Narcissistic Somniloquist

It’s interesting to watch a documentary that advocates the free market at the same time when the biggest financial crisis since the Great Depression is unfolding.

The documentary is based on a book by Daniel Yergin and Joseph Stanislaw.  It tells the story of how competing economic views jostled for the mind-share of governments and the public since World War I.  The narrative covers the historical background of our modern economic system.  It describes how Keynesian economics reigned during the post-WW II era where state control and regulation of major sectors of the economy were the dominant economic ideas and how the shift to free markets started during the Reagan / Thatcher administrations in the 80s.

The authors have a strong disposition towards the free-market and ideas from Jeffrey Sachs and Milton Friedman are illustrated with case studies.  One shortfall of this documentary was that it avoids cases where government intervention especially in numerous East Asian economies played a key role in developing local industry.

What I found tremendously useful was the context in which Commanding Heights lent the current financial crisis.  There is nothing inevitable about globalization or free markets - the “borderless world” that I’ve grown with is probably the most important casualty one the dust settles.  The biggest risk I believe is that protectionist tendencies may overcompensate as countries try to protect and insulate themselves from these financial risks.

A recent article from the Independent was forwarded to me with the headline “Oil shortage a myth, says industry insider“. I was wondering why someone in a prominent position (Richard Pike was the CEO of the Royal Society of Chemists) with little to gain from either supporting or criticizing the oil industry would make such a statement.

Well, a little more investigative work led me to the original article published in the Petroleum Review in June 2006 with a title “Have we underestimated the environmental challenge?” The title seemed like a far cry from the dramatic newspaper headline - I had to find out why.

My interpretation of Dr Pike’s original article was that it made a case for how to account for CO2 sequestration (presumably as a counter to global warming and to meet Kyoto Protocol obligations) - how environmentalists and policy makers must use the larger value (proven + probably) estimates of oil reserves, instead of just the “proven” estimates. The quote “the world is understating the environmental challenge facing generations to come” actually refers to the challenge of actually removing or mitigating the effects of greenhouse gas emissions - and not of producing sufficient oil to meet current demands.

That’s why I found it strange that the Steve Connor (the Science editor of the Independent) picked up on this article and made the connection with Peak Oil, which was not the original intent of the article. Since the article was published in June 2006, oil prices has risen from $63.44 to $135 - it’s more than 100% over two years - so my guess is that there’ll be no shortage of articles trying to explain either (1) why prices are so high and should go higher OR (2) why prices are so high and should collapse.

I don’t think there’s any contradiction with the article’s findings and Peak Oil theory - the problems anticipated by the Peak Oil theory is not one of whether there is sufficient proven or probable reserves but that the production of oil will peak and decline and this prediction is not based on assessments of reserves, but on the amount of oil discovered each year (which peaked in the 1960’s at about 55Gb/year).

The only question is: when is Peak Oil? Latest EIA statistics (http://www.eia.doe.gov/emeu/ipsr/t21.xls ) indicate that world oil production has not increased since 2005 - where the average production plateaued at a little less than 85 mil barrels/day. There is increased public awareness that oil is a finite resource - witness the number of headline stories in the New York Times and bold pronouncements of $200 / barrel and $150 / barrel prices by Goldman Sachs and Deutsche Bank analysts.

But the unfortunate fact of peak oil is that it can only be recognised after it happens.

In the Wall Street Journal today, the International Energy Agency (IEA) is said to be revising its forecasts of oil supply. Here is an excerpt:

For several years, the IEA has predicted that supplies of crude and other liquid fuels will arc gently upward to keep pace with rising demand, topping 116 million barrels a day by 2030, up from around 87 million barrels a day currently. Now, the agency is worried that aging oil fields and diminished investment mean that companies could struggle to surpass 100 million barrels a day over the next two decades.

For decades now, the IEA and it’s US government counterpart (EIA) has forecasted continuing increased oil product that kept pace with economic growth. 2008 will mark the year when these agencies (and major newspapers) finally admit that supplies will be harder to come by. There seems to be a growing awareness amongst investors about the inevitable shortages, driving the prices up.

Today, crude oil is at $135/barrel. It was just at the beginning of this year that oil prices breached the $100 barrier. Where will the limits be? Not until the world can demonstrate demand elasticity sufficient to offset the declines in supply. Right now, although gasoline consumption in the US is down, there is still little short term declines in oil consumption.

In recent months, I have reconstructed my portfolios to target energy investments. I have now broad holdings in oil exploration and production, drilling and services, rail - they have all done exceedingly well. This is probably a small consolation - I was able to identify the trends just months before the market did.
It might matter little if the entire economy is wrecked and there is widespread depression - but why not make hay while the sun shines.

I’ve been participating the the Motley Fool’s CAPS rating system as player ‘akok‘. Here, I share my picks for the impending realities of declining oil production - its not difficult to predict winners or losers. Just extrapolate fuel prices to twice its current level - I’m sure we’ll see $10/gallon gasoline or $300/barrel oil in the next five years (or sooner). Figure out which industries which consume lots of energy, but do not contribute to energy production while serving discretionary consumer spending (e.g., airlines, automobile manufacturers) - these are the losers.

One key risk is the form government intervention will take place. Already the US Congress has voted to stop filling the Strategic Petroleum Reserve - a vain gesture that only saw prices jump 2% the day it was announced. Truckers are demonstrating in front of the White House. President Bush has made two visits to Saudi Arabia to plead for higher production (and received a measly 300,000 b/day for his trouble). There’s always the risk of daft populist measures (like price controls, placing controls on oil futures markets, or *gasp* nationalizing the oil majors) - anything to appease the wrath of an angry population when the bounty of cheap oil is taken from them.

Another article by Jad Mouawad of the New York Times on how the rising oil prices have not spurred additional production. I think he’s a closet Peak Oil evangelist. As oil prices continue to break records, there does not seem to be an end in sight. Nevertheless, recent highs may be attributable to strikes in Nigeria and Scotland leading to panic buying of oil.

Here’s another take on my strategy for peak oil - it’s not elegant, but it makes sense to me: Last supplier standing dictates the price.  Find suppliers with calls to long term supplies of oil, and hang on to them.  Once production decline begins, oil prices may skyrocket.

The downside to this could be that government intervention may occur once supplies begin to decline.  Part of that action may be to penalize oil speculators/investors.  Can’t see how this can happen except under extreme circumstances, but who can foretell the future?