# 3 Coming inflection points and the global economy Part I - Oil



## TjamesX (29 June 2007)

I have started this thread (Part I) to discuss and talk about what I think are some very important trends (which are all related) coming to a close that investors need to be aware of. What are the best investments to make in light of these trends (or more specifically ending of these trends), and how best to diversify.

Some content may be viewed by perma Bulls as overly negative – however I would prefer to keep on the constructive side and look to where best to hold capital in light of some headwinds (particularly for the US) I personally see on the horizon.

*Inflection Point 1 - Peak Oil*

*Current Trend* – world oil production rising for the last 100 years
*Inflection point* – world production Peaking between now and 2010-12

Personally I work in the investment area of energy (oil, gas, electricity) so feel reasonably comfortable about this topic. The simple fact is that most oil producing countries are currently in irreversible production decline, and once they reach that point very rarely come back to break new highs in production. 

As we stand now Saudi Arabia (largest oil exporter) claims to have spare capacity of a few million b/d – and is withholding from the market to keep prices generally stable. Currently Saudi oil supplies between 8-9 mb/d out of a total world demand of 85 mb/d. I Don’t have the figures handy but most (if not all) government and analyst energy models assume Saudi production can grow with world demand to 15 mb/d +. However many in the industry are far more sceptical, most notably Matt Simmons – Investment Energy Banker, he personally attempted to audit Saudi Oil production availability and reserves in his book Twilight In the Desert (I have read). Recently Matt made the call that he believes we have passed peak oil NOW.

http://www.youtube.com/watch?v=4IwtAQzrfiw

*Implications:* Peak Oil is inherently inflationary – especially for countries that are net importers (ie OECD – most notably the US) as it attempts to price users out of the market to reduce demand inline with supply.  Note that even the UK with North sea production in decline is moving to be a net importer. How high can prices go?? – no one knows, but consider that in 1999 prices were $15-20 a barrel and since then the price has more than tripled while at the same time demand has kept increasing!!

*Investment Options:*

In general I would be looking for anything exposed to the price of oil increasing or that provides solutions to limit use of or substitute oil

Direct Oil Shares – Preference would be for smaller players that are coming into production and do not have the large reserve replacement burden of the majors. The more risky might like to go for small explorers that have good prospects. Be careful of the fact that most oil and gas companies are facing massive cost inflation for their projects.

Oil Futures – I have absolutely no experience in trading futures, so people with better experience in this area may be better to advise and how to expose yourself to rising prices. Take note that Oil demand has seasonality and as such prices will tend to fluctuate with seasonal demand in a tight market (see last few years seasonal price volatility)

Canadian Oil Royalty Trusts – Someone else in the industry has mentioned to me that these provide very good exchange traded exposure to the underlying oil price. (anyone have any info??)

Rail – 70% of oil demand comes from transportation and rail is the most energy efficient way from moving bulk goods from A to B……. anyone else notice where W.Buffets largest investments have gone lately?

Oil and Energy Service Companies – The amount of capital investment large oil companies are making at the moment is absolutely staggering, just to keep their production rates flat! The basic premise is all the easy oil is gone and the investment to get that oil out was relatively small compared to what investment will be needed to keep production rates high for as long as possibly (more wells, more expensive, harder to get at, more technically involved etc) – all leads to a massive windfall to oil & gas service companies. Also note that most of the industries infrastructure is old and in general has been underinvested in for a long time.

Energy Substitutes (Fuel and Infrastructure) – A lot of the use of oil comes from transportation, of which there are no immediate easy substitutes on a large scale. Bio diesel is a bandaid fix at best, as it has its own problems with EROEI (Enegry Return on Energy Invested) – its use however will have knock on effects for food pricing. The only long term solution I believe is to move transportation on a large scale to electricity power. From here we can then diversify the energy supply for transportation to coal, gas, nuclear & renewables – whichever turns out to be most cost effective. The implications of this are massive investments in the electricity infrastructure industry (generation, transmission and distribution) – this again will be very inflationary in a macro sense but for the players involved will be a huge windfall, the scale of infrastructure needed will be in multiples of billions.

As to the fuel that is ultimately used, I think picking a winner will be hard, but the macro trend is that all substitute fuels will be winners (fossil and renewable). My general observations from what is happening in the market is that coal is coming back in a big way and we will have to find some way to deal with the CO2. I am pretty certain that someone at some point will crack the renewables game on a baseload scale – but predicting when how and if this happens is a mugs game… in the short term we will find the cheapest solution which buys time.

Risks: Oil price rises are not a one way bet. Recent strength has relied on robust demand that would falter if a world recession were to eventuate. However I believe in all probability a new supply source will not be easily found and any weakness should be seen as a buy on long term fundamentals not changing.

Relevant links

www.theoildrum.com

Discuss………..

Cheers,
TJ


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## moneymajix (29 June 2007)

TjamesX

Fantastic read.

Energy imo is a good place to be looking to invest.

We aren't going to be using any less energy in the future, as far as I can see.


Renewable energy would be my preference as well as gas.


By the way, where did Warrent Buffet invest recently?


Thanks for the post.


Cheers
MM


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## Boyou (29 June 2007)

Fascinating reading! 

I don't work in the energy sector ,but I do like to keep my long range eye on developments.

One thought about energy reguirements as we go forward.I read an interesting article about energy use in the mining sector...seems to me that if anything inhibits mining it will not be demand ,but available Gas and Oil to fuel the boom.

Thanks for the posting I will be keeping my eye on this thread.

Cheers Ya'll; )


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## doogie_goes_off (29 June 2007)

I had a dead loss on ABJ - biodiesel got creamed once the Howard Govt got on the ethanol bandwagon. Does anyone think biodiesel demand will take off and when!


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## TjamesX (29 June 2007)

moneymajix said:


> TjamesX
> 
> Fantastic read.
> 
> ...




Renewable energy IMO is speculative until they can bed down costs and technical difficulties. It is populist from a warm fuzzy perspective but its ability to provide on mass on demand energy so far is questionable. Wind at the moment is getting competitive in the US for base electricity - but not in Aus and relies on subsidies.

Hot rock Geothermal is a possibility - but still poses technical problems.

From a pure investement perspective I would prefer to look at investments that have more certainty. The certainty is energy supply will become more expensive. The trick is working out who is more likely to win in solving the problem

Gas will be a bridging solution to energy supply (for electricity) and hence will benefit. however the trick with gas is that its lack of easy transportability means it tends to be dislocated from world energy prices, and is more a local supply and demand phenomenon. Gas prices can vary significantly from region to region (US is 2-3 times more expensive than Aus). As world LNG develops and local supply becomes constrained this may change, but for Aus (east coast) at least not all gas players will be winners IMO.



moneymajix said:


> By the way, where did Warrent Buffet invest recently?
> 
> Thanks for the post.
> 
> Cheers




http://www.cbc.ca/canada/story/2007/04/09/railstocks.html

I am unaware of any listed railway plays in AUS however



Boyou said:


> Fascinating reading!
> 
> I don't work in the energy sector ,but I do like to keep my long range eye on developments.
> 
> ...




You are quite right. This is especially becoming a huge problem in WA where their gas supply industry is now becoming linked to LNG prices. However my belief is that coal will be the big winner from this in the long term - and emissions will rise.


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## DB008 (29 June 2007)

I was actually thinking about this the other day. Have we passed peak oil???
Does anyone else have opinion on this?? How much oil is left in the world?? Anyone?
I haven't ever owned a car, but have always held a car license. Went on a long weekend with a friend and filled up the car, $70 for 50 odd litres. I just felt sorry for everyonewho has a car (which is almost everyone).


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## Smurf1976 (29 June 2007)

DB008 said:


> I was actually thinking about this the other day. Have we passed peak oil???
> Does anyone else have opinion on this?? How much oil is left in the world?? Anyone?



I've posted in detail on this one some time ago. In short, I'll use this analogy.

It's a hot Summer day. It's 4pm and 42 degrees at the moment. At 3:45 it got to 42.5 degrees which is the highest so far today.

Have we reached the maximum temperature yet? I don't know and neither does anyone else. But we're close, very close if we haven't yet reached it. We're very fast running out of time to get past 42.5, especially given the storm clouds rapidly building up on the horizon. 42.5 at 3:45pm may not be the peak, but it's close enough to say it won't be getting much hotter.

How's this relate to oil? Peak production to date was May 2005 on a monthly basis. 2007 is so far doing worse than 2006. Have we peaked? Quite possibly, but only after significant decline can we say it with any certainty. Just like we don't know if 42.5 degrees was the top for the day until it's back in the 30's. All we know is that it's somewhere close.

On a more scientific point, Kuwait has effectively admitted what I and practially everyone else who has studied the subject has been screaming for years. OPEC members, particularly those in the Middle East, are reporting bogus reserve data which is closer to total oil ever discovered rather than that remaining. 

Kuwait just cut their official reserves by some 50% and I very much doubt Saudi, Iran or the others are telling the truth either since they are all up to the exact same tricks with miraculous discoveries that nobody knows anything about and official reserve data that rarely if ever changes.

IMO peak will either be May 2005 or sometime between now and December 2009 in view of the actual field development taking place and allowing for reasonable delays etc. That's close enough to being now as far as I'm concerned. I could be wrong of course.


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## TjamesX (30 June 2007)

Smurf1976 said:


> I've posted in detail on this one some time ago. In short, I'll use this analogy.
> 
> It's a hot Summer day. It's 4pm and 42 degrees at the moment. At 3:45 it got to 42.5 degrees which is the highest so far today.
> 
> ...




I like the analogy. The simple fact is we wont know for sure until a few years after the fact. But at the end of the day the world has not been able to increase oil production for 2+ years while the price has skyrocketed - if you look at all the majors, they are having problems keeping production flat while at the same time being shut out of nationalised oil regimes.

After reading Simmons book I realised the guy knew what he was talking about. He is confident enough to call it now... so until proven otherwise I'm happy to believe him.

The only thing that will delay the evidence is a world recession which reduces demand and prices with it.... in which case I think Oil will be a screaming buy as everyone will switch off peak oil again.



Smurf1976 said:


> On a more scientific point, Kuwait has effectively admitted what I and practially everyone else who has studied the subject has been screaming for years. OPEC members, particularly those in the Middle East, are reporting bogus reserve data which is closer to total oil ever discovered rather than that remaining.
> 
> Kuwait just cut their official reserves by some 50% and I very much doubt Saudi, Iran or the others are telling the truth either since they are all up to the exact same tricks with miraculous discoveries that nobody knows anything about and official reserve data that rarely if ever changes.
> 
> IMO peak will either be May 2005 or sometime between now and December 2009 in view of the actual field development taking place and allowing for reasonable delays etc. That's close enough to being now as far as I'm concerned. I could be wrong of course.




Smurf what due you think are good investments in light of Peak Oil? I'm sceptical of most local producers

The more I think about it, I think oil service companies will be a screaming buy - but I don't know too many Aus listed?

Cheers,
TJ


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## spartn (30 June 2007)

As far as i am concerned, when the downturn in petrol production occurs, we are up Sh*t Creek, at present the world is currently using around 80 million barrels of Oil in a day ' remember that is barrel', a barrel contitutes around 42 gallons or letres I can't remember which one it is.

Here is a list of possible alterernatives:

Hydrogen - At present most experts believe an hydrogen economy is 30 - 50 years away, if not longer because even though it could be a possible alternative, very small demand at present, is not making the Petrol giants spend large amounts of $$ on R&D.

Ethanol - I am so against the use against ethanol in any way shape or form, more than 1 billion people world wide are already starving from lack of food, alot of the food is being sent to the poor continents from the west, what is going to happen if we start increasing your relience on ethanol, and anyway there is no way we can produce ethanol in a way that would fully cover our dependance on fuel.

Nuclear Energy - Nuclear energy produces a hell of alot of energy, 1 kg of Uranium produces the same amount of energy as 3,000,000 kg of Coal, however to fully produce the amount of energy as fossil fuels, it would take around 10,000 'large not small' nuclear power plants, and even if that was possible, with that many power plants it would take between 15-20 years to go throught the entire world supply of uranium.

Cold Fusion - Doesn't exist.

Wind - Yeah, only if you want to spend around $10,000 a year on electricity, even the hippies would agree its not viable.

Wave - possible, but very very small amount of energy would be created at a very high amount of cost.

Solar - I really think it is the only kind of way possible to cover the worlds energy demands, but not the way people are producing it, however to cover the US energgy demands, it would take land the size of California, covered entirely with solar panels, however scientists believe that every single minute enough sunlight hits earth to produce a whole years energy demands, however solar would only really work if it work as a partnership with fuel cells.

When it come to solar this is a really innovated way, SOLAR GLASS.

http://www.xsunx.com/

Most people dont understand that only 70% of the world oil is being used as fuel, look at alot of your household goods which use oil based products in it, Medicines, makeups, hair gels, paints (all of them), hair shampoo.

We are not just stuffed energy wise, but our whole way of life is stuffed, personally this is not elses fault then the 2 past generations who fully made our whole way of life dependant on oil in the past 100 years.

Spartn

:viking:


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## spartn (30 June 2007)

DB008 said:


> I was actually thinking about this the other day. Have we passed peak oil???
> Does anyone else have opinion on this?? How much oil is left in the world?? Anyone?
> I haven't ever owned a car, but have always held a car license. Went on a long weekend with a friend and filled up the car, $70 for 50 odd litres. I just felt sorry for everyonewho has a car (which is almost everyone).




Personally i think we have passed 'Peak Oil', reason for the first half of the 20the centuary three of the biggest locations in the world which produced oil was, Baku in Azerbaijan, at one stage Venezuela was the biggest producer of Oil anywhere in the world, and Texas.

At present, Baku is a Ghost Town, Venezuela is producing 25-30% off its peak, Texas around the same, there have been massive amounts oil found in the middle east, Saudi Arabia has already Taken 1 TRILLION BARRELS of oil out of the ground, how much could they possibilly have left. Oil Sands can not be relied upon when it comes to production amounts, Oil Shale, could replace every world supply of oil, but takes up double the energy it gives back.

Spartn

:viking:


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## algis (30 June 2007)

I am uncertain on the basis by which figures for proven oil reserves are based.  One thing I do know is that fossil fuel can be derived from sources of varying quality.  Note that Canada's oil sand reserves are 2nd only to Saudi Arabia.  It has only in more recent times become a more realisable source as commodity costs allow to make the refining process of oil sands (oil of effectively 'poorer quality'... once it's refined it's of the same quality of all refined oil) viable.  

Check
www.odac-info.org/assessments/documents/MamdSal_25thNAEConf.pdf
for a review on the credibility of global oil reserves.

Good note on investment in rail stock.  Rail infrastructure has been let down in a massive way since Federation in this country (look at what we have for level crossings - Kerang was a matter of when, not if).  Heavy reliance on trucks for interstate freight results in drivers being pushed to the limit, nationwide inefficiency (fuel and clogging up of roads) and issues with safety.


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## TjamesX (10 July 2007)

IEA has released their medium term outlook for world oil supply and demand and they are starting to paint a bleak picture. This is a significant admission from a major energy institution and their outlook is for significant tightning over the next five years.

Links;

http://www.smh.com.au/news/business/global-oil-crunch-looming/2007/07/10/1183833484000.html

http://themessthatgreenspanmade.blogspot.com/2007/07/were-going-to-need-good-recession.html

http://www.theoildrum.com/node/2755

Note they are still assuming Saudi will be able to produce at rates significantly higher than current rates of production.

Seems everyone took the eye off the ball when oil plummeted to $50 earlier this year... this will not go away any time soon

TJ


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## Smurf1976 (11 July 2007)

TjamesX said:


> this will not go away any time soon



A somewhat profound statement IMO.

Some date around about now is set to join the Depression, the World Wars and European settlement of Australia as a major point in history that will be well known to those not yet born. My greatest hope is that they learn of the geological reality of oil depletion in a scientific sense rather than associating it as merely the trigger for some war or other drastic outcome that followed.

Personally, whenever I'm in a situation where the issue of oil is raised I simply utter one word - "peak". Generally there ends up being one or two that look me in the eye and nod whilst the rest stare blankly as though I'd said something about a spaceship landing on the street outside. 

Peak oil thus meets the most important requirement of a damaging shock. It is totally unexpected by the vast majority of the population to the point they won't recognise it even when it hits. Most have at least considered the possibility of an earthquake, fire or terrorist attack and will recognize such an event for what it is pretty quickly and act accordingly to minimise the damage. I doubt that many will ever comprehend peak oil - possibly a good thing since it may avoid panic.


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## Spaghetti (11 July 2007)

*Interesting reading, will paste an article from NY times. Nothing new but serves to underline the problem.*

DESPITE four years of high prices and warnings about climate change, a new report predicts world oil demand will rise faster than previously expected over the next five years while production slips, threatening a supply crisis.

In the report, the International Energy Agency, which is based in Paris and advises 26 industrial nations, said that global oil demand would rise by an average of 2.2 per cent a year from this year to 2012, up from a forecast in February of 2 per cent annual growth from 2006 to 2011.

The share of world oil consumption represented by the developing world, including emerging industrial economies, will rise to 46 per cent of global demand by 2012 from 42 per cent, the report said.

"Demand is growing and, as people become accustomed to higher prices, they are starting to return to their previous trends of high consumption," said Lawrence Eagles, head of oil market analysis at the energy agency, which is linked to the Organisation for Economic Cooperation and Development. "It's important that we have more investment and a greater emphasis on energy efficiency."

The pressures on fuel supplies are growing because booming Asian economies are using more fuel to power their manufacturing industries, including the production of growing numbers of cars. Rapid growth in petrochemicals industries and the spread of low-cost airlines are also lifting demand.

Amid these demand factors, there is a scarcity of refining plants and the personnel to operate them. Supplies are also a concern because of deteriorating output from some countries outside the Organisation of the Petroleum Exporting Countries, the grouping of the biggest producers.

The world "needs more than 3 million barrels per day of new oil each year to offset the falling production in the mature fields outside of OPEC," Mr Eagles said.

Other analysts said that behind the overall numbers were signs energy habits were moving in two directions. In developed countries, and especially the European Union, obligations agreed to by governments to conserve energy and use renewable energy are expected to ease pressure on oil supplies.

But that trend is being offset in developing nations. While they still use far less energy per capita, they are making goods for rich consumers elsewhere and are increasingly adopting heavy energy-consuming lifestyles that include the use of cars, refrigerators and air conditioners.

Colette Lewiner, who monitors energy at the Capgemini consultancy in Paris, said, "My view is that energy consciousness will figure strongly in Western countries and could contribute to demand decrease but it's not at all sure that we will see the same trends in China and India."

Mr Eagles welcomed progress in Europe and Asia, where governments are mandating more efficient cars. He said the "United States is very clearly coming to the point where there would be a landmark change in fuel-efficiency policies".

He said that stepped-up investment in refining capacity could help reduce petroleum prices over the next three years but those effects were likely to be short-lived.

Beyond 2010, Mr Eagles warned, "tightness in OPEC's spare capacity will reassert itself". And by 2012, he said, there would either have to be limits on demand or additional supplies to avoid further price increases.

Mr Eagles said that biofuels were unlikely to be a quick solution. By 2012, he said, biofuels would account for only 2 per cent of global energy supplies.

The New York Times


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## Uncle Festivus (11 July 2007)

Isn't something happening now with oil prices? Petrol (around Sydney) is creeping back above $1.40 again, getting closer to the 'consumer backlash' level we saw the last time it got to these levels. Only this has been a steady climb in oil prices for a few months now. If there's one thing that will spoil the party is oil over $70 & US consumers not consuming (2 actually). 

So what are the other 2 inflection points? Consumer credit & housing?

*CHICAGO (MarketWatch) -- A consumer-spending slowdown, underscored Tuesday by hefty earnings warnings from two major retailers, is likely to be revealed Thursday when the nation's largest retailers turn in June sales results.*
Analysts are nearly universal in their assessment that June's numbers will be weak and disappointing.

*SAN FRANCISCO (MarketWatch) -- Wall Street's two largest rating agencies signaled on Tuesday that problems in the subprime mortgage market aren't going away and will probably get worse as rising delinquencies weigh on U.S. house prices. *
Standard & Poor's said it may downgrade $12 billion of subprime residential mortgage-backed securities (RMBS), while rival Moody's Investors Service downgraded 399.

*BOSTON (MarketWatch) -- Home-building bellwether D.R. Horton Inc. early Tuesday said quarterly orders for new homes fell 40% from a year earlier and that it expects to post a loss after impairment charges.*


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## TjamesX (11 July 2007)

Uncle Festivus said:


> Isn't something happening now with oil prices? Petrol (around Sydney) is creeping back above $1.40 again, getting closer to the 'consumer backlash' level we saw the last time it got to these levels. Only this has been a steady climb in oil prices for a few months now. If there's one thing that will spoil the party is oil over $70 & US consumers not consuming (2 actually).




It's been off the radar in Aus because the prices dropped dramatically earlier this year and the higher aussie dollar has softened the impact. We may see an all time high when we hit hurricane season in the US.... and then a seasonal dip after.... as I mentioned earlier if we hit a worldwide bump then oil prices will fall in the *short term*



Uncle Festivus said:


> So what are the other 2 inflection points? Consumer credit & housing?




Close......

II) Inflation (as reported by central banks )
III) Debt

But I am less comfortable about either of these topics, however I see them as being as equally important as peak oil. I believe the trend in lowering and stable reported inflation is well and truly over - and implicit in that is the trend for growth in debt and credit. But at the moment I haven't got time to pull together the info for the posts.

Cheers,
TJ


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## TjamesX (11 July 2007)

To the topic at hand...... investments to make in light of tightening oil supply market.

At present I have 2;

PSA - Petsec... from where I sit is one of the best priced small oil & gas co's based on fundamentals.. Recent entry at $1.46

CIG - Caspian Oil.... a small speculative play where I have already taken some profits, drilling is expected in the next few months... Entry at 5.5 cents

I would like to focus on entries into Oil and gas service companies.... I have none at present. I have held PCG before but I think there isn't much upside at present with Cape's offer still pending and Kashagan project seems to continue with problems.

Any other ideas??

TJ


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