ANWR, Peak oil theory, and oil economics - were are we going?
I just listened to the 100th brain-stem politician screaming about opening up ANWR for oil development. As an economist, and an energy user, this is really starting to annoy me. These same fear mongers also claim that the US economy will crash due to the high cost of hydrocarbons. Actually I believe the opposite is true. The US oil fueled economy is old and tired IMHO. A new vibrant US economy is coming if we start real investing in all the oil alternative technologies.
While the US should continue to drill in all our current developed areas (US land, GOM up to 2 miles of coastline, etc.), their is no economic reason to drill in ANWR:
"An Energy Information Administration analysis in 2004 concluded that "By 2025 ANWR is projected to reach .9M barrels a day". This report further states that it would take about 12 years for the US to receive any hydrocarbon from ANWR. So if ANWR were approved today, the US would get its first barrels of oil in 2020. Of course between now and 2020, there would be a huge increase in infrastructure, and construction activity to develop ANWR. This activity needs energy, specifically diesel fuel for all this construction. So the US would have a further rise in oil demand while this project is being built-out, increasing fuel cost for all Americans.
So with this above time-frame in mind, it appears the politicians feel we will still be highly dependent on oil in 2020-2040? We could just build cars that don't use oil, would not this be more logical? My view is just let economics work. Gas at the pump of 5-10 dollars a gallon would make the manufacturing of the combustion engine vehicle a big ole dodo bird - kinda like these politicians.
Even better, the US does not need any technological breakthrough to make the current vehicle engine extinct. Coal liquification into diesel fuel has been done on a large scale since WW2. Can the CTL technology be clean? Well yes it could, but not at 3 bucks a gallon. The diesel engine is 35% more efficient than a combustion engine, so if we use coal vs oil, this one component change would make the US independent from middle eastern oil.
We also have natural gas powered cars, fuel cell, and electric cars. These technologies are here today, and will continue to improve every year if we allow natural economics to continue.
Peak oil theory
This is a very misunderstood concept. Peak oil has very little to do with actual oil reserves. Lets assume the world has 100 years of oil reserves, hell for argument sake lets just bump that figure up to 2000 years supply of oil reserves. So with 2000 years of oil left, how can the peak oil theory stand up? Actually very well. One needs to understand economics, and infrastructure.
Peak oil has nothing to do with reserves, but instead the rate of extraction, distribution, and refinement. Wiki gives a concise view:"Peak oil is the point in time when the maximum rate of global petroleum production is reached, after which the rate of production enters its terminal decline."
Currently world oil extraction and distribution is about 85 million barrels a day. Is this the peak? Hard to say, but we can say based on economics, the world is either at the peak or within 10-15 % of a possible peak.
Of course we need assumptions, An economist can't get through the day without a few assumptions! Here are my world oil economic assumptions.
1) World-wide demand for energy, and transportation energy will continue to increase between 1-3% per annum.
2) Supply and distribution of oil will be between 85-88 milion barrels a day.
3) World-wide pollution taxes, or Cap and trade programs to increase dramatically over the next 10 years, the effect of which is a 10-20% tax on polluting sources of energy(oil, & coal).
So if the world is currently capped at about 85M barrels a day of extraction and distribution, but demand for oil rises 3% per annum - what happens?. Since the demand curve for oil is very inelastic, this means the price of oil can rise very sharply in the short term. This is what we have seen during the past 3-4 years.
For me, as a long term investor, I am very interested in the next question: What about the pricing dynamics for oil in the long term. This is also the most important question for any decision on ANWR, since consumers will not see any significant oil from ANWR until 2025.
Long term oil economics:
This is more complex than it appears. As stated above the short term economics indicates much higher oil related energy prices given the above assumptions. Governments and investors all over the world are very interested in this topic. We all see that it is transportation - vehicles, that drive the demand and price for oil. For the first time, it is clear that alternative vehicles will be competitive - long term.
In order for current oil extraction, and distribution to even stay at 85M a day, or to increase this amount, oil infrastructure investment must increase. For future extraction, the world needs new oil platforms and deep sea oil rigs. For transportation, the world needs VLCC's, 500,000 dead weight tons of steel. Once transported we need large refineries to create the distillates. After refining, we need miles of steel pipelines, trucks, etc. In the medium term, I like investing in steel stocks.
The cost of the above infrastructure is huge. Building a VLCC takes years, at a cost of over 120 million. This cost has risen over 50% in just a few years. As fuel cost rise, the cost to make everything also rise - Steel plates, large diesel engines, precision tolls,etc...This economic dynamic is the same for the very expensive new rigs, refining capacity, and transportation pipelines and vehicles.
Here comes the crux. CEO's of firms in the oil industry must always do a financial cost benefit analysis of these new large infrastructure purchases. With the current high cost of gas and diesel($4-5 dollars a gallon), and pollution taxes in the future increasing this price to over $5 a gallon for the foreseeable future, alternative natural gas engines(1-3 dollars a gallon), and electric vehicle engines(under $1 a gallon), and coal-diesel engines(4 dollars a gallon) are all economically preferred.
With the much higher differential in the cost of powering the current oil based vehicle engines, the world will quickly adopt natural gas, battery, fuel cell powered vehicles over the next 10 years. So why invest 120 million dollars in a large crude carrier, when it could be obsolete in 10 years? The same thinking applies to large oil rigs, new refineries, etc. And again, why waste money money drilling in ANWR - by the time the US gets the oil, we probably will not even need it.
As in investing and life, timing is everything. When will firms stop ordering all this expensive oil infrastructure equipment? If they were prudent, I would expect a drop-off in oil infrastructure demand over the next 3-5 years.
What will happen with oil prices?
As stated above, oil prices will continue to stay high in the short run, but at some point in the next few years, I predict a sharp downturn in oil prices, as alternative power sources are used in vehicles. This is how economics should work. I am surprised this shift has taken 100 years. As an investor, this changes how I value many energy firms.
Firms that are 100% levered to the extraction and distribution of oil, will have falling cash flows after 2013-2015 IMHO. Individuals and businesses change their vehicles quite often - every 3-5 years, so one can see how the technological changes in transportation area can impact the demand for oil fairly quickly. As for electric generation, this timing is different. We don't change our power plants out every 5 years. So the demand for coal, and natural gas will remain strong at least 10 years out.
As I have written before, firms that are in the natural gas business will outperform the oil related firms in the future. Also firms in battery, fuel cell technology should outperform. These changes will invigorate the US economy if the government stays out of the way. Current ethanol mandates, and ANWR drilling plans, all have one purpose - to slow down the natural economic change from oil to all its alternatives.
Some of my favorite long term stocks for this peak oil economics are:
- Precision Drilling (PDS)
- Apache Corporation (APA)
- Chesapeake Energy (CHK)
- Pengrowth Energy Trust (PGH)
- Provident Energy Trust (PVX)
- Pride International (PDE)
- Bronco Drilling (BRNC)
- Helmerich & Payne (HP)
- Swift Energy (SFY)
- Pioneer Drilling (PDC)
- EnCana Corporation (ECA)
- Nabors Industries (NBR)
- Devon Energy (DVN)
- Capstone Turbine (CPST)
- FuelCell Energy (FCEL)