The Dollar and the Price of Oil

One of the major energy facilities in the Gulf is the Louisiana Offshore Oil Port, or the LOOP. The LOOP is basically an oil terminal located at sea, south of Port Fourchon. The LOOP is designed to handle ultra-large oil tankers up to 750,000 tons — about 10 times the size of a Nimitz-class aircraft carrier.

These huge oil tankers get built (most of them in Korea), and after launch, they hardly ever pull into port again. They’re just too big (over 1,500 feet long.) They don’t fit into most of the world’s harbors. So the big tankers load up on oil at offshore terminals in oil-exporting nations and offload at places like the LOOP.

At any rate, the LOOP handles about 1.2 million barrels of oil per day of U.S. imports. That’s about 13 percent of total U.S. imports. So if the LOOP goes down? Houston, we have a problem.

And where does that LOOP oil go? It gets pumped ashore, of course, and that requires electricity. Once the oil comes ashore, it gets stored in subterranean salt caverns. (The LOOP storage facility holds about 50 million barrels of oil.) Again, lifting and moving all this oil requires lots of pipelines, pumps and electricity.

So there is a lot of worry about any damage to the LOOP or its associated pipes, pumps and electric power. If we lost the LOOP, U.S. oil markets would suffer greatly. And anticipating this, with our last hurricane threat (Gustav), the U.S. Minerals Management Service announced that it would release oil from the Strategic Petroleum Reserve in case of any significant loss of output from the Gulf offshore. So if the LOOP went down, the MMS was ready to turn the valves on the SPR. That’s pretty serious stuff, eh?

Concern About Other Damage

In addition to the surface structures south of Louisiana, that part of the offshore energy patch has many thousands of miles of underwater pipelines and other installations. So if the water column got churned up? That could lead to seafloor scouring, underwater mudslides or slumping. Really, it could have become a total mess.

And what about the oil industry ashore? What about the electrical infrastructure? The big problem with Katrina for the oil industry was that a lot of power lines went down. There was not enough electricity in the wires to run pumps, both to drain water and to run refineries. And without pumps, the pipelines don’t work too well, either. So oil, gas and refined products cannot move.

OK, this whole hurricane in the Gulf of Mexico thing could have been a mess.

No Disaster, Oil Falls, Dollar Rises

But there was no hurricane energy disaster. Gustav rolled right down the center of the alley. By rights, it should have been a strike. Gustav had the aim. Gustav followed the right track. But Gustav didn’t knock down any pins. Gustav went over, under, around and through some of the most densely packed drilling infrastructure on the planet. And Gustav caused very little damage — at least based on what we know so far. It’s a credit to the robust design and construction of the offshore facilities and equipment.

So lacking severe damage, the price of oil fell. And the price of natural gas fell. And even the price of gold tanked, below $800 per ounce.

But are these price changes just because the Gustav winds didn’t blow hard enough? Or because the waves were not high enough to damage the energy platforms? No, not at all.

The other side of the energy story is the dollar story. The U.S. dollar has been rising lately, since mid-July. And that’s actually the larger story. The dollar is up against the euro, the pound and numerous other world currencies.

The strengthening dollar means that prices for energy, precious metals and commodities are weakening. But that does not mean that the long-term bull market in energy, precious metals and commodities is over.

It’s not as if the energy industry is finding large, new areas of oil and gas deposits. That’s not happening, and it’s worse for the West because resource nationalism is placing more and more of the world off-limits to the established firms.

And it’s not as if there are vast new deposits of precious metals being discovered, let alone mined. Indeed, South African gold production is on track to fall 10 percent this year, due to power shortages and exhaustion of high-grade reserves.

Part of the world (Europe) is in a recession. Part of the world (Asia) is starting to show signs of a slowdown in growth rates. And the U.S. banking system is broken, so the credit market has seized up like an engine without any oil in the crankcase.

As all of this goes on, it’s frustrating to watch energy companies decline in value. These are good companies, with solid business models and fine management teams.

Firms that control deposits of energy resources, precious metals or other minerals or unique technology OUGHT to be doing well. But in this market, a lot of good firms are getting taken down with the bad ones.

Here’s something to keep in mind. When the turnaround comes, it will be the good firms — with control over resources or technology and with good management — that should turn around first.

Until we meet again…
Byron W. King
September 16, 2008

The Daily Reckoning