Why 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.

Britain’s real celebrities

Posted by admin in Non-Finanical Articles Tuesday July 15, 2008 10:38 am

Tony Blair’s victory party back in 1997 saw assorted celebrities mixing it with the new prime minister.

 

In a nation hooked on junk food TV and oozing celebrity gossip from every multimedia orifice, the groovy new prime minister showed early on he was a modern leader in tune with popular tastes.

 

Nothing wrong with that, of course. A politician needs to be an advanced reader of the popular mood. Where it starts to pale is where it appears to promote style over substance. Where the distinction in the public mind, aided and abetted by popularity seeking politicians, becomes blurred. So we reach a point where there seems to be confusion in the national mind over the national contribution of some guy with a reedy voice and a banjo and some other guy who has achieved the unlikely impact of genuinely making the world a slightly better place.

Strangely, enough this weird and wonderful country is rich in the rare people that comprise the latter group. They don’t make the headlines so you don’t hear too much about them but some of them still breathing today and walk among us.

Let me indulge in three brief examples:

 

Tim Berners-Lee

 

If you don’t already know the name, Mr Berners-Lee is the man who invented the World Wide Web. An innovation that interlinked the individual pages of content on the internet. In so doing he opened up the internet to almost effortless navigation. It has developed rapidly and become what entrepreneur Luke Johnson calls “the best library ever known”, available to all with a computer and an online connection.

 

Born in London to parents who were both mathematicians, Mr Berners-Lee was on a six-month contract in CERN (the European Particle Physics Laboratory) in Switzerland in 1980 when he came up with the idea of hypertext to help share information among researchers. In 1989, he saw the opportunity to link this idea with the internet and in August 1990 the World Wide Web was born with CERN itself launching the first website. By 1994 there were 10,000 websites around the world and its growth has been explosive ever since. By spring this year, there were over 100m websites.

 

Frank Whittle

 

Only 5’1” and from the wrong side of the tracks, Frank Whittle squeaked into RAF Cranwell, the officer training college, on raw ability. While there he penned his great invention at the tender age of 21. It was 1928 and the idea was the jet engine.

 

To say he was ahead of his time is something of an understatement given in the late 1920s the RAF were buzzing around in biplanes. But Whittle realised propeller driven planes had limitations. They could only fly so fast and so high. The higher you go, the thinner the air, the less effective your propeller in cutting through it. His invention overcame these limitations as well as making for a smoother, quieter ride with an engine that needed less clanking parts.

 

For all this, he was unable to develop his idea and his patents lapsed when he couldn’t afford the £5 to renew them. He finally got backing in 1936 and the critical needs of a world war saw the first British jet plane take to the air in 1941. By 1944, the RAF had its first jet fighter squadron. War munitions minister, Lord Beaverbrook, called it a “step change” in technological progress and it was. Planes could fly further, faster and above the elements rather than being buffeted through or underneath cloud cover.

 

Such was the significance of his work, it briefly gave Britain an edge in the nascent post-war business of commercial jet aeroplanes, with Britain’s de Havilland Comet becoming the world’s first jet-powered commercial airliner.

Ironically, the Germans developed and flew a jet plane in 1939, weeks before the outbreak of the Second World War. The engineer who designed the German engine, Hans von Ohain, survived the war and met Whittle after it ended. He is reported to have commented Germany would never have attacked Britain if it had developed a jet fighter in 1939.

 

John Shepherd-Barron

 

Remember the days when the bank’s closed at 3.30pm and lunch time ritual was standing in snail-like queues for your cash? Remember too, going to buy your traveller’s cheques and trying to figure out how much cash you would need for your holiday? Those days are gone thanks to inventor John Shepherd-Barron.

 

This former Managing Director of banknote maker De La Rue plc found inspiration in the bath one evening to adapt a vending machine to distribute cash via a small plastic card and personal identification number (PIN) system. Barclays bank picked up on the idea immediately and the first hole-in-the-wall cash machine opened for business in Enfield, north London in 1967 with actor Reg Varney being the first customer to draw out £10. Enough for a good night out back then.

 

As a result of Mr Shepherd-Barron’s inspiration you can pretty much travel to the end of God’s money-changing earth today with a 3 inch by 2 inch plastic card in your pocket and a four digit pin code in your head. With it you can draw your euros, dollars, Malaysian ringgits or any other local currency immediately, at modest cost and in the quantity you need. Mr Shepherd-Barron himself admits to acknowledging the full significance of his invention when on holiday in Thailand. A farmer in a straw hat pulled up on a bullock cart to draw cash from an ATM.

 

Though this inventor believes the days are numbered for his invention. He predicts cash will be obsolete in five years time.

 

Patchy Recognition from the Nation

 

And how does the nation treat its great inventors? The track record appears mixed at best, even amongst this small sample. Mr Shepherd-Barron’s personal recompense for his brainwave was nothing. All credit and compensation went to his employer and he was ignored by the nation for 37 years. He was recognised finally late in life. His comment on receiving the news at age 79 said it all: “Better late than never.”

 

Frank Whittle’s company, Power Jets, was nationalised under a socialist government and he was paid off with a knighthood and £10,000 cash. He eventually left Britain and emigrated to Canada.

 

Tim Berners-Lee gave his idea freely to the world with no patent and no royalties due and he remains personally contactable via an email address through his website.

 

The nation appears to have been quicker off the mark in this instance. He was knighted in 2004.

 

But then, as we know, honouring achievement and service is at best a warped business in the real world of Westminster power politics. When the nation’s highest honours are a tradable commodity waved by politicians seeking donations at vain rich people interested at exchanging cash for status. £1m is about the going rate for a “K” (knighthood) and £2m plus for a “P” (peerage) according to press reports in connection with the cash for honours inquiry. An inquiry that saw Tony Blair became the first serving prime minister to be questioned by police in the course of an investigation.

 

But the main point is this. In an age when our sensibilities are assaulted and insulted remorselessly by often worthless, frequently damaged non-entities offered up to us as ‘celebrities’, it needs a reality check on who the real celebrities are ,or were, amongst us in the context of their contribution to our lives. When the BBC ran a series in 2002 entitled The 100 Greatest Britons, the contribution of actor Michael Crawford, pop singers David Bowie, John Lennon and Sir Paul McCartney, comedian Eric Morecambe and footballer David Beckham were all deemed greater than any of the three characters mentioned here.

 

But consider this next time you’re on a plane, flying to your foreign bolthole of choice. Pause for thought on the genius that facilitated your quick and smooth flight there. On arrival, remember the ease with which you get the cash you need without testing often linguistically challenged skills on some stroppy foreign bank clerk; and finally, appreciate the convenience of being able to tune in immediately to the world as you choose to receive it, anywhere in the world, via a computer and the wonders of the World Wide Web.

 

How ‘Cool Britannia’ is that?