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Today's Market WrapUp 04.13.2009 Mon Tue Wed Thu Fri Allison Archive Get Real It would be a soothing scenario to wake up one day and know that our country is now powered by vast wind and solar farms, putting out ample clean, renewable energy to run our homes, cars and businesses. Unfortunately, that scenario will remain just a distant dream for now, although I hope it will one day be a reality for my children. In the meantime, we need to get real, as the fundamentals point to higher energy prices and more scarcity in the decade ahead. As with all crises, it will be a time of change, hardship and opportunity. Those who believe the current weakness in global energy demand is the wave of the future may indeed be right, as long as the “future” applies to 2009. Those with a longer term horizon should prepare for a different reality. Role of Renewable Energy Consumption as a % of total supply – December 2007
As you can see in the chart above, solar and wind energy are barely blips on the screen in terms of contributions to our energy supply. It is clear we need a massive increase in solar and wind power generation. As technology advances, the cost efficiency of each should improve over time. In addition, the Pickens Plan to wean us off imported oil is also worth serious consideration. It makes sense to utilize domestic natural gas much more for transportation. However, the days of solar and wind powering our economy are in the distant future, perhaps beyond our life spans. In the more immediate future (less than a decade), the price and availability of energy will likely dominate our world. A nuclear renaissance? Expect nuclear energy to enjoy a resurgence in the years ahead. It should gradually become more politically acceptable as the cost of alternatives soar, and as other major economies (China and India) build reactors as quickly as they can in the coming decade. Notice the current low level of per-person nuclear power consumption in China and India.
According to Matt Simmons, the oil industry has effectively stopped all new supply additions worldwide, waiting for prices to recover. The longer prices stay low, the more supply will suffer. Rig counts continue to drop around the world, and Simmons believes there is the “potential for a catastrophic collapse in supply.” The fundamentals still apply Oil now accounts for 95% of transportation energy worldwide. By-products from oil create materials we use everyday, including plastic, chemicals and synthetic rubber. Technology will certainly help in future years to recover and discover more oil, but a finite, depleting resource will continue to deplete, no matter how smart our technology. Depletion is relentless and irreversible. It has been pointed out many times, but the Top 10 largest oil fields (by production) in the world produce 20% of the world’s oil. Of the more than 40,000 oil fields that exist (on shore and offshore) that is fairly astounding. The average age of the top 10 fields is 48 years, greybeard status. The next 10 largest oil fields account for 7% of world output, at an average age of 52 years. What is particularly worrisome is some of the fields in the 2nd 10 used to be in the Top 10, but are now in decline. Thus, here we have 20 of the world’s critical oil field giants, including Saudi Arabia’s Ghawar and Kuwait’s Burgan fields, representing more than one quarter of global production, in decline or at serious risk of decline within the next decade. As one ominous example, Mexico’s Cantarell oil field, once the 2nd largest in the world (and the last major oil field discovery in 1976), is now in major decline, depleting at an astounding rate of 30% annually. These are just 20 fields, averaging 50 years of age out of more than 40,000. That should say something about the low-hanging fruit being long gone. Indeed, it has been estimated that 60% of the world’s oil production come from fields discovered before 1970. Running out of cheap oil The key point is that we are not running out of oil anytime soon. But we are rapidly running out of cheap oil. As oil becomes harder to find in quantity and more expensive to extract from hostile deep-water locations or energy-intensive tar sands mining operations, the growing depletion rate among the Top 20 super giants will wreak havoc on the supply of inexpensive oil. Oil will continue to be available, but there may be less of it and it will certainly cost more. This is good news for the alternatives; solar, wind and nuclear, as they become more cost competitive. The bad news is they are a fraction of our energy output. It will take a long time, more than a decade, perhaps much more, to replace oil. Even using natural gas for transportation will require massively expensive infrastructure changes to make it viable, but it could happen much sooner. Natural gas may be our best hope of becoming energy independent again in our lifetimes. The Gap The crisis arises from the journey of leaving behind our cheap-oil past and embracing our renewable energy future. There is a gap of unknown duration that is heading our way. The gap will be a time of adjustment, and it will likely include much higher energy costs. It will be traumatic for those who do not see it coming. It may also prove to be very profitable for those who recognize that oil will become a much more precious and costly resource in the future. For all the talk of “clean alternatives,” how are we going to get from 7% of domestic energy supply (mostly hydroelectric and biomass at present) to a significant percentage, say 75%? This investment will cost many trillions of dollars. It will certainly create green jobs, but who will pay for it? Last I checked, we are the world’s largest debtor nation, struggling to borrow enough overseas just to fund our current massive debt. Are we going to simply print the money to build this clean energy infrastructure? What will that do to the currency we use to pay our energy bills? And of course many forget that it will take a long time to replace our transportation fleet with electric alternatives, even if electric cars become viable within the next 5 years or so. It could happen more quickly with natural gas, but it would still be a fossil fuel. Government intervention As usual, government intervention means higher prices in most areas of life. The “cap and trade” proposals by the new administration amount to an energy tax on coal and other fossil fuels. The proceeds from this tax will be used to fund various government projects. The end result of course, means higher energy costs across the board, which may be the government’s primary intention. As the cost of fossil fuel energy goes up, the alternative energy projects look more cost-effective. But the result is still higher energy costs for all consumers and businesses. Oil will still drive global transportation It seems logical that oil will continue to be a significant part of the global energy mix for the foreseeable future. The difference will be that hundreds of millions of new drivers in China, India and other developing countries will be buying the same precious gasoline in future years, bidding up the price.
Looking to future global growth So while the world continues to suffer through a painful but necessary deleveraging process, we need to look beyond to the re-birth of global growth in the years ahead (even if US growth stagnates). The drop in the global demand for oil is temporary, given a growing and developing world. The drop in the supply of cheap oil is more serious. We must get real about our options as a nation, and begin to prepare for the energy crunch that will surely wash ashore in due time. Energy sector holds great promise One should also consider the profit potential of the energy sector. The best managed producers, explorers, drillers and refiners, in geopolitically stable locations, stand to prosper mightily as the world begins its mad scramble for energy in the years ahead. The leaders among the alternative energy companies also have the potential for spectacular growth in the decade ahead. The price of energy may indeed continue to fall this year, as the global economy contracts and struggles to regain significant traction. Last Friday, the International Energy Agency lowered its estimate for global oil demand in 2009. The IEA cut its forecast for demand this year by one million barrels to 83.4 million barrels a day, 2.8% lower than last year. The agency also noted a growing consensus that economic and oil demand recovery will be deferred to 2010. For value investors, the time to look at energy is when the news is bleak for the sector, not following the momentum-chasing herd at $147 a barrel. But with trillions upon trillions of stimulus dollars already pumped into the system worldwide and more likely to come, economic stability will return at some point and prices will rise, perhaps far higher than intended. Most of the world lives with a “right now” short-term perspective. Without planning or preparation, we may all one day wake up and realize that we are now living in a world of $10/gallon gasoline and there is no where to hide. I try to identify long-term trends for my clients. I believe the rising cost of energy will be one of those trends that will unfold with the return of global growth and last for many years. The bridge to renewable energy may be treacherous, but with foresight, it could also be a time of opportunity. Today’s Markets The Dow fell 25.57, or 0.3 percent, to 8,057.81. Broader stock indicators advanced. The Standard & Poor's 500 index rose 2.17, or 0.3 percent, to 858.73, and the Nasdaq composite index rose 0.77, or 0.1 percent, to 1,653.31. Gold futures finished above $890 an ounce Monday, as concerns about bank earnings and possible bankruptcy for General Motors led some investors back to the precious metal following its third-straight weekly loss. Gold for April delivery finished up $12.50, or 1.4%, at $894.70 an ounce. The more active June contract rose $12.50, or 1.4%, to $895.80 an ounce. Separately, copper for May delivery jumped 2.8% to end at $2.13 a pound, a level untouched since late October of last year. The metal received a boost from upbeat economic data from China. Crude for May delivery dropped 4.2%, or $2.19, to $50.05 a barrel in North American electronic trading. Although the oil contract pared earlier losses - it had fallen as much as 6.5% -- the decline was still the steepest since March 30. Weighing on energy prices, the Paris-based IEA said Friday that it is cutting its demand projection by 1 million barrels a day. Wishing you a good evening, Tony Allison Copyright © 2009 All rights reserved.
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