Letters to the Editor: Peak Oil

My articles on Kuwaiti oil reserves, oil reserve estimation, and the president’s State of the Union speech generated a lot of thoughtful commentary from the readers. We appreciate that you take the time to think about what we are writing, and even more that you care enough to comment. Here is a sampling, starting with an e-mail to Greg Grillot from Bob in Upland, Calif.:

“Byron does understand oil. Would it be an imposition for him to tell us when he feels we will see $100 oil so I can look for some profits in my oil investments?“

Byron’s Reply: Thank you, Bob. I have been following the oil industry for over 30 years. I read the geology and engineering textbooks in college, and got oil on my boots while working for the former Gulf Oil Company (now part of Chevron) in the Exploration & Production Division. I left Gulf to spend some time in the U.S. Navy, another story entirely. But through it all, then and now, I have spent time in the oil patch and kept up on the technical literature.

In my present occupation as an attorney in Super Bowl Steelers country, I do a lot of things, to include working in the arenas of land and leasing and oil and gas development. So yes, I like to think that I understand oil. But I assure you that almost every day I learn new things about oil, its history and chemistry, and the nuts and bolts of the oil business. There is no end of knowledge.

As to the question of when we will see $100 oil…First, the disclaimer. I do not have a copy of tomorrow’s newspaper, let alone the newspaper for next week or next month. If, for example, there were a terrorist bombing that severely damaged or shut down a loading terminal in Kuwait or Saudi Arabia, you would see the price of oil shoot up on a trajectory like that of the space shuttle. Or if things keep on heating up with the situation in Iran, and the government of Iran decides to interfere with the tanker routes in the Straits of Hormuz, you will see the price of oil simply explode.

Will something like this take place next week or next month? I sure hope not. But could it occur some time? Yes, it is possible. So there is your $100 oil, and a lot more. My colleague Dan Denning has written extensively on this topic in his monthly newsletter, Strategic Investment.

Getting back to Bob’s question, absent some extreme terrorist or military event like the examples I used above, will market forces keep on pushing up the price of oil? The short answer is yes, so just wait and watch. The longer answer is that there are day-to-day fluctuations in the price of oil due to those same market forces. So the listed price for oil goes up, and then the price comes down.

My opinion is that you should use the pullbacks as an opportunity to accumulate positions in well-managed companies with ownership interests in oil and gas in the ground. Or, equally as good over the long term, you should be investing in firms that provide critical services and equipment to the oil industry.

If you attended the Agora Wealth Symposium last August in Vancouver, you may have heard me give a plug for one of the best-managed oil field service companies in the business, Core Laboratories (NYSE: CLB). Since last August, the price of the stock in Core Labs has increased by about 75%. Why? Core Labs provides services to oil producers, as well as to pipeline and refinery operators, that increase the efficiency of recovery of oil from the ground, and in throughput and output from refineries. In other words, Core Labs provides services to people who already have the oil in hand, so there is no geological risk, or no “dry holes.”

Core Labs assists operators in determining the best way to produce oil from the rocks in the ground, such as to maximize ultimate oil recovery. In addition, Core Labs assists pipeline companies in improving efficiency in transmission, and assists refiners in maximizing the product yield from a barrel of oil. As the price of oil rises, the value of the services provided by Core Labs increases in tandem. The company is a moneymaker in this business. Obviously, you should do your own research on any investment, but Core Labs has been a great company during the past run-up in the price of oil.

If you will indulge me just a bit more on the subject of investing, my colleague Justice Litle publishes a monthly newsletter called Outstanding Investments, which focuses on exactly these types of opportunities in natural resource and energy companies. Justice’s newsletter has been rated No. 1 in its class by the authoritative Hulbert’s Financial Digest.

A reader named Roger from West-by-God Virginia e-mailed me to say the following:

“In your article on the State of the Union speech, you referred to the ‘so-called free market’ for fuels and energy sources. Why did you characterize it that way? Do you think that the government should plan and run the energy markets of the country?”

Byron’s Reply: Good question, Roger. Why did I use the expression “so-called free market?” To paraphrase former President Clinton, It depends on how you define “free market.” First of all, we denominate all of our economic activity in U.S. dollars, which are also Federal Reserve notes. (Just look at what it says on the face of your greenbacks.) So right away, we run our economy via a government “plan” for the currency.

The Federal Reserve has done a poor job of managing the U.S. dollar over the years, which is why a nominal dollar from 1913, the year when the Fed was established, is now worth about 4 cents. And this figure is straight from the records of the U.S. Treasury Department. So right away, you might figure out that the United States is having a long-term problem with its currency.

I do not want to get into a discussion of monetary theory, but the inflation in the currency supply over many decades and the decline of the U.S. dollar over the years has done much to corrupt what would otherwise be the natural flow of funds into energy investment.

If inflation destroys capital, then we have a big problem. There are few industries more capital-intensive than the energy industry. How does one plan for long-term energy investment in an era of monetary inflation and corruption of the currency?

The U.S. government is running massive deficits. The national debt is out of sight. Interest payments on the national debt are not quite, but approaching, the size of the budget for the Department of Defense. The U.S. economy, and the U.S. government in particular, relies upon over $2 billion of foreign loans every day just to keep the lights on. And we flatter ourselves to think that we live in a “free market” economy? I don’t think so.

Getting more specific to oil and gas and related hydrocarbon fuels, let’s take a look. Over a period of many years, the federal and state governments have been taxing gasoline at the pump and using the funds to build highways. The highways have not just provided access to relatively undeveloped countryside, but subsidized the expansion of human activities distant from the nation’s traditional urban cores.

For a long time, we called it “growth.” But now we have a nation that is a landscape of urban sprawl, and an associated lifestyle of commuting. Would the present state of cities like Los Angeles, Las Vegas, or Phoenix be possible, particularly in such arid climates, without cheap gasoline and subsidized roads? No way.

Compounding the problem, most freight in the nation travels in over-the-road trucks, with an average fuel burn of 4 miles per gallon of diesel. Author James Kunstler refers to the “3,000 mile Caesar salad,” meaning that the lettuce you ate with your lunch came to you via refrigerated truck, over a 3,000 mile road network. All of this rests on the depleting resource known as oil. Is this mixture of tax policy and government roads really the hallmark of a “free market” economy? Or ask the related question, is this sustainable over time, considering the rather rapid depletion of the world’s known oil reserves? No way.

Roger also asked if I think that the government should run the energy markets. No, no, a thousand times no! Let private industry drill the wells, run the pumps, refine and ship the product. Let private industry build the plants of the future, and market and deliver the energy supplies that the population will require. The government should seldom be in the business of turning wrenches on the main stack of plumbing.

But that does not mean the federal and state governments should not play a role in developing a national energy strategy. There are innumerable issues that need to be addressed in such a strategy, far more than I can detail in this article. But I should say that a national energy strategy needs to address current and future demand patterns, sources of supply, future levels of technology, as well as how we intend to pay for it as a nation. And let me add that it will not be cheap.

Sweden, for example, is presently taking the most significant strategic step of any advanced Western economy by trying to wean itself off oil completely within 15 years. According to the “energy committee” of the Royal Swedish Academy of Sciences (the same people who hand out the Nobel Prizes), there is a growing awareness that global oil supplies are peaking and will shortly enter into the phase of irreversible decline.

In connection with this impending Peak Oil event, the Swedish government believes that a global economic recession will result due to oil shortages and high oil prices. Thus the official policy of the Swedish government is to replace all fossil fuels with renewable energy sources before climate change destroys economies, and growing oil scarcity leads to huge new price rises.

According to Swedish Minister for Sustainable Development Mona Sahlin, “our dependency on oil should be broken by 2020… There shall always be better alternatives to oil, which means no house should need oil for heating, and no driver should need to turn solely to gasoline.” Another Swedish government official has been quoted as saying, “We want to be both mentally and technically prepared for a world without oil. The plan is a response to global climate change, rising petroleum prices, and warnings by some experts that the world may soon be running out of oil.”

Sweden has an energy committee composed of the people who award the Nobel Prize? Sweden has a minister of sustainable development? Sweden wants to become mentally and technically prepared for a world without oil? Very clever, those Swedes. (And have you driven a Volvo lately?) You did not hear anything like this in the State of the Union speech, now did you?

I received another e-mail from David, a professor of chemistry at an Ivy League university. David said:

“What I would like to know is how many of those guys out there promoting ethanol know that an ethanol-based fuel is energy-negative by a mile? And even if you could make it energy-positive, the very act of growing ethanol to burn as motor fuel would turn the world into one big dust bowl. I guess the question is, how many of those guys are clueless and how many are simply liars? …

“It would be great if the Peak Oil crowd was as nuts as people say (ed: Oh yeah? Smile when you say that, pal). But I’ve looked at it as much as a non-oil specialist can look at it and still hold down a job. I concluded that it is a scary scenario. What is particularly problematic for me is that my training as a physical scientist helps me see the proposed alternative energy technologies for what they are — a load of baloney in many cases.

“I spent a particularly harrowing hour with a high-ranking official from the U.S. Environmental Protection Agency who answers directly to President Bush. He was not a tree hugger but he sure took Peak Oil seriously. I asked him for his best guess on the date and he said, ‘2010.’ Of course, that answer is becoming a little too common for comfort. It is scary. We talked about the alternatives and he could not have painted a more gruesome picture. He also expressed utter amazement at the complete lack of attention to the issue.”

Byron’s Reply: This is why I love reading the e-mails from our readers. I happen to know who David is and where he works. He is a top-notch researcher in the field of chemistry and chemical biology, and firmly established in the upper echelons of American science. David’s e-mail speaks for itself. Do me a favor. Read it again. It is that good.

There is no lack of attention to the Peak Oil issue from me here at Whiskey & Gunpowder. I have been banging this drum, in one way or another, since Bill Bonner invited me onboard and I published my very first article, entitled “The Ghost of Colonel Drake.” (Thanks Bill!) And neither is there any lack of attention to the Peak Oil issue from my colleagues at Agora Financial. We are there. We are onboard. We are serious. And, to be purely mercenary about it, we have made some money off the issue. But if you wait for the band to start playing “Nearer My God to Thee,” it will be too late.

One final comment and parting shot. If I still have not convinced you of the merits of the cause, you ought to know that Peak Oil people have better parties, and hang out with prettier girls and cuter guys.

Until we meet again…

Byron W. King
February 14, 2006