America's Oil Crunch
There is a new Middle East taking shape – one filled with Muslim extremism, teetering sheikdoms, and perhaps falling governments. It is a Middle East that could send oil prices soaring.
The recent bombing in Saudi Arabia underscores just how shaky this region is – an area that holds two-thirds of the world’s oil. And while America’s occupation of Iraq may have given Wall Street a temporary high, the hangover could be devastating. We anticipate a hangover that features stubbornly high oil and natural gas prices.
Many investors will recall that high energy prices were a major part of the equation that made the 1970s one of the worst decades on record for stock investors. Well… the oil market of 2003 may not be so different from the oil market of 1973. One important difference, however, is that the United States relies far more heavily on foreign energy supplies today than it did 30 years ago…and that’s not a good thing.
Oil Production Decline: Jihad vs McWorld
In his book, Jihad vs. McWorld, Benjamin R. Barber writes: “The world still spins on the energy of fossil fuels – non- recyclable and irreplaceable. The United States represents an especially foreboding case study, for here is one of the world’s richest countries using up its own resources in an orgy of consumption that’s reflected neither in elevated living standards nor in proportionately larger GDP. Nor have we learned much from two major crises in supply and our ever more debilitating dependency on foreign oil…”
The United States is a geological pincushion. More oil wells have been drilled in the continental United States than the rest of the world combined. Yet, U.S. oil production continues to decline with each year, resulting in less and less domestic production.
Consider the following facts:
* The United States accounts for less than 4 percent of the world’s oil production, but consumes more than 30 percent of world oil supplies.
* Since 1970, U.S. crude oil production has declined by nearly 50 percent, falling from 11.3 million barrels per day (mb/d) to 6.1 mb/d. Over the past few years, U.S. production is declining at a rate of 4 percent per year.
* Since 1970, U.S. oil reserves have fallen by more than 40 percent, or from 38 billion barrels to 22 billion barrels.
* The average oil well in the continental United States pumps about 300 b/d. The average well in the Middle East produces 10,000 b/d.
* Of the 530,000 operating oil wells in the U.S. in 2000, 78 percent were “stripper wells,” each of which produced less than 10 barrels per day. These wells accounted for 0.3 billion barrels of production in 2000, or about 15 percent of total U.S. crude oil production.
* The last elephant oil field (more than a billion barrels) discovered in the United States was in Prudhoe Bay, Alaska, which elevated U.S. crude production for nearly two decades. Now, as Prudhoe Bay empties out, domestic crude production is set for a steep decline.
* For the Lower 48 States, the apex in the oil discovery rate was hit in 1957. U.S. proven oil reserves peaked five years later in 1962. Another decade later, U.S. oil production peaked. Since then, America has come to depend on ever-greater amounts of foreign oil.
Oil Production Decline: Postponing the Inevitable
“Oil reserves have fallen so far to the point that annual U.S. oil consumption is now equivalent to about 1/4 of total proven reserves,” writes the Hubbert Peak of Oil Production (http://www.hubbertpeak.com/us/). “This means that, if the U.S. had to supply its own oil, and no new discoveries occurred, its oil would be gone in four years! By importing 55 percent of its oil, the inevitable is being postponed. But for how long can this continue?”
Indefinitely, as long as the U.S. government can guarantee available and cheap oil supplies delivered from the Middle East. If it cannot, then the United States faces severe challenges for the future.
America is heavily addicted to foreign crude oil. Of the 78 mb/d that the world consumes in petroleum, the United States siphons off almost 20 mb/d. Even though new technologies have reduced petroleum use on a per-capita basis for the United States, our SUV-loving population consumes ever-increasing amounts of oil. With America’s largest oil pools in severe decline and little expectation that any significant oil fields remain to be discovered, the United States is quickly heading towards a future where it will import two-thirds of the petroleum it burns.
Oil dependency also means that the U.S. is vulnerable to supply interruptions from Mid East wars or striking oil workers. How high will the oil price go? That, too, depends largely on what happens in the Middle East.
Oil Production Decline: Stabilizing the Region
The signs are not promising. Saddam Hussein was a cruel leader, but for many years the United States tolerated him because, in a perverse way, he helped stabilize the region. And a stable Middle East is an oil-producing Middle East. With him gone, the United States must try to create stability in the region. This will probably prove to be an impossible task. After all, the American peacekeeping mission was driven out of Beirut. How can we hope to bring stability twenty years later to Iraq?
During the 1991 Gulf War, oil prices rose above $40 a barrel. Adjusted for inflation (as measured by changes in the Consumer Price Index), $40 in 1991 translates to about $60 in 2003. Civil strife in the Arab world could propel oil prices above $50 a barrel range. Large-scale civil strife in Saudi Arabia, could send the oil price rocketing as high as $100 a barrel.
Skyrocketing oil prices would bring far more harm than good to the economies of the world. But there is a silver lining: investors can profit from rising oil prices. Even if the Middle East somehow manages to become an oasis of tranquility and harmony, the bull market in oil is just beginning. Global oil supplies are running down – even in the OPEC countries – while global demand continues to escalate.
We hope that the smoldering geopolitical bonfires in the Middle East do not erupt into a conflagration. We hope for peace in the region, but we do not expect it. So we suggest you prepare your portfolio for escalating civil strife and terrorist activity in the Middle East. Prepare to profit from a volatile bull market in crude oil by buying a basket of carefully selected oil and gas stocks.
For the Daily Reckoning
May 21, 2003
“You’re pretty sure stocks will hit epic lows before they hit new epic highs, right?”
(We continue our auto-interrogation, after an interruption when we were traveling.)
Yep, is our reply.
“On what do you base this guess?”
Experience, intuition and theory. Once a major top is reached, you should expect a major bottom.
“Okay, but what about bonds? With yields at 50-year lows, haven’t bonds reached a major top? Shouldn’t we sell?”
Ah…good question. “Maybe” is our good answer. Bonds have been in a major bull market for many years – as interest rates have fallen for the last 21 years. But, unlike stocks, the bull market in bonds has not yet topped out. Bonds continue to rise – even while the U.S. Treasury Secretary and Fed Reserve governors do all they can to destroy confidence in the dollar.
Sakakibara explained it; the Fed created a bubble in the bond market by lowering rates and pushing money into the system. And as Eric describes below, the Japanese – either because they are fools or geniuses – are taking advantage of it.
Most everyone we know takes the Fed at its word and on its record; if there’s one thing the Fed can do, say they, it is destroy the dollar. And almost all economists believe the Fed has the tools to do the job. “We have…a printing press,” Ben Bernanke confirmed last August.
“Fears of deflation are overblown,” concludes an MSNBC report. So says a “panel of prominent economists”, otherwise known as the “shadow open market committee.”
Well, that does it for us here at the Daily Reckoning. If prominent economists think this whole deflation thing is “overblown”, it must be a lead-pipe cinch that deflation will never be a problem.
But prominent economists in Japan – notably Eisuke Sakakibara himself – don’t believe it. They’ve watched deflation gradually wear down prices…despite their efforts to inflate. And now they see a way to profit from it – by buying America’s bonds in anticipation that the U.S. economy will follow Japan’s lead.
Can bond prices continue to rise? We note that long bond yields of 2.5% were common in the ’50s. And while nominal yields are at record lows, real yields still have room to fall. As deflationary forces knock down prices, the difference between the nominal yield and the real yield widens. Even at a zero percent nominal yield, if inflation were running at minus 3%, bond holders would still realize a positive return of 3%. Tax-free.
Richard Bernstein of Merrill Lynch points out that, historically, people have kept about as much of their investment money in bonds as in stocks. Now, they are overweighted towards stocks, with two thirds of their money in them. By this measure, too, bonds have room to go up.
So who knows? The Japanese are buying. Usually, whether it is golf courses, great paintings, landmark real estate or stocks, they buy at the top…but even the Japanese are not reliably moronic.
We’ll have to wait and see…
Eric Fry in New York…
– Monday’s anxiety-inducing 185-point Dow selloff inspired very little “dip-buying” yesterday…The dips simply refused to buy. A tepid early morning advance evaporated by the closing bell, as the Dow and the Nasdaq fell a couple of points each.
– We’ve heard all the swell reasons why investors should be buying stocks right now. The Wall Street strategists have told us that corporate earnings will recover in the second half of the year and that Greenspan will keep his omnipotent thumb on interest rates…Sounds swell! But we are still not convinced.
– For one thing, we’ve noticed – without any help from the Wall Street strategists – that Snow is raining on the dollar’s parade…which could be a big problem for the stock market. Treasury Secretary Snow’s mystifyingly stupid efforts to “talk down” the dollar could lead to a major loss of confidence in ALL dollar-denominated assets, especially stocks selling for 35 times earnings. At least the Bush Administration is consistent; its domestic policies are as reckless and cavalier as its foreign policies…But that’s just one Republican’s opinion.
– While stocks were taking a breather yesterday, gold and government bonds both continued their bizarre, joined-at- the-hip rally. The gold market added to Monday’s hefty $9.50 gain by advancing another $2.30 to $366.70 an ounce.
– Meanwhile, the bond market continues to dazzle and amaze. Bonds refuse to yield…literally. The 10-year and 30-year issues seem to yield less every day. The 10-year Treasury note ended yesterday’s trading session yielding a 45-year low of 3.36%. The 30-year bond soared two points, pushing its yield to a new record-low of 4.37%, compared to 4.48% on Monday.
– The New York office of the Daily Reckoning steadfastly believes – wrongly, so far – that the U.S. bond market is one of the most compelling “sells” in the world of global finance. It’s conceivable, of course, that the 10-year yield will plummet below 3% before marching higher. Heck, the yield could fall to 2%! Nevertheless, your New York editor would take the bet (in small quantities) that one year from now, the 10-year Treasury yield will be higher than it is today.
– So who’s buying these things?…The Japanese?…That’s Stephanie Pomboy’s theory, and it seems plausible to us. “The action in the 30-year has Japan’s fingers all over it,” observes Pomboy in her latest missive from MacroMavens. “After all, the Japanese are desperate to stem the rise in the yen. They can accomplish this by continuing to drop yen in the vast foreign exchange ocean or, more effectively, they can step-up their purchases of U.S. assets.”
– Pomboy continues: “Since the Fed’s gambit to debase the dollar without simultaneously pushing interest rates higher requires that foreigners remain a captive audience for our soon-to-be-debauched paper, having the Japanese stick around is most helpful. Indeed, as the largest single holder by far of U.S. Treasury debt, they can make or break things for the Fed.” Hmmm…if Pomboy’s theory is on target, the Japanese could solidify, once and for all, their reputation as the world’s least value-conscious investors.
– While the Japanese are busy snapping up long-dated, low- yielding paper, America’s monetary authorities are working around the clock to insure that yen-based investors in U.S. bonds will receive large negative returns. In other words, they are working to debase the dollar.
– Snow, Greenspan, Bernanke and all the other members of Washington’s “Dollar Destruction Gang” behave as though it is prudent and commendable to destroy the dollar’s global purchasing power. They behave as though it is strenuous, noble work to destroy what preceding generations of Americans have sacrificed and struggled to create. The dollar did not become the world’s reserve currency by accident. Nor did it effortlessly and instantly become “America’s most successful export,” as James Grant calls it.
– The Greenspan-Snow project to weaken the dollar is like the work of a man who lines the perimeter of his house with kindling and firewood so that he may burn it to the ground more easily. If the man were to succeed in burning his house to the ground, would his family praise his hard work? Would his children say, “Dad, this is great! Now we can dine al fresco EVERY night! You’re a genius!”?
– We think we understand the lunatic theory that motivates the dollar-destruction project. A weak dollar, in theory, spurs export growth while reflating the economy. We think we understand, therefore, why the U.S. Treasury and the Fed consider it “God’s work” to crater the dollar. But we suspect that a steep dollar decline would produce devilish consequences for our economy…while sending the gold price heavenward.
Bill Bonner, Back on Amelia Island…
*** Steve Sjuggerud’s house backs up to a golf course on one side…the ocean is not far away on the other.
“But this is not an expensive house,” Steve explained. “In fact, there really aren’t many areas of the country where house prices have gone crazy. I looked at the real estate trends of the last 20 years and adjusted prices for inflation. You see right away that house prices are not in a bubble. In fact, they’re more affordable than they’ve been for two decades.”
*** The population of Amelia Island has doubled in the last 4 years, Steve told us. But the place doesn’t seem crowded. Last night, the ‘downtown’ area seemed deserted. Restaurants had few customers. There were almost no people on the sidewalks.
“It must get busy in mid-winter,” we suggested.
“Not really,” Steve replied. “It’s pretty quiet here all year round.”
*** The decline in the dollar so far, opined John Snow over the weekend, has been “really fairly moderate.” To many observers, this suggested that U.S. monetary officials expected more. Maybe they even wanted more. For weren’t they now saying that a moderate decline in the U.S. dollar would be good for the economy?
George Soros and other currency speculators hit the bid, selling dollars, and thus giving the U.S. Treasury Secretary what he seemed to be asking for.
Snow had spoken honestly at the G8 meeting in Europe. He gave his views of a strong dollar as one in which people had faith, not necessarily one in which they wanted to store their wealth.
“The problem is,” explains Bill Fleckenstein, “you cannot get your currency to go down a little bit to where you want it, and then assume it will stop there. Once these things are put into motion, they always go longer than you think possible, and they always overshoot. I think we have an incredibly dangerous period in front of us, as our financial, economic, and balance sheet situation is far riskier than the last time we had a dollar crisis, which was in 1987. The economy was overheating then. Now I believe it’s getting set to contract. The world is swimming in dollars. We have a monstrous amount of debt outstanding. The size of our trade deficit, $1.5 billion a day, is just gargantuan. Plus, we’ve got trillions of dollars’ worth of derivatives exposure. So, if you wanted to set the stage for a potential dramatic accident, it’s been set.
“I can only shake my head at the economic folly of the last seven or eight years as we have tried to speculate our way to prosperity. So many people have been misled into thinking the policies were all good or manageable. How this all plays out is not yet knowable, but it’s a given that we face financial and economic turmoil. When one’s own government, against a backdrop of precarious fundamentals, stands up and says, “Sell our currency,” which is basically what Snow did, it’s a recipe for disaster.”
*** “Gold should be at about $700 right now,” estimated analyst Paul Van Eeden at yesterday’s private conference. “$3000 an ounce is more like it,” added my old friend, Doug Casey.