overall curves of our ascent up the side of the growth bubble, and they will track our decent as well.

Dmitri Orlov recently wrote a nice piece about what that downhill curve will look like, Peak Oil is History :

I feel that the time is ripe for me to weigh in on the subject and declare, unequivocally, that Peak Oil is indeed bunk. Not the part about global oil production reaching a peak sometime right around now then declining inexorably: that part seems true enough. Nor the part about oil production in any given province becoming constrained by geology and technology once the peak is reached: that part, under properly designed experimental conditions, seems predictive as well. In fact, the depletion model has been confirmed beautifully by the example of the continental United States minus Alaska since 1970. But the idea that this same depletion model can be applied to the planet as a whole, is, I feel, something that must be rejected as utterly and completely bogus.

Let us look at it another way. As I mentioned, Peak Oil theory has been quite good at predicting the depletion profile of certain stable and prosperous countries and provinces. But these predictions become meaningless when extrapolated to the world as a whole, for one very obvious reason: the world cannot import oil.

Some might also wonder why a shortage of oil should automatically trigger a collapse. It turns out that, in an industrialized economy, a drop in oil consumption precipitates a proportional drop in overall economic activity. Oil is the feedstock used to make the vast majority of transportation fuels — which are used to move products and deliver services throughout the economy. In the US in particular, there is a very strong correlation between GDP and motor vehicle miles traveled. Thus, the US economy can be said to run on oil, in a rather direct and immediate way: less oil implies a smaller economy. At what point does the economy shrink so much that it can no longer meet its own maintenance requirements? In order to continue functioning, all sorts of infrastructure, plant and equipment must be maintained and replaced in a timely manner, or it stops functioning. Once that point is reached, economic activity becomes constrained not just by the availability of transportation fuels, but also by the availability of serviceable equipment. At some point the economy shrinks so much as to invalidate the financial assumptions on which it is based, making it impossible to continue importing oil on credit. Once that point is reached, the amount of transportation fuels available is no longer limited just by the availability of oil, but also constrained by the inability to finance oil imports.

And in the last paragraph I quote, you see where this starts to tie in with the topic of this posting. The airline industry operates under these same restrictions and rules.

Orlov is often tossed in the doomer crowd, but I don’t agree with this, even though he would tend to agree that he believes the US system is on a straight track to collapse. I hesitate to label him in this way because I think he’s simply too rational to be tossed in with the other people out there who promote such a viewpoint, generally based on very sloppy reasoning, and in my opinion deeply flawed understandings of what human nature and culture are.

Basically the key point to grasp here is that we have had a fairly smooth, albeit bumpy, uphill climb, in pursuit of the mystical, and arithmetically impossible, perpetual growth we’ve grown to accept far too uncritically as one possible reality we can pursue, out of many. Ignoring, that is, the fact that nothing can grow for ever.

Bubble economics, what we’ve been bouncing around in now for many years, going from one to the next, is merely an attempt to keep a system running that has reached the end of its rope. Ie, when real growth stops, start inflating bubbles. This is basically what Alan Greenspan did his entire career. The more bubbles we allow the harder the descent will be. This is somewhat sad, since it suggests that were we to stop being so silly, we could smooth thing out a bit. Norway, for example, has been discussing increasing the capitalization requirements of its banks from 10 to 1 loans/assets to 6 to 1 (assets means real cash by the way, not weird exotic derivatives with no actual market value, you know, the ones that US banks hold as assets and that keep them from going technically bankrupt today). Read an interesting overview of Norway’s own banking collapse, and the Norges Bank analysis of this crisis.

Here in the US, including that funny money, it’s I believe over 12 to 1, and if you forced hard accounting, ie, only counting actual fully liquid cash, who knows what it would be, probably 50 or 100 to one I’d guess. In other words, it’s not an absolute requirement that corrupt financiers use political influence and blackmail on equally corrupt government officials to force bad policies.

So it’s useful to see some concrete pointers along the way while we’re riding up and down these speculative and ultimately doomed bubbles. The failure of the 50 seat jet for regional flights is precisely such a metric, and ties in neatly to a larger pattern of airline consolidations that have occurred since the oil price spikes of 2008. Here’s a few recent examples: British Airways CEO Sizes Up Next Deal After Iberia , Ryanair’s O’Leary Ponders One-Euro Toilets, Standing Passengers, and another interesting one, Shell in Talks to Sell Swedish, Finnish Refinery Units to St1 . Airlines merge because growth isn’t possible any way at this point, with oil prices hovering around $70 per barrel, despite some absurd predictions from our friends over at theAutomaticEarth for prices in the $20 per barrel range. Budget airlines, as you’ve noticed by now, are cutting closer and closer to the bone, to cut all non fuel related costs to the absolute minimum possible to get the planes flying and out of the red money losing zone they have all been hovering around, with a few exceptions, since 2008 (Airlines Predict $9 Billion Global Loss).

The last item, selling refineries, is most telling. What global oil companies know is very different from what they say, but what they do is based on what they know. And what they know is that they are basically now unable to increase the petroleum reserves held by their companies, which makes the entire idea of running in-house refining operations something with a finite future. So as in the stock market, the smart players get out first, leaving the small time operators to take the losses, or maybe sending assets to smaller operators who may actually be able to run them at a profit as oil depletion sets in more seriously, with constantly escalating and/or unstable prices.

So where does that leave us? Basically it leaves us peeking over the edges of that big bubble we’ve grown up with since the great depression really kicked us out of our last big growth spurt. Only this time there’s one huge difference, well, actually, there’s a lot of huge differences, but the main ones are finite resources now impeding growth, along with long range planning failures allowing things like outsourcing local production to China and other low cost countries.

To make that more clear, we won’t be able to produce our way out of this coming wind-down, though China believes they will be able to do it. We’ll see how they do, given not enough land or water to sustain their current population, I’m not going to hold my breath for their future though.

So the two metrics I am working with, air travel and the internet, are the signs I’m going to pay attention to. You can actually add any you want, simply see our current society, the industrialized version that is, as a big bubble, you can draw big rings around that bubble, though you can only, as Orlov points out, see the part we’ve gone up. Each big ring corresponds to a key resource, and the machinery it runs. For example, coal and steam engines, coal fired electric power, still the most common way of producing electricity globally, oil and cars, diesel engines, airplanes, and bunker fuel run shipping fleets, which form the very real, steel, backbone of that abstraction we call ‘globalization’. And that backbone runs on cheap bunker fuel, the lowest grade of all the fuel oils. The same thing, by the way, happened in global shipping in 2008 when oil prices skyrocketed as happened with air travel, but it didn’t hit the news as much because bunker fuel just isn’t very interesting.

The internet is a special case, because every single node of that web is a computer, requiring massively toxic, and expensive, and barely profitable, chip production plants that now cost in the billions to create, and which leave behind a toxic trail of garbage, things like all those CRT monitors, oceans of mice, keyboards, motherboards, and so on. And that web is connected using electricity, which must be always on, all the time, all along all of the strands of that web, which themselves are physical cables, dug under ground, spanning the oceans, but most certainly NOT virtual in any way, shape, or form. These pieces make the internet the most sensitive component of our modern industrial system, being as a whole the most complex.

Airplanes, on the other hand, are much more flexible, for example, you can wind down regional flights, focus all flights on regional hubs, like they do now, to adapt to higher fuel costs, rising ticket prices, lowered ticket sales, and so on.

This is why the airline executive put oil prices at $100 the point where the entire model fails. At that point, ticket prices are so high that too many flyers can’t afford to fly, which leaves airplanes unfilled, which forces fewer flights, which lowers income for the airline industry.

With fewer planes selling, the big airplane makers, Boeing, Airbus, and some new Asian contenders, are left fighting over a shrinking pie. These companies too rely on economies of scale to make their aircraft affordable. Fewer sales, prices have to rise per plane. Prices rising per plane, have to raise per seat ticket prices (for example, I’m taking a flight this week that cost about $120 round trip 3 years ago, it’s now $320). Higher ticket prices, fewer tickets sold. See how it spirals down? This is why the airline industry is such an excellent model and test case for actual collapse and decline.

So watching airlines is a great way to gauge the overall health of the global system.

The internet, however, is the most delicate, and the most fragile. The failures to look for there are smaller ruptures in the weaker nodes of the web, 2nd and 3rd world countries failing intermittently, local server farms going offline briefly. I haven’t seen any such signs yet, though I’m not following 2nd and 3rd world web sites, hosted in those countries. In many ways, you won’t see these signs, since as local data centers fail, many sites will simply re-situate themselves to more stable areas, like a Venezuelan site moving to US based hosting companies.

So let’s watch this, the movement is unfortunately below the speed that humans are designed to react to, and there’s too much data out there, and far too much gibberish being spread by the corporate media, the governments, and various other far more insidious entities, like the Koch Brothers.

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