Does Peak Oil Really Matter?

The Daily Reckoning PRESENTS: Peak Oil is certainly a serious matter in the long run – but in the near future, Justice Litle asserts that the phenomenon will not a have a direct impact on the energy landscape. Read on…

DOES PEAK OIL REALLY MATTER?

Does it really matter that the United States has two trillion barrels worth of recoverable oil shale resting in the shadow of the Rockies? Not anytime soon it doesn’t.

Before you spit out your coffee, let me explain. (If I’m too late, I apologize.)

In terms of the long run – we’re talking decades here – Peak Oil is serious business. The same is true of that oil shale bonanza out in Colorado and Utah. Eventually, we might find the will and the way to tap it. But in the intermediate term…meaning the next five years or so…neither Peak Oil nor recoverable U.S. oil shale will have any real bearing on the energy landscape.

While it may be playing an indirect role, the Peak Oil phenomenon has not kicked in as a direct price driver for energy yet, and may not do so for a while. It is true that Saudi fields are looking sketchy to some outsiders, and new replacement reserves are getting harder and harder for the globetrotting oil majors to find. But there are more factors there than meet the eye. The toughness of finding new replacement reserves, for example, is arguably more of a geopolitical issue – it has a lot to do with state-run energy behemoths muscling out the private players where the pickings are good.

Back to U.S. oil shale. I’ve had a number of my Outstanding Investment subscribers write in after receiving a special report titled “The U.S. Government’s Secret Colorado Oil Discovery.” It spoke of “the next American oil boom” and said the United States could become “the new Middle East.” This led at least a few readers to ask reasonable questions like, “What does this mean for the energy bull market?”

How does this affect the Peak Oil scenario?

Consider this recent quote from Bob Loucks, a former manager with Shell who oversaw its shale oil recovery operations: “Despite all the attempts to develop a shale oil industry in the United States over the past 100 years, the fact remains that no proven method exists for efficiently moving the oil from the rock there are a number of candidate processes possible, but none has demonstrated a practical 3 capability to produce oil.”

Bob Loucks is no diehard pessimist or skeptic. In addition to his field experience, he is also the author of the book Shale Oil: Tapping the Treasure. Loucks is long-term bullish on the prospects for America’s oil shale. But he recognizes that, here and now, we are still not there yet technologically.

There are a number of problems yet to be solved before U.S. oil shale can be recovered on any type of meaningful scale, let alone a mass scale. And getting the extraction technology right is only one monkey wrench in the works with U.S. oil shale. There are others.

For example, there are questions of air quality regarding domestic oil shale operations. How badly would these operations pollute the air? Would the levels be acceptable? Shell isn’t sure.

There are questions of water availability. During the extraction process, how much water would be required? Shell isn’t sure. An early “guess” is two to three barrels of water per barrel of shale. This could be a conservative estimate. Either way, will the massive amounts of water necessary for heavy-duty shale extraction even be available in the first place, given that the Colorado River Basin is already running low? There are seven Western states – fast-growing states – fighting over the Colorado River’s water as it is. Are they supposed to happily set aside their interests and share water rights with a humongously thirsty newcomer? Oh, and there are farmers with skin in the game, too.

There are questions of a power source. Just as it takes money to make money, it takes energy to recover energy. Regarding a study that took place last year, the Grand Junction Daily Sentinel reports:

“The 2005 RAND study estimated that a commercial- scale oil shale plant for Shell would require the construction of the largest power plant in Colorado history, costing about $3 billion, and would consume 5 million tons of coal each year and produce greenhouse gases in the process.”

Environmentalists are still up in arms over itty-bitty ANWR (the possibility of drilling in the Arctic National Wildlife Refuge). Do we expect the green crusaders to smile and go right along with construction of the largest coal-fired power plant in history in one of America’s most beautiful Western states, when a patch of Alaskan ice and a couple of scraggly caribou already had them lathered into a frenzy?

We may actually tap America’s oil shale one day. But it won’t be today. Nor tomorrow. Nor the day after. That day will be many, many years into the future, if ever. There are just far too many logistics problems yet to be solved: technological issues, water issues, power issues, labor issues, political issues. As noted here before, the West is famous for NIMBY and BANANA politics (“Not in My Back Yard” and “Build Absolutely Nothing Anywhere Near Anybody”). Trying to develop oil shale deposits in Colorado and Utah here and now would blow up into the biggest NIMBY/BANANA double-whammy environmental debacle of all time.

For those of you who still worry what the overhang of recoverable U.S. oil shale might do to the energy markets, a simple question: Remember Canada? Our neighbors to the north are sitting on their own private Saudi Arabia too, in the form of the Athabasca oil sands. We’ve all known about that for a while. And those oil sands are being developed at flat-out top speed; because the Athabasca region is so sparsely populated, Canadian oil sands have virtually none of the NIMBY/BANANA headaches a U.S. oil shale project would face.

Consider why oil is still in the $60s and $70s with all that northern bitumen just ready for extraction. How can it be that the price of crude is so expensive when there is so much recoverable oil in the ground? Because the whole trick is getting it OUT of the ground.

I’ve used this analogy before, but it’s the best one I can think of offhand. Imagine a magic gas station with tanks that never run dry. Infinite amounts of gasoline for all! Now imagine that this one magic gas station has to serve thousands of cars at once with its six pumps. It doesn’t matter that there is plenty of gasoline for everyone. The problem is getting it out of the ground (or, in this case, the tanks). With only six pumps and thousands of cars waiting to fill up, you are going to get gas lines hundreds of cars long. And that gas is going to be very expensive, even though there is plenty of it (a virtually infinite supply of it!) because high prices are a clearing mechanism for determining who really wants it bad when real-time availability is limited. The problem is a bottleneck in extraction and distribution.

This is analogous to our present-day scenario, and the main reason I don’t think Peak Oil matters much for the time being. The high cost of energy is being set at the margins and driven by an intersection of demand and geopolitics. Secular demand for energy is growing at such an aggressive long-term clip that available supply sources are running flat out to supply it. Oil fields have a maximum rate of output per day; if you push an oil field too hard, you risk permanent damage and a loss of some of the reserves. It’s a good thing substitution technologies are already starting to kick in, because if they weren’t, prices might be even higher.

It is an infrastructure problem…a bottleneck problem. The fact that there are billions of barrels worth of recoverable oil in the form of tar sands and shale doesn’t really matter at this point. Heck, “peak infrastructure” is a better explanation than “Peak Oil” for the long-term commodity bull. At some point, the world’s inadequate extraction and distribution infrastructure for energy and metals will finally catch up with demand – and when that happens, the commodity boom will be well and truly over. But that day is 5-10 years away or more.

I would love it if that Colorado oil shale report were true. It wouldn’t be so hot for oil stocks – when you think about it, everything BUT oil stocks would boom if America became “the new Middle East” – but it would be a wonderful benefit for the United States and the global economy. Too bad the logistical conclusions are impossibly, ridiculously optimistic.

The main point here is that the long-term energy bull market we are in is more of a demand-driven infrastructure arbitrage, playing out over a period of many years, than a Peak Oil phenomenon. By the time Peak Oil really kicks in, things on the ground will look quite different. And we will hopefully be much farther down the alternative energy road than we are now, enabling us to better deal with the strain.

Regards,

Justice Litle
for The Daily Reckoning
June 21, 2006

P.S. One thing is for certain – we can’t rely on Saudi oil indefinitely…because despite what most people think, their supply isn’t unlimited. In fact, Saudi oil production is about to drop sharply – and then keep going down for good.

Once the truth about the Saudi oil situation gets out, it will send shock waves through the global economy. Find out how to protect yourself and get rich off energy sources and technologies that the world will scramble to buy at any price.

Editor’s Note: Justice Litle is an editor of Outstanding Investments, ranked number one by Hulbert’s Financial Digest for total return performance over the past five years. He has worked with soybean farmers, cattle ranchers, energy consultants, currency hedgers, scrap metal dealers and everything in between, including multiple hedge funds. Mr. Litle also acted as head trader for a private equity partnership, and made contributions to Trend Following: How Great Traders Make Millions in Up or Down Markets, a popular trading book by Mike Covel (FT/Prentice Hall).

A large headline in the Financial Times proclaims: “Global economy heads towards a soft landing.”

It is a marvelous line, made unwittingly more poignant for being placed over a photo of an addled-looking Noel Forgeard and an Airbus 320. Neither Airbus nor Forgeard managed a soft landing last week. Both crashed…the former because it couldn’t deliver the planes it promised and the latter because he sold shares in advance of a profit warning that sent the aforementioned stock down like a kamikaze pilot. Five billion dollars was wiped off of Airbuses’ capitalization. Good timing on Forgeard’s part.

What the article itself was concerned with was not the sudden crash of Airbus, but the gentle descent of the entire world economy. How do we know it will land softly? Two hundred and forty economists have said so.

“Economic growth is set to slow this year and next amid rising interest rates, weaker house prices, high commodity and energy prices and fresh geopolitical tensions,” the FT summarizes. “The global liquidity bubble, which propped up global growth for so long, is now being pricked by central banks desperate to stem surging consumer price inflation.”

Here at The Daily Reckoning we watch the markets, too, and even more, the market commentary.

Ms. Market, we have found, is like a woman – coy, changeable and contemptuous of our efforts to understand her. Will she be perky and charming today? Or will she be sulky and distant? What is bothering her now? Oh my, my…she seems frisky today, doesn’t she? We will never fathom what moves her; we might as well be a golden retriever trying to decipher the Tokyo train schedules.

But market commentary is another thing altogether. It is more masculine, which is to say it is more logical, more understandable, more reliable, and more thoroughly imbecilic. Just read the papers. You will find analyses there that even a 10-year-old could grasp. Are they correct? No more correct than a man trying to dope out his mistress’s moods. Are they useful? Yes, of course. Mainly because they are almost always wrong.

Commentators, it seems, are from Mars. Markets are from Venus.

And like Mars and Venus, they move in separate orbits.

We say that, mind you, in earnest admiration. Not of the financial media nor of the pundits, but of the elegant way in which the world is designed to deceive the mass of men. In order for the markets to function as they do, most investors must be wrong most of the time. Otherwise, they would look ahead and thwart the trend. A developing bull market requires that most people distrust it. Otherwise, they would jump in right away and bring the whole thing to a premature conclusion. Likewise, a market peak needs a preponderance of bullish investors at the very moment when bullishness is the most unprofitable sentiment one could have.

The financial media, amplifying popular sentiments rather than filtering them, helps investors arrive where they shouldn’t be exactly when they most shouldn’t be there.

As near as we can tell, the league of extraordinary economists is right so far. They have only to look out the window; the sky is so dark with inflation hawks, it looks like a scene out of “The Birds.” German producer prices are rising at the fastest rate in 24 years, we learn from yesterday’s press. The European Central Bank is tightening up to fight it. In Japan, the ZIRP – or zero interest rate policy – is set to end “without delay,” says the country’s top central banker. China, meanwhile, has begun taking liquidity out of the market as quickly as its own central bankers can manage. And, in America, a further rate increase next week is said to be a “done deal,” with another one now expected in August.

“By curtailing the rate of growth of liquidity and making it more expensive for companies or individuals to borrow,” the FT continues, “central banks are hitting share prices, bond markets, commodity and precious metal prices as well as the international housing market.”

Again, we see nothing to argue with. We have seen what has happened in the financial markets. Houses are not marked to market the way copper and Airbus shares are. If they were, we suspect we’d see a decline there, too.

No, it is not the landing we doubt. That is a known and well-reported fact. It’s the qualifier “soft” that we wonder about. How do 240 economists know we will have a landing that is soft rather than hard? How do they know what mood Ms. Market will be in tomorrow or the day after? How does a Martian understand what a Venusian is up to?

They don’t. They have no more idea than we do. But their unanimity gives us a clue about where the money will be made. With so many people betting on a soft landing, the long odds on a hard one are bound to be attractive.

More news from The Rude Awakening…

————–

Greg Guenthner, reporting from Charm City:

“Ethanol is a rock star on Wall Street, and every brokerage firm knows it. That’s why the pin-stripped hucksters at Wall and Broad have been dressing up lots of ethanol companies as hot new IPOs to sell to an adoring public.”

For the rest of this story, and for more insights into today’s markets, see The Rude Awakening.

————–

And more thoughts from England…

*** Financial crises often destroy the middle and lower classes. The rich figure out what is going on. They find ways to protect themselves. After all, how did they get to be rich in the first place?

On the other hand, America’s middle classes have no idea what is happening to them. They do not understand the Fed, credit bubbles, debt, or paper currencies. And why should they? They have public officials, and elected representatives, who are supposed to watch over those details for them!

But their public servants lie to them…and set them up, leaving them unprepared for what could turn out to be one of the worst financial catastrophes in history. Didn’t Mr. Greenspan himself tell them that it was safe to put money in mutual funds in the late ’90s, because “once or twice in a century [comes] a phenomenon that will carry productivity trends national and globally to a new, higher track”? And didn’t this same bureaucrat urge them to take advantage of adjustable rate mortgages in the heyday of the real estate boom? And now, they are told that jobs are plentiful and their incomes are rising. “Keep on borrowing,” is the sotto voce message.

Mr. Bush thinks he should get more credit for creating so many jobs and so much prosperity. He is puzzled by why Americans are not more grateful. Here, we rush to explain:

Jobs are plentiful, that much is true. But they are jobs that don’t pay very well. And while average incomes are going up, incomes for most people are not. In fact, there are more and more people earning less and less. Average wages are rising, because pay levels at the top are soaring. Goldman Sachs employees, for one, have never had it so good. But for most people, wages are going down. Weekly wages fell 0.7% last month. They’re down 0.2% for the year. Half the months from ’01 through ’04 saw no wage gains. And for 90% of workers, those earning less than $184,800 per year, median incomes fell 0.5% during the period ’01-’04.

These are the same people who don’t pay cash for their houses, who depend on jobs for their livings, and who, especially lower down the income ladder, have no savings and owe large amounts on small houses, which they service out of small incomes. Now, their ARMs are being reset higher, even as their house values and incomes drift lower.

The feds spared the nation a serious correction in 2001. But they did it at the expense of America’s working classes, who were lured deep into debt in order to keep spending. Now that rates are rising, they find it impossible to continue. And they are left in a position you might wish upon your enemies, but not your friends. They are not only relatively poorer than they were – compared to the rich in America as well as the poor in Asia, whose incomes have been racing ahead – they are poorer in absolute terms, too. Their net assets are few. Their debts are many. And their incomes are lower than they were five years ago.

When middle and lower classes finally figure out what has happened to them, they are not going to be very happy about it.

*** “Enjoy the party,” said our friend Tim Price late last year, “but make sure you dance near the door.” You can do that in the financial markets…by buying put options, setting tight stop losses, or using a form of portfolio insurance. But what can you do in the housing market? There, by the time you realize the party is over, the doorway is already jammed with people trying to find their car keys. For Sale signs go up quickly. Before you know it, the buyers disappear. As soon as they sense falling prices, they wait…hoping to get the property they want at a lower price.

*** “It sounds like Representative Tim Ryan (D-17th district) of Ohio read your book Empire of Debt,” writes one reader. “I saw him on CSPAN last night with the charts of interest and the long term results of economic damage with the money being sent overseas, particularly China and Japan.”

*** Another reader writes:

“Sign of the Times? Here’s a message I received today on our local-community e-mail list.

“‘Gas siphoners have been hitting our neighborhood regularly in the middle of the night and they break the gas caps as well. Apparently they are in a red truck. We are across the street from Schallenberger Elementary School. They hit numerous houses in the area frequently.’

“Where do we live?

“In an upscale area in the heart of Silicon Valley.”