Sunday, March 27, 2011

Is just-in-time nearly out of time?

Some things are worth repeating. This piece, which was originally posted in August 2006, takes on added significance given events in Japan where worldwide links in the just-in-time supply chain are breaking down. Essentially, nothing has changed. In fact, we appear to be more vulnerable to disruptions than ever before. The only thing (surprisingly) that seems no longer applicable is my worry about North American natural gas supplies. Other than that, the piece is almost as fresh today as it was when when I wrote it five years ago. Several links were updated and others removed because they no longer lead anywhere.

Civilization, that is, the congregation of people in large settlements we call cities, is thought to owe its origins in part to the invention of agriculture. By growing surpluses of food crops farmers enabled the creation of an urban non-farming class who engaged in all manner of cultural, governmental, and commercial activities. These activities now preoccupy the vast majority of people in advanced economies.

From year to year the new settlements of ancient civilizations ensured their continuity through one very important measure: the storage of surplus food crops, especially grain. This enabled them to withstand a bad harvest or even two or three without facing collapse.

What a supreme irony then that the sine qua non of civilization--maintaining a store of essential materials--should in our time be considered a source of inefficiency and waste to be avoided at all costs. The long tradition of saving for a rainy day (or as we will see, in our case, a drought-stricken decade) has now been rejected in favor of the so-called just-in-time revolution. For those who didn't get the memo, just-in-time inventory management means that everything needed for the manufacture of any good is delivered to the factory just as it is needed or nearly so. Inventory levels are kept at minimal levels which frees up cash for other purposes.

Just-in-time methods have become synonymous with lean, well-managed international corporations. And, they are now the Achilles heel of a global trading system at risk on several fronts.

It is no accident that just-in-time methods came of age in the 1990s and were adopted by nearly every organization big enough to benefit from them. The relative tranquillity of the '90s made fears of any widespread disruption of supply lines fade from memory. With the collapse of the Soviet Union, there were no more superpower confrontations. The ambitions of Saddam Hussein to control a vast portion of the world's oil supply were contained. The sea-lanes were secured by the dominance of the U. S. fleet. Cheap energy meant cheap transportation which encouraged the expansion of trade. And, this allowed the wholesale removal of industries from places of high cost to places where labor and resources were the cheapest. In addition, the bear market in raw materials continued. This lulled purchasing managers into believing that needed materials would be cheaper tomorrow and the day after that and the day after that. So, why keep anything but minimal inventories?

These conditions created fertile ground for just-in-time ideas in almost every corner of the globe and in almost every organization including government and nonprofits. And, under such conditions it was inarguably better to keep inventories lean. As a result, spartan inventories soon became a necessity as company after company sought competitive advantage through this type of cost-cutting.

Whether just-in-time inventory is an idea for all time or was merely suited to a unique moment in history is now being tested. Prices for many critical industrial commodities have now skyrocketed. At the end of 2001 copper could be had for about 65 cents a pound. Last week it closed at about $3.50 a pound. Nickel hovered near $2 a pound in 2001 and now sells for almost $13 a pound. Oil sold for about $20 a barrel in late 2001 and now sits above $70. And, the list goes on. Memo to purchasing managers: Things are not getting cheaper anymore! [For comparison, last Friday, March 25, 2011 cash prices for the commodities mentioned above were as follows: copper $4.41, nickel $12.24, and oil $105.]

The United States military now sits astride one of the greatest known reservoirs of oil in the world, Iraq. But that military appears impotent to increase oil production in the face of continuing chaos and an emerging civil war in the country. Iran and North Korea now ignore demands from the world's only putative superpower whose strength, financial and military, is being sapped every day by its engagement in Iraq.

U. S. friction with China over high Chinese trade surpluses, an undervalued currency, Taiwan, and China's increasingly close relations with Venezuela and Iran--which were sought in order to secure precious oil and natural gas--does not bode well for the future stability of the world and the free movement of goods.

The willingness of Russia to curtail gas supplies to the Ukraine and ultimately to Europe demonstrates the precariousness of energy supplies. In our own hemisphere, Hurricane Katrina laid bare the vulnerability of both the U.S. and world energy infrastructure to natural disasters. And, the recent pipeline problem at Alaska's Prudhoe Bay oil field showed our vulnerability to mere poor maintenance. The world now appears to have a razor thin cushion of excess oil production capacity.

Rising energy costs are starting to take their toll on the trucking industry. But despite rising fuel costs, marine and rail shipments remain relatively affordable even if capacity is being strained.

All of this has been put down to temporary and cyclical factors such as the general bull market in commodities and increased demand from the growing economies of China and India. And, if that's true, then there is little cause for alarm except among those companies that can't obtain the supplies they need at prices that allow them to be competitive.

However, the drop in world grain stocks paints a more ominous picture. Those stocks have declined to about 57 days of supply. The last time grain stocks were this low was in 1972, just before grain prices doubled. [For comparison, world grains stocks had fallen to 72 days of consumption by August 2010. Corn supplies are projected to fall to just 18 days supply by August 2011.] And, as more and more grain is converted into fuel rather than food, the situation may worsen. High oil prices encourage such conversion.

Low grain stocks are also partly the result of declining harvests. And, declining harvests are partly due to drought in critical grain growing regions of the world: the U. S. western and Plains states, Canada, southern Africa and much of Europe. If global warming is the culprit, this problem is not going away.

Of more immediate concern is the way just-in-time ideas have filtered into the retail food system. Grocery stores are believed to have no more than a three-day supply of food. That means those who don't grow their own food (which is most of us) will find themselves going hungry within a week of an emergency that shuts down the just-in-time delivery system to stores. What could do that? Try an avian flu pandemic.

And, that brings us to the medical field which has long been applying the minimalist, just-in-time view to its operations. The corporate mentality driving both for-profit and non-profit hospitals has resulted in an attempt to keep capacity to a minimum in order to drive down costs. But, the effect has been to undermine surge capacity, that is, the capacity to treat large numbers of patients from a mass casualty event such as a terrorist attack or a flu pandemic. The issue also applies to vaccines, drugs and medical equipment that might be needed in an emergency.

As for energy supplies, one almost certain near-term crisis will come to North America when its natural gas production begins to decline. [New shale gas production turned this situation around.] That crisis could arrive as early as this winter and it's one reason the U. S. Federal Energy Regulatory Commission is trying to encourage the creation of additional natural gas storage.

When it comes to oil, there is a recognition on the part of nearly every major importing nation that just-in-time inventories are not enough. The United States, the European Union and China all have plans for or already have in place large state-run petroleum inventories, normally referred to as strategic petroleum reserves.

Perhaps the ultimate expression of the just-in-time idea is Wal-Mart's so-called warehouse-on-wheels. Only in a cheap oil environment would the idea of motion be added to the idea of warehouse. Wal-Mart tries to keep much of its inventory on the road in trucks to maintain low costs and flexibility. This is the ultimate in just-in-time delivery. But, those who believe world peak oil production will soon be upon us with its skyrocketing oil prices think that Wal-Mart would quickly crumble under the resulting financial and logistical strain.

When any resource becomes scarce, the natural tendency of people is to hoard it. That has the effect of sending the price higher which makes people think they should hoard it all the more.

In the coming years we may be faced with such a dynamic in many markets. The most devastating and far-reaching effects could come in the energy markets. Will the just-in-time religion which swept the world in the 1990s survive such a dynamic? Will the new fashion be to plan ahead and make sure we have extra supplies of metals, fuel, medicine and food on hand to run our factories and our civilization when disruptions occur?

Such a novel idea, isn't it? Or maybe it's an idea that's as old as civilization itself.

Friday, March 25, 2011

Can a peak oil novel change the conversation?


The following piece appeared on 321energy by invitation from the owners of that site.

Those who are aware that world oil production is nearing or has perhaps passed its all-time peak will no doubt find the following scenario familiar: You're at a party or other event talking with a group of people you've only just met and you mention peak oil. All you get are blank stares. Absolutely no one knows what you are talking about.

To those who stay on top of the oil news, it's hard to believe that most people, even most supposedly educated and informed people, have no clue about the trajectory of the world's most important commodity. With all the websites, blogs, articles, videos, documentaries, and books devoted to the topic of peak oil, somehow it seems inconceivable that the peak oil idea has gotten so little purchase on the public mind.

So, we say to ourselves that we must redouble our efforts to try to get the word out. But it occurred to me back in 2007 that we might not be getting the word out in all the right ways. I realized then that much of what the public learns it learns through entertainment and the arts, and that these were neglected avenues for peak oil activists. And so, I resolved to write a peak oil-themed novel. That novel finally came to fruition last year with the title Prelude.

My aim was as follows: Write an engaging thriller that would appeal to readers because it is a good thriller, not because it is a book about peak oil. Story first, message second! I imagined that the book's initial path of distribution, however, would be through those who are peak oil aware. They would read the book and decide (I hoped) that it was an excellent tool for spreading awareness about peak oil--a book that anyone who liked to read novels would find compelling.

So far things are going according to plan. Many people have said they enjoyed Prelude, even those who already know a lot about peak oil. And, more important, they have recommended it, given it or lent it to friends, family members and colleagues. My own experience is that people who have read the book and who had no prior familiarity with the peak oil issue say essentially, "I had no idea!" These newly aware readers seem anxious to tell others what they have learned.

A few other novels that mention peak oil have been published since I conceived of Prelude. I count this all to the good. Peak oil themes have also found their way into art, cartoons, stand-up comedy, theater, songs and even poetry. This is an excellent start, and I expect mentions of peak oil in the arts and entertainment to continue to increase as the reality of our situation unfolds.

My own approach was to set the story of Prelude in contemporary society. I believed that readers would more readily identify with a world familiar to them than one set in the distant future or transfigured by an imaginary crisis. I wanted to create a story that would allow people to reinterpret the news they are getting about energy within the context of peak oil and set them on the road to further inquiry. Only time will tell if I have succeeded.

I am, however, encouraged by the gracious people at 321energy, especially Bob Moriarty and Jim Nrg. They feel so strongly that Prelude can and should succeed that they invited me to write this piece. On top of that they offered to feature the book on this site, an extraordinary gesture for a site devoted mostly to investment information. But I think both men understand how much better off the world would be if everyone understood peak oil, and families, communities, businesses and governments began to prepare for its consequences.

If you end up reading Prelude and find it compelling, I hope you will pass it on or recommend it. There have been cases in the past where a novel has broadly informed and dramatically galvanized public opinion. Uncle Tom's Cabin, the novel about slavery published in 1852, revolutionized Americans' thinking on the topic. It turned out to be the second bestselling book of the 19th century, right behind the Bible. Two generations later Upton Sinclair wrote The Jungle, which followed the life of a worker in a Chicago meatpacking plant. Appearing in early 1906, it so enraged the public about unsanitary conditions in such plants that it led to the passage of the Pure Food and Drug Act by the end of that year.

Could Prelude result in something as dramatic as all that? Well, it's already changing the conversation for some people. And, with the help of the good folks at 321energy and the book's expanding readership, who knows?
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To learn more about Prelude, visit www.preludethenovel.com.

Sunday, March 20, 2011

Calculating calamity: Japan's nuclear accident and the "antifragile" alternative

Famed student of risk and probability and author of The Black Swan Nassim Nicholas Taleb tells us that in 2003 Japan's nuclear safety agency set as a goal that fatalities resulting from radiation exposure to civilians living near any nuclear installation in Japan should be no more than one every million years. Eight years after that goal was adopted, it looks like it will be exceeded and perhaps by quite a bit, especially now that radiation is showing up in food and water near the stricken Fukushima Dai-ichi plant. (Keep in mind that "fatalities" refers not just to immediate deaths but also to excess cancer deaths due to radiation exposure which can take years and even decades to show up.)

Taleb writes that it is irresponsible to ask people to rely on the calculation of small probabilities for man-made systems since these probabilities are almost impossible to calculate with any accuracy. (To read his reasoning, see entry 142 on the notebook section of his website entitled "Time to understand a few facts about small probabilities [criminal stupidity of statistical science].") Natural systems that have operated for eons may more easily lend themselves to the calculation of such probabilities. But man-made systems have a relatively short history to draw from, especially the nuclear infrastructure which is no more than 60 years old. Calculations for man-made systems that result in incidents occurring every million years should be dismissed on their face as useless.

Furthermore, he notes, models used to calculate such risk tend to underestimate small probabilities. What's worse, the consequences are almost always wildly underestimated as well. Beyond this, if people are told that a harmful event has a small chance of happening, say, 1 in a 1,000, they tend to dismiss it, even if that event might have severe consequences. This is because they don't understand that risk is the product of probability times severity.

If the worst that walking across your room could do is cause a bruise from falling, you wouldn't think much about it. Even if the chance of getting a bruise were significant, you'd probably be careful and figure it's worth the risk. But if walking across your room subjected you to the possibility of losing your arm, you might contemplate your next move a bit more.

But, the point Taleb makes is that the people of Japan did not know they were subjecting themselves to this severe a risk. If they had, they might have prepared for it or they might have even rejected nuclear power altogether in favor of other energy sources. But, both the probability and severity of this event were outside the models the regulatory agencies used. This is one of the major reasons we often underestimate risk and severity. But even if such an event had been included, the consequences would most likely have been considerably underestimated.

It is the nature of complex societies to continually underestimate risks. What we tend to do is to assign a probability to a possible harmful event and think that by assigning that probability we have understood the event and its consequences. It is a kind of statistical incantation that is no more useful than shouting at the rain. But because it comes wrapped inside a pseudo-scientific package, we are induced to believe it. If important men and women with PhDs have calculated the numbers, they must be reliable, right?

When it comes to calculating the extremes of physical attributes such as the height or weight of human beings, we have a large number of cases and we have the limits of biology and physics to guide us. No human can be 100 feet tall or weigh 10,000 pounds. But when it comes to social phenomena, we are often lost. Human-built systems produce unpredictable outcomes precisely because humans are so unpredictable. They have behavior patterns, but those patterns can't be described in equations. In our world, millions and even billions of people are making decisions which affect markets, technology and society every day, and no one is capable of observing and calculating the effects of such decisions. This makes any resulting patterns difficult if not impossible to ascertain. And, when we try to gauge the effect of actual and possible natural phenomena on human-built systems and vice versa with the precision of several decimal places, we are only fooling ourselves.

So what should we do? Normally, we say we should try to make our systems more robust, that is, harder to destroy or cripple under extreme conditions. This seems altogether reasonable. But what if there is another choice? What if it is possible to build systems that thrive when subjected to large variations? Taleb points to such a possibility in an article entitled "Antifragility or The Property Of Disorder-Loving Systems." The text is difficult unless you've read his other work extensively. But look at the chart, and you will begin to get an idea of what he means by antifragility.

The relocalization movement should take note that as serious a thinker as Taleb has characterized a decentralized, artisan-based culture as one that is antifragile. It might be useful to figure out how to explain this advantage to interested audiences who are watching the complex systems of modern society crumble around them.

Wednesday, March 16, 2011

Prelude goes international

Prelude, my peak oil novel, is now available internationally through many online and brick and mortar bookstores. To get a sense of the ever-widening scope of distribution, have a look at the “Where to Order” page on the Prelude site or see the sidebar on this blog. Those in Europe and Japan will find the book easy to get and much cheaper to ship since their orders will be originating in or near their home countries. Distribution in Canada is also widening as independent bookstores now have Prelude listed in their ordering systems. Amazon Canada is listing the book online as well.

By midsummer Prelude will be printed and distributed in Australia making the book easier for those in the land down under to obtain.

Prelude is currently only available in English. But I’m hoping that will change in the year ahead.

Sunday, March 13, 2011

Memo to market: High oil prices are DE-flationary

As the European Central Bank (ECB) prepares to raise interest rates to prevent inflation, the bank cites rising commodity prices, particularly oil prices, as a sign of that inflation. What the bank and other market participants don't seem to understand is that high commodity prices and, in particular, high oil prices are deflationary.

The logic is so simple it's hard to understand why smart people with advanced degrees can't see it. Commodities, particularly oil, pull money away from other sectors of the economy. When people are forced to choose between paying for heat and gasoline or paying the mortgage, they pay for heat and gasoline. Cars don't budge without gasoline (unless you can afford an electric one) and most people need their cars to get to work. The heat can be turned off rather quickly by the utility company in comparison to the glacial pace of a mortgage foreclosure that can take many months and sometimes more than a year.

This situation is particularly problematic because it pulls money out of the financial sector. And, despite all the nonsense about the financial industry being on the mend, the industry is actually becoming more and more vulnerable by the day as it increases its exposure and leverage to financial and commodity markets. The speculative animal spirits of the banks, hedge funds and other large investors, buoyed by all the virtually free money available for borrowing and huge taxpayer-financed injections into zombie banks, may now be hurtling us toward another jaw-dropping financial catastrophe. As Hyman Minsky might put it, stability and prosperity lead to instability and crisis as market participants become more and more emboldened on the upswing creating the illusion that all is well. Then, when prices and credit expansion go beyond what the economy can sustain, a decline ensues that is often dramatic as confidence suddenly shifts to revulsion and fear.

As housing prices continue to sink, the immense amount of bad mortgage debt still floating around the financial system becomes even more putrid than before. Someday the institutions which hold the debt will have to stop pretending that they are going to get paid back. But the prelude to that will be deflation brought on by the high prices of oil and commodities which tend to depress economic activity as household spending is reserved for essentials rather than discretionary items. As the animal spirits in the markets get dampened by the realities in the economy, the stage is set for a crisis--a turning point when confidence and liquidity turn into fear and illiquidity as big investors try to exit positions all at the same time.

Compounding the deflationary forces inherent in high commodity prices are severe cutbacks by states hit by declining revenues, federal cutbacks, and austerity programs now being implemented across Europe. All of these add to the deflationary juggernaut.

It is certainly possible that commodity prices including oil could rise much higher before the effects described above finally topple the economy. And, it's possible that those prices could moderate and fall gently in a way that might lengthen any economic recovery under way. But it does seem that we are much closer to a top in commodity prices than to a bottom.

The U.S. Federal Reserve Board seems to agree that high oil prices could be deflationary. One of the Fed governors indicated that the Fed's attempts to boost the economy by buying government bonds (and thus lowering long-term interest rates) could be extended if oil prices continue to rise.

I don't know what the interest rate policy for the ECB or the Federal Reserve should be. I think neither have good options. I do know that 10 of the last 11 recessions were preceded by oil price shocks. And, this time we are dealing with shocks not only in oil, but also in food, just as we did in 2008. And, I don't have to remind readers what happened after that.

Will we see a repeat of 2008 in 2011? Mark Twain used to say that "history doesn't repeat itself, but it does rhyme." So far the stanzas of 2011 seems to be rhyming quite well with those of 2008. There have been price spikes in food and oil followed by denials that these could derail the economy coupled with unrest on the streets of many countries related in part to high food and energy costs. But I'd say look for an unexpected divergence between the two periods. Whether that divergence turns out to be detrimental or felicitous will, however, not change the fact that high commodity prices are deflationary.

Sunday, March 06, 2011

The tyranny of the future

So often each of us evaluates the present based on our fantasy of the future. That fantasy has been heavily influenced by the science fiction genre in books and film--a genre which is, of course, an outgrowth of faith in unlimited technological progress. In one of the popular Star Trek movies, the future is referred to poetically as the "undiscovered country," a phrase borrowed from Hamlet where it really refers to death. Perhaps the screenwriter was cleverer than we realize.

Most people imagine the future to be a place of plenty where energy is abundant and cheap, where every door is an automatic door and, most important, all of the problems of the present have been solved by technology: no pollution, no disease (or at least a lot less of it), no climate change, no high prices, no violence (at least no street violence) and no poverty (except, of course, on planets that haven't yet reached our level of development). It's a recipe for inaction and passivity in the face of the many daunting challenges humankind now faces. And, it has a political dimension that suits the current power structure: "Just sit back and we'll take care of the future. You don't need to challenge our ideas or authority because everything will work out for the best." It is a message right out of the mouth of Dr. Pangloss in Candide that we live in "the best of all possible worlds."

This is, of course, not the only fantasy about the future. There are grim forecasts of darkened landscapes of destruction caused by war or by mere neglect following some civilization-destroying catastrophe--a plague, a severe solar storm which knocks out the electrical grid, a famine caused by biotechnology gone awry, or a world hopelessly scorched by runaway global warming. And, this is yet another recipe for paralysis. What can one really do in the face of such catastrophes? As friend of mine once said, "You can't prepare for the end of civilization."

But, you can prepare for something short of that. An outcome between "the best of all possible worlds" techno-optimism and a Mad Max-style collapse of civilization actually calls for more imagination, and, above all, it calls for action. And, that is when the future stops being a narrow-minded tyrant and becomes a field of imagination and possibilities. This is no license for soft-headed optimism, but rather a goad to pragmatic thinking about the needs of people and societies and the biosphere that supports them.

What do humans actually need to lead full and joyful lives? That is the question we should start with. Admittedly, it is not an easy question to answer. To a certain extent it will be geographically and culturally determined. But right now fossil fuels are doing all the talking, telling us that unlimited resource consumption is our glorious birthright and the key to human achievement and happiness.

But, people achieved happiness, fulfillment, and even long life before fossil fuels, and they may very well do so after fossil fuels have stopped being burned. H.D.F. Kitto in his famous popular guide to the life of the ancient Greeks points out that for those living in Greece at the time--if they survived fatal childhood diseases--the Mediterranean climate afforded a lifespan of 60, 70 and even 80 years for many. Not bad for a nation without modern medicine. Longevity then is not merely the property of modern peoples. And, it is, in the end, not the sole criterion for a good life; 100 years in prison seems worse, not better, than 60 years in prison.

We are constantly told that the way in which we live today is better than the way people lived before the modern industrial age. Perhaps that should at least be prefaced with the qualification that some privileged people who lead middle- and upper-class lives in wealthy industrial countries should count themselves better off than their ancestors. But it is worth noting that even the culturally advanced ancient Greeks imagined that their golden age had long since passed and that their civilization was well decayed. Ironically, today, we consider that supposed period of decay to be the time of their greatest achievements.

What lies ahead for humanity may end up seeming better or worse than what we have today. But it will certainly be different. Wouldn't it be a good idea for each of us to consider our role in this future rather than have that role defined for us by fantasies that lead to paralysis or lure us into a naive passivity?