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TheGarcipian (34.08)

Consumption Junction, What’s Your Function?

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May 24, 2008 – Comments (12) | RELATED TICKERS: XOM , CVX , COP

Ok, so I’m really dating myself with that childhood favorite title, but it’s apropos for today’s topic: our insatiable appetite for petroleum products. I’ve meant to write about oil & gasoline prices for the past 6 months, but have never had enough time to collect all my thoughts & data in one place (and I doubt this will be that “one place”), so please pardon me if this blog entry seems a bit “stream-of-conscious”. Maybe this will be an ongoing series… This is partly in response to Congress’ political posturing this past week at looking into Big Oil’s massive profits, and partly in response to people who keep complaining about the price of gasoline at the pump, and particularly that Big Oil is gouging them. It is not meant solely as a defense or rationalization of the profits made by Big Oil, though maybe partially.

My dad was an employee for Exxon for 32+ years, so oil has always been an important part of our family life. But I’ve never been a fan of the enormous bonuses any CEO (oil or otherwise) grants himself/herself when their company has underperformed the S&P500, especially when that bonus comes during a 12-month period when other employees are being laid off and/or having their benefits and salaries cut. As I’ve written before (here in the comments of a previous blog), there must be a balance between Labor and Management.

Why have gasoline prices risen so much over the past year? Maybe it seems simply elementary to Motley Fool readers (and especially CAPS players), but it mostly comes down to the laws of Supply and Demand. Current estimates put our oil imports at 72% of our oil consumption. China and India, and to a lesser extent Latin American countries like Brazil, Chile & Argentina, as well as Russia and other former Soviet countries, are all putting their hands out for more and more oil. As they mechanize and transform from agriculturally-based home life into suburban domains, China & India are growing at a phenomenal rate with respect to their own populations. Millions more are driving in Asia now than just a few years ago. The rate of increase in their demand for oil is much faster than was our own in the 1950’s after we (the USA) came out of WWII with a new sense of worldly pride & well-earned respect and tons of new factories and a GDP that spelled “consumer” with a capital C. It was that time that launched our suburban lifestyles, partially due to cheap oil but mostly due to the massive productivity gains we enjoyed because of that horrific war. China is going through much the same process, but one that could be considered on steroids and methamphetamines when compared to the USA’s growth through the 1950’s.

I’m not a big fan of CNN’s talk show host Glenn Beck (too conservative for my tastes) but I try to keep an open mind when delving into areas new to me (or even old to me, for that matter). Plus, learning what the enemy thinks can give you a better appreciation of his perspective, as well as your own. Heh.

Anyway, Glenn Beck had oil man T. Boone Pickens, Jr., on his 5/22/2008 show (a transcript is here), and they brought up some good points. Pickens is the CEO/chairman of the hedge fund BP Capital Management and has been involved in the “oil bidness” since forever, including his father before him. (And you should really read the article to find out why this oil man is investing in wind power!). Pickens stated that current world production is 85 million barrels of oil produced daily. 85M bbls/day sounds like a lot, and it is. But do you know what the current demand load is? Pickens states that it’s 86.4M bbls/day. So, there’s already a shortfall of 1.4M bbls/day. The make-up difference is coming out of inventories, which obviously will continue to force the price further up for gasoline and all petroleum by-products, until either more inventory is added to the supply side or the appetite is cut on the demand side.

On the demand curve, the USA comprises only 4% of the world’s population but consumes 25% of the world’s oil. Holy Tar Pits, that’s a lot of consumption! We are beyond ravenous in appetite, and now that we are just starting to feel the pain-at-the-pump that Europe has already felt for more than twenty years ago, it’s time to ask ourselves some questions. Does this economically-driven price increase bother me, and if so, what am I going to do about it or how am I going to adjust my life to deal with it? Also, how can I benefit from this harsh economic reality?

Also compounding the problem of an insufficient supply (or a rapacious demand, depending upon your perspective) is that oil is (still, amazingly) priced in US dollars. When the Fed cuts interest rates (as they’ve done over the past year, erringly in my opinion), it makes the US dollar instantly worth less on the world market. So, the price of oil gets adjusted upwards by OPEC and others on the world market to account for this. Similar price increases are occurring for other commodities like food (wheat, rice, corn). However, pricing oil in US dollars is a good thing, I think. If the world were ever to move to pricing oil in Euros (like Russia’s Putin wants), that would be bad for us (but that’s the subject of another blog entirely).

There are those who say we should throw open the interior of the USA and pump out every drop of oil we have within the confines of our country, but that’s only pushing the problem off to another day. We need to start focusing on solving the inevitable decline of oil on a worldwide basis. It’s a national security issue, for sure. Are we going to drive our jet fighters with windmill or solar power? I don’t think so. Maybe with individualized tiny nuclear reactors, but even that’s a stretch of the imagination. Forget your soccer mom appointments and insatiable desire to drive everywhere, even across the bloody parking lot to get a “good parking space” at the next-door store. For the sake of our own security, we need to address this problem now. (And this is why I think we really invaded Iraq – to put a pro-USA presence there and stabilize the flow of oil to the West.)  The Saudis to date have paid lip service to Bush but haven’t done anything really in terms of stepping up production, quietly and non-verbally telling Not-So-Curious George to deal with it on his own. Nice “friends” we have in the Mid-East. Or perhaps I’ve got this totally wrong? Maybe.  In any case, serious federal money needs to start flowing into R&D for alternative fuels.

The lack of Saudi action on stepping up production obviously has political implications for Saudi Arabia and its Arab colleagues, as well as situational drivers of its own. But there’s another, less-talked-about possibility. It’s the subject of this National Geographic article: the Saudis have possibly hit their peak production and are incapable of producing much more than, say, 10%-20% over what they’re doing now. We will likely never know for sure (because it’s a state secret), unless of course if we invaded them too. Logically though, a sharp rise in prices, to say nothing of the huge profits being made in oil, would in all cases of the past spark new discoveries and/or technologies to discover more oil or better ways to reach & process less-conventional oil (like the tar-sand deposits in western Canada). But those have not come to pass (“yet”, say the optimists). Sadad I. Al Husseini, the man in this National Geographic article, points out via his research that oil production has been at 85M bbls/day for several years, not increasing as we’d normally expect with increasing prices (he’s conveniently been retired from his work by the Saudi government after his public disclosures). Worldwide production continues to drop by as much as 8% per year, yet since most of the large fields have already been discovered (we think) and drained or dying, that leaves us having to find many much smaller oil fields to replace any one large dying oil field, just to keep pace with current demand. Each smaller field has many of the same startup costs as a large field, but output will be much less, so obviously the price per barrel extracted from the ground will continue to increase as we go forward. Does this picture make you feel as queasy as I do?

Face it: We are not going back to $3.00/gallon gasoline. Ever. Not unless we conquer Saudi Arabia and home-squat on their estimated 250 billion bbls, or find some huge as-yet-undiscovered oil field, neither of which is likely in the next decade or two. And current estimates vary wildly for a total oil depletion as early as the year 2020, or possibly as high as 2080. In most cases, the people being born today stand a very good chance at seeing the end of oil as we know it. (I’ll try to cover the reasoning behind this in a future blog).

Here’s the more likely scenario… I’ve read a very rough translation estimate: A $24 rise in a barrel of oil translates to a $1 rise in the pump price of gasoline. There’s probably a lot of play in that number, but let’s use it to see what might be more likely than finding a huge as-yet-undiscovered oil field. T. Boone Pickens predicts that oil will top $150/bbl sometime before the end of this year, and I agree with him (frankly, I think it’s going to be a bit higher than that, possibly $155/bbl or $160/bbl). I’ve been thinking along these same lines since September/October 2007. Given the current $132/bbl oil today, a target price of $150 is only $18/bbl away. That would add another 18/24ths of a dollar to your gasoline price. Currently in Oregon, we are teetering at $4.00/gal, so we’ll see another $0.75/gal by year’s end, probably at the tail-end of summer, August or September. Then, it’ll take a break and settle back down (as it usually does) during the fall and winter, only to rise again next spring and summer. We’ll see $5.00/gallon next year quite easily, and maybe even $6.00/gal if oil goes to $180/bbl next year.

Regardless of whoever wins this US Presidential election, it’s going to be a tough time for him/her to convince the American public that these prices are mostly out of our hands, at least from the supply side of the equation. And when Congress holds such blustering hearings as they did this past week, that only obfuscates the problems further. As my good friend “MauiPeter” recently suggested to me: “So, regardless of who gets in the White House next January, and regardless of the drawdown of US troops from Iraq, you can bet that the US is not going to give up the strategic military advantage of being in Iraq and keeping the pressure on Saudi Arabia.”  I hope to write more about “MauiPeter” in future blogs on this subject, primarily because he knows a lot about this subject.

From an investor’s perspective, I’ve hedged against these inflationary costs, devaluing US dollars, and rising petroleum prices by personally investing in Exxon-Mobil (XOM), Diamond Offshore (DO), Hercules Offshore (HERO), McDermott International (MDR), iShares Latin America Fund (ILF), iShares MSCI Canada Index (EWC), iShares MSCI Brazil Index (EWZ), iPath MSCI India Index (INP), and am considering Dawson Geophysical (DWSN). You can do the same. I think all of these companies will continue to have good long-term prospects.

Outside of indirect “offset investing” like I outlined in the previous paragraph, I’ve got a more direct, perhaps too simplistic, solution. But even the most complex solutions start with very simple steps. Start by making the smallest of differences in your daily routine: limit your driving if you can, or better yet, consolidate your errands to one or two days a week. Call first instead of driving to the store to see if they have what you want. Instead of sitting in the McDonald’s drive-thru line, park that SUV, get your fat butt out of the car and walk inside. The exercise will do you good and you’ll save gas and pollution. Recycle as much as you can so that energy (oil and coal mostly) is not wasted in producing another soda bottle (plastic or metal) or plastic tray or plastic drink top. Reuse your bags (both plastic & paper) when shopping at the local grocery store. Minimize your waste of plastics; a lot of petroleum goes into making plastic. Those are the falling-off-a-log-simple things we can all do. If you have more time and inclination, write your Congressman and demand that what they should be doing is actively pursuing research into alternative energy sources. Spur on the ingenuity of Americans by giving big grants for hard scientific research. Demand that the President reinstitute the EPA standards that he stripped away in 2001 in order that we improve gasoline mileage, not worsen it. All this Congressional and Presidential grandstanding this past week is getting us nowhere fast, except to make it appear to the Average Joe that his elected officials actually care about him and his pain at the pump. It’s all great theater, but the ticket price for that show is already way too expensive for any of us to pay. And believe me, it’s getting more expensive every day that we waste…

We’re never going back to $3/gallon gasoline, but these tactics will help slow the inevitable price increases in this precious declining natural resource. As Husseini points out in the National Geographic article on this page, “the bigger challenge may be inducing oil-hungry societies to curb demand.”

Ya think?

12 Comments – Post Your Own

#1) On May 24, 2008 at 9:38 AM, WillSurfForFood (59.73) wrote:

Great blog.

I've come to the same conclusion about Iraq: it was about oil and we are not leaving there anytime soon no matter who gets elected.  

 

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#2) On May 24, 2008 at 10:28 AM, MauiPeter (< 20) wrote:

Well-written blog TheGarcipian!!! My comment about the strategic advantage to the US by keeping military forces in Iraq was based on George Friedman's excellent book America's Secret War: Inside the Hidden Worldwide Struggle Between America and Its Enemies. Friedman heads a Washington D.C. think tank called StratFor that has been characterized as a "private CIA". StratFor's releases are available by subscription. Occasionally they are published by John Mauldin as part of his free email newsletter service.

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#3) On May 24, 2008 at 10:44 AM, ajm101 (< 20) wrote:

Hi Garcipian!  Great post, and while I was replying I realized I was putting down a little too much for just one comment.... if you're interested, I replied to you on my blog here http://caps.fool.com/Blogs/ViewPost.aspx?bpid=56275&t=01001701549635207093.

Thanks very much for your sharing your insights.

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#4) On May 24, 2008 at 11:14 AM, ATWDLimited (< 20) wrote:

Good post, but I have some disagreements. I really don't think Iraq was invaded for oil, I mean Price of US war is no where close to value of the oil in Iraq or Saudi Arabia. also, we have more coal than anyone, so we got a lot of fuel right here. Third oil price tension would drop if we drilled here and the money we make here would be put to use investing in new energy sources, instead of just vanishing to the coffers of foreign nations. Fourth why are we still talking about finding alternatives, when we already have the most efficient process ever? It is called nuclear, it has the highest mass to energy conversion, and if we invest in nuclear fusion power plants, it uses hydrogen and fuses to make helium, we will have the cleanest most efficient, cheapest fuel ever. It is the same way the sun works, imagine the waste would be helium, we could fill balloons and have a party. Any rate we need to open our coal,n natural gas and oil reserves ASAP, in fact we should have opened them 30 years ago during the last energy crisis, but the environmentalists and the lame Liberals did not want to, so now look at what happens. They blocked nuclear too, if we went nuclear we would be fine today, with lots of oil for our cars, and nice clean cheap electricity, but we are still playing games in Congress, those idiots were really pathetic, and unless we push them to do something the right way they will just play politics/power games.

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#5) On May 24, 2008 at 11:54 AM, ajm101 (< 20) wrote:

ATWDLimited

1. of course the Iraq war was about oil.  All of the leaders and architects of the war wrote a public letter to Bill Clinton when he was president arguing such and signed it.  It's a matter of public record: http://en.wikipedia.org/wiki/Project_for_the_New_American_Century#Open_letter_to_President_Clinton_on_Iraq

2. how much do you think is in ANWR and the continental shelf?  ANWR is supposed to be 5-10bboe, which is not a game changer in a .08bboe/day global market.

3. did someone figure out how to harness fusion energy, because I thought that technology didn't exist yet.  and the alpha and gamma radiation generated by a fusion reaction will irradiate shielding (which needs to be replaced as it's degraded), so it's not completely accurate to say the only byproduct is helium.

Sorry, I don't mean to be argumentative, but I think some of these points are inaccurate, but are unchallenged in certain forums.  I would be happy to be proven wrong!  And I totally agree on the coal/gas-to-liquids.

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#6) On May 24, 2008 at 12:04 PM, ATWDLimited (< 20) wrote:

There is 16 billion barrels of oil in ANWR actual and it takes up only 2,000 acres. Like I said, its part of the solution, I did not say no new algae fuels, or no solar or wind, just staying its part of a comprehensive approach to the problem Combined with increases in coal, natural gas, coal to liquid, LNG, CNG, nuclear, solar, algae biofuel, wind and hydro electric we could become energy independent. Anyway, we got a lot untapped resources and frankly oil is one of them.

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#7) On May 24, 2008 at 12:21 PM, ajm101 (< 20) wrote:

Okay, I'm not vehemently against ANWR production.  I do think the 2000 acre figure is misleading (I believe that counts the posts holding up pipelines, but not the area under the pipes themselves, etc... it comes from industry and is like taking NAR's word on housing trends :) ).

I just think that it's possible right now to use existing infrastructure to become energy production independent, combined w/ reducing consumption without drilling ANWR or the Florida coast.

Anyway, the Chuchki and Beaufort seas are open for development and have larger reserves (I know the sea ice presents almost impossible difficulties... maybe something FTI can deal with?).

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#8) On May 24, 2008 at 1:29 PM, DataExec (< 20) wrote:

In estimating future crude oil prices consider the impact of the traders on oil pricing.  The traders became a dominant influence in the early 80's and, in essence, create the market pricing defying classic supply and demand theory.  Current estimates indicate that actual end users (refiners) are involved with less than 23% of the transactions.  It's the large bulk of buyers (long and short) that are making the transactions and setting the prices.  There is no logic related to supply/demand that can account for the rapid run-up from $110 to $135/ barrel.  The same illogic applies to the large drops when a small gunboat attempts to kidnap workers off the coast of Nigeria. 

Some experts contend that on a pure supply/demand curve today's pricing should be less than $85/barrel.  The major E&P companies that have to make the mult-billion, multi-year bets using their capital for new wells are currently basing their decsions based on a crude price between $60 and $70/barrel.  Meaning that they will assume that price will hold and will make capital investments accordingly.  Unfortunately, when the traders crash, it moves very swiftly, e.g. $8/barrel in 1998.

Additionally, experts disagree on the exact date of peak oil but it is generally placed between a couple of years ago and 2012.  Demand growth will continue in emerging countries.  Conservation and alternative will reduce growth in developed countries.  Prices will not stabilize anytime soon.

My bets are on a select group of high performance deep water drillers (RIG, DO, NE).  Demand for their services will not diminish anytime soon.

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#9) On May 24, 2008 at 5:30 PM, TheGarcipian (34.08) wrote:

MauiPeter: A very hearty welcome to the CAPS system!  I'm very glad you joined us, and I think others in this community will benefit from your readings on the subject of oil. Really, drink up; the Kool-Aid is just a formality... it's very good Kool-Aid. Heh. I'll work with you offline to show you the ropes. Hopefully, you'll be posting and blogging in no time.

ATWD: I agree with you; I too would like to see more R&D going into nuclear energy. As ajm101 pointed out, there are some risks with nuclear, but considering the bang-for-the-buck, it's the cheapest form of energy we have. It's sort of the airliner form of travel as compared to the horse-n-buggy version of the same: initial costs are very high, but then extremely cheap for the finished product. Unfortunately, when something goes wrong (an accident), it's threatens more people and has a larger impact than the older form. However, when you consider the overall impact to the environment, people's safety and relative expenses, nuclear beats out any other form of energy production, hands down. Unfortunately, we've got much more work to do here, to mitigate or eliminate the safety risks, convert people's mindset away from the horse-n-buggy and into the nuclear age, and time is a-wastin'. Regarding ANWR, I need to do more research here before I can answer intelligently. I've heard estimates of oil supplies there that don't sound like much (less than a year's supply of oil for the entire US?), but that's just heresay. If your quote of 16B bbls is accurate, and if the USA consumes 25% of 86.4M bbls/day, then that 16 billion barrels would last us 740 days (16,000/(.25*86.4)), which is just over two years. Like you said, it's not a complete solution, but would obviously have to be part of a comprehensive solution.

Which brings me back to my original point: conservation. Slow the consumption (the demand) and the prices should fall. Of course, that presumes that China and India don't ramp up to fill the void that we Americans would create by being more conservative in our fuel usage. And it doesn't address the trader's impact, as DataExec points out. I don't know enough about how traders can move the price of oil that much. I think they will have some impact, but I still hold to the statements made in my original post above. It's obviously a very complicated problem, and it will take a series of solutions to address it.

All in all, thanks everyone for your posts. Keep those thoughts coming. 

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#10) On May 27, 2008 at 11:33 AM, binv271828 (< 20) wrote:

Hi Garcipian, Awesome post! This is such great topic and is so important to the US, the economy and our lives! And ultimately good for investors as we look to the next big technologies in alternative energy. I wrote a blog that discusses many of the same topics and ideas: Case for Alternative Energy / State of USD / Peak Oil. Most of my blog talks about renewable alternative energy and I really like how you are focusing on the conservation aspect.

I couldn’t agree more. We will never see $3 gas again. The global demand is now too high. The US demand is out of control and has been for far too long. But now Chinese and Indian demand is increasing for not only their industrial complexes, but also for an increased standard of living. FourthAxis has an awesome response on bellard's blog regarding increased consumption and the changing of eating habits a...... (see response 3) . I seriously doubt that even if US consumption waned that it would make a serious dent in global demand. For the United States, the world’s largest consumer and importer, this trend should be alarming. But more importantly it should be so OBVIOUS. Demand is increasing, and so prices are increasing.

But the other obvious part of the equation is the decline of the USD, but somehow oil prices get blamed on speculation (some part is sure, but I would argue that not even the majority is speculation). Oil is priced in USD. It is a very sad and very unfortunate fact that the USD is being debased and devalued by the current government's fiscal policy. The US Dollar Index is on a very steady decline. There is no reason for it to rise in the current environment. FED is printing money and trying to inflate the US out of its current economic dilemma. Oil prices are high, not speculatively and not artificially, but due to global demand and weakness of the USD.

So two paths for the US to secure it’s energy future: Production (and for our future and our children’s future it should be clean renewable energy production) and reduced consumption. And I think the reduced consumption aspect is so important and I really like the way you talked about it in this blog. I like how you put it in context of the big picture.

I also like how you point out the fact that virtually all the plastics that we use are petroleum based. There are two sources of exceptionally mindless wastes of plastic that are so incredible easy to fix: Shopping bags and water bottles. There are two simple ways to reduce a huge amount of plastic consumption:

- Reusable shopping bags. These are the “green bags” that you can now buy in virtually every grocery store now. Just buy half a dozen (should cost about $10 bucks). And after you bring your groceries into the house, put the bags back in your trunk so they are ready for you for your next shopping trip.
- Water bottles. There is so much waste in these for a one time use. Just buy a couple of durable plastic or glass bottles and a Brita filter for the sink. Fill up your bottles in the morning before work. It will save you tons of money in the long run, and save tons of waste. Everybody wins!

Thanks a lot for such a great post! And I would love to get your opinion on my blog for some the upcoming alternative energy technology viabilities!

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#11) On May 28, 2008 at 11:32 PM, russiangambit (28.77) wrote:

> All this Congressional and Presidential grandstanding this past week is getting us nowhere fast, except to make it appear to the Average Joe that his elected officials actually care about him and his pain at the pump. It’s all great theater, but the ticket price for that show is already way too expensive for any of us to pay. And believe me, it’s getting more expensive every day that we waste…

I leave in Houston, the oil-capital of the world -)). And you won't believe the attitudes here. People take any suggestion of conservation as a personal offense. What do you mean, they can't drive their 2-story tracks anymore? It is all a big consipracy by green lefty liberals. They are waiting for the governmentto do something. Confiscating Exxon's profits would be a step in the right direction  -)).

On a serious note, I am very intrested to see America transformed by the price of oil. It is a new bright world ahead of us. Progress is always born out of necessity and crisis. 

 

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#12) On June 03, 2008 at 10:02 PM, TheGarcipian (34.08) wrote:

Yes, it will be a very different America, and indeed a different world as oil reserves and future prospects of oil both dwindle. I've just posted a follow-up to this blog (Part 3) which talks about a Newsweek article touching on the "Coming Energy Wars". If we don't start replacing or, at the very least, augmenting our oil consumption and increasing our conservation efforts (the real point behind these blogs, so far), then we are all going to be in for a world of hurt. And I mean that quite literally.

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