I began this update in the cabin of an MD80 en route to Seattle from San Diego. It was a clear day as we departed out of Lindberg Airfield. Our plane took off toward the ocean, banked to the right and headed north. I saw a vast patchwork of homes and highways that define the Southern California coastline. The coastline—as it appeared from the air—looked like one continuous city.

As we moved further inland and ascended to our final cruising altitude of 31,000 feet, the patchwork of homes and roads were replaced by the green quilt of the San Joaquin Valley. The San Joaquin Valley has been called ”the world’s richest agricultural valley,” a technological miracle made possible through energy. Fertilizers made from fossil fuels enrich the cotton fields, vineyards, orange groves and various crops that are produced from this region. Energy powers the John Deere harvesters and J. I. Case tractors that enable farmers to handle increased crop yields, while diesel fuel powers the big rigs that bring the crops to market. Energy also powers the air conditioners that make the valley’s summer heat more palatable. The Kern County oil fields stand out as a reminder that this robust agricultural and urban region rests on a platform of cheap energy and abundant water.

The San Joaquin Valley is looked upon as a symbol of success, a melding of modern capitalism and ingenuity that has produced an agricultural miracle. The region's abundant crop output is dependent on mechanization, which in turn is dependent on cheap fossil fuels. But this success is overshadowed by enormous environmental problems that increasingly confront our 21^st century world. Cheap energy, water scarcity, soil erosion, land becoming too compacted and salty for farming, and fertile soils plowed over by asphalt point to a clash between nature and urbanization. The San Joaquin Valley needs energy and water. Without these two natural resources, the miracles of the valley disappear. Energy has become more expensive from the fertilizers that are made from oil to the diesel fuel that powers the tractors and the semis that move the crops to market. In some areas of the valley pinched Kern County farmers are considering selling a part of their water allocations to the state’s thirsty Metropolitan District. It may become more profitable to sell water than farm crops.

California's cities keep growing in size. More homes and freeways are being built, which means more water and energy will be needed in a state that contains over 11% of the nation's population. The San Joaquin Valley not only produces the crops that Californians consume, but a large part of its surplus also feeds other western states and foreign countries.

The Clash of Two Worlds
The problems that confront the San Joaquin Valley are the same problems that confront other agricultural regions around the world. Water and energy are moving to center stage and are likely to remain there for the balance of this century. A clash between nature and urbanization is about to unfold. At stake is an industrialized world dependent on growth to support its rising debt levels and an emerging world hell bent on industrializing. Both worlds require energy, water, and food to support a population base that has grown from 3.5 billion humans to today’s 6.4 billion in three decades.

Growing Water Needs
While the issue of water isn’t front-page news—as is energy—it soon will be. The western states from Arizona, California, Colorado, Nevada, and New Mexico to Utah and Wyoming are preparing for the possibility of water shortages for the first time since the Hoover Dam was built in the 1930s.[1] The drought that has permeated the region is now entering its sixth year.

Lake Powell has lost nearly 60 percent of its water. If water levels continue to fall, the lake will be unable to generate electricity by 2007. In nearby Las Vegas the regional water agency is removing the equivalent of football fields of grass from playgrounds, golf courses and lawns in order to conserve water. [2] In California, the high Sierra snow pack is melting faster and earlier than during any springtime in the last 80 years. In Colorado, dropping reservoirs are restricting water use to 1.2 million Denver residents who are now restricted to watering their lawns only twice a week. In the Jefferson River Basin, Montana’s “beef basket” is reeling from the high cost of water and its limited availability. It has impacted the region's commerce from the local ranchers to supermarkets and restaurants. In the words of Dennis Miotke, who oversees water allocation for the region, “A lot of ranchers over the last several years sank everything they had into irrigating their pastures. But if they don’t have water, it's like trying to run a bank without money.” The Clark Canyon Reservoir, which provides water to the region, has been reduced to 36 percent capacity as a result of the drought.[3]

Not since the dustbowl of the 1930s has the West seen anything like the epic drought it now faces. This water issue isn’t local or regional. The issue has become global as a growing population and concomitant urbanization puts increasing demands on the earth’s resources.

Ignored Bull Market in Commodities
The booming commodities bull market is every bit as much the result of a growing world population as it is to neglect and under investment. It is a classic case of supply and demand. While investors and fund managers seem fixated on the equities markets, a roaring bull market in commodities has passed and left the equities markets behind. Throughout the 1990s money poured into technology stocks. Brick and mortar companies were basically ignored. Very little capital flowed into mining, agriculture, or forestry. The commodity sector has been starved for capital for more than a decade. Lower prices led to capital outflows and investments elsewhere. While commodity investments lacked capital, the world economy began to grow as never before thanks to the triumph of capitalism around the globe, especially in China. Demand soared as supplies shrank. Deficits were made up from surplus inventories accumulated over decades. Eventually demand exceeded supply and available resources, so prices have risen sharply.

China's Consumption Appetite
The greatest impact on the commodity markets comes from China, India and the rest of Asia where the majority of the world’s population resides. China now consumes 27 percent of the world’s steel, 55 percent of the world’s cement, and 25 percent of its aluminum. It has become the second largest importer of oil in the world behind the U.S. China has to increasingly import more of its food—over 3 percent last year and growing. China’s once massive stockpiles of wheat and corn have been steadily falling. Since 2000 China has been a net importer of wheat. An increasing number of affluent Chinese are consuming more beef, wheat and vegetable oil. As affluence increases, so does the demand for a better diet. The taste palettes of the Chinese consumer are being felt in agricultural markets around the globe. Soybean prices are up 80 percent during the last year.

Some say that China’s voracious appetite for commodities will soon cool down. Others aren’t as sanguine about price relief coming from China. The sheer size of China’s population and the removal of arable land due to urbanization suggest that China’s demand for agricultural commodities is here to stay. Jim Rogers (this week’s Financial Sense Newshour’s guest), who just recently returned from China, believes that China’s economy could indeed cool down as a result of government efforts to slow it down. Rogers believes that the slowdown could end as a hard landing instead of a soft one. Rogers’s points out that governments have very seldom delivered soft landings. Hard landings are the historical precedent. However, Rogers believes that any downturn in commodities that results from a slowdown in China’s economy will only be brief. To Rogers’ way of thinking, the bull market in commodities will last well beyond this decade only to be punctuated periodically by occasional pullbacks. There is no stopping China. It simply has become too big.

China will continue to be an importer of energy and other raw materials as its economy industrializes and becomes the power center of global manufacturing. This will mean greater imports of everything from iron ore, copper, lead, and zinc to coal and oil. China’s imports of food will also continue to grow and put pressure on the world’s agricultural commodities like corn, wheat and soybeans. Urbanization and industrialization are the main drivers of the Chinese economy. Its once verdant coastal plain has given away to greater urbanization. Factories, high rise buildings, and asphalt roads have replaced farmland. Like the U.S., which must now import the majority of its energy and increasing amounts of raw materials, China is no longer self-sufficient in energy and raw materials. The impact of China’s needs has been labeled “The China Syndrome.” On any given day over one fifth of the world’s bulk freighters are unavailable for delivery. Many of these ships stand idle off Chinese ports in Qingdao and Ningbo waiting for as long as three weeks to unload. As a result of China’ voracious appetite for commodities, bulk freight costs have more than doubled in the last year. Shipyards in Japan and Korea have orders well into 2007. Last year orders for new ships more than doubled to 1,600 vessels.[4]

China’s leaders are attempting to slowdown their economy by restricting loan growth for development in industries such as steel, cement, and real estate. The announcement to curb growth caused an initial sell off in the commodities markets looking for price relief. But prices are now bouncing back and recent press releases out of Beijing indicate that its central bank has no immediate plans to raise interest rates. As far as slowing down, economists in the region now estimate China’s economic growth in the second quarter could come in as high as 11.4 percent.

Global Population Demands
Demand for commodities is global and it is structural. A population of 6.4 billion people growing by 400 million a year is something that goes beyond the debate of inflation or deflation. A recession, depression, wide scale debt default, or a stock market crash doesn’t eliminate the daily dietary and energy needs of 6.4 billion people. As far as the thought of a recession or stock market crash eliminating the energy crunch, think again. A 1,250 pound steer requires an investment of 283 gallons of oil. This includes the fertilizer to grow the corn that feeds the steer to the diesel that powers the machinery that runs the farm. [5] Water, energy, and food are basic necessities—not luxury goods that can be bought with discretionary income. Economists and analysts need to distinguish between what goes into the weekly grocery basket versus a discretionary decision to eat out.

For almost the entire 20^th century, food production outpaced population growth. Grain, which is the staple diet of the majority of the world’s population, is now experiencing a production decline. Grain harvests for the past five years have leveled off, while the world’s population continues to grow. Numerous reasons are given for the falloff from the loss of arable land, fresh water shortages, and urbanization to a change in weather.

A growing population, growing urbanization and industrialization are all part of the reason why commodity prices are rising after a multi-decade slumber. After hitting a low in October of 2001 at 183.52, the CRB Index has risen to today’s close of 273.66. It is up 49 percent over the last few years. Individual commodities such as oil and silver have risen even more. Oil prices have doubled and until its recent pullback, so has silver. Since January of this year the CRB Index has risen from 255.29 to 273.66, a gain of over 7 percent. This compares to losses in the stock and bond markets this year.

While economists and analysts dismiss the higher costs of food and energy, consumers have no such luxury. Their monthly budgets are under duress, forcing many consumers to finance monthly living expenses through credit card debt or cash out financings from their homes.

And Then There's Energy Issues
Energy prices are also acting as an additional tax on the economy. Gas prices seem to go up every week. Up until recently, occasional energy spikes have been looked upon as a nuisance, a temporary problem that has to be endured until more supply is brought on line. I don’t believe that this time the problems are temporary. The real problem is “depletion,” a concept that very few on Wall Street understand. While markets appear hopeful that Saudi Arabia’s increased output will soon reach the market, it will be too late for this summer's driving season. As consumers, we will have to grin and bear the higher costs of getting to and from work or a summer holiday. If fuel costs don’t relent in their price rise soon, travel—whether for business or a holiday—may soon become a luxury. In addition to featuring nightly complaints from consumers, our local news station now features stories of families limiting their driving and shopping due to higher fuel costs. In my own family, two of my sons are actually considering hybrid cars rather than the hot cars their peers drive. The local news station—in addition to featuring nightly complaints from consumers—now features stories of families limiting their driving and shopping due to higher fuel costs.

U.S. Overconsumption of Oil, Gas and Power
I sometimes wonder why the tell tale signs of an impending energy crunch were ignored. The first energy crisis of this new century began appropriately in California, the center of the high tech revolution, granola, sprouts, the land of the SUV, urban sprawl, Hollywood make believe, the gnatcatcher, the coastal sage bush, and the growing environmental movement.

California’s energy crisis was quickly blamed on the power companies and a misguided utility deregulation program. As it turned out, our crisis was solved by favorable weather. However, the energy problems of the state still remain. This state has built very few power plants given the size of its population. We must now import power into the state. We haven’t built any new refineries in California in close to three decades. Yet, our environmental fuel standards for gasoline are so special that only California refineries can produce it. If we run short on gasoline, we can’t turn to other states for gas as we can for power. There is no uniform environmental standard for clean burning gas. Instead there is a maze of different environmental fuel standards mandated by different states and municipalities resulting in a Heinz 57 mix of environmental fuels across the country. If there are shortages in one region of the country, they can’t be met by surpluses elsewhere. Our environmental laws have become a hodgepodge of different rules and regulation with no consistency or logic.

Even then the story of energy goes well beyond the traditional conflicts between industry and environmentalists. Americans are the biggest consumers of energy in the world with 5 percent of the world’s population burning 25 percent of the world’s oil. We are the least energy-literate people on earth. We love our technology, but have no idea what it takes to power it or where it comes from. The gas we burn in our SUVs, motor homes, jet skis, motorcycles or powerboats probably came from somewhere other than the United States. Our energy security is based on aircraft carriers, nuclear submarines and our marines. This is a shallow security blanket. In a speech given a few years ago at the Royal United Services Institute in London, Robert McFarlane, former national security advisor to President Ronald Reagan gave a surprise message. According to McFarlane, “...increasing America’s energy security will be achieved not by building and deploying more aircraft carriers and tanks in the Persian Gulf, but by increasing energy efficiency and automobile fuel economy at home. [6](Three quarters of every barrel of oil consumed in this country goes to transportation.)

Energy is a Problem of Where and How Much
The problem for the U.S.—and other western powers as well—is that the vast majority of the world’s oil resides in the Middle East and the Caspian states. Five nations in the Persian Gulf and two countries in particular, Saudi Arabia and Iraq, are sitting on the mother lode of oil.

As oil prices hover close to $40 a barrel, western powers are asking—if not pleading—with Saudi Arabia and OPEC to increase output. In reality when we ask OPEC to increase output that falls mainly on the Saudis who have the only real spare capacity and ability to increase production. Iraq has that ability, but it is a geopolitical basket case.

In its June issue, National Geographic's cover story is titled “The End Of Cheap Oil.” Tom Appenzeller's article featured a geological map of the world detailing where the oil is and how much is left. The most striking aspect of the map is how little oil is left outside the Middle East. Besides Venezuela and Russia, the largest blocs of oil are to be found in Saudi Arabia (261 billion), Iran (126 billion), Iraq (115 billion) Kuwait (99 billion, U.A.E. (98 billion).[7] By contrast the United States has only 23 billion in oil reserves left.

The big hope in North America is Canada’s tar sands, which contain 174 billion barrels of unconventional oil. Shell Oil, one of the big three operators of the tar sands, is producing 600,000 barrels of oil a day. The oil is more expensive to produce, requiring two tons of sand for each barrel of oil that is produced. Optimists are hopeful that within the next decade production could rise to 2 million barrels per day. [See NG's map, "Oil: Where It Is and How Much is Left."]

Yet outside the tar sands, which have come on stream with technology and cost savings, there has been no major discovery of oil in the last three decades. The North Sea and Prudhoe Bay oil deposits were discovered decades ago. Since 2000 the rate of new discoveries has fallen dramatically.

According to the 2004 edition of Petroleum Review, there were only 13 discoveries of 500 million barrels in 2000, only six in 2001 and just two in 2002. In 2003 there wasn’t a single discovery of over 500 million barrels. [8] The latest large discovery is BP’s "Thunder Horse” which covers a 54-mile stretch in the Gulf of Mexico. To get at the 1 billion barrels of oil, BP has had to drill 17,000 feet below the seafloor.

In a recent publication to shareholders ExxonMobil’s exploration division president, Jon Thompson, told shareholders ”We estimate that world oil and gas production from existing fields is declining at an average rate of 4-6 percent a year.” To meet projected demand the industry will have to add 100 million oil equivalent barrels a day of new production. That translates to finding, developing, and producing new oil and gas equal to 8 out of every 10 barrels of oil produced today.[9] It is one reason why the major oil companies have consolidated. One of few options for increasing reserves is to go out and buy them. The other route is through the negotiating table. If you are an ExxonMobil or ChevronTexaco or BP, the new strategy to increase reserves is to negotiate for them. According to a recent WSJ article, the age of elephant strikes are over. “There has been just one great find in the past 30 years: the 1999 discovery of Kashagan, a field off Kazakhstan in the Caspian Sea.”[10] The simple fact is that most of the world’s oil reserves remain in the hands of state-owned oil companies in the Middle East.  Oil consumption is outpacing the industry’s ability to find and replace its production and loss of reserves. All the majors have deal teams and these teams are just as likely to be made up of diplomats as they are geologists.

Global Competition for Reserves
By January of this year the U.S. had only 13 days worth of oil held in reserve with all of the nation’s refineries running at full capacity. Industrial states from the U.S. to Japan are rushing to increase their oil stockpiles. Japan, which must compete with China for Russian oil and pipelines, is urging Asian nations to build up their oil reserves. Japan has stockpiled more than 160 days of the oil it uses. China, the world’s second largest consumer of oil has only 21 days. Oil security will become the focal point at a June meeting in Manila. Western nations are scrambling to increase their strategic stockpiles of oil almost as a premonition of something that lies directly ahead. It is rumored that some nations have gone so far as to print up rationing tickets for fuel.

Perhaps it is the change in terrorist activity. Recent attacks have centered on the oil industry by targeting oil facilities, terminals, and oil workers. What has been buried in the back pages of the newspapers is the subtle shift by governments to start stockpiling reserves. In “The New Great Game,” author Lutz Kleveman describes the Middle East as the world’s largest gas station where madmen go around constantly lighting matches. Kleveman’s book, required reading in my opinion, goes on to describe the 21^st century version of The Great Game, immortalized by Rudyard Kipling’s novel, Kim. Whereas the 19^th century version involved the clash of imperial ambitions between Tsarist Russia and Great Britain today’s game is the struggle to control the world’s remaining energy reserves. It pits the U.S. against the resource ambitions of Russia, China, and Iran. Statesmen and generals played the 19th century game. Statesmen and generals still play this game, but they are joined by geologists, oil barons and warlords. It is a high stakes game for the world’s most valuable resource.

Right now energy security for the U.S. entails carrier battle groups, marines and soldiers throughout the Middle East. In order to secure access to foreign oil, China is pursuing relations with terrorist states. A recent congressional study on economic security reports that China’s foreign policy is now like the U.S.’s driven by access to energy and strategic raw materials. China provides technology and weapons components to Iran, Syria, and until recently Iraq in exchange for access to oil. China has also moved troops into the Sudan in order to secure its foreign oil.

When you have a world economy that runs on a single fuel source, energy security becomes paramount. However, energy security entails more than protecting the sea lanes or oil terminals. It also involves ensuring access to supplies to meet immediate demands of a growing economy. This means having access to the necessary fuels needed to power transportation as well the fuel needed to run power plants that produce electricity. Author Paul Roberts in his book, The End of Oil defines energy security: "...energy security goes well beyond mere questions of supply. No matter how much oil or gas we can find, this supply is worthless unless we have in place the physical infrastructure, the political stability, and the financial and technological resources to get it to those who need it—criteria that are growing more difficult to meet.”[11]

Energy Infrastructure and Alternatives Behind The Times
Regarding the issues of energy security, the United States has fallen far behind. We have built no new refineries in this country in the last two decades. The last new refinery was built in the mid 70’s. We have over 50 different varieties of gasoline making it difficult to supply areas that are experiencing peak demand. As a result of allowing our energy infrastructure to go into decline, we now must import more of our gasoline from places like Venezuela. Even then new EPA standards will make it more difficult to import foreign gasoline. If a crisis erupts this summer, there are very few alternatives.

Problems with our energy infrastructure go beyond refineries. We haven’t built enough power plants in this country to keep up with the demand for electricity. The power plants that we are building run on natural gas. It is a fuel that is in short supply here in the U.S. and must be imported. Natural gas has the same problem as oil. Natural gas has become the fuel of choice by governments in the U.S. and in Europe. However like oil, the largest deposits of natural gas lie in massive gas fields in Iran, Qatar, Turkmenistan, and Russia. This presents a logistics problem since the largest gas supplies are located far from the biggest markets such as the U.S. and in China. For the U.S. it will mean building new LNG (liquefied natural gas) terminals. LNG is far more expensive to handle and transport and creates its own unique security issues. Many states and cities have been opposed to building LNG terminals because of environmental opposition and related security issues. In San Diego our local utility has found it easier to build its next gas powered plant in Mexico. The Baja Peninsula is becoming a new energy hub for gas powered plants and LNG terminals that will power them. All of the major energy companies from Shell to ConocoPhillips are moving and investing in the region. ConocoPhillips is building five regasification terminals in Baja.

While natural gas may be the preferred fuel of choice, it remains in short supply in North America. North America burns nearly one-third of the world’s natural gas, yet has less than 2 percent of the world’s natural gas deposits. The U.S. is making a policy decision to switch to natural gas. The problem with this policy is that we have very little of it. We are just now waking up to the fact that the natural gas we desire will have to be procured mainly from the Middle East, leaving the U.S. in the same precarious position as it finds itself with oil.

Time is Running Out
What is clear from reviewing the energy markets is the reality that there is no silver bullet when it comes to energy. If the facts are examined, it is clear that unless we begin to act now to conserve energy and begin looking at alternative energy sources, we may indeed be staring at the Perfect Storm. We need to start having a rational debate regarding energy in this country or else we will be forced to deal with the issue in a crisis mode. Our politicians need to free themselves from special interest groups—whether power companies or environmentalists. Facts need to be discussed and disclosed. Most Americans are unaware that oil discovery in the U.S. peaked in 1930 and that is was followed 40 years later by a peak in production. Global discovery of oil peaked during the 1960s. Since the early 80’s the world has been running a net oil deficit that keeps getting bigger.

Oil geologists believe oil production will peak sometime within this decade and for OPEC sometime in the next decade. Peak oil production doesn’t mean we have run out of oil. It means that there will simply be less of it. For economies that are built on assumptions of continuous economic growth, this will mean recessions or even worse—depressions. The brownouts, powerouts, and price spikes over the last few years are warning signs of things to come. The jump in natural gas prices over the last few years is already starting to take its toll on whole industries from chemical manufacturers to producers of fertilizer. By early 2003 a quarter of U.S. fertilizer factories had been shut down. Companies began to shift production overseas where there was access to feedstock.

In Argentina recently industrial production suffered its biggest decline in three years halting six months of production as natural gas shortages forced manufacturers to cut output. One brick maker, Fanelli SA had to halt production for four days because it had no gas to power its furnaces.[12] The shortage of gas in the country came as result of government price controls, which stopped investment in expanding gas supplies. The country now faces decisions on whether to cut gas supply to its biggest industrial users or to cut gas to households during the winter months. This is no way to grow an economy.

The problems faced in Argentina may also be coming home to roost in the U.S. The August 2003 blackout affected over 50 million homes and businesses in the U.S. and Canada. The problem stems from generation capacity, which has not kept up by growth in the nation's transmission infrastructure. In China blackouts and brownouts are becoming routine. These kinds of problems are now starting to surface here in the U.S. and globally in Europe, and South America.

The obvious solution to these approaching energy crises is renewable energy and conservation. There are brand new markets that are just in the incubation stage that need to be accelerated from fuel cells, wind power, biomass, hydropower, geothermal and clean coal, to the revitalization of nuclear power. There isn’t one silver bullet when it comes to energy. Yet given the possibility that we are approaching peak oil, we need to begin to find that silver bullet. Otherwise we may find ourselves swept upon a sea of crises moving from one storm to the next culminating in the Perfect Storm. To achieve this smooth transition from nonrenewables such as oil and natural gas to renewable energy will take time—if not decades. We simply do not have decades before the peak of oil production occurs. The geological time clock is ticking. That is why water and energy have moved to center stage.

Jim Puplava

[1]  Johnson, Kirk, "Drought Settles in, Lake Shrinks and West’s worries grow," New Times, May 2, 2004.
[2]  Ibid.
[3]  Wilkinson, Todd, "West faces a sixth year of epic drought", Christian Science Monitor, April 27, 2004.
[4]  Goodman, Peter S., “Booming china devouring raw materials,” Washington Post, Friday, May 21, 2004.
[5]  Appenzeller, Tom, "The End of Cheap Oil," National Geographic, June 2004, p. 99.
[6]  "Oil, Security, War: The geopolitics of U.S. Energy Planning," Multinational Monitor, Jan/Feb 2003, Vol. 24, No. 1 & 2.
[7]  Appenzeller, Tom, "The End of Cheap Oil," National Geographic, June 2004, p. 90.
[8]  Heinberg, Richard, Powerdown: Options and Actions for a Post-Carbon World, New Society Publishers, Canada, 2004.
[9]  Ibid., p. 24.
[10] Bahree, Bhushan, "As fresh Prospects dry up, petroleum Industry strikes deals," The Wall Street Journal, May 18, 2004.
[11] Roberts, Paul, The End of Oil: on the edge of a perilous new world, Houghton Mifflin Co., 2004, p.239.
[12] "Argentina April Output has biggest drop in 3 years," Bloomberg, May 18, 2004.