The Hard Truth About Crude

Our resource man, John Myers, ponders what to expect from black gold as "social and political shock waves will be felt worldwide once oil production peaks."

"The country is facing the most serious energy shortages since the 1970s. Without a solution, the energy crisis will threaten prosperity and national security and change the way Americans live."

– Spencer Abraham, U.S. Energy Secretary

Here are some facts you should consider when debating whether oil is a profitable investment opportunity. After reading these four bits of information, I’m sure you’ll agree there’s money still to be made from black gold.

* The United States, with 5% of the world’s population, consumes more than one-quarter of the world’s oil production.

* The United States is guzzling oil at record rates. In 2004 the United States will consume 7.5 billion barrels of oil.

* U.S. oil production is at its lowest level since the early 1950s and is declining by more than 2% per year.

* Since 1970, U.S. oil reserves have fallen from 50 billion to 20 billion barrels. By the end of this decade, the United States will have less than 15 billion barrels in oil reserves.

For these reasons and then some, my investment advisory, Outstanding Investments, is bullish on oil prices over the short term and throughout the rest of the decade.

Oil Bulls: Opec Refuses to Open the Spigots

In December, OPEC announced that it would not increase its output quotas despite a wellspring of worries regarding the region – specifically the situation in Iraq and the political instability of Saudi Arabia. OPEC’s refusal to open the spigots comes at a time when North Sea and Russian oil production is in decline. This coming year Canadian and Chinese oil production will rise, but their output will not nearly offset the decline in the two previously mentioned regions.

Decline in oil production flies into the teeth of rising world oil demand, projected to grow by about 1 million barrels per day in 2004. Roughly one-third of this increase will be the result of increased demand in the United States along with China.

Given these supply and demand numbers, I believe that even if a political calm settles in the Middle East, oil prices will move above $30 per barrel by the second quarter 2004.

During the last two weeks of November, commercial crude oil inventories in the United States fell by nearly 10 million barrels. On the import front, evidence suggests that Middle East exports to Asia are increasing, with the United States importing more oil from Canada and Mexico. America’s neighbors are a stopgap for oil supplies, but neither country has the wherewithal to keep the United States flush with oil for any time to come.

Meanwhile, America’s rotary rig count, which once totaled more than 5,000 active in the early 1980s, stands just above 700 today. Even with crude oil prices above $28 a barrel, American oil companies have slashed domestic exploration budgets because they understand one fact – America is drilled out.

Oil Bulls: Buying Out Canada

Since 2000, U.S. oil companies have replenished their reserves by acquiring other oil companies, many of which are headquartered in Canada. These Canadian companies have significant reserves and will continue to provide an expedient solution to America’s brewing energy crisis.

In short, I believe U.S. buyouts of Canadian oil and gas companies will continue. And we’re looking into more takeover candidates for OI recommendations.

But Canada is not a panacea that will cure America’s oil crisis. This was supported by some somber predictions at a November energy symposium in Ottawa, Canada. According to several of the industry’s top experts, Canadian and worldwide production of oil and natural gas will peak sometime before 2020.

The only solution, said symposium speakers, will be higher energy prices from the gas pump right on through to household electricity.

University of British Columbia professor Bill Rees, a well- known expert on the world’s remaining oil and gas stockpile, predicts that "social and political shock waves will be felt worldwide once oil production peaks."

The consensus is that world production in both conventional oil and natural gas could peak as early as 2017. America’s energy crunch could happen much, much sooner.

Regards,

John Myers,
for The Daily Reckoning
January 13, 2004

P.S. A December 2003 Energy Information Administration release states that "without a substantial increase in crude oil imports…it may be difficult to supply enough products for current demand."

Translation: Crude oil, already expensive, will become more costly in 2004 and considerably more expensive during the second half of this decade as domestic production and oil reserves decline.

OI Prediction: We look for crude oil to break above $40 in 2004 even without political or military calamity in the Middle East. In the event of war, social upheaval or armed revolution in the Persian Gulf, oil could spike to $50 per barrel…and maybe even more.

Editor’s note: John Myers – son of the great goldbug C.V. Myers – is the editor of Outstanding Investments. Our man on the scene in Calgary, John has his fingers on the pulse of natural resource profits – including oil, gas, energy and gold.

The Times of London is full of absurdities and grostequeries today. How delightful!

"Killer leopards terrorize Bombay," says one headline.

"Cannibal told of victim’s ‘appetite,’" begins the continuing coverage of the flesh-eater’s trial in Germany.

Another article tells of the latest money-making scheme in Argentina. "Bodysnatchers bungle ransom for remains," says the headline. Instead of kidnapping a live victim, criminals are now digging up the bones of relatives and demanding ransom money to give them back. These mugs got the wrong bones.

And there on page 11, next to a photo of giant retired sumo wrestler Konishiki and his bride is a photo of former Treasury secretary, Paul O’Neill. As Addison alluded to yesterday, we made fun of O’Neill when he was in the cabinet, but we’ve come to like the guy since he was booted out. The man dares to think and says right out loud what is on his mind.

What lands O’Neill on page 11 this time is what he said to author Ron Suskind. President Bush seemed to him "like a blind man in a room of deaf people," and he intended from the get-go to topple Saddam Hussein. The weapons of mass destruction and terrorist bugaboo were just jaw-flapping and justification, according to the former insider.

His remarks are, of course, insulting and reckless. Blind people should demand an apology; the only problem with them is that they can’t see. And as far as we know, no nation has ever been truly harmed by a blind man, while many have been brought to ruin by people with vision in both eyes.

It was Paul O’Neill, we recall, who wanted to know just how far in the hole the U.S. government really was. So, he hired a couple of economists to figure it out. The resulting figure – $44 trillion – was so enormous that the report was widely ignored.

Most people merely focus on the current indebtedness of the American people. (See below more details from Mr. Michael Hodges.)

Also in today’s news is much discussion of unemployment. The December numbers were a disappointment to everyone. Overall, even in the Christmas shopping season, only 1,000 new jobs were added – most of them marginal.

"Contrary to popular spin," writes Stephen Roach, "the U.S. labor market is not on the mend. In the final five months of 2003, a total of only 278,000 new jobs were added by nonfarm businesses – a gain that is easily matched in a single month of a typical hiring-led recovery. Moreover, literally all of the job growth that has occurred over this period has been concentrated in three industry segments – temporary staffing, education, and healthcare – which collectively added 286,000 positions in the final five months of last year. The "animal spirits" of a broad-based hiring-led revival by U.S. businesses are all but absent. Jobs may be rising in America’s low-cost contingent workforce (temps) and in high-cost areas that are shielded from international competition (health and education), but positions continue to be eliminated in manufacturing, retail trade, and financial and information services."

"For this stage in a ‘recovery,’" Roach elaborates, "we’re 2.4 million jobs short – even when compared to the most jobless recovery ever, 10 years ago.

"Factories dumped 26,000 American workers in December…the 41st consecutive month of decline. And the work week shrank from 33.9 hours to 33.7…with average weekly earnings down even in dollar terms."

Worse, the ‘participate rate’ is going down. This measures the number of people who are actively working or looking for work. When times get tough, a lot of people just decide to give up; they are no long participating in the workforce. Economists estimate that if these people were added back into the unemployment numbers, the rate of joblessness would be close to 10%.

The Fed can stimulate borrowing and spending, we conclude, but not hiring. Low rates and E-Z credit terms lure Americans to buy…but a large part of the spending finds its way overseas, where the jobs are created.

It’s still a reckless, feckless "No-Job Recovery," says CNN. "The greater the imbalances," concludes Roach, "the more combustible the flashpoint – suggesting to me that the day of reckoning could be sooner rather than later. Such an endgame would be all the more treacherous for an increasingly asset-based, wealth-dependent U.S. economy. This key risk seems all but forgotten in the hubris of the Fed’s victory lap."

And now, over to Eric Fry, with more market news:

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Eric Fry, mingling with the traders in Manhattan…

– Tech stocks sizzled again yesterday, while the rest of stock market maintained its white-hot glow. The Nasdaq Composite jumped 1.2% to 2,112 – its best level since July 2001 – while the Dow edged ahead 26 points at 10,485. Month-to-date, the tech-powered Nasdaq is ahead more than 5%, while the stodgy old Dow has gained less than half a percent.

– Clearly, the lumpeninvestoriat prefers sexy Nasdaq stocks to the buttoned-up Dow variety. The Nasdaq’s impressive performance is not the only sign that the lumps’ increasing bullishness is beginning to look a lot like recklessness. Friend, colleague and options professional, Jay Shartsis, says that the recent action in the options market reflects "brazen fearlessness." – Shartsis notes that the prices of the S&P 100 Index (OEX) puts and calls are trading near parity with one another. "Normally, puts would be 3 or 4 times the price of calls," he says. "So this near-parity pricing means no fear at all." Another ominous options-based indicator, according to Shartsis, is the fact that the 21-day dollar-weighted equity put/call ratio just got down to 20 cents traded in puts for every $1 in calls.

– "At the stock market bottom last March," he reports, "that figure was about $1.20 in puts for every $1 in calls, rather a high level of fear. Since then, this ratio has been going down all year. I was surprised to see it drop under 40 cents, and 20 cents is just unbelievable, a level not seen since the height of the mania in 1999. I thought quite a few more years would need to pass before such a rare level of optimism was seen again! This is an important indicator and it’s flashing bright red right now. Can it drop down to 10? Yes, but that’s too remote a possibility to bet on." – And that’s not all, says the bearish options pro. The investors’ sentiment numbers are "absolutely remarkable. The latest readings should concern those who are bullish," Shartsis tells your New York editor. "This morning’s research fax from Chris Cadbury is a wake-up call for anybody who is bullish. On Wednesday, Consensus disclosed 81% bulls…Consensus last reported more than 80% bulls 7 years ago." – Shartsis concludes: "It doesn’t seem like a good bet to stay long a market that has off-the-chart bullish expectations, wildly overbought momentum extremes, enormous distance from its 50-day moving average, unparalleled bulletin board hysteria, etc. etc., and I stopped counting how many days up without a pullback."

– When the stock market goes up every day, and investors make money month after month, almost no one – except an incorrigible bear – can imagine that the good times will ever end. But they can – and do – end abruptly. So, even while we are enjoying the good times on Wall Street, we’d advise keeping a wary eye on the future.

– Here’s some food for thought: The U.S. stock market is tracing out a pattern that is eerily reminiscent of the Nikkei’s post-bubble trading pattern.

– "The Nikkei topped out at nearly 39,000 at the end of 1989," your New York editor remarked during his appearance last week on CNNfn. "31 months later it bottomed at 14,194, then rallied 50% over the next 13 months to 21,281, at which time it tumbled again to 16,216.

– "So far, the U.S. stock market’s post-bubble trajectory has been frighteningly similar," your editor continued. "The S&P 500 topped out at 1,552 in March of 2003. 31 months later it bottomed at 768. Over the ensuing 14 months it has rallied 47% to its current level. If the Nikkei’s precedent holds, the S&P’s rally will end any day now and the index will tumble about 24% between now and April."

– That’s not all, dear reader; the Nikkei did not merely rally 50% one time; it launched three distinct 50% rallies. In 1995-6 it soared from 14,000 to 22,000, exactly like the 1992 rally. Then, from late 1998 to 2000 it jumped 50% from 13,000 to 21,000…on its way to 7,600 in April of last year.

– "If the Dow were to chart a course identical to the Nikkei’s," your editor remarked on the air, "it would fall to 8,000 by spring…on its way to 2,400 in April 2014."

[Editor’s note: the eerie parallel between the Nikkei Dow and that of the American persuasion figures heavily in the conclusions drawn by Bill and Addison in Financial Reckoning Day. If you haven’t read the book yet, it’s #1 on the NY Times Business Bestseller list…now would be a good time to bone up on collapsing credit bubbles:

Financial Reckoning Day ]

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Bill Bonner, back in London…

*** "Under Bush’s leadership," says Laura Tyson, dean of the London School of Economics, in next week’s Business Week, "the government has made a series of inconsistent promises that, taken together, cannot be honored: promises of future Medicare and Social Security benefits, promises of substantial investment in military and homeland security, promises of leaving no child behind, promises of generous corporate subsidies and tax breaks, promises of timely repayment of federal debt, and promises of tax rates far below those necessary to cover other commitments. [Not to mention Americans walking around on Mars…]

"Something’s got to give. But what?" Tyson’s answer of what lies ahead – "A long-term fiscal crisis."

*** Michael Hodges…on the hole America has dug for itself:

"America has become more a debt ‘junkie’ – than ever before with total debt of $34 trillion, or $119,442 per man, woman and child. Sixty one percent – $21 trillion – of this debt was created since 1990, a period primarily driven by debt instead of by productive activity.

"Two great questions: Can the production of debt forever replace the production of goods?

"Can Americans forever borrow their way to prosperity?

"One answer: NO WAY!!

"Total Debt in America is now over $34 Trillion, or $119,442 per man, woman and child. Debt in the past decade increased faster than ever in relation to national income, and debt intensity last year increased even faster!" For a run-down of the build-up in total U.S. debt over the past 10 years, see Mr. Hodges’ article on the Daily Reckoning website:

America’s Total Debt Report

*** A reader writes:

"On reading today’s DR (1/6/04) I felt compelled to respond to the reader who is taking you to task for missing the run-up in the market. If my memory serves me well (and it may not), early in 2003 I believe Marc Faber suggested gold and silver were positioned to rise and he even dropped the names of several mining concerns. Now it’s possible I read this in Strategic Investment, instead of the DR.

"In any event, among the suggestions were Pan American Silver and CDE for which I am very grateful. Eleven months ago I bought 5000 shares of PAAS and 10,000 shares of CDE. The market value of those shares today is over $100,000 above my entry cost; PAAS has nearly tripled and CDE has more than quadrupled and with every few cents that silver rises, the stocks continue to skyrocket. My gold pick (DROOY – suggested by Dan in SI) has not done nearly as well, but there too I have a gain of close to $15,000 on 17,000 shares. I personally have never had any faith in the stock market and prefer an investment I can hold in my hand, live on or look at from my front door. I have been on board with Bonner et al since the late 1980’s and in the course of that time I too missed the big stock market bubble.

"But following the insight and vision of SI, I have instead invested in land, timber, gold, silver, and some precious stones. They are all still in my hand, under my feet or within view – and I sleep well at night. I appreciate the wit and effort put forth by the entire staff of the DR and SI. P.S. Having graduated right before the ‘summer of love,’ I suspect Mogambo and I attended too many of the same social functions – that’s why I’m not sure if my memory serves me correctly. It’s a wonder it serves me at all."

See: Strategic Investment

*** Many readers are wondering…where is the Mogambo Guru? Has he taken a much deserved vacation? Or merely taken his own advice and headed for the hills? We don’t know, dear reader, but with any luck, an answer is forthcoming. Until we find out, if you do happen to spot him…best approach with caution.

*** "You mean, you really go to dance parties with the French?" asked an American who has lived here for 23 years. "The French are so funny. Everything they do has to be rationally thought out and planned, even when they dance. The French rock…for example. It’s modeled after American rock and roll dancing…but it’s completely different. It looks a little like American dancing, but it’s extremely structured. Almost Pythagorean…Just look at their faces. They have to really concentrate to get it right. You can practically see them working out the geometry in their heads as they dance."

"Well, we have never actually mastered the French rock," we replied. "But we weren’t very good at American rock either."