Friday, February 22, 2008
By Peter McKenzie-Brown I’ve been a gold bug since the beginning of 2001, and you will probably notice on this chart that my timing was pretty good – especially so since the market in gold shares turned before the price of bullion did. In my opinion, the volatile price of gold shown here is directly tied to the recent dramatic increases in oil prices. I think this chart is the best available picture of gold prices over the last quarter century. It's a point-and-figure chart, consisting of columns of Xs (upticks) and Os (downticks) to represent price movements over time. As Stockcharts.com explains, there are several advantages to using P&F charts instead of the more traditional bar or candlestick charts. Briefly, point-and-figure charts automatically eliminate the insignificant price movements that often make bar charts appear ‘noisy;’ remove the often misleading effects of time from the analysis process; make recognizing support/resistance levels much easier; make trend line recognition a no-brainer; and help you stay focused on long-term price developments. In that context, you will notice that there has been more price volatility in the last six years (when the present uptrend began) than in the previous 20 combined. Within that context, please note that The Privateer's technical analyst recently identified an extremely bullish on this chart – the dashed green line on the far right. If this trend stays intact, we won’t see $900 gold again for a long, long while. Point-and-figure charts can’t tell you when gold will run through $1000 per ounce, but this one gives a very strong opinion that it will. Perhaps you should buy some gold producers - or, if you can handle even greater volatility, a leveraged bull fund like HGU. Why? In my opinion the price we are paying for gold is directly related to the price we are paying for oil. And gold's fast-moving price reflects a rapidly deteriorating situation in the petroleum industry. A few weeks ago I answered the big question of the day – will oil prices climb or collapse? – with arguments that prices are still on an upward trajectory. I recently had a discussion with an oilman - he has created a $5 billion enterprise in Canada, and is still in the saddle - who tended to agree. He was just back from the Cambridge Energy Research Associates conference in Houston, where one participant was Matt Simmons. Author of Twilight in the Desert, Simmons is a fierce sceptic of Saudi Arabia’s ability to increase or even maintain oil production capacity beyond the next few years. In a recent pronouncement, he proposed that the world reached maximum production two years ago. The apparent increase in supply since that time has been essentially a drawdown in global inventory. Gold prices reflect political instability. And if Simmons is correct, the near-term geopolitical outlook is quite dangerous. Imagine battles for supply, complicated by Jihadism, disrupting the world order. Imagine regional conflict between large landmasses, as in the US vs. the Middle East and Islamic terrorism (already reality); Putin keeping his hand on the valve to dictate terms to parts of Europe (already reality); regional struggles between India and China for Southeast Asian resources, especially petroleum; America using the terms of the US/Canada free trade agreement to demand ever more of Canada’s oil and gas production. Peak Oil: And that, of course, takes us to the topic of peak oil - the notion that the world has produced about half its producible reserves, and that implied demand will soon outpace available supply. You usually see a peak in oil prices in the spring, and the low point for oil demand is usually in December, but that is not what peak oil is about. What it is about can be seen more clearly in this simple fact: we have $90 oil, and most companies are still missing their production targets. Maybe the oil just isn’t there. Let's look at that in a broader context. It took about 250 million years to create all this oil, and we have used about half of it in the last three generations. That’s amazing. Worse, western oil companies are now decapitalizing – buying back stock and otherwise returning cash to shareholders, rather than exploring for large new fields which aren't there. Decapitalization is one way to acknowledge the problem of peak oil. Whether you do or don’t believe in peak oil, there hasn’t been sufficient reinvestment in the business. There’s been a classic cycle of underinvestment. What are the major companies doing with their cash flow? Spending some on new development and buying back stock to increase shareholder value. Some major companies (e.g., ConocoPhillips) are replacing as little as 15% of their reserves. This underinvestment has several causes. For one, 80% of the world’s reserves are national oil – owned by countries where aliens can’t invest directly. These countries are mostly not known for their efficient use of capital: Venezuela, Sudan, Saudi Arabia. Other known reserves and resources are located in places that are difficult and undesirable to explore, like the Arctic. The problem has been articulated for a full century. The oilman I was talking to put it in these no-nonsense terms: “Petroleum is a capital-intensive business. You’ve got to keep offsetting depletion and there’s a massive amount of capital required just to maintain production. And suppose there’s not enough investment to both offset the decline and grow production in the near term. What’s going to happen if India and China continue to boom and expand their requirements for energy?” That is a good question. After listing a number of large producing basins and giant fields in decline, he pointed out that “the only country that has the potential to grow production over the next 5-10 years is Canada, because of the oil sands.” He returned to his central theme: “Whether you believe in peak oil or not, there is not enough money going back into the oil industry to offset production. It’s a huge issue.” There are a couple of ironies in this. For one, a logical conclusion from peak oil theory is that, by accelerating production to meet demand, you are accelerating oil depletion. We consumed the first half of the planet’s oil reserves in three generations. How long will it take to consume the rest? Using a geologist’s understanding of the underworld, peak oil prophet M. King Hubbert suggested that the world’s crude oil production will take as long to decline as it took to peak – roughly speaking, three generations. But isn’t it possible that, because of improved production technologies and much greater markets in the post-peak world, it will actually take much less time? The question matters. The other irony is that oil companies, whether they understand the peak oil issue or not, are responding to developments through a program of decapitalization – as I have already suggested, returning cash flow to investors, with an eye to eventually leaving the oil part of the business. Giant and other large fields not being available through exploration, much of the private sector is now involved in the orderly and efficient liquidation of existing assets through mergers and acquisitions. This matter also matters.
Saturday, February 09, 2008
By Peter McKenzie-Brown
Energy security, always a critical mission for any nation, will steadily acquire greater urgency and priority. As it does, international tensions and the risk of conflict will rise, and these growing threats will make it increasingly difficult for governments to focus on longer-term challenges, such as climate or alternative fuels – challenges that are in themselves critical to energy security yet which, paradoxically, will be seen as distractions from the campaign to keep the energy flowing. This is the ultimate dilemma of energy security in the modern energy system. The more obvious it becomes that an oil dominated energy economy is inherently insecure, the harder it becomes to move on to something else.I am a big fan of Paul Roberts, whose book The End of Oil: On the Edge of a Perilous New World (from which I copied this passage) is one of the best tomes available about the current energy situation. The book was published in 2004, though. Although Roberts accurately spotted the major trends and concisely explained the issues, the period in which he did his research and writing was one of high optimism compared to the situation today. Sometimes he seems almost naïve. The big word today is recession, with fears around the world that the US may already be there, and that Europe and Japan will soon follow. Perhaps the ballyhooed “disconnect” between growth in the developing world and that in the west is nonsense, goes the thinking: growth in China, India and other rapidly developing countries actually will respond to a slowdown in the West. Those fears have raised concerns in the oil markets: Will demand for the commodity decline so much during the recession that surpluses will wash around the world, driving prices down? Fearing a crash in demand, the price of West Texas Intermediate briefly dropped to its lowest level in three months at the end of January. Then, as I suggested elsewhere, reality began to intrude: OPEC doesn’t have a lot more oil (in the sense of productive capacity) they can produce. Geopolitics, rising demand and historically tight supply still govern the price of oil. Traders aren't likely to let oil prices decline from their current lofty levels. (Natural gas prices, by contrast, are likely to rise rather quickly.) Won’t a slowing of oil demand give the world a respite – buy a bit more time during which we can “do something” about the energy mess? Not if the decline in demand is caused by recession. The world’s energy problems need money to be solved. In an era of job loss, declining consumer spending, huge government and trade deficits (in the United States and other western countries), rising inflation, tightening credit and seemingly interminable religious and energy wars around the world, money for energy solutions is increasingly unavailable. Add to these problems the uninspired leadership in the US, Canada and much of the rest of the world (especially in respect to the intimately related issue of carbon emissions) and the outlook seems particularly bleak. How bad can things get? I’ll give the last word to Paul Roberts, who describes a grim worst case in which crude oil production has peaked, followed by “global recession, worldwide unemployment, economic chaos, and, perhaps, a dangerous and escalating competition among the big oil-importing nations over the remaining reserves in the Middle East.” In an afterword to the reissue of his book, Roberts describes an important change in people’s awareness – by which he mostly means that of the American people. He writes,
More people and policymakers now seem to understand that the energy system is in serious and growing trouble and that without a fundamentally new approach we are almost assured of a catastrophic failure. What our new awareness actually means is hard to say. It may be the first tentative step toward building a more sustainable energy economy. Or it may simply mean that when our energy system does begin to fail, and begin to lose everything that energy once supplied, we won’t be so surprised.