The Great Contraction: How the End of Cheap Money and Energy Will Degrade or Renew Civilisation

Nafeez Ahmed predicted the 2008 financial crash. But it was not resolved and has led to a more profound crisis which will require a major restructuring of the global economy to survive

The global economy is moving into a deepening crisis – but what’s really driving this remains poorly understood. This is not just another recession, it is the unwinding of a global system that is increasingly out of sync with planetary systems.

The coming global financial and economic crisis is not simply about monetary policy, debt, the impact of the war in Ukraine, or other piecemeal factors – although those are all relevant. It is about unsustainable mountains of debt-based finance, coming up against the ceiling of a fundamentally self-cannibalising fossil fuel energy crisis, which is rapidly breaching planetary boundaries and destroying our life support systems.

A decade ago, I predicted the global financial system was moving inexorably toward a new major crisis, one that would erupt around the 2020s. It would have two intertwined triggers: the end of cheap money and the decline of cheap oil. And it would have two intertwined consequences: inflation, with a risk of hyperinflation; and currency devaluation. Together, these would create the conditions for a far more devastating global economic crisis.

That crisis is unfolding now. But to understand it, we need to understand the structural causes of what happened in 2008.

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The 2008 Financial Crash

In his landmark warning at the International Monetary Fund in September 2006, economist Nouriel Roubini pinpointed three interrelated factors behind what he said would be an imminent global recession: global oil price shocks that were driving up inflation; mounting debt based on excessive lending to prop-up consumer spending, especially concentrated in overheated housing markets; and the deeply interconnected nature of financial networks that meant any such shock in the United States would transmit worldwide.

Roubini recognised that oil shock-driven inflation would make a cascade of debt-defaults on mortgages far more likely. What he didn’t address is the system dynamics behind these processes – dynamics which would guarantee a deeper financial crisis about a decade after.

The oil price shocks that punctured the housing bubble, triggering the 2008 financial crash, happened because around 2004 to 2005, something was shifting in the global energy system.

Instead of continually growing, the global production of cheap, conventional oil started to slow, cap off, and then plateau. Oil industry experts say that a resource ‘peaks’ in production at roughly the point when half its reserves are depleted. After that point, the rate of production gradually tapers off.

We now know that it wasn’t all oil production that had peaked – rather, only the cheapest kind of oil had hit a dramatic slow-down, resulting in an undulating plateau. So we weren’t running out of oil. Instead, we began shifting to more difficult-to-extract oil sources that need more energy just to get the oil out. That leaves us with less energy for economic activity and wider society.

From 2005 to 2007, total world oil production declined for the first time in history. Meanwhile, demand for oil continued to boom, driven by huge GDP growth which rose 9.4% from 2004 to 2005, and 10% from 2006 to 2007.

As rocketing demand hit the ceiling of dwindling supply, oil prices doubled between June 2007 and June 2008. This drove-up costs of living to unaffordable levels.

Consumers couldn’t afford to keep spending, including debt-repayments. Then the housing bubble burst.

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Shale to the Rescue?

Many of the major banks and financial institutions at this point were insolvent. If left to the dictates of contagion, the entire global financial system would have evaporated with little prospect of returning.

Governments and financial institutions responded by injecting new money into the system at record levels through quantitative easing (QE). The problem with this form of QE is that it was effectively based on further borrowing from private commercial markets, underpinning the creation of new cheap money.

This massive influx of cheap borrowing rehabilitated the banks, and allowed funds to continue flowing to both investors and consumers, reviving economic activity.

Buoyed by higher prices, oil firms invested in innovative drilling techniques like fracking in the US. Huge unconventional fossil fuel sources previously assumed to be uneconomical opened up in the form of shale oil and gas. This was one of the major sectors where major new investments were financed by QE.

After the 2008 crash, demand plummeted. But shale oil and gas production ramped up to record levels, because the oil industry bases investment and production targets on forecasts of demand, linked to previous expectations of rising economic growth.

The result was a massive glut of oil and gas on global markets. The excess of supply relative to crashing demand due to global recession led market prices of oil and gas to plummet. This created the illusion that we had entered a bold new era of super-cheap fossil fuel abundance. As QE kicked in, the avalanche of cheap money boosted the new shale enterprises.

Conventional ‘peak oil’ forecasts were wrong. We didn’t hit increasing triple digit oil prices in a world of evermore scarce oil. It seemed, on its face, that we had all the ingredients we needed to return to, if not exceed, previous levels of economic growth – cheap energy and cheap money.

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Beneath the Mask

But this convenient marriage of cheap energy and money concealed the fact that crisis had only been forestalled, not resolved.

A decade ago, I had warned that US shale was less a ‘boom’ than a “ponzi scheme” enabled by excessive borrowing. I argued we would likely see shale oil and gas peak around 2025. In the meantime, the “unsustainable shale bubble” would fuel “a temporary economic recovery that masks deeper structural instabilities”. Eventually, I wrote, the bubble would burst “under the weight of its own debt obligations”.

At the time, warnings such as this were ridiculed by bullish oil industry executives and liberal pundits alike.

Shale gas has indeed ballooned in a way that was unthinkable in the 1990s thanks to the commercialisation of hydraulic fracturing (fracking). The US is now the largest liquid natural gas (LNG) exporter in the world.

But the economics do not add up.

The shift from conventional to unconventional oil and gas did not actually create super-cheap fossil fuels, but the opposite, by increasing the costs of production. Shale needs more energy, not less, to get the energy out. In other words, the energy return on investment (EROI) – the amount of energy we get out relative to what we put in – underwent accelerated decline after the plateau of conventional oil in 2005 (it had already been gradually declining over the preceding decades).

This put shale oil and gas enterprises in a precarious position.

They needed to keep profits up in a higher production cost environment while the market price was low. So they ramped up drilling rates in the most productive areas to maximise output and sales, which in turn accelerated well depletion rates. Many shale enterprises became dependent on cheap money to cover their higher production costs. Hundreds of billions of dollars were loaned to the industry.

It was only a matter of time before this became unsustainable as growing production challenges converged with mounting debt levels and diminishing profitability.

It didn’t take long for the bankruptcies – unforeseen by most industry executives and pundits – to start. From 2015 to 2019, 172 North American shale operators went bankrupt. The rout didn’t stop, but escalated over the ensuing years, peaking in 2020 as Coronavirus pandemic safety measures saw oil demand crash.

By 2021, global oil supplies tightened, and the resulting price rises began to allow shale operators to break even. Then Russia’s invasion of Ukraine sent prices rocketing, creating a lucrative new economic environment.

The oil price hikes of 2022 allowed shale enterprises to pay off outstanding debts and return to profitability. Yet even in this favourable economic environment, shale industries have not wanted to lift production significantly despite the large global gas shortfalls due to the Russia-Ukraine conflict – and despite pressure from the Biden administration and an opportunity to consolidate the US position as a gas exporter.