Saturday, October 28, 2006

I’ve Got Good News and Bad News

October 28, 2006

I am writing this in Boston while attending the (Association for the Study of Peak Oil) ASPO-USA’s conference, “A Midnight Ride for Peak Oil” (you know, the Paul Revere motiff thing).

The conference was a big draw. Held at Boston University’s School of Management, ASPO-USO did an excellent job of drawing academic heavy weights from Harvard, MIT, Cal Berkley… you get the idea. Dozens of top shelf talent and scores of aspiring top shelf talent presented, mingled, lectured, and very rarely bored about 500 attendees for the past 3 days.

The good news I got out of the conference is that we might enjoy the western, developed-nation lifestyle for several more years. The bad news is that we have driven over the imaginary cliff and that even if we pump the brakes now, it will have far less effect than if we had applied said brakes while the rubber of the tires was still in contact with the proverbial road.

Further good news is that while conventional oil and lease condensates have more than likely peaked, “all liquids” might not peak for 2 to 8 years, because of coal to liquid, tar sands to liquid, and heavy oil to liquid technologies. The bad news is really bad. There seemed to be a consensus among the scientific personnel that the Green House Gases (“GHG”) produced by these technologies would cause most of the world’s coastal regions to flood, and the higher ground to dry up and blow away, with various and sundry truly unpleasant experiences to be had along the way; a fun crowd, by any measure.

It seemed, even though the conference was titled after “Peak Oil” that the luminaries seemed to be far more alarmed at the prospect of environmental disaster from GHG’s than from a pending transportation fuel shortage and its concomitant effect on the economy and financial markets. As the greatest impacts of global warming seems to be on agriculture, it seems that these scientists, too, believe that people will be far more interested in eating than in driving.

For those concerned with the impacts of these issues to their personal experience – you are on the right track. I do not believe that there are any viable macro (society wide) solutions, only micro (individual) solutions. Oh, there will be lots of huffing and puffing and blowing, and legal billing, but I don’t see an easy transition period in the offing. So without further ado, let us get to the important points.


There was much discussion as to whether Peak already happened, or will it take another 1 to 8 years, though there seemed to be a consensus around 2005 at the earliest to 2012 at the latest. I really did not see much point in splitting hairs over the time frame. Why? When the world’s oil production peaks is not really relevant to us Americans. By mathematical necessity (Exports = Domestic Production – Domestic Consumption in the Exporting Nations), peak oil will arrive in importing countries, like the U.S. and most of Europe, several years before it arrives in the data for world oil production. Since it is nearly 2007, and the most optimistic pessimists (can I actually say that?) speaking at the conference put the date of peak out in 2012, it seems reasonable to conclude that Peak has already occurred or will occur quite soon in the U.S. The U.S. Department of Energy’s EIA data point to a peak for the U.S. in 2004. In any event, we should treat this as a risk management problem, because:

"We are heavily dependent on a resource the exact availability of which no-one seems to know - and people who insist there's no problem have not proven so. It is thus prudent to behave as if the resource was in short supply.” - Matt Simmons

We have many new projects coming on line in the next 4 years, but not a lot thereafter. Can these new projects produce enough oil to replace the production we will lose during this time frame from depletion, as well as add to total production as required to grow the economy? THAT, my friends, is the $64 question. Though there was much debate about it, we don’t need to concern ourselves with that, in my opinion. Within 10 months from today, by September 2007, we will have enough production data to answer the question. So why guess?

This is not to say that Oil could not trade down to $35 – or up to $100. It can, even if we have already peaked, and I make no prediction on the short-term price of the commodity. One must follow the data coming out the EIA.

Natural Gas

Natural Gas production (“NG”) is in such a state of crisis in North America that one of the speakers said that using NG for the purposes of converting Tar Sands in Canada into synthetic crude was akin to lighting candles with $100 bills during a blackout. Another said using NG for processing Tar Sands was “taking gold and turning it into lead”. Not one of the scientists presenting thought NG production could be expanded in North America – Peak Gas has arrived for the continent.

“Natural gas is increasingly of more urgent concern in North America than Peak Oil. If we stopped drilling right now, our production would decline by 30% next year, and 30% the year after, etc. LNG will compete against other countries, a 35% energy loss in transportation, and Not-In-My-BackYard opposition. There still exists some demand side destruction left, but then we will be close to the bone” Nate Hagens.

I love that “demand side destruction” line. Dr. Roger Bazdek, who presented at the conference and is a co-author of the Hirsch report, said “demand destruction is a euphemism for recession and depression”. This is the issue most dear to people who have spent a lifetime building a business and a portfolio.

Liquefied Natural Gas (LNG) is no panacea, according to the speakers, but we knew this. If we must rely on LNG imports we have big problems.

15% to 30% of NG is used in compressing and reliquifying LNG. Much of the NG (Methane) is lost into the atmosphere during the processes, and Methane is a much more powerful GHG than CO2. The U.S. would need at least 30 new LNG receiving terminals – in the absence of martial law it is hard to see how that might occur in the next 20 years.
Relying on LNG requires the U.S. to be MORE dependent on foreign energy suppliers than we are now.

Roughly 28% of electricity in this country is produced using NG as the input. Should the availability of this fuel decline substantially, the U.S. would either increase the use of coal, or decrease the availability of electricity to the economy. In the immortal words of Matt Simmons: “We must grow electricity, or we will not grow our economy”. The problem is that coal is an environmental disaster, and at some point, local, state and/or the Federal Governments will step in and legislate carbon emissions.

One of the scientists, Dan Schrag, Professor of Geochemistry in the Department of Earth and Planetary Sciences at Harvard University, felt that a solution to the coal/CO2 problem might be sequestering CO2 under the sea floor, in deep ocean water. He stood out as one of the few optimists.

Non-conventional reserves

While the resource base is large, the recoverable reserves from Tar Sands, Shale Oil, Heavy Oil… is less than 10% of the resource. It was stated over and over again that as far as these resources were concerned we are severely limited in our ability to deliver them to the market. Further, the environmental impacts from these reserves will severely limit their production.

Can the U.S. economy continue to grow with declining NG and liquid petroleum product inputs? I don’t think so. Yes, we have plenty of coal, but it seems the best way to sequester Carbon at this time is to leave it in the ground, unburned. Is the stock market worth 18 times earnings in a zero growth world? Can consumers service the debt of their mortgages in a zero growth world?

What about alternatives? Not one of the scientists presenting felt that any alternative fuel would have a significant impact before 2030, if ever.

Across the country from the Boston Conference a CEO of one of the world’s largest oil companies was telling his audience:

"The ease with which we all lived in the last 50 years, with cheap energy, is coming to a close," John Hofmeister, president of Shell Oil Co., told a City Club luncheon crowd Friday in Portland. "The next 50 years cannot be like the last 50 years."
“The oil demand-and-supply equation”, Hofmeister said, “now constantly flirts with crisis. Americans need to develop a sense of privilege rather than entitlement when it comes to energy use.”

I’d like to repeat that line - “now constantly flirts with crisis” - as it seems vaguely important. Also, I want to drive home that this is not coming from an environmentalist or scientist, but a hardcore, multi-millionaire capitalist with the most to lose in the kind of paradigm switch envisioned.

After sitting through a marathon of presentations, my sense was that:

Alternative energy sources (Ethanol, Bio Diesel, Wind, Solar) will have little impact.

Oil and gas availability will decline, although the date of the decline and the steepness of the decline is not well understood (which means things could be much worse, or much better, than they appear), but that in any event, it is not that far out in the future.

Coal will not be able to come to the rescue in the near term due to its impact on the environment, and because 100% of the electricity generating plants built in the U.S. over the past 7 years were NG fired plants, not coal fired plants.

Non-Conventional Resources (Tar Sands, Oil Shale, Heavy Oil) will not move the peak back at all, but will lessen the steepness of the decline. However, we might find that their environmental impacts are not worth the price of admission.

The Media is doing a great disservice to the American people with their irresponsible reporting of the issue. What I heard from America's best and brighest scientists bears no resemblance of what I see reported in the media. Presumably, the media is getting its data from these scientists. I am not a big believer in conspiricy theories - so I will chalk it up to incompetence.

We must watch closely the activites of our own environmental regulators as well as the National Oil company's of the Oil Producing Nations such as Russia and Saudi Arabia. In my opinion, their policies will impact the markets in the short term at least as much as depletion.

The potential impact of this on the U.S. economy, currency, financial markets, and real estate markets is real and unprecedented.

Greg Jeffers

Mentatt (at) yahoo (dot) com

Monday, October 23, 2006

What If?

BTW, I am heading to Boston this Wednesday, October 25, 2006, for the Boston University Conference “A Midnight Ride for Peak Oil”. I will post my notes sometime next week.

Thomas Jeffers & Co., LLC

“Global warming and escalating energy prices may make the North American status quo of vehicle-based commuting, large suburban homes, mammoth shopping malls and urban sprawl economically unsustainable. Yet such dire pronouncements are daunting for most people.” And…

``The U.S. in essence borrows about $2 billion a day, every day, principally from Asian states, to finance its consumption,'' the paper states. ``The single-largest category of imports is the approximately $1 billion per working day borrowed to import oil. The accumulating debt increases the risk of a flight from the dollar or major increases in interest rates.'' October 23, 2006, Front Page Article, Global Warming May Be Mother of All Finance Woes: John F. Wasik

These kinds of comments are making it into some pretty mainstream, establishment media publications – not just the “loony left”, as we derisively referred to many of the environmentalists back in the ‘80’s and ‘90’s (as it turns out, Wall Street was wrong on that whole global warming thing), MAYBE this is worth paying attention to…

What if? A reasonable question if ever I heard one. Think not? You must have never experienced a losing investment. It is usually the risk you did not consider, did not see, or dismissed outright, that comes along and levels you. Just ask South Florida’s single-family home investors…

If you go to the following link: and then click the “1c”

You will find yourself at the U.S. Department of Energy’s EIA monthly production number of crude oil and lease condensates. It is fairly plain to see that conventional crude oil production has actually declined over the past 24 months.

And if you go to the following link:

Go to and then click 1c

You will find yourself at the U.S. Department of Agriculture’s “Reports by Commodity, Index of Estimates.”
I love the Internet, you can actually get useful, factual data… sometimes.

So let’s play a little “what if”.

What if the world has another poor crop year in 2007, and Wheat inventories drop below 50 days of supply (currently around 57 days), and Corn inventories drop below 25 days currently around 31 days). In 2008 more of the same, with inventories at 44 days for Wheat and 21 days for Corn. And, “what if” the Peak Oil guys are correct and we have an on going energy “problem” (“crisis” has been overused), and are unable to increase our production of oil.

Now, I dislike being so pecuniary, but this Blog is directed at how energy and carbon constraints might affect one’s net worth… the above scenario is not a good one for a lot of investors.

Now, just for ONE moment, let us forget prices. Let’s talk physics, not economics, but only for a second so that I can make my point and get back to economics…

Let us suppose that total oil availability for the U.S. falls from 20.7 mbpd (million barrels per day) in 2006, to 20.5 mbpd in 2007, 20.3 mbpd in 2008, and 20 mbpd in 2009. Never mind where I came up with these numbers (but I am willing to bet they are close) - we are playing “what if”, remember? Work with me. If the total liquid petroleum supplies available for consumption for the U.S. fall from 20.7 mbpd in 2006 to 20 mbpd in 2009… Who/what benefits? Who/what is harmed? How do you profit? What are the probabilities? Don’t worry about the price, concern yourself only with aggregate supply. Remember, a Joule of energy has no idea how much it cost its consumer.

The insurance industry is built on taking low probability/high consequence events (think plane crashes and hurricanes) and quantifying their impact probability. Unfortunately, I do not believe that the above scenario is low probability. Most non-politically motivated students of this issue believe that the probability of this occurring before 2020 is approaching 90 – 99 % (that is anecdotal by the way, not empirical… but you get my point). So, is the probability distribution linear (you know, 13 years left between here and 2020, so 1/13 for 2007, 1/12 for 2008, 1/11 2009…), Logistic, Gaussian (if you are not familiar with these just go to and search them)… who knows, and why bother? Getting this exactly right is not necessary. What IS necessary is taking appropriate action prior to negative market reaction. Not sure what that is? Me neither, or I wouldn’t need my day job. But I have some ideas. Stay tuned.

Greg Jeffers

Mentatt (at)

Friday, October 13, 2006

Grains, Brain’s, Heat, Meat, Land & Sam I am

"Facts do not cease to exist because they are ignored." - Aldous Huxley

The price of wheat is up 55% in less than 1 year, and all I hear anybody talk about is how expensive gasoline is and where is the price of gas headed... Doesn’t the average American family spend more on food than gasoline? What’s going on here?

Here is an interesting statistic and “fun fact to know” brought to you by yours truly (with help from the U.S. Dept. of Labor): in 1920 the average American family spent over 50% of their income on food. In 2004, that same family spent “only” 18% of their income on food. What happened during those 84 years to bring down the price of food per income $? Hydrocarbons happened. We use hydrocarbons to fertilize, pesticide, sow, irrigate, harvest, store, transport, process, refrigerate, and finally cook our agricultural output. It is estimated that more than 80 cents of every food dollar is to pay for the hydrocarbon input. But I digress…

The price of wheat was “lock limit up” 3 days this week in the Chicago Board of Trade. Corn prices are soaring, too. Wheat, corn, along with rice, directly and indirectly as animal feed, supply the majority of mankind’s caloric intake. So why haven’t we heard politicians pouring out their usual vitriolic rancor at… “Greedy” farmers? Heck, we’ve got “greedy” oil companies, “greedy” healthcare “profiteers”, and certainly we have heard form a few “greedy” politicians. Somehow I just don’t see those same politicians heaping their ire atop of some Norman Rockwell-esq farmer’s co-op.

One of our client’s manages a pork-processing company’s “live production field” out West. I asked him if this would affect the price of meat significantly. He replied that 55% of the costs associated with pork production is feed.

So, we have a big problem in the making, and perhaps an opportunity.

I think the following quote lays out the problem fairly succinctly:

“For the sixth time in the past seven years, the human race will grow less food than it eats this year. We closed the gap by eating into food stocks accumulated in better times, but there is no doubt that the situation is getting serious. The world's food stocks have shrunk by half since 1999, from a reserve big enough to feed the entire world for 116 days, then to a predicted low of only 57 days by the end of this year.

That is well below the official safety level, and there is no sign that the downward trend is going to reverse. If it doesn't, then at some point not too far down the road we reach the point of absolute food shortages, and rationing by price kicks in.” - Gwynne Dyer

Mr. Dyer was speaking of wheat. The corn situation is much worse, in terms of remaining day's supply.

"The crop is pegged at 10.905 billion bushels, 1.9 percent smaller than forecast in September, the USDA said. A crop of that size would also be 1.9 percent smaller than a year ago. Projected U.S. inventories before next year's harvest will be less than 31 days of use. Global reserves will fall to the lowest since 1984, the USDA said." 10.13.06

I had covered the shortage of grains in a previous post, so lest you think I just shipped out to the department of redundancy department… I didn’t. I thought the above quotes needed to be heard (read?). I wanted to point out that we are consuming food faster than we are producing it by digging into inventories, our food savings account. But unlike, money, we cannot borrrow food. Soon we will be consuming liquid fuels faster than we can extract it (I hate to use the word “produce” when discussing oil. G-d produced the oil - we merely extract it). I am convinced that if the trend in food production versus consumption continues for another year or two…

1. We will suddenly find the "Brains" and the “political will” to address “global warming”
2. The value of certain Real Estate assets will plummet
3. The value of certain Real Estate assets will rise
4. Financial Markets will experience a seismic shift, punishing some and rewarding others

This is no Dr. Sueues tale. These issues are coming at us, right here, right now. Discounting these MEGA ISSUES might have serious, negative effects on your net worth. They might, in fact, create fantastic opportunities. But you gotta think out side the box like you never have before.

Mentatt “at” yahoo “dot” com

Thursday, October 12, 2006

Natural Gas: Running on Empty?

The following quotes are from the U.S. Department of Energy's EIA website:

“Nationwide, 58 percent of all households depend on natural gas as their primary heating fuel.”

“Thirty percent of all U.S. households rely on electricity as their primary heating fuel”

Remember that 19.5% (EIA data for 2006) of electricity generation comes from Natural Gas (“NG”) therefore 64% of households rely on NG, directly or indirectly, for heat. As recently as 2004, NG accounted for 24% of electricity generation. If a glut condition for NG exists right now in the U.S., why the decline in NG as a percentage of electricity generation? Glad you brought it up, but I’ll cover that in future post… (In case you were wondering, the remaining electricity generation comes from: 48.6% Coal, 19.5% Nuclear, 7.8 Hydro, 1.6% Petroleum, and 3% Other.)

At this moment, the U.S. has more NG than it has room to store. At today’s rate of consumption, North America has less than 10 years of NG reserves (US Army Corps of Engineers). Yes, we have a glut today – and a disaster coming in the near future.

Unlike Oil, NG markets are local. Although the U.S. imports 1% to 2% of its NG in the form of Liquid Natural Gas (“LNG”), these imports cannot be easily increased due to infrastructure issues that are at least a decade away from mitigation – if we addressed them tomorrow (the U.S. has only 5 LNG terminals, and one of these is on the island of Puerto Rico. There is no pipeline between Puerto Rico and the Mainland.). The remaining 98 % of NG consumed domestically comes from Canada, Mexico, and the U.S., and is transported to markets via an intricate pipeline system.

The problem is that when NG Wells begins to decline, they do so at a much steeper rate than conventional Oil Wells do. After the initial surge, Oil must be pumped out of the ground, or brought to the surface using water injections to flood the oil to the surface or a gas such as carbon dioxide to “repressurize” the Well and force it to a collection point. This is not true of NG; NG comes out of the ground under pressure – until it doesn’t. Then it simply stops coming out of the ground. You can’t pump it, and you can’t inject water (no, hydro fraction, or “frac job” in industry parlance, does not count) – the well or field is dry, end of story, and the end comes with little or no warning.

Since 2002 drilling for NG in North America has increased 20 % per year, but production has been declining by better than 4%. We are now severely constrained in our equipment infrastructure, and will be unable to maintain that frenzied growth in drilling activity.

Between 1995 and 2005, the U.S. added 220,000 Gigawatts of gas powered electrical capacity. It is clear now what a blunder that strategy was, as NG supplies will be insufficient to generate the aggregate plant capacity. Or maybe not, as it is likely that Coal would have been used in its stead, with its attendent environmental impact. I think it is important to consider that the process of liquefying and gasifying imported LNG is a HUGE environmental liability. A significant amount of Methane (CH4) escapes into the atmosphere during these processes, and Methane is much more powerful greenhouse gas than is carbon dioxide (CO2) (notice the "C" in those gas compounds). This will certainly be a consideration in the future. But that’s an environmental issue - this discussion is about future electricity availability.

As Matt Simmons, with a great gift for the understatement, said: “We have to grow our electricity supply, or we will not grow our economy”. Will it be Peak Oil, followed by Peak Gas (and Peak Heat) followed by Peak Electricity? The data does not look good.

Mentatt “at”
If you have a data point to share with me, please email at the address above.

Monday, October 9, 2006

The Future Constrained Environment

Well at least I know someone actually reads this blog. I received an email from a real estate investor who wanted to know what the price of wheat had to do with my theory on a pending energy crisis.

On October 2, 2006, I published a blog titled “Energy Constrained, Carbon Constrained”. I view the competition for investment dollars through a filter of declining liquid petroleum availability AND a filter of soon to come regulation of carbon emissions. At the moment, the political will necessary to tackle these issues is not apparent. That will change rather quickly should the supply of grains needed to feed the world’s people come under attack from weather patterns caused by global warming or the inability of farmers to afford hydrocarbon based fertilizer, pesticide, and other hydrocarbon inputs based on today’s agricultural product's economic yields.

Is there a connection between declining grain supplies and energy and environmental issues? It is really not a big reach. Would governments get off their butts if the supply constraints experienced in energy last year suddenly appeared in the supply chain for food? You can take that to the bank – history clearly shows that real hunger is a powerful motivator. Would the policies enacted affect your investments? I believe that they would, and that’s why I wrote about the shortage, at least for the time being, of grain. That these issues are arising contemporaneously is not, I believe, a coincidence. And that the proposed substitution/soultion for liquid transportaion fuels is to be found in the distillation of grains - well, as I said - I am convinced people would choose eating over driving.

Mentatt (at) yahoo (dot) com
People don’t need to drive, but they do need to eat

Wheat futures rose to the highest prices in 10 years. As a matter of fact, they were closed lock limit up at the Chicago Board of Trade (that is industry speak for the maximum that prices are allowed to go up in a single day; lock limit down is the opposite). Corn prices are surging to multi year highs as well. Worldwide inventories, in terms of the number of days’ supply, are at their lowest levels in over 30 years. At this time we have somewhere between 57 and 56 days of grain supply in world carry over stocks. These 57 days of supply stand between us - and the abyss. So it’s a good thing to obsess over. The last time our days-of-supply was this low was 1972 - and grain prices doubled. Further, it was not just our days-of-supply that fell. Total production fell in 2005 and again in 2006.

The issue is not insignificant, if I may claim the use of understatement. What happened? How did we get here? Here are a couple of possible explanations...

1. The weather did it. Global warming, drought, excessively high temperatures…
2. Energy inputs have fallen in the agricultural system, thereby diminishing harvest yields

Or, perhaps some combination of the two. There was no disease issue. No locusts. No plagues. What if this trend should continue for a few more years? Think we might be motivated?

Still, whatever the cause, the fact is the public is being told by the federal government and our national politicians via brain dead, boob-tube reporters, that we need to wean ourselves off of imported oil and substitute said oil with, among other things, corn ethanol.

The only problem is – we might not have enough grain to feed everybody!

“The newest, potentially huge claimant on world grain supplies, the use of grain to produce fuel ethanol, is concentrated in the United States where a projected 55 million tons, or one fifth of the projected 268-million-ton corn harvest for 2006, will be used for this purpose. This year the climbing use of corn to produce automotive fuel will catch up with the U.S. export of corn, which is also estimated at 55 million tons (See Figure). For perspective, although 55 million tons is only 16 percent of the U.S. grain harvest, it exceeds the total grain harvest of Canada.” – Lester Brown, Earth Policy Institute

I am going to go out on a limb here and take a position. I believe that people will prefer eating to driving. There. I said it. I get paid the big bucks to make the tough calls.

Remember our worldwide grain inventory issues the next time some tooth capped, plastic surgery refugee of a TV reporter looks the camera squarely in the lens and tells you, the American public:

“What oil crisis? Don’t worry, be happy!”

mentatt (at) yahoo (dot) com

Sunday, October 8, 2006

Don’t Believe a Word OPEC Says. The Organization is Incapable of the Truth

The following quote is from a article published today…

“Saudi Arabia and five other OPEC members cut oil output by a total of 1 million barrels a day in an effort to revive prices that lost a quarter of their value in two months, a spokesman for the group said.”

Never, ever, believe anything that OPEC says. Never believe that they did something for the reasons they state. NEVER. Further, OPEC has never warned the markets. Whatever cut they are talking about today you can be sure happened already.

Since one cannot believe their statements, one has to wonder as to their true motivations and circumstances. Was there, in fact, a voluntary cut – or was there an inability to meet recent production levels. This we will know within 12 months, and it is very much worth paying close attention to.

If, as I suspect, OPEC has been producing flat out; and if, for whatever reason, OPEC is unable to maintain their production at these levels; does anyone really believe that OPEC would come out and be truthful about these circumstances?

I have no immediate data point to support this contention, but it would seem to me...

1. With prices only 13% below their yearly average (who compares commodity prices to their top tic? These are not equities) and with prices still far outside and above their historical range
2. With peak winter demand for oil in the Northern Hemisphere just weeks away
3. With inventories only in the middle of their “days of usage” range for the past 8 years
4. With no proven ability to increase production quickly if a cold winter should materialize
5. And with the American Energy Secretary Sam Bodman ringing their phone off the hook pointing this out

That OPEC (we are really talking Saudi Arabia here; the Saudi’s, Russia, and Iran account for over 50% of world oil exports. Iran needs hard currency much more than oil, and Russia is not a member of OPEC. Every one else is “small potatoes”) would be disinclined to snub their largest customer, political patron, and military protector just prior to the mid term elections. Especially a Republican President, and a Bush at that. I have no political axe to grind. I am merely pointing out the close relationship of the Saudi’s and the Bush family and the Republican Party. The Saudi’s need us, and we need them.

The Saudi’s own roughly 8 % of the U.S. equity markets, and are fully aware of the risk high crude oil prices present to the world economy, especially at a time when the risk of severe damage to the economy from the bursting of the housing bubble is a serious concern.

The argument that the production cuts, if in fact we see production cuts, are in reaction to the recent oil price decline sounds plausible, until you take it to task, and then the argument seems somewhat specious - at best.

Is OPEC really cutting oil production voluntarily? Or is geology cutting oil production for them. Stay tuned.

Mentatt (at) yahoo (dot) com

Friday, October 6, 2006

There are now 4 kinds of lies: mine, yours, statistics, and OPEC’s

It was reported in the American Media today that OPEC planned production cuts of 1 million barrels per day (“bpd”). The report cited “unidentified people”.

The U.S. Secretary of Energy was not happy about the report.

"We still need oil for sure. We still need all the oil we can get," U.S. Energy Secretary Sam Bodman told Reuters in a telephone interview October 5, 2006. Bodman said he plans to drive that point home in conversations with OPEC oil ministers. Peak winter demand for heating fuel lies just around the corner.

The media reports have consistently trumpeted “high inventories”. Relative to what? Inventories always build at this time of year, before the winter peak oil demand, and we have not built any new storage facilities to speak of since 2000, even though the economy has grown roughly 20% since then. U.S. oil consumption has increased roughly 5 % during that time, but more importantly, world oil consumption has increased nearly 9% (BP Statistical Review). Some economists point out the difference in economic growth and oil consumption and conclude that the economy is less dependant on oil. Yea? Thankfully, I couldn’t think as slow as those guys if I was asleep. It would seem to me that our economy is that much more LEVERAGED to oil (Secretary Bodman would seem to fall into my camp), and that any decline in the availability would have a correspondingly larger negative impact on the economy, which would also explain the runup in prices. A decline in prices might presage a worldwide recession.

It has been reported that the Kingdom of Saudi Arabia (“KSA”) intends to invest $24 Billion to expand oil production over the next 5 years.

“At a mid-September OPEC meeting in Vienna, Oil Minister Naimi said Saudi Arabia plans to expand production in seven fields to add 2.4 million barrels per day of capacity, boosting its total to about 12.5 million barrels per day by 2009. On Oct. 1, the Saudis announced they would start work in early 2007 on a new oilfield called Moneefa, which will have 900,000 barrels of capacity and come on line in 2011.” Business Week Online, October 5, 2006.

Clearly the KSA is not concerned with a long term drop in the price of oil caused by over capacity. At least $24 billion worth of not concerned.

Further, how can you trust any comments coming out of OPEC? This is not a unified, all for one and one for all merry bunch of guys. Whatever jawboning you hear – for the most part is just that.

``There is no agreement for an informal cut, or any type of cut,'' Kuwait's oil minister, Sheikh Ali-Jarrah al-Sabah, said in an interview. ``I've had no consultations with other ministers.'' Bloomberg October 5, 2006

Here is one quote that I find to be a reasonable attempt at the truth.

" ‘There is concern that the volatility in the markets is so beyond anyone's control that it could cause severe damage to the world economy,’ says Sadad Al Husseini, the retired exploration and production chief of Saudi Aramco, the national oil company. The Saudis, he says, ‘are determined to try and manage better.’ “ October 5, 2006

Count on continuing volatility, perhaps wild volatility, in the price of oil, but don’t count on anything anyone within OPEC says.

mentatt (at) yahoo (dot) com

Thursday, October 5, 2006

The Exponential Function

“Anyone who believes we can have exponential growth in a finite world is either a mad man – or an economist” - Aldus Huxley


Many a mathematician, physicist, and geologist in the country is familiar with, and most do not dispute, the validity of the argument that we are faced with an unprecedented problem in the form of a permanent energy crisis (just Google "Hirsch Report Peak Oil" and read what the U.S. Department of Energy published in February, 2005). Yet the mainstream press and the public are either uniformed or in complete denial.

The mathematical necessity of the matter can be better illuminated if we become familiar with the concept of the exponential function. Dr. Albert Bartlett, professor emeritus of physics at the University of Colorado (Boulder), has been speaking about the subject for the past several decades and has written an excellent book, which I heartily recommend, titled “The Essential Exponential Function for the Future of our Planet”. For those of you disinclined to read this tome, this paper might suffice.

We have all heard the word “exponential”, but I think a definition is in order. The following is from a lecture given by Dr. Bartlett at the University of Colorado to describe the exponential function.

“This is a mathematical function that you'd write down if you're going to describe the size of anything that was growing steadily. If you had something that was growing at 5% per year, you'd write the exponential function to show how large that growing quantity was year after year. And so we are talking about a situation where the requirements required for the growing quantity to increase by a fixed fraction is a constant 5% per year. The 5% is a fixed fraction, the three years a fixed length of time. So that's what we want to talk about. Its just ordinary steady growth.

Well if it takes a fixed length of time to grow 5%, it follows it takes a longer fixed length of time to grow 100%. That longer time's called the doubling time and we need to know how you calculate that doubling time. It's easy. You just take the number 70, divide it by the percent growth per unit time and that gives you the doubling time. So our example of 5% per year, you divide that into 70, you find that growing quantity will double in size every 14 years.
Well, you might ask, where did that seventy come from, well, the answer is that it's approximately one hundred multiplied by the natural logarithm of two. If you wanted the time to triple you would use the natural log of three. So it's all very logical. But you don't have to remember where it came from, just remember 70.”
Please don’t let your eyes glaze over, I promise not to mention logarithm again; for our purposes here, as Dr. Bartlett says, just remember 70, and doubling time (“T2”).

So what is so important about the rule of 70 and doubling time? Just this, if something is growing at 7% per year, it will double every 10 years (70/7). Something growing at 5% doubles every 14 years (70/5). More importantly, the total amount of the unit measured at the end of the doubling period will be greater than the total of ALL of the preceding doubling periods, and at the end of 10 T2’s is over 1000 times the size of the original amount (1,2,4,8,16,32,64,128,256,512,1024 – 1024 is 10th doubling time). For example, total world Oil consumption grew at 7% per year during the 1950’s, 60’s and most of the 70’s. Using the rule of 70 that means that the world consumed more Oil in the 1960’s than it had in all of human history prior to January of 1960 (look at the above numerical progression - 16 is greater than the total of all the numbers before it (1+2+4+8=15), as are each subsequent number). During the decade of the‘70’s the world consumed more oil than it had from 1859 (Colonel Drake drill’s his well) to December 31, 1969. After the Oil shocks of the 70’s, the period 1980 to present saw much lower exponential growth in Oil consumption, 100% by geological necessity. Had the world continued to double its consumption of Oil each decade from 1980 to the present, the world’s entire endowment of oil would have been consumed, and you and I would be cooking over a dung fire tonight.

To date, the world has consumed just over 1,000,045,000,000 (1 trillion, 45 billion) barrels of oil out of a likely endowment of 2.06 trillion barrels (Dr. Ken Deffeys, professor of geology, Princeton University, and author of "Beyond Oil", another book I strongly recommend). We are currently consuming roughly 30,000,000,000 (30 billion) per year. Well, if there were no steady increase in the use of oil (exponential growth) we would be completely out of oil in 33.3 years (If you want to add a slush number, go right ahead). But this is not the case because A: Demand is increasing at roughly 1.8 % per year and (however) B: Once an oil field has produced more than half of its total endowment of recoverable oil, its production declines each and every year (this is called terminal decline). The last barrels do not come out of the ground at the same speed as the barrels coming out of the ground today. Think about it: what finite resource continues to increase in production until the last unit is consumed? Not a one. The production of gold, oil, iron, coal, etc… from any one field follows a bell curve production cycle; slow but rising in the beginning, the left side of the curve, peaking in the middle, and declining on the right side, the down slope of the bell curve.

So what does this mean to you? Desire to consume oil (notice I did not use the word “demand”) will continue to increase exponentially, but the supply available to satisfy that desire will not be able to grow once the world’s oil supply enters terminal decline. Exponential growth collides head on with terminal decline. No one disputes this. No government, no research university, no oil company executive. Oil is a finite resource and by mathematical necessity its production must peak at some point, and then enter terminal decline. The only debate is when. If the world’s reserve estimates are correct, and I believe they are hopelessly exaggerated by oil producing countries for political gain (future posts will coer this issues), and future discoveries total 160 to 200 billion barrels, the peak is RIGHT NOW, + - 5 years.

We have been receiving price signals from the Oil and Natural Gas markets (some would argue those signals have broken down with the recent decline in price, but volatility is one of the signals), political signals from national governments in the form of resource wars (Iraq), political blackmail (Russia turning off Europe’s Natural Gas Pipeline last January), and the 9/11 attacks on the World Trade Center (Radical Islam is much more aware of this crisis the average American). et al.

Once you understand the exponential function, (its mirror image, the logarithmic function, is the subject of a future post), and how its tenets impact the concept of sustained growth of anything – the economy, population, compound interest, inflation… - you will never view anything that is growing steadily the same again.

mentatt (at) yahoo (dot) com
The United Kingdom passes from Oil exporter to Oil importer

“Houston, we have a BIG problem” - Matt Simmons, speaking before the U.S. Department of Defense, June, 2006, the seriousness of the energy situation facing the United States.

Based on data published by the 2006 British Petroleum Statistical Review, Europe’s Oil imports are expected to grow 29% by 2012. Currently, the European Union’s population of 460 million consumes over 15 million barrel per day (”bpd”). Until the discovery of the North Sea’s prodigious oil fields Europe essentially imported all of its liquid petroleum fuel requirements. Unfortunately, the North Sea’s production has been declining at roughly 8% per year since 2000 (1999 for the UK and 2001 for Norway if you want to be picky), and many knowledgeable (I never use the word "expert" unless I am quoting someone) people believe that there is a high likelihood that the rate of decline will accelerate.

“Applying a 0.5% growth in consumption and a 8% production decline rate points to EU oil imports growing from 9.8 million barrels per day (bpd) in 2005 to 12.6 million bpd by 2012 - an increase of 29% over the next 6 years.” Dr. Euan Mearns, PhD

Dr. Mearns believes that the UK alone, which was an exporter as of 2005, will need to import over 1 million bpd by 2020. Where is Europe’s new import requirement going to come from? Said another way, which exporter(s) are going to have the capacity to step up their exports (production – domestic consumption) 2.8 million bpd – and that’s just for Europe. During the same time Asia’s import requirement will grow by at least 5 million bpd.

The world has been unable to increase production for at least 22 months (each month’s production has been within 1% of the monthly average during that time frame) at an average production of just over 84 million bpd of “All Liquids” (crude oil production has actually fallen during the time frame, the difference is NGL and condensates). So tell me, where is the extra 7.8 million bpd going to come from? – and that’s just for Europe and Asia, to say nothing for growth in demand in the rest of the world.

Indonesia, a member of OPEC, has gone from an expoter to an importer. The UK is making the transition. Mexico might cross over in 2010-12. If the net number of barrels available for export worldwide declines on a continuous basis what is the effect on the price of the marginal barrel of Oil?

It is going to be a wild ride.

mentatt (at) Yahoo (dot) com

Tuesday, October 3, 2006

Markets zig & zag. Markets don’t zig & zig.

Today someone asked me: “If there is an Oil supply problem coming in the near future, why is the price of Oil going down?” A fair question, I believe. I casually replied that markets zig & zag (these are technical terms), they don’t zig and zig. Let me translate: markets such as that for crude oil move up and down for a variety of reasons: seasonal, political, economic… they do not move up and up or down and down or flat and flat. If they did, why the hell would we need traders, bankers, economists, analysts...

I have no definitive answer for the price movement of any security, commodity, property, etc… in the short term. If I did, I wouldn’t need to be gainfully employed (nor would any of the professional economists we hear so much from in the media). That disclosure aside, oil, like any commodity, trades at the margins. It’s that last barrel that moves prices up or down, not the million before it. 1% too much oil can move the price of 100% of the oil down 25%, (we just saw that in the last 6 weeks with oil falling from $78 to $58). The mirror image is true, too. 1% too little oil and the price might be $75, $85, $100…

That, in my humble opinion, is where we are going (and where we have been). We will continue to see substantial volatility in the price of oil in the spot and front month markets as we move back and forth from 1% too much, to 1% too little. Now pay close attention – the price of oil just zagged, hard (now please see title of article).

China, India, the Former Soviet Union, and most of Asia with the exception of Japan, demand more and more oil to power their economies - and winter is coming (Unless it gets called off again). Although the U.S. consumes 25% of the world’s oil, it’s the MARGINAL consumer that matters. Why are the Asian economies the marginal consumer? To paraphrase Willie Sutton – because that’s where the growth is; because that’s where major industrialization is taking place; because that’s where the population is. If China’s population enjoyed our lifestyle, they would be consuming over 80 million barrels of liquid petroleum products per day – about 95 % of what the entire world now consumes. Where is that oil going to come from? What country? What field? What province? We have identified the marginal consumer - where is the marginal producer?

1% too little will be here before you know it.
Big Spending on Exploration & Production (and not a lot to show for it);

John S. Herold, Inc., a Stamfod, Ct., based research firm recently compiled data from the 203 largest, publicly traded, energy exploration and production companies. I’ll sum it up quick.

The companies raised their 2005 budget for exploration and production by a total of $277 BILIION, up 31% from 2004.

For their trouble, these companies increased their gross production 1%, and their reserves by 2%.

Even more telling, they spent $35 Billion on exploration, the balance of their E & P budget was spent on production. THEY SPENT $65 BILLION ON DIVIDENDS AND STOCK BUY BACKS.

This should be quite disconcerting for those of you clinging to the mistaken economic concept (geology trumps economics when it comes to oil extraction) that the incentive of higher prices will lead to greater production and reserves increases, as it should for our energy policy makers and their data production minions.

The most recent discovery of a super giant oil field was in the mid 1970’s in Mexico. We have not found a field like Cantarell in over 30 years. Either we have been incredibly unlucky for 3 decades, or there are no more super giants left to discover. Makes sense to me, considering that we are now drilling down in 7,000 feet of water and 20,000 feet of earth, 170 miles from land, in search of new deposits. That would certainly not make a lot of sense if there were a super giant just waiting around to be discovered in Central Park.

If the top 203 E & P companies increase E & P spending $277 Billion per year and cannot increase production by more than 1%… Think about it: the industry is spending a TOTAL of nearly $1 Trillion on E & P to increase production 1% per year when consumption is growing nearly 2% per year. To paraphrase Mark Twain: Reports of the demise of the energy crisis have been greatly exaggerated:

Greg Jeffers

mentatt (at) yahoo (dot) com

Monday, October 2, 2006

Energy Constrained, Carbon Constrained – "That’s just the way it is"

Investors should familiarize themselves with 2 concepts - an energy constrained environment, and a carbon constrained environment. This will certainly be THE big business story over the next decade (I use the singular form for the 2 as they are 2 sides of the same coin).

Those of you who have been reading my reports are familiar with my view of the challenges future energy supplies, or lack thereof, present. Previously, I have made no mention of what I believe will be substantial government regulation by various foreign and domestic governing bodies of the amount of greenhouse gases, particularly Carbon dominated compounds, which are released into the atmosphere as a result of the combustion of hydrocarbons (notice the ‘carbon” in hydrocarbon) for industry, transportation, heating & cooling, etc…

There are many intelligent, and some not so intelligent, proposals for using market mechanisms to reduce the rate of carbon released into the atmosphere. I will not bore you with the list here (but I will in a future post). Suffice it to say, they are coming, they will be politicized, they will make a lot of people unhappy, and they will affect us all - profoundly. I believe that some other non-market mechanisms, like rationing carbon emissions, are extremely likely.

My firm considers issues for Real Estate investors (our subsidiary SEC registered Broker/Dealer does the same for financial market participants. Federal securities regulations prohibit me, as I hold a securities license, from making specific recommendations in individual securities or other strategies in this forum. I am permitted to comment in general on markets, industries, economic conditions, currencies, etc…), and I believe that these issues are coming at us like a freight train with its lights off and its whistle broken. So pay attention. Educate yourself. Consider the possibilities and probabilities that these eventualities will come to pass at a time that will affect your current holdings.

You might perform an online search for MIT’s Energy initiative. Here is an interesting, and short, article from MIT’s Technology Review:

Don’t listen to the media. Hit the search engines and Amazon. With the wondrous web you can educate yourself with data from the source, not filtered through some cerebrally numbed talking head (I sit up at night thinking of new descriptions for these “journalists”).

Speaking of cerebrally numbed… a recent Gallop Poll said 42% of Americans believe that the Bush Administration manipulated the Oil markets in an effort to lower the pump price of gasoline prior to the mid-term elections next month. George Will said the following regarding the idiotic claims that The President was not “handling” the price of oil earlier this year. “Does anybody over the age of 7 really believe that a President can “handle” the price of oil in the world market?” I could not have said it better, myself. Still it begs the question: Is 42% of the U.S. age 7 or under? GET REAL, PEOPLE!

I have a better question. When the U.S. Department of Energy was created in 1977, the United States imported approximately 15% of the oil it consumed; was it the department’s intention that the United States would depend on imported oil for roughly 60% of its consumption today? Projections of as high as 80% dependence on foreign oil by 2020 have been reported. Does anybody over the age of 7 think that this is a good idea?

Mentatt (at) Yahoo (dot) com