What Happens When The Oil Economy Collapses?

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The question is simple and stark, but there will be a gradient of effects, and side-effects, and after-effects. As the oil economy collapses, the world will change. And it will change a great deal.

Let’s start with some of the basics.

Oil company values — which are currently topping the charts — will collapse. That means that certain investors (many investors) will “lose money,” or see their net worth drop. To put this into a little more perspective, we highlighted recently that Tesla [TSLA] has passed the US “Big 3” automakers in market cap, currently sitting at $60.15 billion (compared to GM at $51.73 billion and Ford at $44.76 billion). Meanwhile, Exxon’s market cap sits at $354.59 billion, Chevron’s market cap is $204.76 billion, and Saudi Aramco’s expected to be valued at $1–10 trillion.

Some of our top commenters have made it clear — the oil bubble could collapse at any moment. What’s holding it together is the prospect of growth, but large portions of the investment community should soon realize that cost-competitive, more convenient, and more enjoyable electric transport; city, state, and national actions to fight air pollution; and broader governmental and corporate action to stop global warming mean that oil is a dead industry walking. As more investors and money managers decide oil & gas is not a smart “investment” for the future, more and more money will pull out of the industry. People, institutions, and companies making early exits will be fine, but the ones who wait a bit too long to understand where things are headed will suffer from the popping oil bubble.

But that’s just the beginning of things. At this scale, certain companies collapsing, a certain number of people losing their jobs and needing to find a new career, and certain investors falling in net worth is all fairly disruptive. However, it’s not that simple.

Some countries, of course, have centered their economies around oil & gas. As the oil economy collapses, they are screwed. Countries like Saudi Arabia, Russia, and Qatar will face a dramatic drop in GDP, which means a dramatic drop in cash for its citizens and for basic services. That leads to migration, internal unrest, and probably not too infrequently, civil war and war with neighbors. To be poor is enough of a challenge itself, but to fall from great wealth to poverty is a whole other animal. We’re already facing about international challenges of migration, war, and terrorism, but things could get a lot dirtier … they will.

One more interesting thing to consider, however, is how much a collapse of the oil economy will affect global “superpowers” and global economic matters. Russia, as already noted, is in for a period of economic downfall and shock. How Russia responds as that reality hits is an open question. But Russia’s “arch nemesis” is probably in for a similar shock. That arch nemesis would be the United States, of course.

The oil & gas industry does not dominate the US economy like it does in various “petro states,” but the US is the world’s largest producer of oil and gas, and there’s a more complicated matter for the US.

I may not have the complete picture on this topic — well, I’m sure I don’t — so I’m interested to read critiques and extra context, and I’ll summarize it in the simplest and most concise terms I can find. It stems back to 1971 when President Richard Nixon dropped the US dollar’s link to gold (because of what seemed like the beginnings of a kind of “run on the bank,” which was providing both a steep and long-term threat to the US dollar and US economy). This turned the US dollar into a “floating currency,” which did allow the US to print money without facing the limit of gold reserves. But it also threatened the stability of the dollar and the faith other countries placed in it, which could have led to lower demand for the US dollar and US debt securities (loans made to the US government). Within a couple of years, though, President Nixon and Secretary of State Henry Kissinger had a solution — the petrodollar. They worked out a deal with Saudi Arabia that essentially went like this: Saudi Arabia got weapons and protection from the USA (most notably, protection from Israel), and it just had to price/sell oil in USD and invest surplus oil proceeds into US debt securities. Saudi Arabia led the way at the USA’s invitation, and the world followed.

“By 1975, all of the oil-producing nations of OPEC had agreed to price their oil in dollars and to hold their surplus oil proceeds in US government debt securities in exchange for the generous offers by the US.” Demand for US dollars would be strong for decades to come (providing justification for the US to print as much money as it deemed necessary), demand for US debt securities would be strong for decades to come (allowing the US to live on debt much more so than it would be able to otherwise), and the Middle East would be weaponized and militarized much more than it had been, with the US standing guard and offering mafia-like protection.

I don’t want to go too far down this road right now, but if you are interested in diving into precisely how/why the US jumped into the Iraq War, check this out. Short summary: Saddam Hussein decided in 2000 that Iraq would stop selling oil in USD and switch to EUR instead, and it fully made the switch by 2002. Needless to say, certain US political heads saw this as an existential threat to the US economy and eventually found (invented) a justification for invading Iraq. After all, what would happen if, led by Iraq, other countries decided to sell oil in euros instead of dollars, demand for dollars then dropped, and demand for US debt securities then dropped?

Currencies around the world are all now “floating currencies,” as I understand it, since they are tied to the global floating currency of the US dollar. The matters discussed above are important for understanding demand for the US dollar, the ability of the US to print money as it feels necessary, and extravagant/artificial demand for US debt; but faith in the US economy as a whole is also important for those things, and as I noted higher up, the US is not a petro state whose GDP will crash when demand for oil crashes … especially if that demand for oil is replaced by demand for Tesla electric cars and batteries.

However, there are other reasons for people and other countries to question the stability and economic security of the United States, to question how much they want their fate and their currency tied to the US dollar, and to question how much they want to own US debt securities. And I’m not even talking about Donald Trump — Trump is more like an extremely inflammatory, annoying, debilitating symptom than the root problem.

Standard & Poor’s downgraded the US credit rating for the first time in history in 2011 due to Congressional Republicans’ decision “to turn the debt ceiling into a political football and the Republicans intransigence on tax increases,” as Think Progress summarized at the time. This political extremism hasn’t disappeared, and Republican obsession with tax cuts for the super rich is as strong as ever. With a humongous military — larger (in terms of funding) than the next 7–8 militaries combined — the US has been heavily spending abroad, has fallen behind globally in terms of education and other core ingredients for a strong economy, and yet maintains relatively low taxes compared to other countries. The results include a great deal of debt, a shaky economy, a stagnant economy, and a stagnant or shrinking middle class.

Hmm, does that sound like a country to tie your fate to? Do you think the credit rating drop hurt foreign leaders’ confidence in US debt securities? Do you think Donald Trump is giving the world faith that the US hasn’t lost its mind?

After that long side story, let’s get back to this question of what will happen when the oil economy collapses. The US may not be a petro state, but lack of demand for US dollars, reduced interest in US debt securities, and the collapse of one of the USA’s larger industries will combine to send a mighty blow to the US economy. I don’t see a way around that, but feel free to enlighten me if I’m missing part of the story. Combine that with the other concerns about the US economy, and you could see that “run on the bank” threat return, leading to a spike in US economic challenges.

Yes, investing in cleantech will boost the US economy, boost US manufacturing, and boost overall faith in the US a great deal. Being the home of Tesla, SunPower, First Solar, GE, and other cleantech leaders is the direction to head in. The Obama administration did a great job investing in cleantech sectors, investing in our future, and trying to further diversify the US economy and protect it against the disruption and instability that will come from an oil economy collapse. But there’s much more to be done, and Republicans in Congress and the White House are trying to roll back progress.

For the US, I think we’re left with a gradient of potential scenarios that run from: 1) crashing under the weight of all the issues mentioned above (and many more — inflated healthcare costs, incessant funneling of money to the 0.01%, companies’ and countries’ growing dependence on China, etc.), to 2) a bump in the road that is easily overcome by leadership in cleantech, robotics, AI, and other sectors. If the world switched to electric transport much quicker than most people are presuming, with Tesla leading the way, will the issues above still crush the US economy? Or will we benefit from a cleantech industrial renaissance? Or will the future be something completely different from either of these possibilities?

And how about the rest of the world? How about Europe? China? India? El Salvador? I’m not a global economist, but my understanding is that the world is very much a global, integrated economy now. I was surprised at how much the US Great Recession hurt Europe and other countries. If the US economy crashes — not to mention the US economy plus the economies of various petro states — even if China, Europe, and others look a bit better relatively speaking, they will still be hurt. I take Chinese leaders at their word when they emphasize that a trade war with the US would not be good for anyone, but a trade war might be a small issue compared to the collapse of the oil economy.

Clearly, I’m not advocating that we prop up the oil economy. We have to get off oil. But it seems that it’d be wise to get one’s house in order as much as possible before big-time investors really start pulling their money out of oil & gas companies. Where to put your money instead is an issue we’ll discuss at our coming Cleantech Revolution Tour conference. I hope you can join us!

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Images by Kyle Field, ZiaLater, unknown, DonkeyHotey, Duke Energy, and a sensible & sane White House