Greg’s Note: Speculation on the oil market has been unchanged for the past several years. Strategic Investment’s Dan Amoss explains why the way people speculate on this highly volatile and lucrative market is wrong and needs to be reexamined. Will $100 oil finally convince people to change their thought process, or are things going to stay this way forever. Enjoy, and send comments to your managing editor here: firstname.lastname@example.org
Whiskey & Gunpowder
PEOPLE ARE AMAZED BY NUMBERS. Benchmarks and records can have huge psychological effects on the way people view a problem. So why are people so slow to react to this new milestone?
Oil has finally reached $100 per barrel, yet few people on the distant end of oil supply lines are aware of how fast the status quo can change. The status quo tells us to expect more oil when we want it. That market forces always bring ample oil supplies to market. That oil producers will always accept a fixed amount of paper money in exchange for concentrated liquid energy.
But the status quo view of the oil market has been wrong for years. Many still use speculation and geopolitics, rather than supply and demand, to explain rising prices. These pundits never question whether the exchange of paper money for black gold is sustainable. In the old days, when oil prices rose, big exporters like the Saudis recycled most of their oil money into the
The oil trade has radically changed, and investors need to understand these changes. So it helps to look at a model of a hypothetical oil exporting country.
Jeffrey Brown’s Export Land Model accomplishes this. It shows how dramatically exports can decline when two things occur at the same time: Domestic consumption increases while production declines. Brown, an independent petroleum geologist who writes for The Oil Drum, presented his Export Land Model at the ASPO-USA conference in October. When you really think about this model, the debate over how much oil is in the ground becomes trivial. Rather, we should think about how much oil could be available for export in the coming decade.
Brown’s model is easy to understand. It makes sense. Several historical examples validate it. Yet this line of thinking is totally outside the mainstream. As Brown explains, his model represents:
“A hypothetical country with ultimate recoverable reserves of about 38 billion barrels… The model showed the effect on net exports of a country that hit peak production and started declining at 5% per year. The exporting country consumes 50% of its production, and that consumption is increasing by 2.5% per year. The 5% decline rate is loosely based on the post-peak
The red line in this chart shows that “export land” starts off exporting one million barrels per day. Because production, the black line, is declining at 5% per year and consumption, the gray line, is increasing at 2.5% per year, exports plunge to zero in less than a decade. Brown mentions two other important points about the model. First,
“Only about 1.7 billion barrels, or 10%, of remaining post-peak recoverable reserves would be exported.
“Second, the overall exponential net export decline rate, about 29% per year over the eight-year net export decline period, is much more rapid than the production decline rate of 5% per year.”
The following chart shows how Brown’s model compares with two recent case histories:
The top five net oil exporters from 2000-2005 were
Geopolitical Power Will Shift to Oil Exporters
How will the
Hugo Chavez just announced that
Mexican oil production is declining so fast that it will likely become a net oil importer within a few years.
Another thing to keep in mind, which we saw unfold in early November, is Ben Bernanke’s dilemma. With oil and gold at record highs, can he really afford to slash short-term interest rates to help save housing? Though he likes to bluff, he can’t afford to push rates down to 1%, as Greenspan did in the last easing cycle. If he did, another round of dollar weakness would drive international investors to gold and tangible assets even faster. It would also make oil less expensive in stronger foreign currencies, which would draw more oil supply to foreign markets.
Under a worst-case scenario, within a few years, much of the world’s tradable crude oil could be withdrawn from futures markets and locked up under long-term supply agreements with “favored” customers. And current trends point to the
Middle Eastern Wealth Looking Inward
I maintain regular contact with a private equity fund manager. He just returned from a trip to the
“The gulf is earning $1 trillion every two years, assuming $80 oil. We met with one of the ruling families in the region, and it anticipates no fall in oil prices anytime soon. One question I asked on the trip was how long we should expect the U.S. dollar/Middle East currency pegs to last. I expected a lot of strange looks and party line answers about how they’d be shooting themselves in the foot, since the
Since the dollar is about half of the Kuwaiti currency basket, the impact has been somewhat muted. My contact also noted an unmistakable trend common to all Middle Eastern sovereign wealth funds — they are moving away from U.S. Treasuries with two specific goals in mind. First, they are looking for higher returns in alternative asset classes like hedge and private equity funds. And second, they want to shift portfolio exposure from the West to their home markets — particularly in local infrastructure. This includes roads, utilities, schools and hospitals. Growing Middle Eastern wealth is leading to higher living standards, which leads naturally to higher oil consumption.
This isn’t the behavior of investors seeking to maintain their end of the status quo “oil for U.S. dollar” trade. So the writing is on the wall for the petrodollar trade.
What does this mean for the
If spikes like these continue, the equipment will become worn out quickly and oil prices will then continue to rise.
P.P.S.: While I will continue to work diligently for all my readers of Strategic Investment, starting Friday, January 18, we will be offering my brand new service, the Strategic Short Report. Stay tuned, and look for details coming very soon.
Saturday, January 12, 2008
The End of the Petrodollar Trade
Posted by Saigon Charlie