The nature of humans is to assume everything is okay until the day it isn’t. Then of course it’s too late and we all look for someone to blame, except ourselves of course. Americans started the “age of petroleum energy” in 1859 in Titusville, Pennsylvania, and have come to expect cheap and abundant energy ever since. Even today, a quart of oil is cheaper than milk, or even bottled water. However, the earth’s one-time gift of oil is at or near its peak of giving, and most Americans are not even remotely aware or prepared for the changes ahead.
The level of awareness for most of us only extends to grumbling at the gas pump and blaming the “greedy” oil companies for the inconvenience. Most are unaware that “Big Oil” controls about 17% of world oil production. The other 83% is controlled by national oil companies, representing countries such as Saudi Arabia, Russia, Iran and Venezuela.
Fifty years ago, America easily supplied its own energy needs, and much of the rest of the world as well. Today, we import nearly 70% of our energy from outside our boarders. As much as we would like to believe in alternative energy sources, they currently represent only 2-3% of our energy needs. We are a carbon-based society, and will likely remain so for the next few decades.
For many years our politicians have spoken confidently of once again becoming energy independent. However reality seems to be gradually creeping into the halls of government. The Assistant Energy Secretary Alexander Karsner recently was quoted that “the places where oil can be found and extracted and brought to bear in the world are decreasing. It will get harder, and demand will outstrip supply for probably the rest of my lifetime.” The government realizes there is no magic bullet right around the corner, but is reluctant to call for dramatic action unless a crisis is at hand.
Global Demand - Why it Will not Level Off
According to the CERA Report, world oil depletion is approximately 4 million barrels per day, per year. That amount must be discovered every year just to replace what we’ve lost. Excess capacity, mainly in Saudi Arabia, is also shrinking, and it would clearly not be in OPEC’s best interest to max out their oil fields just to keep the world oil price stable.
The larger problem is demand, however. The CERA Report also projected global demand to grow to an additional 59 million barrels per day by 2017. That means adding the equivalent of six Saudi Arabia’s in one decade! This does not appear remotely feasible given the decade lead times between discovery and production, even if enough oil had been discovered, which it hasn’t.
Ultimately it comes down to mathematics. The global population was roughly one billion people when the oil age began in the 19th century. Today the global population is 6.6 billion, and rising rapidly. As long as the world population keeps expanding and developing, it will be very difficult to curtail demand without much higher prices.
Developing World - Demand Growing Rapidly
Currently new oil demand is coming from China (390 thousand barrels per day growth in 2008), India (140 kbpd), Saudi Arabia (150 kbpd) and other Middle Eastern countries (330 kbpd). India and China consume only a third as much oil as the US. If the Chinese and Indians ever consumed as much oil per capita as Americans, world oil demand would rise from the current 86 million barrels per day to 200 million barrels per day. For some perspective, ConocoPhillips CEO James Mulva was quoted in November that he doubted world oil producers would be able to meet forecast long-term energy demand growth. Also, Total SA CEO Christophe de Margerie said in October it was "optimistic" to expect oil production to ever surpass 100 million barrels a day.
What these developing countries have in common are young populations, rapidly expanding economies and incomes, and heavily subsidized oil prices. Even with the world oil price hovering around $110 per barrel, it is unlikely these countries will risk social unrest by removing the massive oil subsidy. These are all creditor nations with large trade balance reserves, and each can afford to stimulate domestic oil demand for the foreseeable future.
In addition, other subsidized countries such as Venezuela, Mexico and Russia are exhibiting soaring domestic demand growth and are beginning to cannibalize oil exports. That is indeed the crux of the issue. If this rapidly growing demand in the developing world continues, then demand must fall rapidly in the developed world, or shortages will be upon us.
Food Prices Rise with Energy
The industrial food supply system is one of the biggest consumers of fossil fuels. Massive amounts of oil and gas are used in the manufacture of fertilizers and pesticides. All stages of food production use fossil fuels; from planting, to irrigation, feeding, harvesting, processing and distribution. As the demand for energy and food continues to rise, the price to deliver both is likely to rise as well.
As of this month, there are food riots in over 30 countries, as basic food costs around the world have skyrocketed in the past year. This phenomenon may be relatively short term in nature, but it should serve as a shot across the bow as one of the critical issues related to the peaking of global oil production. The potential for future widespread geopolitical strife is very real.
Mexico’s Declining Production
Mexico, the second largest supplier of crude oil to the US after Canada (1.5 million barrels per day), is facing a crisis with no easy solutions. Mexico’s proven oil reserves are expected to run out in approximately 9 years with the rapid depletion of the Cantarell oil field. Pemex, the government controlled oil company, is on the verge of bankruptcy and has neither the resources nor the technology to carry out critical exploration for new oil discoveries.
According to the Inter Press Service News Agency (IPS), the government of Mexico continues to siphon off nearly all of the Pemex revenues, which finance 40% of the government budget. A new draft law has recently been introduced to allow Pemex greater freedom with respect to making decisions on its budget, re-investing earnings and contracting out to private companies. The early debate was met by threats of social uprising by the left wing opposition. The bill has an uncertain fate, according to the IPS.
Time is running short, and the implications of Mexico as a net importer of energy will directly affect the US. Mexican oil output now stands at 2.9 million barrels per day, down 300,000 barrels per day in just two years. As Mexico’s production declines, the US will look to Canada to fill the gap. However, the extremely high production costs of the Canadian oil sands will make oil available, but at high prices that will likely stay that way.
Time to Get Started
As Europe, China and Japan have done, the US needs to expand nuclear power capacity. It will still likely take a decade from start to finish per nuclear plant, but the longer we delay, the more dependent we become. How many refineries, nuclear power plants and new drilling rigs are on the drawing board in the US? China is planning to build 2-3 nuclear power facilities every year for the next 20 years. Wind power, solar and Biofuels have roles to play as well, but they cannot come close to replacing fossil fuel in a decade, and certainly Biofuels can’t power all our trains, planes and automobiles anytime soon.
If we don’t move beyond the “denial stage” as a country to the “realization stage” and begin to transcend politics and take action, we are likely to move directly to the “panic stage” with very little preparation. America will not run out of energy, but it will likely be less abundant and considerably more expensive in the future.
As the world’s largest debtor nation that borrows $2.5 billion per day from foreign sources to pay our bills, and imports 70% of our energy needs, the US can’t afford the luxury of waiting for technology to eventually save the day. We must begin to take steps immediately.
Even the White House is admitting the hour is growing late. Edward Lazear, chairman of the White House Council of Economic Advisers recently stated: “We could have been thinking about all of this 10 or 15 years ago when it comes to alternatives or new exploration, and we weren’t.” Look for massive conservation efforts in the future. But since so much of our energy use revolves around transportation, conservation will not be the silver bullet, unless we resort to draconian measures such as mandatory gas rationing.
Living in a state of blissful denial is only a viable strategy until the day reality pulls into town. Realization and preparation are strategies that make more sense in dealing with the waning of the Petroleum Age.
Make the Best of it as an Investor
As the lifeblood of global commerce, energy will be in great demand, even as the price rises. I have had my clients in the energy sector for many years, and continue to see great opportunities in the years ahead. Investors should focus on high quality exploration and production companies, oil service companies, as well as uranium, solar and wind producers for the long term. Capital will continue to flood the critical global energy sector. The best companies, with the best prospects, in relatively stable geopolitical areas, will be extremely profitable in the years ahead.
Today’s Markets
U.S. stocks on Monday finished the session slightly lower with investors still digesting the poor results from General Electric, while receiving further evidence of the ailing financial sector from Wachovia Corporation.
The Dow Jones Industrial Average fell 23.36 to close at 12,302.06. The S&P 500 Index closed down 4.51 to close at 1,328.32. The Nasdaq also closed lower, ending at 2,275.82, down 14.42.
In another sign of trouble in the embattled financial sector, Wachovia said that it would raise $7 billion in capital and slash its dividend after posting a $350 million first-quarter loss.
Crude-oil futures were up more than a dollar to close above $111 a barrel on Monday, propelled by the dollar's decline against other major currencies. Also pushing crude prices higher were supply disruptions in both a US pipeline and in Nigeria. Gold futures finished slightly higher Monday, as weakness in the US dollar underpinned demand for the precious metal.
Wishing you a good evening,
Tony Allison
Registered Representative
