China: Panda or Dragon?

This article appears in the August 2008 issue of Oilweek.

By Peter McKenzie-Brown

A symbol of unrivalled wisdom and power, China’s dragon is a long, scaly, snake-like creature with the paws of a tiger and the claws of an eagle. This chimera is an emblem of ancient imperial power. Indeed, the dynastic emperors were known as dragons.

The revolutions of the twentieth century made a break with the past, and the present regime does not think the dragon is a proper symbol of China. Instead, the country’s rulers prefer to use the giant panda – that loveable, bamboo-eating member of the bear family – as the national emblem. By tradition a rare and noble creature, the panda has been part of diplomacy since 685 CE, when an emperor of the Tang dynasty sent a pair to his counterpart in Japan.

As the world sets its eyes on Beijing, where the Olympics will showcase progress since the death of Mao Zedong two decades ago, this commentary asks a simple question. Is the panda in charge of Chinese energy strategy, or is it the dragon? From the security of its bamboo forest, the gentle panda would stress comparative advantage. The dragon would rely on cunning, speed and power.

The charts below show growth in China’s oil consumption (top) and the country's oil production - both since the death of Chairman Mao

Until 15 years ago, China exported oil to neighbouring countries. Today, it has an almost insatiable appetite for the stuff. Since the Great Helmsman’s death in 1976, the People’s Republic has become the world’s second largest oil consumer (behind the U.S.) During those years Chinese consumption has quadrupled to about 7.7 million barrels per day while production – about 3.7 million barrels per day – has barely doubled.

The International Energy Agency thinks China will burn 16.5 million barrels per day by 2030, after buying 13.1million barrels abroad. Think about it: Saudi Arabia’s total output is now less than 11 million barrels per day.

Thrift: This article suggests that such parabolic growth requires the skills of the dragon to survive. In that spirit, China is now applying its extraordinary energy in four ways to meet its petroleum and other resource needs. The first is domestic resource development. Diplomatic manoeuvres on behalf of its petroleum industry are the second. The third involves partnerships with Western companies. Last is what the mandarins call “thrift.”

Based on efficiency, conservation and innovation, thrift is sometimes called the fifth form of energy.

China’s rise is making the world a more energy-efficient place. The country’s energy intensity – the amount of energy it uses per unit of GDP – has dropped by about 75% in the last 20 years, largely because of more efficient industry. Its energy intensity higher than America’s but lower than Canada’s, in 2006 China adopted the slogan “Save energy, cut emissions” as part of a drive to cut energy intensity even further. The country is thus improving its energy efficiency while increasing its energy-intensive role as workshop of the world. So don’t blame the Chinese for the world’s energy woes. They are doing an effective job of managing energy.

A latecomer to the world’s petroleum stage, China is now simultaneously the world’s second-largest oil consumer, the third-largest net importer, and the fifth-largest producer. In the last 15 years the dragon has been sending its agents into the world to secure the new energy supplies it desperately needs. Compared to the West’s international producers, China’s national oil companies arrived late to the petroleum Olympics, and they are not large contenders. The prizes left in play are expensive, and often in countries where Western companies refuse to operate because of human rights issues and geopolitical risk.

Through petroleum-related state-owned enterprises (SOEs) – China National Petroleum Corporation (CNPC), China National Offshore Oil Corporation (CNOOC) and China Petroleum and Chemical Corporation (Sinopec) – China started investing outside the country in 1993, just as the country became a net oil importer. China’s first petroleum acquisition was in Thailand, but CNPC acquired exploration acreage in Canada and Peru the same year. The amount of equity oil generated by those projects was relatively insignificant, and this remained the case for several years.

In terms of Canada’s ties with China, 1997 was an important year. As the British were preparing to return Hong Kong to China, Sir Li Ka-shing, the colony’s richest man and chairman of the Hutchison Whampoa conglomerate, became the owner of Husky Energy. Husky’s headquarters continued to be in Calgary, and the acquisition did not affect the company in the short term. However, Husky has since expanded its assets offshore China, and is now the largest foreign owner of exploration blocks there. All its holdings there are in the South China Sea.

Since 2001 Husky has signed eleven production sharing contracts in collaboration with the China National Offshore Oil Company (CNOOC) – now publically listed, but 70% owned by the government of China. Husky can participate in these projects up to 51%, and the company describes its entry into China as part of a strategy to develop conventional oil and gas outside North America. Certainly the company is also part of Chinese strategy, also. It is one source of capital for mandarins focused on securing energy supplies by developing the Middle Kingdom’s domestic resources.

The Venezuela Card: China cannot secure Canadian oil supplies as long as the only export pipelines from Alberta lead into the United States. Especially after the two countries announced in 2005 an agreement on energy cooperation, it was therefore astonishing when CNPC announced last year that it had pulled out of an agreement to take a 50% stake in the proposed Enbridge-operated Gateway Pipeline. When completed, the pipeline will transport 400,000 barrels of oil per day to Kitimat BC for overseas export. According to the terms of the original deal, CNPC would take 200,000 barrels per day of throughput, with the balance being exported to refiners in California. If the line had been expanded to 800,000 barrels per day capacity, CNPC could have acquired a larger stake.

For a country with rapidly rising oil demand, what’s not to like about this deal? When PetroChina vice president Song Yi-wu announced the dragon’s decision, he put it in the political context of a nation re-evaluating its commitment to Canada’s oilsands.

Projects take too long to get off the ground here, he said, and the political environment “frustrates” Chinese investors. Song said China would slow down its involvement in the Canadian oilsands business, give up its involvement in the Gateway pipeline project and wait for better investment policies and politically friendly opportunities in the future. Translation: Chinese policy-makers were frustrated over the unwillingness of Canadian producers to partner with CNPC in a production/refining venture that would see Canadian bitumen and heavy oil sent to Asia for processing.

Forecasting that CNPC couldn’t begin to produce bitumen from the oilsands for at least another decade, he made it clear that China’s near-term heavy oil strategies were pointed directly at Venezuela, where a “warm-hearted” President Hugo Chavez has taken steps to nationalize oil operations. Song said China is building energy security for its people in “politically friendly” countries, which include Venezuela, Saudi Arabia, Russia and a host of Asian and African nations – Burma, for example, and Sudan. Call it the Venezuela card.

The Venezuela card suggests a competitive advantage for China that Western countries often will not play. The dragon sees oil security as an urgent need, and is willing to exert whatever cunning, speed and power it must to meet its future needs. Not surprisingly, given its political structure and domestic situation, China will not let issues like liberal democracy and human rights stand in the way of its quest for energy.

Do Western oil companies let political and human rights niceties stand in the way of business? It’s a matter of degree, of course, but it is not difficult to find examples of North American and European companies pulling out because of political risk and public pressure based on human rights abuses. In Canada the most famous case is that of Talisman.

Ten years ago the company acquired a 25 percent interest in a developing oil project in Sudan. The production facilities, pipeline and offshore loading terminal were being built and the wells were being drilled. By the summer of 1999, oil was flowing and being exported. By 2002, the project was producing 240,000 barrels of oil a day, with the equity oil being distributed to the project’s participants, three of which were subsidiaries of state-owned oil companies from China, Malaysia, and Sudan. The only privately owned company in this consortium, Talisman bowed to public pressure based on Sudan’s human rights record and sold its 25% interest to an oil company owned by the government of India.

The pattern is clear. The Asian players were unconcerned about human rights. There is a subtext here about Asian strategies toward energy. Especially in the face of a high-profile divestment campaign like that launched against Talisman, Western companies will buckle in the face of pressure related to human rights, environmental integrity and so on. Chinese and other Asian companies will not. For example, all three of China’s oil and gas SOEs are active in Burma. Latecomers to the petroleum Olympics, they measure petroleum victory in terms of land, reserves and production.

Comparative Advantages: Chinese industry’s willingness to overlook “soft” issues like human rights gives it a distinct comparative advantage. China’s willingness to bring diplomacy to bear on behalf of its SOEs gives it another. These advantages are rebalancing the planet toward East Asia. The dragon is rising.

Chinese energy policy is directed by government, and some 70% of the world’s petroleum resources are now controlled by national oil companies like Saudi Aramco and Petróleos de Venezuela. State-to-state negotiations are especially important when one of the participants is an emerging superpower.

Much of China's efforts are directed to the energy-rich nations of Central Asia, which can deliver energy overland instead of by tanker. For example, a trans-Kazakhstan pipeline is already delivering oil from the Caspian Sea.

Two other factors in China’s favour deserve mention. One is that Southeast Asia is home to many in the Chinese Diaspora – the descendants of the many waves of migration from China over the last millennium. Particularly as colonialism collapsed after the Second World War, they came to control great assets and even some national economies. By some estimates the third largest economic entity in the world, the Overseas Chinese began repatriating capital to China in the 1990s, thereby igniting the Chinese miracle. Today they occupy key positions in Southeast Asian business and government, and strengthen local ties with China.

Another factor working for China began during Cultural Revolution – that decade of social, political, and economic madness from 1966 until the arrest of the Gang of Four. Despite mutual fascination and incomprehension, during those years black African governments and African revolutionary movements were the recipients of Chinese aid (both military and economic) and other diplomatic efforts. African governments – many of them successors to those revolutionary movements – remember China’s efforts during that time. That diplomacy is now paying off with preferential access to petroleum leases and production sharing contracts.

A classic example is Angola, in West Africa. Mainly because of the expansion of its oil industry that country has the fastest-growing economy in the world, and its growth is mainly driven by Chinese explorers and producers. China’s SOEs got access to Angola’s offshore as a ‘Thank you’ to the People’s Republic of China. Despite desperate poverty at home during the Cultural Revolution, the dragon still found the wherewithal to support Angola’s independence movements during those critical years.

China’s Peaceful Rise: A final point deserves comment. In the late 1990s, China’s central government developed what it called “the new security concept.” The idea is that the Cold War mentality of antagonistic blocks no longer makes sense. In a globalizing world, nations can increase their security through diplomatic and economic interaction. This notion has become part of a foreign policy doctrine known among diplomats as “China’s peaceful rise” – a policy that, for example, encourages Chinese businesses to form partnerships with Western firms. For Canada, which is one of the few countries likely to increase production in the coming decade, it has important implications.

Consider, for example, that Enbridge is undeterred by CNPC’s decision to pull out of the Gateway Pipeline. “The appeal (of this pipeline) to Canadian producers is that you would get another bid on the crude oil from somewhere other than the United States,” said Enbridge’s executive vice president, Steve Wuori. Also, of course, pipeline costs would be less.

“When (Enbridge) first started we were aiming (to complete the project in) 2011,” Wuori says. “But now we are targeting 2012-2014.” Will Canada be able to supply new markets with heavy? Wuori thinks so. “Production forecasts up to 2020 for the oil sands support that kind of growth potential, even if you risk it for economics and environmental concerns.”

Although China has placed less than 1% of the $50 billion investment in the oilsands since the early 1990s, it is still part of the equation. China’s most significant direct investment has been the SinoCanadian Petroleum joint venture, through which Sinopec owns a 40% stake in Synenco’s Northern Lights project. CNOOC made its presence known with the acquisition of a small interest in MEG Energy, which is focusing on a project at Christina Lake.

Obsessed with diversifying its oil sources and avoiding dependence on a single supplier, Beijing sees Canada as a country in the U.S. sphere of influence, a country where oil could be held hostage to political concerns. It has little enthusiasm for multibillion-dollar oil deals in a country whose relations with China have been soured by human-rights disputes. Think Tibet.

“China doesn’t want to make a multibillion-dollar commitment to a country where the political contacts are constrained,” says Jiang Wen-ran of the University of Alberta’s China Institute. Professor Jiang adds that the Middle Kingdom worries about Canada’s business practices. Canadians can’t explain how they will triple production from the oilsands given environmental constraints. The costs of environmental protection seem out of control. Labour costs are reaching the moon.

The Panda Speaks: This article has focused on the areas of Chinese petroleum development where Westerners are more likely to see a dragon than a panda. Of course, in modern China it is the giant panda that speaks for the neo-imperial court. To conclude, let’s listen to what this species has to say.

According to China’s State Council, a policy-making arm of the People’s Republic, “The basic themes of China’s energy strategy are giving priority to thrift, relying on domestic resources, encouraging diverse patterns of development, relying on science and technology, protecting the environments, and increasing international cooperation for mutual benefit.”

The panda adds that its energy development is based on “the principle of relying on domestic resources and the basic state policy of opening to the outside world.” In its efforts to ensure a stable supply of energy, the country wants “a steady increase in domestic energy production.” It also wants to “promote the common development of energy around the world.” China’s energy development “will bring more opportunities for other countries.” It will “expand the global market, and make positive contributions to the world’s energy security and stability.”

All this will help perfect the national system of “socialism with Chinese characteristics.”

Damage Control

Gasoline and other fuel prices are subsidized in the three representative oil-producing countries graphed on the top right - to the point that gasoline costs $0.12 per gallon in Caracas.

Compare the growth in oil consumption in those countries to growth for the world as a whole. Did you notice a pattern?

By Peter McKenzie-Brown

The world has two kinds of energy-consuming jurisdictions: Those which respond to high oil prices, and those which don’t. In this post, I want to help define which is which. I also want to offer a few explanations why dramatic increases in energy prices have not yet damaged the world economy. These are intimately related issues.

I recently had an interview with Marcel Coutu, the chair of Syncrude – the world’s largest oil sands plant. Syncrude has been in operation for 30 years, and it has gone through a great deal of debottlenecking and expansion. It now produces 350,000 barrels of light, synthetic oil per day.

I asked Marcel for his thoughts on peak oil, and he gave me a few comments that summarize things precisely.

All OPEC can now do is raise prices by cutting production. They cannot lower prices by increasing production because they don’t have the capacity. We are in a very pure free market situation, with prices being set by supply and demand. When I look at that dynamic, I have stopped worrying about the demand side. No matter how much the US goes into recession, for any period that is important to any of us, any decline in consumption there will be offset by increased demand elsewhere – in China and India, but also in developing countries that produce their own crude oil. Those countries generally subsidize oil products, and subsidies accelerate demand growth.

At these prices you are seeing some conservation somewhere, but it is being more than offset by increased demand somewhere else. Whether people are still going to be buying at $200 a barrel I don't know, but by the time we get to $200 it will be the supply side that will keep things tight and moving upward.

He didn’t seem to think this was a major global problem, and I wish I had asked why not.

Three Theories: Historically, rapid increases in oil prices have led to global recession. This certainly applies to the stagflation that influenced the decade after the energy crisis of 1973. The terrible recession of 1982 was without doubt related to the energy crisis of 1979-80. And the long, gradual boom that began in ’83 was closely tied to declining oil prices, and accelerated by their collapse in 1986.

What I think we need to ask ourselves is why high oil prices don’t seem to be doing a lot of damage to the global economy. According to The Economist, there are three possible explanations.

An important and interesting idea is that high oil prices are not hurting the economy simply because they themselves are the result of rapid economic growth around the world. “Rather than oil harming the global economy, it is global expansion that is driving up the price of oil” says the world's great champion of liberalism.

Another explanation is that developed economies are more efficient in their use of energy, thanks partly to the increased importance of service industries and the diminished role of manufacturing. For example, the EIA has calculated that the energy intensity of America's GDP fell by 42% between 1980 and 2007.

A third notion is that the oil price rise has been steady, not sudden. This has given the economy time to adjust. The Economist writes, “Giovanni Serio of Goldman Sachs points out that in 1973 there was a severe supply shock because of the oil embargo, when the world had to cope with 10-15% less crude almost overnight. Not this time.” It’s worth adding that during 1979-80, the percentage increases in oil prices were not as great as they were in the early 1970s, but in absolute terms those increases were greater by far.

The Role of Emerging Economies: As Marcel Coutu explained at the beginning of this article, the most important factor for higher prices has been the shift toward greater consumption by developing economies.

The US, for example, has responded to high prices by cutting consumption slightly. According to one source, the decline will be 1.1% this year, such that American consumption next year will be no higher than it was in 2004. Given such a niggardly response, growing demand from China and other emerging markets will be more than enough to offset this shortfall. With supply growth slight to neutral, the steady increase in demand is hauling prices remorselessly higher. It would take a recession in emerging markets to drive commodity prices substantially lower, and to date recession in those economies is not in the cards.

A couple of points deserve comment here. One is that the achievements of Western nations in reducing energy intensity are nothing compared to the achievements of China. According to an excellent paper on China’s energy consumption and demand , since 1980 China’s energy intensity has dropped by about 75% – nearly twice the drop in the US. The reason is that in every way the world's next superpower has become far more efficient.

Of course, I am raising this point because it suggests a very deep irony: Exporting the world’s manufacturing sector to developing countries has not only enabled the West to become a more efficient energy consumer. It has also helped those countries to become more efficient. Don’t blame the Chinese, in other words: They are doing a far better job at using the world’s resources efficiently than the West can even imagine.

Final Thoughts: These ideas, too, hark back to Marcel Coutu’s earlier comments. By subsidizing energy consumption within oil exporting countries, the world is contributing to inefficient energy consumption. Some of the cheapest gasoline prices in the world are in Saudi Arabia, Kuwait and Venezuela – the last being the all-out winner, with gasoline selling for $0.12 per gallon. The economies of these countries are not known for their gathering efficiency, yet the charts illustrate how much more dramatically oil consumption accelerates when prices are subsidized than when they are not.

The plain truth is that energy importers are subsidizing the inefficient consumption of oil in these countries because of the geographical reality that they have oil to export. Yet the countries we are most anxious about - China and India, for example - are the ones that are increasing their energy consumption not because of large subsidies, but because they are able to provide goods and services with greater energy efficiency than the rest of us.

Asia’s Century and the Age of Dread

Graphic from here.

By Peter McKenzie-Brown

We are living in an age of dread – quite different from earlier periods since the Second World War. In most of the recent past, there seemed to be a sense that we could change or fix things – end war, abolish poverty, create social justice. That’s no longer the case.

Now there seems to be a sense that the world's problems are intractable: nuclear proliferation, terrorism and religious conflict; peak oil; increasing immiseration of the poor in much of the developing world, recently amplified by a food crisis; rising and possibly incurable homelessness in the rich world; greater threat of global pandemics; the cynical abuse of political systems in such hellholes as Zimbabwe and Burma; blatant destruction of ecosystems around the world. That sense seems far more dominant in Canada than it did in Thailand, where I lived until recently.

Despite years of prosperity and an economy happily based on resource extraction, Canada is yet less optimistic that global crises can be solved than I remember. Indeed, there seems to be greater cynicism about the willingness of government and the “international community” to act responsibly, and greater doubt about even their ability to effectively intervene. Thus, an age of dread - dread that even more problems of the seemingly intractable sort are on the way.

There are many ways to explain this. “I found your thesis on the Age of Dread interesting,” wrote my friend Peter Freeouf from Thailand, “especially since you compared it with how we looked at the world when we were young in the 1960s and the 1970s.”

Baby Boomer Theory: “I think you circled on the reason right there but didn’t hit on it directly,” he continued. “We’re getting old - into our 60s – and we dread our advancing decline and coming demise. And this colours our perspective enormously – in most developing countries the portion of the population over 60 is mushrooming in proportion to the rest of the population.

“There are horrific problems facing humanity – no doubt of that. There were, too, in the 1960s. With all the young people around then – the post-WWII generation was huge in America, Europe, Japan, and elsewhere – there was a certain air of optimism, frivolity even, in the way we thought we could change the world. But now that we’re much older and we can feel decrepitude creeping upon us, our underlying mood has shifted to one of ‘dread.’

“That doesn’t mean that the world isn’t facing some very dreadful problems and that life is not increasingly miserable for millions upon millions. It most certainly is – and since there are so many more humans on Earth than there were 40 years ago, the conditions for many have worsened. Africa is the most obvious example, but elsewhere too - in Central Asia, the Middle-East (especially places like Egypt, Sudan, Somalia), Latin America, Southeast Asia (Burma, Cambodia).

“And the most powerful country in the world – economically, militarily and culturally – has had the self-inflicted disaster of nearly eight years of rule by a clique of strutting, incompetent, ignorant and arrogant frat boys....”

I like Peter’s theory, but I think it is wrong. There are many moving parts in the Age of Dread, but in my view the represent several fundamental but intertwined global conflicts. These are economic, environmental, political and religious.

Asia’s Century: The optimists among us would point to the dramatic improvement in life expectancy and living standards in recent times, nearly miraculous achievements in science and technology, the rapid spread of literacy and numeracy in the developing world, and the creation of small-scale wealth and opportunity through such remarkable innovations as micro-credit and rapid developments in global infrastructure for mobile communications.

To this rejoinder, those firmly footed in the age of dread would point to dreadful interlinks among these optimistic developments. The harder China works, the scarcer oil will become and the more the natural environment will turn upon humanity. The faster India grows, the higher food prices become.

People from Dubai to Shanghai say this is Asia’s century, and they may be right. For example, according to the report from a 2006 economic forum,

“The new century belongs to Asia” agreed more than 300 senior government, business and civil society leaders at the World Economic Forum on East Asia. The region will fulfill this potential, participants said, provided it meets the following top challenges:
• Create or assign regional institutions to discuss energy, security and environmental issues
• Address the impact of Indian and Chinese growth on the future competitiveness of South-East Asia
• Increase energy efficiency in major consuming countries and industries
• Sustain Japan’s recovery while cutting its fiscal deficit and resolve Japan’s historical and territorial disputes with China and Korea.

They've got the issues right, but can a talking club find solutions? Probably not: national self-interest almost always reduces areas of agreement to their lowest common denominators.

The issues are greater than the privileged West observing its power and privilege drifting into Asia. That said, this is undoubtedly a time in which the West is being occluded. Less than a decade into the third millennium, this seems obvious.

It is happening in part because we have passed the limits to growth – a concept first popularized in a 1972 book by that title. Published in an era very like the one we face today, The Limits to Growth modelled the impact of a rapidly growing world population on a world of finite resource supplies and rising pollution. It lost favour to the point of eventually becoming an object of derision in some business circles. Read it again, Sam – but be sure to get the 30-year update, summarized here.

From the assassination of Archduke Ferdinand (that event precipitated the First World War) to the Troubles in Northern Ireland, terrorism is religious or ideological when it isn’t state-sponsored. Today’s atrocities are no different, but the possibility for mayhem is greater; witness 9/11. Conflict between the West and the House of Islam arises. Resource wars begin in Iraq.

All recent nuclear proliferation has been in Asia. One of the three recent members of the nuclear club, Pakistan, is increasingly anti-Western and Islamic. So are both of the wannabees: Iran and Syria. The other two nuclear-armed countries on the list are India and North Korea. Asia’s Century looks increasingly nuclear.

Like economic growth and resource limits, rogue regimes are part of this general malaise – the age of dread. A cyclone hits Myanmar’s breadbasket; its thugs are unable and unwilling to help a people who, without bad luck, would have no luck at all. Rice becomes yet scarcer.

Look around you. There is much to dread but, as that icon from the 60s has it, "with all its sham, drudgery, and broken dreams, it is still a beautiful world. Be cheerful. Strive to be happy."

Gas Goes Global

This article appears in the May issue of Oilweek; image from here.

By Peter McKenzie-Brown

Last year was awful for Canadian natural gas producers. Development and production costs were at record levels, yet the average Canadian price at AECO was $7.66 per thousand cubic feet – seventy-four cents lower than American producers received at Henry Hub. But then, as suddenly as they had ebbed, prices began to flow. At time of writing, spot prices for natural gas are much higher than their 2007 average, and climbing.

To a surprising degree, these changes reflect global changes in the natural gas business. Historically, natural gas has been a regional business, and North America continues to be somewhat isolated from gas developments elsewhere in the world. According to CEO Robin Mann of AJM Petroleum Consultants, North American markets are presently somewhat isolated from the situation. However, he has no doubt that “gas is becoming a global commodity. Whether we like it or not, we are going to be caught up in it” – and, probably, sooner than you think.

The globalization of the world’s natural gas industry is being driven by a combination of economic and geopolitical forces. For example, consider the world’s second-largest gas-consuming region, Europe.

Geopolitics of change: Democracies around the world celebrated this decade’s revolutions in Eastern Europe. Serbia’s overthrow of its strongman in 2000 was quickly followed by the Orange Revolution in Ukraine and the Rose Revolution in Georgia. In each case the western world applauded.

Their biggest neighbour didn’t, though. Not known for its democratic credentials, the Russian bear responded to each revolution by clawing at the gas taps. It also apparently equipped saboteurs with explosives and sent them inside the country to destroy Georgia’s distribution link from the giant Russian gas monopoly, Gazprom. On instructions from Moscow, Gazprom even stopped deliveries to tiny Belarus for hesitating to “reunify” with Mother Russia. Belarusians had to quickly get used to being Russia’s 90th region.

These countries aren’t members of the European Union. However, expansion to 27 members has increased Europe’s dependence on Russian natural gas, so this pattern of behaviour has become a matter of deep concern. Now reliant on Gazprom for more than 60% of its gas supply, Europe is scrambling to find new sources.

Europe’s mad scramble is one driver behind the globalization of gas. Another is rapidly growing gas demand in the developing world – another trend with geopolitical overtones. The author of a best-selling book (A Thousand Barrels per Second) recently issued in Japanese and Chinese translations, ARC Financial’s Peter Tertzakian used China to illustrate the shift.

Coal and oil have played themselves out as easily harnessed and accessible fuels in that country, he says, and the country has to diversify into other fuels. “China’s pattern of energy usage is following the pattern of all other already industrialized countries. First you dam up all your rivers, then you move on to coal, then you start using oil as a booster rocket for the economy. Once you’ve done that, increasing your use of those fuels becomes unsustainable and you have to make a rapid shift to alternative energies – and the alternatives for China and other industrializing countries are natural gas and nuclear energy.”

Here, more geopolitical overtones enter the scene: The growing markets of East Asia and the nervous markets of Europe do not have a great deal of domestic gas supply. The planet’s greatest reserves are in the Middle East and the former Soviet Union – both of them diplomatically touchy regions. And most of the world’s other stranded supplies are in remote countries with access to the sea. These factors are helping drive a surprisingly rapid transformation of the global gas business.

A geophysicist by training, AJM’s Mann is bullish about the global gas market for the long-term. To a large extent this is because so much of the world’s gas potential is either undeveloped or stranded. This means a great deal is there to be developed for sale as LNG or, as in much of Southeast Asia, by subsea pipeline.

In terms of untapped potential, top of his list is West Africa. “We’re doing some work in Congo, where a few years ago you would be crazy to go, and that’s making me optimistic. There’s a chance that some West African governments will get their act together and stay true to their word, and if that happens that stretch of the continent could become a real hotbed of activity. There’s a lot of potential there.” However, he cautions, “we’ve been to this movie before. They could go back to their old ways, and this thing could blow up in their face.”

The biggest arbitrage: In Peter Tertzakian’s office is a meeting table with a single ornament in the centre: about the size of two fists, a wooden model of the globe. When you talk to him about the world gas business, he caresses this artefact, frequently turning it on its silent axis to demonstrate his points.

There are, of course, only two commercial ways to transport natural gas: by pipeline, and as LNG. Pipelines are being built with abandon, including vast networks of undersea lines that are, for example, connecting the vast Southeast Asian archipelago. For the most part, though, pipelines connect regions; they cannot connect the world.

For that, you need liquefied natural gas (LNG) – methane under such high pressures and deep cold that it forms into a liquid that can be shipped by tanker. To create a global market you also need a motive. Try this one on for size: “Natural gas,” says Tertzakian, “represents the biggest arbitrage opportunity in the world.”

Arbitrage is the practice of taking advantage of a price differential between two or more markets. A combination of matching deals that capitalize upon the imbalance, the difference between the market prices generates the profit. There isn’t much arbitrage opportunity in oil, because the global oil market is very efficient market, from hub to hub. There are lots of tankers on the seas, so arbitrage can easily be worked out. But for natural gas, which can sell in Chile and North Africa for as little as $1-2 per thousand cubic feet, arbitrage isn’t yet easy.

How do you get it from those sources to the high-priced markets of Europe and Japan and, increasingly, North America? The answer is LNG – although, says Robin Mann, “The major issue for LNG development seems to be in the development of liquefaction plants. They are expensive to build and two of them were recently cancelled. Increasingly right now we have regasification terminals that can receive (LNG) but we don’t have enough overseas exporters” to deliver production to overseas markets. That is changing. “The globalization of the gas business is happening much faster than I thought,” says Tertzakian, but he believes it’s a phenomenon Canada needs to embrace.

He lists a number of key reasons. For one, “every energy commodity today is under stress and tension, and the world is jockeying to figure out what energy mix they are going to use.” The competition for available energy is intense, and this is driving up prices worldwide. Contrary to the notion that “cheap LNG is going to come in and clobber us,” Tertzakian argues that LNG is the “friend” of North America’s gas producers. “It’s the most expensive molecule that sets the price,” he says, “not the cheapest molecule. That’s Economics 101.”

Another reason global gas markets have become so much more efficient is that LNG contracts have shifted from the old “port to port” model. A buyer can now redirect a shipment anywhere, and anywhere usually means to the customer willing to pay the highest price. Since the world’s LNG receiving terminals are underutilized, there is stiff competition for offshore supply. As a result – out comes the small wooden globe – “cargos have been shipped right around the world, from Trinidad all the way over here, to China. If (customers) are paying $15 in China or Japan but only $5 or $6 in the United States, East Asia is where the gas is going to go.” Only a few years ago, he says, no one could have predicted that.

LNG technology is changing quickly. New tankers are twice as big as they were in the past, so per unit transportation costs are coming down. Also, some tankers now have their own liquefaction facilities. Instead of receiving liquefied gas from an onshore plant, these tankers essentially just need a natural gas connection. Once connected to a pipe, they can liquefy the gas as they pump it into their holds.

The environmental advantages of gas are yet another compelling reason for countries to increase their use of the commodity. As things stand now, in developing Asia people are choking from diesel fumes and coal emissions. According to a World Bank study of Chinese pollution only 1% of China’s 560 million city dwellers breathe air the European Union considers safe. The resulting lung disease helps make natural gas a compelling fuel alternative.

Until recently, the world’s oil markets were efficient while the world’s gas markets were not. This is changing. “At the beginning of last year lots of gas tankers were coming to North America, (delivering up to four billion cubic feet (BCF) per day of LNG imports into the US), but by fall they were not,” says Tertzakian. Recently, LNG imports in the US were down to half a BCF per day.

The reason for this dramatic swing is that last summer LNG prices were more than twice as high in the US as in Europe, “so the tankers were all rushing over here. This is representative of the new era, which is one of the semi-globalization of the gas business. The big transatlantic price differences are being ironed out. It is also rather new. Companies like the UK’s BG Group have effectively globalized the industry. Gas is becoming much like oil.”

Although the Atlantic basin is the most advanced illustration of where the gas business is going, Tertzakian says, the Pacific basin is “getting there.” He twirls the globe: “These regions (China, India, the Middle East) have a trump card to play – natural gas – and they are playing it right now.”

Moving parts: For both geographic and political reasons – think NAFTA – North America is to a large extent a self-contained unit in the natural gas scene. But that is changing rapidly, and for many reasons. Among the gas bulls interviewed for this article there is a fascinating debate about whether Canada should consider joining the world’s small number of LNG exporters. This would only make sense, of course, if North America actually developed a surplus of natural gas, and Canada needed to build overseas markets.

“The Americans are trying to decouple from Canadian gas, but I don’t think they necessarily will,” says AJM’s Robin Mann. “The US is in better shape than they were five years ago. East Texas has had some big plays” and the States have been leaders in developing non-conventional resources like coal-bed methane (CBM) and shale gas. “Will this offset all the declines in the US? We don’t think so.”

Part of Mann’s thinking is that Canadian exports are bound to decline. “We need to add roughly 3.5 BCF (of daily productivity) each year just to maintain production. Based on our best guess about this year’s drilling in Western Canada, at the end of 2008 we are going to end up one BCF short. As we move forward to 2015, if all the oil sands projects go ahead, we will need an additional 2.5 BCF per day for oilsands use. Where is that going to come from? Exports to America. When you start adding all these things in, they are going to affect Canada’s exports.”

AJM’s geoscience vice president, Dave Russum, agrees. “CBM and shale gas development is sufficient to prop up American production rates to some degree, but it certainly doesn’t look as though it will grow the rates above current levels and we will in all likelihood see a decline in production in the United States.” The technology for this kind of development has greatly improved, but “the question is price. There is no shortage of gas in the US – the numbers are staggering. However, it is not cheap gas. The Barnett shale is an anomaly because of its location (near Dallas), for example, and despite all its advantages the margins there are pretty skimpy.”

Peter Tertzakian is the contrarian. “There are some yellow flags looming,” he says. “Production from the south-central United States (Texas, Oklahoma, Louisiana and Arkansas) is growing. If this production keeps growing, and it has already squeezed out LNG imports, what are the implications for Canada? A production surge in the US could potentially be a threat. The producers in Texas have much lower costs and much better netbacks; they are closer to the main (pipeline) arteries and they have bigger and more immediate markets.”

A constant theme of the interview with Tertzakian was his perception of the rapidly changing dynamics of the gas business. “There are a lot of moving parts. Everything is shifting. Compare today to only 18 months ago. Now we have the globalization of gas; a resurgence of gas production in the Lower 48; changing technology; changes in Canadian royalties and taxes; increases in demand in Western Canada, especially Alberta. Canadian production is falling off. LNG is being squeezed out. And we have to understand the productive potential of unconventional resources like CBM and shale gas. The gas industry has to be very mindful of all these things. We can’t just sit around and read the weather forecast to get an idea of how much we will be paid for our gas. We have to look around and figure out how we can be competitive.”

Mann acknowledges the competitive advantages of the American industry. “Pricing is higher there and costs are lower. You don’t have winter access problems, moving rigs and equipment around is simple, and the infrastructure is well developed. Also they don’t have the human capital problem that we have here – the Fort McMurray effect, which is driving up labour costs for everyone in the industry. In Canada operating costs for gas producers are going up (despite lower drilling day rates), and they aren’t going to come down.”

Tertzakian stresses that he sees a gas surplus in America as anything but a slam dunk. He sees it as a risk complicated by the fact that “right now we have all these pipes into one market. We only have one customer. That’s a dangerous thing, to only have one customer.” To protect Canadian interests, he suggests building an LNG export terminal in BC “so we are not hostage to a single customer.” He picks up the globe. “Look how close our west coast is to Korea.

As the interview ends, Tertzakian offers a final word of caution. “Generally I’m bullish (about the gas industry). But I think we in western Canada have to be very proactive in thinking about what all the changes mean. We need to be nimble, and we can’t afford just to be a price-taker. The Canadian sector has to work better with government to optimize the value of this resource. What sense would it make to produce this increasingly valuable resource and have it sold at lower prices in the United States if there were higher prices being paid around the world?”

Bedfellows: The Prices of Gold and Oil

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.

The Ultimate Dilemma for Oil-Dominated Economies

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.

Efficient Markets? How Noise Drives Prices

By Peter McKenzie-Brown
This week was remarkable. It began with the Americans twisting Saudi arms so they would increase oil production. Nervous that there might be spigots that could actually be opened, oil prices dropped off their lofty levels. Then a decline on global stock markets was greatly exacerbated by the squeeze forced on France’s Société Générale by a rogue trader. The Martin Luther King holiday market closures compromised an orderly unwinding of those futures contracts, and the decline in the markets turned into a meltdown.

Not knowing that the actions of a 31-year-old rogue had precipitated the collapse, the Fed’s Ben Bernanke flooded the world with cash by precipitously slashing key US interest rates. The markets were also flooded with rumours of a severe US recession impending – one that would take the world with it. Fearing a crash in demand, the price of West Texas Intermediate briefly dropped to its lowest level in three months. Then reality began to intrude: the Saudis don’t have a lot more oil they can produce, and geopolitics, rising demand and historically tight supply still govern the price of oil.

The chartillustrates two things. First, it shows the trading range of oil (the space between the red and green lines) during the last six years. Second, it shows an extended breach in that trading range – essentially, three months of trades above the red line. What used to be resistance has now become support. I consider it highly significant that oil prices popped up after touching their three-month low. In the future, oil is likely to trade above the red line.

One of the great things about technical analysis of this kind is that it is a way of imposing order (straight lines) on a market riven by noise (jagged lines.) However, technical analysis is not an excuse for not understanding what decisions help form the jagged lines of day-to-day trading. Oil prices are governed by a highly sophisticated market – one that can quickly balance innumerable pricing factors to establish appropriate prices for oil, but so doing creates endless charts of jagged lines. Herein I present my perception of how that market developed and of the major factors influencing it. As a Canuck, I will deal with the matter from a Canadian perspective.

The Background: As oil became a vital factor in western life during the twentieth century, exploration for the stuff – a new industry – found more than the world could consume. In response, big companies set prices for the oil they controlled overseas, while governments and regulators in the US helped create a parallel environment in which America’s huge domestic oil industry could prosper from higher prices. By 1970, these different policies had created a global pricing environment in which oil produced in the United States cost $3.18 (U.S.), while oil produced overseas only fetched $1.30 (U.S.)

This situation received a severe blow in 1973 when OPEC began to act as a cartel – an organization committed to keeping prices higher than the market would ordinarily allow. They were so successful that OPEC’s member states made price control the organization’s primary purpose, and for more than a decade a statement from OPEC was enough to give world energy markets the jitters.

The energy crises of the period were possible because the world was no longer awash with oil. In particular, production in the United States (then the world’s largest producer) had begun to decline. The Western world needed new supplies, and the volumes required were only available from OPEC members. This period culminated with the Iranian Revolution of 1979-80, which brought panic to oil markets. Dubai oil prices rose from about $2.00 (U.S.) per barrel in 1972 to $36 (U.S.) in 1980.

All this was far more traumatic a generation ago than the rapid oil price increases of the last ten years. The reason is that – at least, in relative terms – oil then played a much larger role in the world economy.

Spot and Futures Prices: The market responded dramatically, and predictably, to these painful price increases. Consumers used less oil while producers pumped more. OPEC soon lost the ability to keep prices high. Then, in 1986, Saudi Arabia, an OPEC leader, flooded the market with oil in an effort to re-establish market share. As a result, prices plunged. Dubai oil dropped to $13, and fluctuated around that level for more than a decade. It did not move decisively upward again until 2000, when tight oil supplies began to squeeze prices higher.

Aided by the convergence of computer and telecommunication technology and by increasing competition among global oil producers, the world’s response to these three “price shocks” – the price spikes of 1973 and 1980-1981 and the price collapse of 1986 – was to create a sophisticated global energy market. After much turmoil, this market, which now accommodates innumerable buyers and sellers, imposed a laissez-faire discipline on the matter of global oil pricing.

In this market, petroleum prices take the forms of “spot” and “futures” prices. Spot prices represent what traders charge for oil for immediate settlement – usually, delivery within two days. Futures prices are prices for delivery of oil at a certain date in the future – as soon as one month, as far into the future as nine years – at specified prices.

Driven by a global network of traders working around the clock (except weekends and holidays), spot trades take into account the needs of refineries and a constant stream of geopolitical and economic data. The markets are more strongly influenced by information about how much crude oil inventory is in America’s stockpiles than by OPEC statements about how much oil they are going to produce. News about hurricanes and other extreme weather events also figure into price calculations. So do rumours and worries about conditions in the world’s large economies.

The world’s energy traders bring uncountable resources, facts, needs, expectations and beliefs about the future into their collective trading decisions. This interplay of intelligence and knowledge creates a group mind capable of processing extraordinary amounts of information as it establishes global prices. Charts of spot prices changing minute by minute can be found on numerous web sites.

Benchmark Pricing: Spot prices represent the business end of crude oil pricing, but futures contracts are the ones that truly set prices. As their name implies, futures contracts anticipate what prices will be in the future. Investors and speculators buy these contracts on major commodity exchanges, and spot traders use them as their main references as they negotiate prices. Traders have developed many strategies using futures contracts. They are commonly used for financial speculation, but they also have practical business uses. Refiners can use them to secure the price they will pay for oil at certain points in the future, for example.

To create futures markets, exchanges had to settle on particular kinds of oil to serve as benchmarks. The price of a barrel is highly dependent on both its grade (which is determined by factors such as its specific gravity and its sulfur content) and its point of delivery. In North America, the benchmark price on the New York Mercantile Exchange (NYMEX) is West Texas intermediate oil (WTI), delivered at Cushing, Oklahoma.

There are other benchmark crude oil contracts. Of these, the most important is Brent light, delivered at a port in the north of Scotland. Traded on the International Commodity Exchange in London, this oil contract essentially determines the price of oil in Europe and Africa. Oman oil, which is traded in Dubai, helps determine the cost of oil in the Middle East.

The US government’s Energy Information Administration uses an entirely different approach to oil price calculations. It calculates the weighted average cost of oil imports (including oil from its biggest supplier, Canada) to determine the world oil price for the United States. Known as the Imported Refiner Acquisition Cost index, this is a lagging indicator. Instead of giving information about what prices are or will be, it describes what they have been.

Edmonton Par: Although Canada is a large and growing oil producer, we are a price taker rather than a price maker. Canadian prices are established by reference to the benchmarks of New York, especially, and of London. Those benchmarks are the price makers.

The “real” price of oil is its spot price – the amount a buyer will pay for oil for real, immediate delivery. One important Canadian pricing standard is Edmonton light oil. How prices for that oil are established illustrates spot pricing in action.

Initially, the price for Edmonton light is set by the companies – Imperial Oil, Petro-Canada, Shell and Suncor – with facilities at Refinery Row, near Alberta’s capital city. Each morning they post the price they will pay for Edmonton light. Those prices closely track the most recent closing price for NYMEX futures contracts. The daily average of the prices offered by those four refiners is known as Edmonton Par, and it is the standard used for calculating oil prices in Western Canada.

Foreign buyers (mostly located in Chicago) negotiate deals that take into account Edmonton Par, the futures price in New York, the spot price in Edmonton, the date the oil will be delivered, the difference in quality between Canadian light and WTI, the cost of transportation and the availability of competing supplies. As with other efficient markets, the price of Canadian oil reflects a balance of the needs and intelligence of many buyers and sellers.

Canada’s Split Personality: Global markets have had quite a big impact on the distribution of oil within Canada and across North America. In particular, they have helped determine which parts of North America use Canadian oil, and which use oil from the US and overseas.

Refiners avoid the high transportation charges required to pipeline oil from Alberta to Toronto and points east. Instead, they buy oil from offshore Newfoundland or from international markets. That oil is delivered to ports in eastern Canada or to a pipeline terminal at the ice-free harbour in Portland, Maine. From those delivery points the oil is piped to major refining centres in Come-by-Chance, Nfld.; Saint John, NB; Montréal and St. Romauld, PQ; and Nanticoke, Ont.; and to smaller eastern refineries.

Oil from western Canada is another story. It is highly competitive from Vancouver to Sarnia, and in parts of the US West and Midwest. Many refiners in those areas have developed equipment designed to refine specific kinds of oil from Canadian producers. That specialized equipment is one part of the industrial infrastructure that has created secure markets for Canadian oil. Another is North America’s complex network of interconnected pipelines, which make delivery relatively easy.

In practice, Canada has a split personality in the matter of oil imports and exports, and this is mostly a function of our planet’s market pricing for oil. We are the seventh largest exporter of oil in the world, but also the seventh largest importer. In 2006, each day Canada exported 1,784,000 barrels of crude oil, mostly from the west. At the same time, however, we imported 849,000 per day into the east. Canada was thus a net exporter of 935,000 barrels of oil per day.
Because a great deal of our oil production is lower-quality heavy oil, in 2006 Canadian production on the whole sold for less than the $66 per barrel fetched by West Texas Intermediate. However, those net exports added more than $55 million per day to our trade balance with the world.

The creation of a sophisticated global marketplace for crude oil coincided closely with the years in which Canada joined the big leagues of global oil producers and exporters. As we have seen, market pricing now suffuses the sector, and it has helped put the industry into its present form. An example is Canada’s decision to import oil for its eastern refineries while exporting oil from the west. In this instance and many others, efficient markets have helped create a cost-efficient industry.

Geopolitical Price-Meters

By Peter McKenzie-Brown
This is the month to celebrate the anniversary of a watershed event. As the graph shows, as this chart began oil prices on the NYMEX hit their lowest point in the last decade. What the chart does not show is that it was also the lowest level in the last 30 years.

More than that of any other commodity, the price of oil is influenced by political and economic geography – complex events better known as geopolitics. Because geopolitics is largely unpredictable, so is the price of oil.
The US Government’s Energy Information Administration has developed a geopolitical chart to illustrate the connections between oil and geopolitics since 1970. At this writing, the chart identifies 74 events during a 26-year period, and is current through January 2006. For details, go to this site. (The EIA uses a different measure of oil prices than the one provided by the NYMEX. That explains the discrepancies between this chart and the one at the beginning of this post.)

With this article, I am offering another “Geopolitical price-meter” for crude oil – a reference that gives those interested the opportunity to read links that describe the connections between oil prices geopolitical events and petroleum prices. I will periodically link this chart to authoritative articles about the influences on oil prices, but I have no plans to go back to 1970.

The articles I am citing are not definitive. Like all journalism, they represent “a first rough draft of history”. However, each gives a sense of issues when the article was written, and each describes geopolitical factors that influence oil prices.

1. 2007/09/28 “Oil prices surge on storm threat; Brent hits record high,” Agence France Presse
2. 2007/01/28 “Saudis signal efforts to control oil prices,” International Herald Tribune
3. 2006/10/21 “Oil Prices Drop Despite OPEC Call to Cut Output,” Washington Post
4. 2006/07/17 “Record Oil? Not Yet.” Forbes
5. 2005/11/11 “Oil prices hover at 4-month lows but analysts warn of cold weather ahead,” Forbes
6. 2005/06/20 “Oil's Price Climbing Toward $60 Level: Overheated Markets Ignore OPEC Talk Of Producing More,” Washington Post
7. 2005/09/01 “Hurricane Katrina: The Oil Supply; Gas Prices Surge as Supply Drops,” New York Times
8. 2005/05/13 “Recovering dollar drops oil below key $50 level,” Financial Times
9. 2005/01/20 “Oil prices on a tightrope: Agency warns of another possible surge,” International Herald Tribune
10. 2004/10/11 “Oil prices surge to new high,” Guardian Unlimited
11. 2004/01/08 “Oil prices stay high, OPEC says wants them lower,” Forbes
12. 2003/10/01 “Russia and Saudi in step over oil price defense,” Forbes
13. 2003/3/20 “Putting Oil Prices in a Wartime Context,” TheStreet.com
14. 2002/11/25 “The price of war and peace for US economy,” The Christian Science Monitor
15. 2002/01/02 “Global Oil Glut Contains Subtle Dangers,” New York Times
16. 2001/10/04 “Oil, Politics and the New Global Fault Lines,” New York Times
17. 2001/09/11 “Price of crude tops $30 a barrel,” Guardian Unlimited
18. 2000/12/04 “Forbes Faces: Saddam Hussein,” Forbes
19. 2000/12/24 “Oil price fall unnerves Gulf states,” BBC News
20. 2000/26/09 “Top Of The News: Oil Prices On Slippery Slope,” Forbes
21. 2000/29/03 “OPEC move hits oil prices,” CNN
22. 1999/24/10 “An Oil Outsider Revives a Cartel,” New York Times
23. 1999/22/03 “OPEC Is Prepared to Reduce Oil Production to Raise Prices,” New York Times

Supercycle Buster

This graph by Chris Skrebowski compares volumes of oil coming on stream to global oil depletion.

By Dave DuByne

You can’t really talk about economic expansion today without muttering a sentence or two about a commodities supercycle. To a large extent, growth in the BRIC countries – Brazil, Russia, India and China – are fuelling this supercycle by gobbling up ever-greater shares of the world’s available resources.

Let's put that in perspective. If you sift through history and study its cycles, you will find a telescoping of linear time. Each era is becoming shorter than the last. The agricultural revolution lasted 7000 years. The scientific revolution took 400. The industrial revolution took a mere 150 years. Wiring our planet with copper cables to transmit and receive messages took the century that ended in the 1980s, while rewiring it with optical cable took only a couple of decades. The speed of global messaging went from years in Magellan’s time to immediacy by email. The telescoping of time cycles appears to be the norm rather than a perfect set of coincidences.

Perhaps this commodity supercycle will be the shortest cycle of them all. Perhaps peak oil will bring on its collapse.

Enter the Dragon: Here in China, there is a palpable frenzy of about the birth of a new commodities supercycle driven by the