This post by John Mauldin should be of interest to many on this list.
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From: [EMAIL PROTECTED]: [EMAIL PROTECTED]: What the Export Land Model Means
for Energy Prices - John Mauldin's Outside the Box E-LetterDate: Mon, 19 May
2008 23:26:27 -0500
Contact John Mauldin
Print Version
Volume 4 - Issue 30May 19, 2008What the Export Land Model Means for Energy
Prices By David Galland
Goldman Sachs recently forecasted that oil would be at $141 a barrel by the end
of the year, and rising to $200 a barrel in the not too distant future. I have
seen other forecasts calling for oil to slip significantly under $100 a barrel
before starting yet another bull market.
I have written for years that we are not going to run out of oil or energy,
just cheap oil. I was just in South Africa, where much of their gas and diesel
comes from coal gasification. At one time this was an expensive way to make
gas, and South Africans had to pay more for their gas than the rest of the
world. Now, it is getting close to "par" to the cost of gas in the US, and is
cheaper than gas in Europe.
In this week's Outside the Box, my friend David Galland at Casey Research
presents some very troubling thoughts on why oil may rise higher than we think
in the next few years. Many of the countries from which the US gets its oil are
seeing production fall, not rise. Some of it is political ineptitude, but much
of it is from oil production peaking.
Yes, we can move to coal gasification, and the US has centuries of coal for
such purposes, but building such plants takes time and capital and political
will, the latter of which is in short supply. In the meantime, and until we get
a full-blown crisis, oil is going to continue on its path to $200 and higher.
But such a rise will not only make gasoline prices higher, it will make a host
of new technologies competitive for the first time. The shift in how we make
energy is inevitable.
As a quick aside, if we would start a project to build a massive nuclear
infrastructure, such as in France, which produces 80% of its energy from
nuclear, while at the same time pushing ahead in a Manhattan-type project the
development of electric cars (or some hybrid), we could reduce our dependence
on foreign oil and lower travel costs by the middle to the end of the next
decade. And the environment would be cleaner and safer.
We are headed to such a future. It would be nice if we did it sooner rather
than wait for a real crisis. But in the meantime, the price of oil is going to
rise and opportunities for investors will rise along with it. My friends at
Casey Research publish an excellent newsletter highlighting the opportunities
not just in exploration companies but in all manner of energy-related firms. As
David writes:
"The good news is that there are no shortage of high-quality energy-related
investments available ... in coal, heavy oil, LNG, photovoltaics, natural gas
consolidators, "run of river" hydroelectric, uranium and small to mid-cap oil
companies with the potential for significant near-term gains in reserves or
production."
They have agreed to give my readers a risk-free three-month trial to the Casey
Energy Speculator. If you like the research you read below and want more of it,
you can click on this link and subscribe.
And now let's see one of the main reasons why the price of oil is going up.
John Mauldin, EditorOutside the Box
What the Export Land Model Means for Energy PricesBy David Galland,Managing
DirectorCasey Research - Casey Energy Speculator
Jeffrey Brown is someone you should know. That's because he can help you
understand today's high energy prices and that, as an investor, can make you a
lot of money.
I'll introduce to you to Jeff Brown in a moment. But first, as it's relevant to
the discussion, I want to touch on an important concept related to investing in
challenging times.
You might call it "the Davy Crockett principle" in honor of something that
American icon said during the War of 1812: "Be sure you are right and then go
ahead."
Simply, it's critical to step away from all the noise and clutter that passes
for knowledge on the financial talk shows, and take the time to be very sure
you are investing in close concert with a powerful unfolding trend. That
accomplished, come what may, you'll come out okay once the dust has settled.
And the earlier you can get on board with a trend, the more money you can make.
In fact, Casey Research chief economist Bud Conrad has shown how, by making
just four trades over the last four decades -- into exactly the right sector at
the beginning of a strong new trend -- you could have turned $35 into $150,000.
Or $350 into $1,500,000 ... or $3,500 into $15 million. And that assumes you
don't use leverage. Toss in some options or futures and the returns run
exponentially higher. Here's the chart.
While it is unlikely anyone actually made those exact trades, it is a certainty
that many investors got in early on one or more of those big moves.
(Interestingly, replacing the last trade -- the move into crude -- with gold
produces a final number of $131,496. Proving there is more than one path to the
top.)
The key point I'm trying to make is simple: focusing your investments on big
trends is a big leg up in your quest for investment success. By then digging in
to find the right opportunities, whether they be in commodities or undervalued
companies that benefit from those trends, assures you earn returns that are
well above average.
More importantly, in the context of the current market environment, the
combination of the right investment in the right trend makes your portfolio
bullet-proof.
Which brings me to the work being done by Jeffrey Brown, a professional
geoscientist with an avid academic and professional interest in something
called the Export Land Model.
Turning off the Taps
You don't have to have an awful lot of gray hair to remember the excitement
around England's massive North Sea oil fields. While discovered in 1969, it
wasn't until well into the 1980s, on the back of surging oil prices, that the
fields came into full production. Turning up the taps, the United Kingdom (as
well as Norway and Germany, who also have North Sea production) became a
significant exporter of oil.
But then, in 1999, something happened: the UK's North Sea production hit peak
... that tipping point after which reservoirs go into decline, setting in
motion both reduced production and progressively higher costs related to
extracting the remaining oil.
While the experience of North Sea oil production provides yet another useful
example of the validity of the Peak Oil theory, what concerns us today is a
critical but usually overlooked aspect of the discussion, exports.
At the time the North Sea peaked in 1999, the U.K. was exporting 1 million
barrels of oil per day. By August 2004, it had become a net importer. What
happened to cause the situation to turn around so quickly?
The Export Land Model
To understand the importance of exports when discussing peak oil, ask yourself
the question, "What's more important: the fact that global oil production is
falling ... or that the oil-exporting nations are cutting off their exports?"
While the two questions are clearly linked, it is the nuance of the export
question that clearly matters the most. Especially if you live in a country
such as the US, which currently imports about 70% of its oil.
Which brings us to the Export Land Model (or ELM, as I will refer to it from
here). The basic thesis expressed by Jeff Brown and other students of the ELM
is that, to fully appreciate the impact of peak oil, you cannot look only at
the production declines so presciently anticipated by MK Hubbard in 1956. You
also have to look at the rate of local consumption and the effect of that
consumption on the ability of a country to export its oil.
The following ELM graph looks at both sides of the equation, and the result as
it applies to exports:
As you can see, for illustrative purposes the ELM assumes that, after a
country's oil production hits peak it will decline at a rate 5% annually, at
the same time that local consumption increases by 2.5%. The red line then shows
the impact those two metrics will have on the ability of the country to export
its excess production. Using these assumptions, the ELM shows that exports
reach zero in 9 years.
Real-world data shows that the metrics used in the ELM are quite conservative.
The chart below plots the hypothetical ELM against the actual data from the
United Kingdom and Indonesia. While the ELM forecast hypothesizes 9 years
between peak to the end of exports, Indonesia's exports ceased 7 years after
peak, and the UK's exports stopped just 6 years after peak.
The important take-away here is not that the UK and Indonesia are no longer
receiving the oil export income of the good old days -- that is entirely a
localized concern.
Rather it is that the global market is now deprived of those exports; between
UK and Indonesia alone, the change over just the last decade amounts to a swing
in the wrong direction of a total of 2 million barrels per day. And those are
just two of a number of important countries which have swung from exporters to
importers in recent years.
China, for example, became a net importer in 1993, the result of flattening
production against skyrocketing consumption. Over the last decade alone,
China's oil consumption has almost doubled, to about 8 million barrels a day,
about half of which is now imported.
So, again, while people tend to focus on production, they are overlooking the
impact on exports forecasted by the ELM. In the case of China, they went from a
net exporter in 1993 to importing 4 million barrels a day today ... with those
imports projected to rise another 50% over the next 10 years.
This is what is creating so much international competition for the remaining
supplies of oil. And why the trend to higher energy prices is so well
entrenched. And if the ELM is right, things are about to get far worse ... far
sooner than most people expect.
The #3 Source of Oil to the US Is About to Go Offline
Mexico provides about 14% of the oil the US imports. On any given day that
makes it either the #2 or #3 leading source for US oil imports after Canada and
Saudi Arabia. Given that the US currently imports close to 70% of its oil
needs, the Mexican oil is critical.
But here's the thing. Using straightforward ELM calculations, Jeffrey Brown is
confident that Mexico will ship its last barrel of oil to the United States --
or anywhere else, for that matter -- about 6 years from now, in 2014. In a
recent interview with Brown, I asked about this forecast.
"Mexico was consuming half of their production at peak in 2004. And if you look
at the '05, '06, '07 data, they're basically on track, on average, to approach
zero net oil exports no later than 2014," he confirmed.
Of course, the US is completely unprepared to replace this source of oil,
especially considering the growing stresses on global oil supplies causing by
ballooning demand from emerging markets. That means the international
competition for available supplies is only going to get more desperate in the
months and years ahead.
What will this mean to oil prices, according to Brown?
"From this point out I think we'll see a geometric progression in prices ...
you know, $50, $100, $200, $400, whatever. The only question now is how short
the periods will be between prices doubling again."
Coincidentally, while this report was in preparation, on April 30, 2008, PEMEX,
Mexico's national oil company, announced it would be unable to fulfill this
year's scheduled oil export obligations to the United States ... falling short
by about 11%, or 184,000 barrels a day.
(As an aside, I also have to believe that Mexico's coming transition to a net
importer and the loss of almost 6% of the country's GDP, now earned from
exporting oil, will trigger serious social issues in that country. But that is
another story for another day.)
The Even Bigger Picture
In my interview, I also asked Jeffrey to share his thoughts on the situation
globally. Here's his response.
"Global production peaked in 2005, and we're now into the third year of
decline. And the critical point to keep in mind is, our model and case
histories show that the decline rate accelerates, year by year. Using the Lower
48 in the United States as an example, you can see the annual declines going
2%, 3%, 5%, 7%, 10%, 15%, 20, on and on. So it's an accelerating decline rate."
Underscoring Brown's concerns:
On April 15, 2008 the Russians, the world's second largest oil exporter,
announced that their oil production appeared to have peaked, with production in
the first quarter of this year declining for the first time in a decade. If
they have indeed peaked then, based on the ELM, the world could lose Russia's
current ~7 million barrels a day in exports within 6 to 9 years.
Echoing the baseline premise of the ELM, Herman Franssen, president of
International Energy Associates, projects that Iran, the world's fifth largest
exporter, may consume an amount equal to their exports by 2015. A prominent oil
analyst, the late Dr. Ali Samsam Bakhtiari, estimated that Iran is either at or
near peak.
Most concerning, this April Saudi Arabia's King Abdullah announced they were
not going to raise oil production above 12.5 million barrels a day. Commenting
on the news, Tom Petrie, vice president of Merrill Lynch, said"King Abdullah's
quote speaks to the fast-emerging reality of what I call 'practical peak oil.'
The Saudis and other exporters are placing a new emphasis on elongating the
petroleum exploitation and depletion cycle. This stems from a growing awareness
of the challenges of conventional resource maturity, as well as rising resource
nationalism. This is likely to result in an earlier occurrence of global peak
oil output than many consumers yet recognize."
Summing it up, Brown told me that "The reality is that this thing is coming so
much faster and so much harder than even most pessimists were expecting."
Rice & Oil: a Useful Comparable
For a useful way to think about energy exports and prices, Jeff Brown points to
the current situation with global rice supplies.
As long as there are abundant local supplies, countries are happy, eager in
fact, to export excess production in order to generate foreign exchange. But as
soon as local consumption exceeds locally available production, then all hell
breaks loose, and the next thing you know countries are banning exports, a move
that has already been undertaken by Vietnam and a number of other countries.
In that scenario, price is eventually no longer a factor in the availability of
the commodity. Vietnam, for example, is not going to let its people starve just
because higher global prices would allow it to earn an extra $10 per bag of
rice.
And so in the face of the prospect of any serious shortage of an important
resource -- energy being maybe the most important - export markets freeze up
and the price begins to be set at the margin, literally based on a global
competition for the dwindling supplies that manage to leak out around the
edges.
"People are crazy not to be focusing on the oil export situation," Dr. Brown
told me.
Any White Knights on the Horizon?
Of course, the question of energy alternatives is a big topic and one which
needs a far more extensive discussion than space allows for here.
Will viable alternatives be developed to help mitigate a domino collapse of oil
exports? Absolutely. Of those alternatives, nuclear, solar, and heavy oil seem
to hold the greatest promise.
But the sheer scope of the problem - with the world now consuming the energy
equivalent of 1 billion barrels of oil every 5 days - assures that we are
probably decades away from a real solution.
In the words of Jeff Brown:
"If you look at the situation in US presidential terms, looking at fossil fuels
plus nuclear, the world burned through the equivalent of 10% of all oil ever
consumed in Bush's first 4-year term. And, in our model, we're going to burn
10% of all remaining conventional crude in the second 4 years of Bush's term.
"That is the equivalent of around 25 billion barrels a year. So that's 100
billion barrels every four years, and we've burned 1,000 billion barrels. It
gets interesting when you consider that current estimates are that we've only
got 1,000 billion barrels of conventional crude remaining. I think with natural
gas liquids, we've got a little bit more. But of the conventional crude oil,
we've got 1,000 billion remaining. Which then begs the question, how fast can
we bring on the tar sands and everything else?"
Grasping for straws, I asked Jeff about an article I had read recently about
the Bakken oil shale reserves around North Dakota.
"They're talking about somewhere between 200 billion and 500 billion barrels in
situ, but the USGS recently came out with a mean estimate of between 2.5 and
4.4 billion barrels recoverable, as an outer limit," he replied, before
continuing:
"In 1966 they said, if Lower 48 ultimately recoverable is 150 billion barrels,
then the US would peak in 1966. If the recoverable oil from the Lower 48
ultimately came in at 200 billion barrels, then the US peak would come in 1971.
The higher-end estimate probably turned out to more accurate, and the U.S.
peaked in 1970. But the point is this: a one-third increase of estimated
ultimate recoverable - a total increase of 50 billion barrels - postponed the
peak by all of 5 years."
Rigging for Persistent High Energy Prices
The trend for sustained higher energy prices appears solidly in motion. If
Brown and the ELM are correct, energy prices will double, then double again.
Even if he is wrong and prices don't rise geometrically, the global dogfight to
replace declining supplies - decidedly exacerbated by the loss of Mexican and
maybe Russian (and ??) exports in the near future - is going to get ugly and
expensive.
So, what's the investment angle? Paradoxically, the larger energy companies are
probably a bad bet, because they are forced to replace their depleting
reserves, which is getting harder and more expensive to do with each passing
day.
It is our contention that, because the solutions to the world's energy problems
are going to involve a variety of energy sources and technologies, you have to
build a portfolio that is equally varied.
That assures you are well positioned to profit from the broader trend, while
avoiding the risks of being overly exposed to a single sector. (As an example,
solar has had a great run, but most solar plays are now overvalued.)
The good news is that there are no shortage of high-quality energy-related
investments available ... in coal, heavy oil, LNG, photovoltaics, natural gas
consolidators, "run of river" hydroelectric, uranium, and small to mid-cap oil
companies with the potential for significant near-term gains in reserves or
production.
In the final analysis, it comes down to two choices: you can either suffer the
consequences of persistent higher energy prices, or use the work Jeffrey Brown
has done with the Export Land Model as an early warning and get positioned to
profit.
The decision is yours, but don't wait long to make it.
David Galland is the Managing Director of Casey Research, publishers of the
Casey Energy Speculator, a comprehensive newsletter dedicated to helping
individuals and institutions uncover today's most undervalued and compelling
energy investments. A no-risk three-month trial subscription is available that
allows you to access all current recommendations and to decide for yourself if
the service is right for you. Learn more by clicking here now.
Your believing the cure for high prices is high prices analyst,John F. [EMAIL
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