Archive for July, 2008
« Previous EntriesWhy crude oil will go the way of spermeceti
Posted by pedalo in Financial Articles Tuesday July 15, 2008 12:09 pm
Captain Ahab had a grudge.
Moby Dick had cost him a leg and in the days when prosthetics weren’t so good.
He wanted revenge in spite of being a Quaker. He was pursuing an obsession to fix the giant albino whale that nearly killed him.
It didn’t happen. Moby Dick fixed him…and his ship…and his hapless crew save one fortunate.
It was a rare victory for the sperm whale over mankind. Fictional, in fact, though the story was based on an actual whale. In truth the species, which can dive to tremendous depths and boasts the largest brain of any animal, was hunted relentlessly in the nineteenth century.
Between 1835-1872 approaching 300,000 sperm whales were killed by the deep water American whaling fleet alone. And their depletion was such that whalers started to struggle for their catch. To this day they remain a “vulnerable” listed species, though their exact numbers can only be guesstimated.
At the time, man had become pretty dependent on Spermeceti, the waxy fluid found in the head of these 40 tonne carnivores. Mainly it was used as lighter fuel for lamps but found a variety of other applications too: transmission fluid, watch oil, vitamins, cosmetics, detergent, additive for motor oils and pharmaceutical products amongst them.
So there was a broad demand for whale oil and the suppliers worked hard to meet it. The result was depletion of a finite natural resource. Sound familiar? Scarcity drove prices up. The cheapest barrel of whale oil rose from $200 in 1820, (rebased 2003 prices) to almost $1,500 by 1855. That kind of price action provokes a reaction…
A Substitute Comes Along
Meantime, a new business was just getting going. It was one that soon would steal their markets and ruin the whaling business.
In 1846, Nova Scotian Abraham Pineo Gesner discovered how to refine kerosene from coal. A little later, Ignacy Lukasiewicz discovered how to do the same thing from the more plentiful supplies of rock oil.
Then in 1854, Yale science professor Benjamin Silliman discovered how to fractionate petroleum by distillation. ie separate petroleum from the hydrocarbon mixture present in crude oil. Word spread rapidly and the first refinery was opened in Baku, Azerbaijan in 1861 - at the time producer of about 90% of the world’s oil.
Five years later in 1859, prospector Edwin Drake sparked the American oil boom when he struck oil a mere 69ft below ground at Titusville, Pennsylvania.
The oil was refined into kerosene (paraffin) and found a market as a cheaper and relatively smoke-free lamp fuel replacement for whale oil. From 1863, European lamp makers switched to manufacturing for the new fuel. Kerosene’s adoption was encouraged further by increasing supply which drove crude oil prices down. The cost fell from $90 a barrel (rebased 2003 prices) in 1860 to $20 a barrel in 1870-80.
The kerosene lamp business didn’t last when the electric light came along but fortunately for the oil business, along came a much bigger market - the internal combustion engine in the late 1800s. By 1914, Henry Ford started producing the Model T and had built 15m of them by the time the production line fell silent in 1927. There are still almost a million of them out there today saysUS talk show host and car nut, Jay Leno.
New markets opened up too: diesel for trains and planes and jet fuel for the new age of post-WW II travel. Today 70% of a barrel of oil is burned up on transportation alone not to mention the myriad other products later spawned by the petrochemical industry – plastics, painkillers, paints, cosmetics to name a few. More than a passing resemblance to the markets once served by whale oil.
Hitting the Depletion Buffer
But much as whale oil ran up against the depletion buffer, so too crude today. The news is awash with the debate on whether we’ve hit the maximum level of production globally, at almost 87m barrels/day – so called Peak Oil. We’ve been going at it hell for leather for a long time now with few major new discoveries in recent decades, so a finite resource has to hit the ceiling sooner or later. Regionally, many places are past their peak with Mexico and the North Sea now in rapid decline. Some say we’ve peaked globally already back in 2005 and supply projections of 100m barrels a day by 2015 and 115bn by 2030 are pie in the sky. Others say we’re years away yet but the last year the world discovered more oil than it used was 1981.
Mr. Market has taken notice and, chased by the speculators and buying by the US Strategic Reserve, sent the crude price galloping higher. The popular mood is angry at the cost burden and looking for a whipping boy. Hapless politicians from oil import-dependent countries are feeling the heat and some have responded by flapping around with plaintive pleas to OPEC to pump more…assuming they can. And Oil Majors too are in the firing line as supposed profit-gouging big business conspiring to scalp motorists.
But wait a second before you get on your high horse. Western oil companies are an impotent sideshow these days. Back in the 1970s, they controlled 75% of the world’s oil patch, today it’s more like 6% says Paolo Scaroni, CEO of Italian oil major Eni. They also controlled around 805 of production. Today, it’s more like 25%. The real players are those you’ve probably never heard of - the National Oil Companies (NOCs) - State-run oil businesses from the producing nations. You know ExxonMobil, have you heard of Aramco? You know Shell, do you know the National Iranian Oil Company?
Measured by reserves on their books, western oil companies are pygmies. The biggest western Oil Major – ExxonMobil with $400bn of revenues last year – has proven reserves of less than a tenth (22.7bn barrels) those of Saudi Arabia’s state oil company Aramco (295bn barrels). According to recent Senate testimony by ExxonMobil, the company said it ranked 14th by reserves with Government owned national oil companies dominating the top spots.
Oil Majors have been on the receiving end of resource nationalism since their heyday in the 1970s. Exiled from easy, abundant oil patches they have been forced onto the difficult, costly mostly offshore fields such as the North Sea, Sakhalin Island and the deep water Gulf of Mexico. Reserve replacement is a struggle and exploration costs are soaring as the industry scrambles for more production. “Easy oil” has gone asserts Shell CEO Jeroen van der Veer. But with shareholders to please and for all their perceived faults, these companies tend to be the ones that get things done; whereas with the NOCs, there’s more reason for doubt. These organisations dance more to the drum of politicians than shareholders. They have skipped on investing in their businesses during the lean years and the 10m barrel/day surplus capacity available in 1985 had been whittled down to 2m bpd two decades later. The ability of OPEC to raise production these days is limited to that traditional swing producer, Saudi Arabia, alone. And when the supply cushion is threadbare, the slightest hiccup can move even a $2trn market.
Why Oil is Cheap
Then, of course, the destination for crude oil is the refineries to turn it into its various products. Here the picture offers little relief. Over the past decade, increases in refining capacity have actually lagged that of supply increases – of themselves nothing to boast about. The last new refinery built in the US was back in 1976, noted Alan Greenspan in his book The Age of Turbulence. This bottleneck is aggravated further as the world’s supply of the best, easiest to refine oil – light sweet crude – is diminishing and the more abundant but, in refining terms demanding - heavier sour crude (higher sulphur content) - is becoming proportionally greater. And this is happening at a time when refiners are faced with greater environmental demands to produce a cleaner product.
Worse, is that existing production is actually falling by an average 4.5% a year according to a study of over 800 leading oilfields by Cambridge Energy Research Associates. This is forcing the leading oil forecasting agencies – the US-based EIA and the Paris-based IEA – to switch their attention from galloping demand to straining supply. And it is the price that has the consuming world caught, once again, like a startled deer in headlights.
Almost 10 years ago the price was around $10 a barrel. Today it is more than $120 having been as high as $135. That’s still cheap says Matt Simmons for all the cost and aggravation of getting it out of the ground, more often than not in extreme conditions these days.
A litre of petrol at the pump averages 115p and diesel almost 129p according to the AA. That’s an unwelcome price rise for motorists (and potentially ruinous for commercial transport) but still only about 65p a pint for petrol. When last was a pint of beer 65p from the less technologically challenging task of onshore brewing?
Demand Destruction
As we live through another oil crisis to echo that of the 70’s as Fed chief Ben Bernanke noted recently, something new is happening. Demand destruction. In the country that accounts for around one in four of every barrel of oil produced and is according to its own President’s admission “addicted” to oil, demand is falling. US fuel demand fell 0.7% in the four weeks to 23 May as old fuel-inefficient aeroplanes are grounded, SUV sales collapse – US sales were down 32% in April, reports the FT and GM is considering selling its gas-guzzling (est. 15m to the gallon) Hummer unit. US consumers have been scaling back on their travel plans for the “driving season” too. US petrol prices are still a steal by European standards but this is a sea change and a measure of how price influences behaviour.
As for crude oil, the exceptional energy it supplies makes it hard to replace but no doubt it too will one day go the way of Spermeceti, at least in its major transportation market. Environmental priorities are hastening the endgame as the world mobilises to reduce carbon emissions. One or more substitutes will steal its major markets in much the same way as it usurped the whale oil business more than a century ago. Maybe it will be electric, hydrogen, biofuel or something else…or a combination of alternatives. Given the grinding relentlessness with which the crude price has run up again, that day may well be closer than we think.
Jim Rogers on China, the Dollar and commodities
Posted by admin in Financial Articles Tuesday July 15, 2008 11:34 am
This was first published November 2006…
Late last month, I crammed into an elegant wood-paneled room of the Merchant Taylor’s livery company in the heart of the City.
We were there to hear about commodities, primarily from legendary investor and long term commodity bull, Jim Rogers.
Sporting trademark bow tie and braces, Jim opened with a quick reprise of his most recent activities. Namely his grand tour of 2000-2002, when he crisc-crossed the globe motoring through 116 countries and clocking up 245,000km in a souped-up yellow Mercedes coupe. This was followed swiftly by his newfound thrill in parenthood, following marriage to his traveling companion. Those who’ve not yet experienced it should take a day off or a week-end away and get started, he advised!
As a student of his views for some time there were few surprises this time around. Below is Jim’s brief tour of the investment scene today…
The Rise of China
Most people don’t understand the full depth of what’s happening in China. It will be the next great country of the world and the Chinese are amongst the world’s best capitalists. The 19th century belonged to the British, the 20th century to America and the 21st century will be China.
The Chinese aspire to have what the West has and the work ethic to get there. They save around 35% of their income whereas Americans save about 1%.
Jim advises teaching our children and grandchildren Mandarin and has hired a Chinese nanny for her daughter with strict instructions to only talk Mandarin to her. Already she is bilingual, he boasts.
Jim though is not a fan of India for reasons given in his latest book, Hot Commodities. He finds the prevailing view there ‘anti-capitalist’ and protectionist, the infrastructure poor, the education system inadequate and the caste system degrading to women and inhibitive of economic progress.
US Dollar
The US dollar is the world’s reserve currency. That’s changing. The US has gone from being a creditor nation to being the largest debtor nation in history.
The US owes $13trn and that number is increasing by $1trn every fifteen months. It is out of control, a serious problem and nobody cares he tells us. Jim has little faith in the new Fed Governor who once quipped he would run the printing presses and shower the country with bank notes from a helicopter if needs to be.
Jim has set up a bank account for his daughter. It’s not in America though. It’s in Switzerland!
Enough said.
Stocks v Bonds v Commodities
There was a huge bull market in bonds in the 1980s and 1990s. It peaked in 2003 and will go down for years.
The bull market in stocks is finished. Stocks are expensive and they will continue to range trade for years.
We are in a secular bull market in commodities. History tells us the shortest bull market in commodities lasted 15 years, the longest 23 years. Jim reckons this one will continue from now until between 2014-2022.
The performance of commodities is uncorrelated to stocks and price is simply a function of supply and demand. The last lead smelter built in the US was in 1969 and all the world’s major ‘elephant’ oilfield discoveries were made before 1970 so the supply side is under pressure. When supply goes down and demand goes up, price rises. It’s very simple.
We’re in the very early stages of the commodity bull market says Jim. The world has plenty of stocks but doesn’t have plenty of commodities. When Time magazine has a picture of a lumberjack on the front cover he promised to be screaming get out assures!
Oil
In 1979 there was an audit of Saudi oil:
110bn proven reserves 67bn probable reserves 68bn possible reserves
In total, that’s 245bn barrels.
Since 1979 they have produced 63bn barrels of oil but they continue to report reserves of 260bn barrels despite having made no new major discoveries.
Something’s wrong. This is a huge problem and there will be a gigantic bull market for years to come.
That’s hopefully an accurate condensation of Jim’s views. He’s pretty consistent and measured by the performance of the commodity index fund he set up in 1998 (the year Merrill Lynch got out of the commodities business), he’s been right on the money with his calls to date.
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