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The Outlook for Oil Prices

Energy & Capital's Weekend Edition

Written by Keith Kohl
Posted November 15, 2009

Welcome to the Energy and Capital Weekend Edition — our insights from the week in investing and this week's top stories from Energy and Capital and our sister publications.


What started out as relatively quiet week for oil prices turned out to be quite an interesting week for oil bulls:

  • On Monday, oil prices quickly rose above $80/bbl as Hurricane Ida moved into the Gulf of Mexico, despite being so late in the Atlantic hurricane season. The storm's effect didn't last long. By Tuesday, Ida was downgraded to a tropical storm, easing its threat on the oil and gas rigs operating in the U.S. Gulf of Mexico.

  • While nearly every oil producing state in the U.S. is struggling, North Dakota has managed to boost their production to more than 230,000 barrels per day. In fact, North Dakota has remained virtually untouched by the recession, due largely in part to this Recession-Proof Secret. If oil prices remain above $60 per barrel (a very likely scenario), the state's crude production is projected to reach 400,000 barrels within the next five years.

  • Putting further pressure on the oil industry, an alarming story was released by the Guardian on Tuesday. An unnamed whistleblower from the IEA stated that the U.S. has played an influential role in the IEA's data. In other words, the IEA has been distorting the rate of decline from existing oil fields. It appears that Peak Oil Reality has struck a new chord with the public.

  • Unfortunately, the news wasn't enough downplay a stronger dollar. As you can see, it's no coincidence that oil prices have been on a hot streak since early March:

    1 year oil chart

  • What started out as a rally for the U.S. dollar on Wednesday and Thursday wasn't enough; Bloomberg reported on Friday the news that the dollar declined as a global economic recovery spurred demand for higher-yielding assets.

  • However, it's not just a dollar story. Asia has developed a craving for all things energy; China's oil demand is expected to pick up sharply in 2010 as an economic recovery picks up speed.

Below, my colleague Chris Nelder continues his reporting from the 2009 ASPO Peak Oil Conference.

But first, in case you missed some of our top stories this week from Energy and Capital or our sister publications, you can find them here.

Enjoy your weekend,

— Keith Kohl

 

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Can the Free Market Keep Us Safe?
— Chris Nelder

On Halloween day this year, I killed part of a beautiful afternoon at a local shooting range with a buddy. It had been quite a while since I did that, and I needed the practice.

[I know some of my gentle readers might find it a little shocking that a peace lovin' hippie like me would do target practice, but I was raised with it. My parents put us boys through the NRA's gun safety program at a fairly early age, before agreeing to take us hunting. Later I was certified to carry a weapon in the line of duty as a security officer. I've always had a healthy respect, if not real love, for guns.]

I was taken aback when I walked in the door at the nondescript, low industrial building. The place was packed. I could hardly find a place to stand and I waited about 15 minutes just to speak to a clerk. The registers were ringing constantly, taking in $100-$300 totals at a whack. Where I come from, we call that a gonga business.

The gun business has been strong this year, without a doubt. Guns have been flying off the shelves and ammo shortages have been common (and surrounded by conspiracy theories).

Unfortunately, most gun makers are small private companies that make high specification steel, leaving Smith & Wesson (NASDAQ: SWHC) as one of the few good tradeable stocks in the sector. And it has done nicely: up 62% YTD after declining from a huge rally in the spring.

Clearly, the general public has had an increased appetite for guns. And let's not kid ourselves - they're not planning to go deer hunting. It's about fear in an increasingly chaotic world and demand for better personal defense.

From an energy standpoint, that fear is certainly justified.

No Plan for Oil Shortages

At the 2009 ASPO Peak Oil Conference, the security outlook for North America was given a surprising twist by Rick Munroe, a Canadian farmer who learned about peak oil some years ago and decided to find out if the military or the government was doing any planning to address the problem.

His efforts turned up three good studies: Alan Smart (ACIL Tasman, 2004); Kathy Leotta (PB, 2004); and Helen Peck (Defence Academy, 2006). But within the actual gears of government, he found naught but denial.

One government official assured him that because Canada is a member of the IEA and has 200 years of oil supply in the tar sands, people should relax. (If you don't immediately realize what a cretinous statement that is, see "The IEA'S Come-to-Jesus Moment" and "Tar Sands: The Oil Junkie's Last Fix," Part 1 and Part 2.)

Munroe found numerous studies about peak oil by the GAO (U.S. Government Accountability Office), which were apparently dropped from any further consideration. As early as 1981 the GAO wrote: "It is questionable whether an adequate organizational structure exists which could effectively manage a crisis."

The IEA's messaging has been clearer. In 2005 it warned that pre-planning is critical, and that the public must be primed and well informed in advance. Yet their strategies for dealing with the impending oil crisis are laughable, boiling down to a short term "surge" in production, and drawing down emergency reserves-at most, a 90-day solution.

Munroe offered a quote by Dr. Helen Peck, a lecturer at Cranfield University in the UK and an expert in complex systems, energy security, and national emergency planning, that highlighted the relationship between food and energy I wrote about in my last article: "The fundamental problem is that it is the very efficiency of the nation's food and drink supply chains, under normal circumstances, that make them so vulnerable under abnormal ones."

Those who try to plan for such emergencies know that in the absence of a plan, the public usually responds to shortages with panic buying and hoarding. Preventing such an outcome requires top-to-bottom pre-planning.

Yet those who have tried it found that mandatory measures are hard to implement. Energy expert and veteran government researcher Roger Bezdek explained at the 2007 peak oil conference that he worked on an oil rationing program in the 1970s, and it was "a nightmare." The team found that they could not improve upon the market, and indeed, he now believes that many of the problems we had in the 70s were due to government interference in the markets.

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In his research, Munroe found a confidential report by the IEA explicitly stating that in the event of a crisis, the market should be left alone and allow price spikes to pass through to all consumers. And as recently as 1996, he says, the GAO expressed its faith in the principle by writing "physical shortages. . . are virtually impossible in a market economy."

We know something about what the market does when supplies run short. It caused oil prices to triple up through last July. In fact that outcome was actually anticipated by a 2005 intelligence exercise called "Oil Shockwave," in which nine former White House cabinet officials convened to simulate what would happen if 4 mbpd of global oil supply were suddenly lost. The predicted result was a near-tripling of the world oil price.

U.S. Secretary of Defense Robert Gates was one of the participants in the exercise, and commented afterward, "The threat is real and urgent, requiring immediate and sustained attention at the highest levels of government."

Yet, four years later, not one city, state, or federal government in North America has a plan to deal with the effects of an oil shortage. The official plan is to have no plan.

We can rest assured that the government won't be on our backs the next time there is a supply interruption. As long as we can pay — even if gas is $7 a gallon — there simply cannot be physical shortages! Hurrah!

Grid Security

The U.S. electrical grid has its own peculiar security issues, as Scott Pugh testified in his presentation at the conference. Pugh is a former captain of the U.S. Navy and now serves with the Department of Homeland Security (DHS).

Few people know this (I certainly didn't), but our national grid has three parts: East, West, and Texas. A major grid fault can take down the entire western or eastern halves of the country without affecting Texas, so, Pugh quipped, "Texas can secede from the union any time they think they should."

It's a good option to have. U.S. grid power is generated by over 1,400 power plants and passes through some 25,000 substations in a network of transmission and distribution lines, all of it privately owned by hundreds of transmission utilities & generating companies. A shutdown at any one of those points can take down large segments of the grid.

In an effort to assess the grid's vulnerability, DHS and DOE staged a cyber attack test in 2007 to see if they could shut down a substation by damaging it with a cyber attack. They succeeded. Subsequent war game scenarios produced frightful results.

Yet, as it now stands, the agencies are primarily working on alternative ways to respond to an attack, and praying for a rapid smart grid transformation which should make more fine-tuned grid control possible. In any case, their hands are somewhat tied, said Pugh, because the government doesn't see fit to interfere too much with the privately owned grid infrastructure.

Laissez Faire or a Dereliction of Duty?

It may be the most heinous dereliction of duty ever witnessed in the history of democracy, but that's where we stand in North America. While the UK, Australia, and New Zealand continue to work hard on contingency plans for an oil emergency, we remain in widespread institutional denial, complacent that our fuel supply will be assured by the wise hand of Mr. Market.

We don't need no stinking plans. Panic buying and hoarding — pshaw! We're going to do the job the free market way, through voluntary demand reduction and switching fuels! Remember how the financial markets worked so much better after the Phil Gramm era of deregulation?

If a supply interruption event should happen, and farmers can't get fuel to plant their crops when the seasons dictate. . . well, the resulting food shortages and price spikes will simply have to be the cost of doing business in a free market system. And if oil and gas companies, airlines, trucking companies, farmers (and, well, just about everybody), can't swing with increasingly frequent fuel price spikes and crashes — then I guess we don't need them.

Our government's blithe laissez faire attitude toward the threats of fuel shortages and grid attacks may be intellectually comforting to free market champions, but I'm willing to bet that should such events seriously compromise national security, they'd turn authoritarian in a heartbeat. . . and that includes me.

After seeing these presentations my first thought was: This is utter insanity. We need to nationalize the grid and prepare for deliberate fuel rationing ASAP.

It's not that the government doesn't know about peak oil. Some of the most important studies on the subject and on its likely effects have been produced there. Indeed, Pugh asserted that the military definitely gets peak oil because "they're paying for fuel in money and blood daily." Their primary focus is on using it more efficiently, he said, but they don't worry about shortages because "there's always going to be enough oil for the military."

I'm sure that's true. But I'm not at all sure it's something we want to test.

Failing to plan is planning to fail. The government's weak, bumbling federal response to Katrina is still relatively fresh in the national psyche. And there is a growing awareness among the rank and file that the free market's ability to govern itself failed miserably in the financial meltdown of 2008, and laid a heavy burden of debt on the next several generations of citizens.

Is it any wonder that people are starting to think about personal defense? About being able to generate and store their own electrical power? About growing their own food and putting up some extra canned goods, water, and batteries in the basement, "just in case?"

Until next time,

chris nelder

Chris

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