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.”

Genesis of a Giant

Thirty years ago this month, Syncrude produced its first barrel of oil. This article appears in the July 2008 issue of The Oilsands Review.

By Peter McKenzie-Brown

Syncrude triumphed over an era which was eerily similar to the one we’re in today.

Many commentators have remarked upon the likenesses between then, the 1970s, and now. A financial crisis in the United States led it in 1971 to end the link between the dollar and gold and to adopt a wave of protectionist policies. America and its allies were mired in interminable and expensive Asian wars. Because of high liquidity in capital markets, price inflation became endemic. Stock markets flattened and employment in non-resource sectors slumped. Rapidly rising food costs contributed to great suffering in the Third World, as it was then known, and to the poor in the richer countries.

After a 20-year decline, in 1973 real oil prices rose rapidly because of new demand, declining supply from key producers, and geopolitical events focused in the Middle East. The oil industry boomed; drilling, development and construction costs skyrocketed. As the decade wore on, the belief that oil was about to “run out” became widespread. So did the view that humanity would soon choke on its own pollution. By the end of that spooky period, forecasts of oil prices tripling from their already high base were common.

Given the similarities between that era and this, it is ironic that the early 1970s were a threat to Syncrude’s existence. The giant seemed doomed until three governments agreed to serve as midwives. This largely forgotten tale is an important part of the plant’s heritage. Few people remember that today’s world beater was nearly the victim of a breached birth.

Origins: For oilsands development to make any sense at all, Alberta needed appropriate policy. This is not a new idea. A hundred years ago Canada’s Senate held hearings on how to develop them.

Having established itself in 1930 as the rightful owner of the resource (by appeal to Britain’s Privy Council), Alberta’s government intensified its efforts to create a long-term policy just after the Second World War. The effort was short-lived, however, because of important discoveries of light oil at Leduc and elsewhere, beginning in 1947. Why develop the sands when high-quality crude was there for the pumping?

The province has always understood that its long-term future lies with the sands, however. Despite gathering volumes of conventional oil production, in 1962 the government announced an oilsands policy for the long term. In response, two proposals came forward. Cities Service Athabasca Inc. proposed a 100,000 barrel per day plant at the site of its Mildred Lake pilot project – the site of the Syncrude project. Including a pipeline to Edmonton, the plant was to cost $56 million, with construction beginning in 1965 and completion in 1968.

In that round the winning bid was for the much smaller Great Canadian Oil Sands Limited (today’s Suncor plant), which initially received approval for a 30,000 barrel per day plant. By the original terms of its license, production from the plant could not exceed 5% of total volumes in markets already supplied by conventional oil from Alberta.

For its part, Cities Service got a rejection letter. Undeterred, in 1964 the company assembled the Syncrude consortium, which later applied for a much larger (140,000 barrel per day) plant. The proposal received approval in late 1969. But before the plant shipped its first barrel of oil nearly ten years later, the project experienced a financial crisis.

Crisis: The reason for the long gap between approval and completion was an alarming escalation of costs besetting major North American projects. High inflation multiplied budgets for practically every aspect of the Syncrude project.

Reviewing project costs in late 1973, the Syncrude consortium found that costs had more than doubled, from $1 billion to $2.3 billion. One of the partners, Atlantic Richfield, needed cash to develop its Prudhoe Bay interests and frankly saw its Alaskan bonanza as a far more attractive bet than investing in the oilsands. In December 1974, the company withdrew its 30 per cent participation in the project. A few days later, the three remaining partners – Gulf Oil, Imperial and Cities Service – informed the Alberta government that they were unwilling to risk more than $1 billion on the project. They would need another $1 billion of risk capital if the project were to go on.

The prospect of Syncrude collapsing was a political and economic nightmare. The world was reeling from the oil crisis of the day. Policy-makers in the rich Western countries considered it a matter of national urgency to develop stable, secure energy supplies. The rich world was experiencing the worst recession since the Second World War, and Canada desperately needed economic stimulus. Because the oilsands were so large and development was so clearly possible, getting Syncrude back on track looked like Canada's best bet for both coherent policy and economic stimulus. From coast to coast to coast, Canadians came to believe the project must not falter.

Alberta reviewed the cost estimates given by the Syncrude consortium. When it found those estimates weren’t out of line, the province helped convene, in February 1973 in Winnipeg, a historic meeting between consortium members and governments.
Three governments joined the consortium as commercial partners, thereby salvaging the project. The federal government took a 15% interest, Alberta 10% and Ontario 5%. Alberta also took full ownership in the no-risk pipeline and electrical utility. The private partners agreed to take a $1.4 billion interest in the project, but gave Alberta the option to convert a $200 million loan to Gulf and Cities Service into equity.

The Billionth Barrel: Syncrude went into operation in the summer of 1978 and produced 5 million barrels of oil within a year. World oil prices leaped skyward in 1979-80 and remained high for the first half of the 1980s. This helped Syncrude become successful financially as well as technically. The collapse of oil prices in 1986 – followed by 15 years of lower prices – intensified the organization’s incentive to reduce costs per barrel while increasing production. Production rose steadily in the ensuing years and, on April 16, 1998, the plant piped its billionth barrel down the line – five years ahead of schedule.

Ten years later, a counter on the Syncrude website zips along at a rate of four barrels a second, estimating the volume the plant has produced: as this magazine goes to press, about 1.9 billion barrels. A giant since inception, Syncrude is too big and complex to easily conceptualize. The largest producer of crude oil from oilsands, 350,000 barrels of oil pour from its processing vessels every day. Every twenty-four hours, the sands wear the metallic equivalent of two full-size pickup trucks off the plant’s mining equipment.

One of the most complex industrial operations anywhere, Syncrude operates the largest network of open-pit mines. It is Canada’s largest single source of oil, producing volumes equal to 15% of total national requirements. It extracts the raw oil known as bitumen from the sand and then turns it into the sweet light crude oil known as Syncrude Sweet Blend by processing it in vast upgrading vessels. The plant’s “synthetic crude” (hence the name) moves by pipeline to refineries in Canada and the United States.

Syncrude plans to increase production to about 500,000 barrels of crude oil per day within the next decade. As it does so – and as it has done for the last three decades – the consortium will continue to introduce new technologies and processes. These will improve the plant’s efficiency and reduce its per-barrel impact on the environment. During the next decade, the consortium estimates, its sulphur dioxide emissions will decline by 60% from today's levels. Reflecting efficiencies of scale and better technology, per barrel energy consumption will drop by 1% annually.

Today the technology is proved, and oilsands development is of global rather than national interest. Many policy-makers now view oilsands development as a critical source of relief for straining international supply. Sitting in the opposition benches are environmental and public health issues. Mainstream in a way they weren’t 30 years ago, they will threaten some of tomorrow’s giants.

Q&A with Marcel Coutu

Syncrude's Chairman of the Board delves into operations, the environment and the demise of oil around the world. This article appears in the July 2008 issue of Oilsands Review.

By Peter McKenzie-Brown
Canadian Oil Sands Trust owns the biggest single share of Syncrude (37%), and the firm’s CEO is also Syncrude’s chairman. Oilsands Review asked Marcel Coutu about operating and environmental issues at the oil sands giant. His edited comments follow.

OSR: Developing new technology has been part of the business from the beginning. To what extent is that still the case?

MC: The first few years of this business were about survival, because oil prices were low and costs were high. When oil prices were low and margins were thin the driver for this business was always lowering costs. That really hasn’t changed much.

Both Syncrude and especially Suncor have been major developers of new technology. Suncor, for example, developed hydro transport – technology that enabled us to move oil sands ore by pipeline rather than truck. So all of a sudden we were operating satellite facilities, without having to truck ore to the processing site. That was a major innovation.

The tailings ponds are a major challenge area. It’s an important functioning part of our operations, and enables us to recycle our water. It’s a major challenge. We need to find ways to separate clay from the water more rapidly. This will help us reclaim land better.

OSR: Oilsands inflation has been high in recent years. How has that affected you?

MC: The one inflation component that has dwarfed all the others is the price of natural gas, which has moved up in parallel with the price of oil. We buy eight-tenths of an MCF of natural gas for every barrel of light sweet product we produce. The rest of our costs are increasing by low double-digit to high single-digit numbers, and over the years those costs add up. Fortunately, oil prices have more than offset operating-cost inflation.

OSR: How much energy do you consume for every barrel of oil you produce?

MC: About 1.5 gigajoules (1.5 MCF of natural gas equivalent) per barrel. That’s higher than 0.8 MCF, the number I mentioned earlier; that refers to purchased energy. The total energy we consume in our operations includes energy we generate as a by-product to our upgrading processes. It is largely electrical energy, in which we are more than self-sufficient.

We produce a lot of waste gas from our processes, and use that to fire gas turbines. We also have a lot of waste heat from our operations, and we raise steam with that heat and put that steam into steam turbines. This makes our operations more efficient.

Beyond that we arbitrage against the price of electrical power around the clock, sometimes selling electricity into the Alberta grid, sometimes buying it, depending on how those conditions align. We arbitrage those markets in both directions. We do the same with natural gas. It’s one of the businesses we do to make ourselves as energy efficient as possible.

OSR: How are you managing carbon dioxide emissions?

MC: We’ve been reducing them from the time we opened the plant gate. Carbon dioxide emissions are all about energy consumption – they are exactly the same thing; reciprocals, if you will. You only create CO2 emissions by burning fuels. We have always been incentivized to keep our energy consumption as low as we can, and lowering consumption means lowering CO2 emissions. We have always been focused on reducing CO2 emissions because they represent a direct cost to us.

OSR: You are a member of ICON, the Integrated CO2 Network. Any thoughts on carbon sequestration?

MC: The plants at Fort McMurray are the largest collectible source of CO2, but it is an expensive proposition. You have three levels of major expenditure there. You could sequester a lot of CO2, but I’ve seen numbers that you are actually generating more CO2 than you are sequestering by going through this process. First you have to construct equipment to extract the CO2, then build a pipeline, then pump the carbon dioxide into the saline aquifers, salt domes, old reservoirs or whatever you use to host the stuff.

OSR: The notion that crude oil supply is about to peak or has peaked is gaining a lot of currency. What do you think?

MC: Natural gas is in vast supply around the world but oil is not. Crude oil production in most of the producing countries in the world is in decline.

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.

OSR: How serious a problem is maintaining global production?

MC: Very. World oil production is generally in decline. You can assume that out of global production of 87 million a day, productivity will come off by 5-10 percent every year, so you have to replace that production each year before you can even begin to satisfy global demand growth. So what we are seeing is the demise of the commodity, since we are never really going to be able to meet the demand. Prices will be volatile, but the trend in my view is that prices will continue to climb. The demand will be fully there regardless of anything that happens to the US economy. The decline is real and cannot be arrested, at least not in the short term. One hundred and fifty dollar oil is within striking distance.

OSR: What is the role of the oil sands in this environment?

MC: Oil sands production is close to a million barrels a day, a little more than 1 per cent of global production. It’s going to take a huge amount of effort, capital and time, maybe ten years, to double Canadian oil sands production. It’s true that the Canadian resource is huge, but accessibility is long and slow. Our impact will be very slow.

One thing we need to bear in mind is that the size of our resource goes up with the price of oil; the higher world oil prices grow the greater our resources become. We have re-evaluated Syncrude’s leases, and that re-evaluation has taken us way up from 9 billion barrels, which was our traditional resource base. That’s good for Canada and Alberta and the rest of it.

OSR: How are you dealing with the labour shortages around Fort Mac Murray?

MC: To answer that, you have to think of labour as being in two buckets. The people in the operational bucket are there for the duration. They have great careers, pension plans and so on. Everyone puts their shoulder to the wheel, and we get the job done. We lose some people, but the situation is manageable.

Then there is the contract bucket – construction workers, pipefitters and so on, who are mostly there to work on expansions. They are there on a temporary basis and they are hard to hold onto. They are the challenging part of the work force. The labour problems we face are focused in that area.

OSR: Having waterfowl fly into the tailings pond brought international attention to Syncrude. Do you want to comment on it?

MC: We’ve extended apologies to everybody. It was really a heartbreaking incident for us. Why did it happen? Because we didn’t have our equipment deployed before the ice thawed. It’s something we have been managing for decades with success, but we got caught by the weather. We didn’t have our deterrents in place.

OSR: What are some of the other environmental issues you face?

MC: In general, our environmental story has been glowing. Where we have done a poor job has been in telling the world about it.

I’d like to comment in three areas – water, air and land. Let’s start with water. At Syncrude we consume two tenths of 1 percent of the water from the Athabasca River for our operations. We recycle as much as we can. If you extrapolate from that, the whole oil sands industry consumes less than 1% of the Athabasca’s flow.

Air is a more serious issue. We reduce our CO2 emissions because it makes economic sense, as I said earlier. But there are nastier things that we have been managing for years and they cost us a lot of money, and the nastiest of them all is sulphur dioxide. Our SO2 emissions peaked at 250 tonnes per day when we were producing around 250,000 barrels a day. In our last expansion we moved from 250,000 barrel per day to 350,000 barrels per day, and we invested about $1 billion in SO2 scrubbing equipment. We not only stopped the growth of SO2 emissions but reduced them slightly from our peak levels. Now we are spending another billion dollars to reduce those emissions to about 150 tonnes per day.

On the land side, in March we were the first company in the whole industry to get certification for land reclamation. We have returned that property to the province. It’s really impressive. You would never know there had been a mine there.

China’s Renewable Energy Plans: Shaken, not Stirred

A factory after the quake.

By David DuByne
The May 12th earthquake in western China’s Sichuan Province will have effects reaching further outside China than Beijing is letting on. Sichuan Province holds the key to China’s hydroelectric power generation plans in its renewable power targets and the area is also a hub for worldwide outsourced wind turbine equipment. Both were badly damaged.

This infrastructure will take months or years to repair, but in the meantime Chinese media report that “The quake in dollar terms is minimal and it seems unlikely to set back China’s economic growth by very much.” I beg to differ.

This earthquake cracked dams and roads, but at the same time it cracked holes in the myth that an ever-expanding China can accommodate an infinite number of companies wanting to open facilities there. We have been hiding behind a wall of outsourcing dependence to solve our domestic pollution and economic problems and that great wall is about to collapse.

The hydroelectric crutch: The quake zone area generated 62 percent of Sichuan province’s total electricity production by way of hydroelectric dams, of which “396 dams were believed badly damaged and many of the power stations on the river systems were damaged and several major reservoirs are being drained to prevent their dams from failing. The seismic safety of these dams is a concern and it is expected that many of them will need repair and strengthening,” according to Ministry of Water Resources minister Chen Lei.

Even before the quake, Beijing had admitted there are major flaws in many of the country’s 87,000 dams. “Roughly 37,000 dams across the country are in a dangerous state,” Ministry of Water Resources deputy minister Jiao Yong said earlier this year, noting that many had been built decades ago.

Two weeks after the quake, the Water Resources Ministry acknowledged that 69 reservoirs and dams were on the verge of collapse, and nearly 3,000 throughout China had sustained damage.

If the always secretive central government is publishing this type of information, I can only conclude that reliable power from that region is no longer assured. This single set of facts revolving around hydroelectric production in western China is a link in a chain that stretches from China right around to your back yard, and that link has broken.

Don’t count your renewable energy eggs before they hatch: China has more dams than any other country – about half the world's total. And the 11th Five Year Plan pins its hopes on rapid and massive development of every metre of flowing water in the rivers of Yunnan, Sichuan, and Gansu Provinces in the west to satisfy the insatiable power demand for factories and homes. The Chinese government will now have to reconsider its aggressive dam-building program.

If hydroelectric projects are scrapped there will be continuous permanent electric shortages throughout the country. China's hydroelectric consumption was around 7% of their total prime energy consumed in 2007.

Pre-quake, the central government was thinking: ‘Sichuan possesses the country's largest possible reserves of hydropower resources, estimated at more than 110 gigawatts. Yunnan has a number of hydropower stations under construction on the lower- and middle-reaches of the Lancang River, with 11 GW and plans for dozens more projects between now and 2016. Gansu’s abundant Yellow River hydropower resources can provide electricity for the neighbouring provinces of Qinghai, Shanxi, Sichuan and Ningxia, and their further potential is great.’

Not anymore.

The China Electricity Council believes less than 20 percent of the country’s hydroelectric resources are being utilized. According to the pre-quake governmental plan, the hydroelectric installed capacity should have reached 125 GW in 2010, accounting for 28 percent of total installed capacity; in 2015 it could have reached 150 GW and by 2020 the goal was 300 GW. These plans are not likely to go forward as planned. This will leave China far behind its electrical generation goals and far short of the capacity it needs to attract manufacturing businesses to that part of the country.

The slow decline: China's Go West Campaign is designed to lure college graduates and businesses to western parts of the country, thereby spurring the economy in China's less affluent interior.

The bait most frequently used by the central government is in the form of Major Economic & Technological Development Zones, Special Economic Zones and City Industry Zones, which confer tax-free status along with preferential transportation and wage agreements. This is great when there is a continuous power supply, but now in the western region that is anything but assured. China’s State Power Grid announced Sichuan’s electricity grid is running at 76% of pre-earthquake levels. Notice how they conveniently leave out the surrounding provinces, which also sustained damage.

A recent article appearing in the China Daily – “China expects power shortages amid surging demand” – quotes the State Electricity Regulatory Commission general office as saying “Guangdong Province would be short of 5.5GW, Guizhou 1GW, and Yunnan 1.5 GW.” Yet again they left out shortages in Sichuan, Gansu, Inner Mongolia, Zhejiang, Jiangsu and Shanxi provinces to get a reliable total. This will be the fifth consecutive year of power shortages countrywide. Now consider this: the last four years were short with all of the country’s hydropower up and running.

This year, power is likely to be 10 GW short, so keep an eye on the power ratings – “normal shortage”, “severe shortage” and “power crisis” – to see how your favourite town or industrial zone is getting along.

It seems there is a masking of the real numbers. What business would want to set up in a country with consistent electrical shortfalls?

Devastation in Beichuan

Combine electrical shortages with the amount of factories that need to be relocated now that fewer enterprises will want to rebuild on an active fault line and the veil begins to lift on what they are hiding. Labourers are refusing to return to work until government inspectors sign off on the integrity of the buildings, despite the fact that it might take months or years before they get around to every company. The psychology of danger for the worker and investor is the overlooked factor X in the Chinese equation. Now, how appealing are the Regional Development Zones in western China??

As for us living outside China, outsourcing heavy industry to China is the norm. Even the worldwide renewable energy sector has many of its wind turbines and solar panels produced in China. Unfortunately, Deyang – a town about an hour and a half north of Chengdu – had wind turbine operations including majors from Europe, Australia and North America carrying out some of their production at Dong Fang Turbine. In the same area there were also carbon fibre blade, wind tower and ball bearing operations supplying parts to Dong Fang. Buildings in the surrounding area from Deyang to Mianyang were heavily damaged or flattened.

Business Week sums it up in an article titled “Dongfang Turbine Badly Hit.” The operations of Dongfang Turbine, China’s largest steam turbine producer and third largest domestic manufacturer of wind turbines was virtually wiped out. Dongfang, which produces 30 percent of China’s locally made turbines estimates direct losses from the earthquake will reach $1 billion. Its parent company, Dongfang Electric Corp., has seen its stock price plummet as the steam turbine business accounted for 20% of its operating revenues in 2007.

Although Chinese media reports suggest that facilities for its wind turbine business was unaffected, sources inside the company said that most of their wind business’ senior engineers have unfortunately perished and one of their wind components factory was badly damaged.

The electric shortage earthquake triangle: Where does this leave us? Peak Oil is apparent and can no longer be denied. We as a world need to begin a transition to renewable power and these circumstances will set the wind industry production in China back a year or two. China’s answer to the electrical shortage will be to build more coal-fired power plants. As outsourced production is now being limited by fault lines and electrical shortages, what will our answer be?

The electric shortage earthquake triangle from Kunming in the west to Chongqing in the east and Lanzhou to the north with Chengdu in the centre is all sketchy territory from now on. The central government was funneling new business to this exact area because there is very little space along the east coast. That’s why there is a massive push to send the economy west. If you have been to coastal China you have seen how densely packed a society can be.

Price is the main reason we buy Chinese goods and have our industries there. However, when something is in short supply it costs more. Electricity is no different. There are now daily diesel shortages along the east coast, electric shortages in the west and along the coast. Add in the recently appreciating yuan and China is no longer the utopia for business it once was. Until the damage in western China is repaired, increased usage of oil, natural gas and coal will replace hydropower to an extent. This in turn creates higher prices in China’s manufacturing sector. You will pay at the check out counter.

Please understand: The rest of the world is far less dependent on China's exports than China is dependent on the rest of the world. We need to prepare to take care of ourselves again. As oil prices continue to rise and the global economy declines, I believe we will see a resurgence of light industry returning to our home countries. China’s electric problems could be partially solved if light industry moved elsewhere and left heavy industries in China. Unemployment is going to become more and more ferocious over the next few years as our fossil fuel based economy declines.

What a great way to put millions of people to work: Bring companies back home. This will take one link out of the globalization dependency chain, and save energy along the way.

Until recently, David DuByne taught business English in Chongqing, China - near the epicentre of the earthquake. He has returned to the United States. His website - Dave's ESL biofuel - is devoted to bio-fuel and oil depletion.

Last of a Breed

This article first appeared in the April 2008 issue of Oilweek.

By Peter McKenzie-Brown

Jim Kinnear makes it sound compelling.

During the last couple of decades, “the trust took over the mid-cap end of the market. The junior companies are the explorers. The independents are doing the large projects – EnCana and CNRL (Canadian Natural Resources). Then there are the super majors. This type of vehicle (the trust) is ideal to fit that part of the market. It’s a difficult business model – how much should we reinvest, how much should we distribute to our unit holders. (The trust) is a very efficient way to reallocate capital. If you acquire an interest in an oil and gas asset, there’s good margins and good cash flow. You’re buying a good income stream. Our concept was to buy a cash flow stream. I’m a financial analyst. BSc – very general degree – then became a financial analyst. These assets provide cash flow, part of which is depletion of assets. You put up $100, get $20 back per year for five years, say, then you own the property. You can get a 15-20 per cent rate of return each year.”

These notes give you an idea of the depth, intensity and direction of Kinnear’s thinking.

Trusts evolved out of managed limited partnership (MLPs) for the wealthy and professionals. They are a financial vehicle developed to answer the question, “Can we expand the closed-end trust?” Trusts and MLPs combine the cash flow business model with a tax ruling that exempts them from tax.

Pengrowth: Kinnear’s Pengrowth was the third trust; the first two were Enerplus and Royal Trust Energy. Kinnear remembers when Marcel Tremblay started up Enerplus in the mid-1980s. “He started his first fund with less than $10 million,” Kinnear says. “He got a comfort letter saying that he could distribute all this cash to his unit holders without paying tax. His unit holders would pay the tax on all the net revenue, not the trust. If unit holders lived in another jurisdiction, like the United States, they would pay tax in that jurisdiction.” Companies and corporations pay tax, but royalty trusts do not. They began as vehicles which pass oil and gas cash flow through to investors, and they still serve this purpose.

Pulling out a writing pad, Kinnear draws a graphic showing how trusts work. With an expensive-looking fountain pen he draws a graphic showing cash flow coming from operations and being dispersed to individual investors.

“You’re buying a cash flow stream,” he says. “We called it financial engineering. It’s like a REIT, except instead of owning buildings we owned revenue-generating oil and gas properties.” Taxes would be paid by investors, who could purchase trust units through stock exchanges. This very clever model enabled taxpayers to defer and avoid taxes – for example, by holding their trust in RSPs. The trust/RSP combination postpones taxes, sometimes almost endlessly.

During a shift as an oil and gas analyst in Calgary, Kinnear acquired some petroleum interests. He incorporated Pengrowth in 1987. The year was significant because, in the dramatic first two months of 1986, oil prices had dropped precipitously from $26 per barrel to ten dollars. The drilling industry was flat on its back. Large projects were being cancelled and postponed. Oil and gas companies were earning negative rates of return. In Alberta, housing prices crashed.

Yet the larger Canadian economy was doing well. “I felt like a turd in the fruit bowl” said the president of a major Calgary-based oil company (not Pengrowth) after addressing a business conference in Toronto in 1987. There seemed to be rising prosperity almost everywhere else – partly because energy prices were so much lower. Lower prices benefitted most of the country, but Alberta suffered.

In those days, the late 1980s, oil and gas properties were there, in the gloom, for the asking, and that’s when Kinnear began to buy properties for Pengrowth. Pengrowth is one of the largest and most profitable energy trusts in Canada. Now 20 years old, the trust is worth about $5 billion (total assets). Enerplus and Pengrowth have both become major players in the energy trust business, and they are close in size. In 2006 Enerplus had $2.7 billion in net equity on the balance sheet, compared to Pengrowth’s $3 billion. Marcel Tremblay left Enerplus quite abruptly in 2001.

Pengrowth Manager: Kinnear has created an organization on which, to a much greater degree than is common, he leaves indelible marks – especially in the area of corporate branding.

Pengrowth is one of a declining number of income trusts which still has a one-person manager – essentially, a management contract with the founder and CEO of the company. Pengrowth Management Ltd. is owned 100% by Jim Kinnear, and it puts millions of dollars into not-for-profit events and charities each year.

This arrangement means that Jim Kinnear’s management fees and bonus include millions of dollars for philanthropic sponsorship. Pengrowth’s major sponsorships tend to be high-profile events: The Pengrowth Saddledome, the Duke of Edinburgh Awards and the Canadian Open – the world’s third oldest open golf tournament. “For all (Pengrowth’s) community endeavours the money comes from the manager,” Kinnear explains, “and I am 100% owner of that.” Since the trust’s purpose is to pass cash flow on to investors, as a trust Pengrowth can’t sponsor charitable events directly. “When we invest in these programs, we don’t just give money, though. We get involved. We help make these organizations better. We really feel we can make a difference.”

Kinnear has an encyclopaedic knowledge of the business and of the energy industry as a whole, especially from the perspective of a dealmaker and a salesman. He brings an analyst’s mind, a quick tongue and a great deal of charm to an interview. How has the report of Alberta’s Royalty Review Panel affected his trust? “We don’t have all the details, but it seems to be only 4-5 per cent. What is really important for us is the maintenance of credits for EOR (enhanced oil recovery).”

Of more concern to him was Jim Flaherty's Scary Halloween Trick. Also known as the Halloween Massacre, federal finance minister Flaherty announced this new tax on October 31, 2006, and it will start taxing trusts in 2011. The tax, which will impose a 31.5% duty on the net income of energy trusts, has a catchy acronym, SIFT. The word stands for “specified investment flow-through tax”.

As a result, the price of Pengrowth units “has declined by about 20 per cent on the markets and (the new rules have) made it more challenging to do our business.”

Besides SIFT, Kinnear gives a litany of problems facing the Canadian industry. “The high dollar has affected costs and adversely affected margins. Over the last two years costs have really skyrocketed. They are now twice what they were in 2001. Globally, everything is way up, construction costs, drilling costs, everything. The cost chart in the last two years has become parabolic. Then there was the royalty review in Alberta. The gas market in North America has had major problems and there’s talk of recession. Stock markets around the world are volatile. We call it piling on. What more can happen?”

Outlook: Given all that piling on, Kinnear seems sanguine about Pengrowth’s future. “We have a number of potential development projects down the road that can offset our depletion over the years,” he says. And “we have a huge accumulation of tax pools, we have about $2.5 billion in tax pools, and we can use those to offset this new tax. We continue to be a high-yielding Canadian energy trust. We want to deliver as much cash as we can to our unit holders before we become taxable.”

He argues that a flight to quality in the industry has driven a lot of investors to Pengrowth. “We have a lot of heritage assets. Judy Creek, Sable Island, Swan Hills and the Weyburn field in Saskatchewan. Weyburn,” he adds parenthetically, “is currently the world's largest carbon capture and storage project.” Producing these assets during this period of high-priced oil means high rates of return. “In 2006 we were among the top ten oil and gas property acquisitors in North America. We can double the size of our assets under the SIFT rules.” He also notes with satisfaction that the federal government expects to have Canada’s tax rates at the lowest level in the G-8 by 2012.

Asked about the price outlook, he says “We’re not very good at calling prices. We think there will be recovering gas prices over the next year or so. Storage in Canada is closer to the five-year average than it was, and gas drilling is down” both in Canada and, recently, the US.

Will oil prices climb or collapse? Kinnear is just back from a CERA (Cambridge Energy Research Associates) conference in Houston. One speaker was Matt Simons – author of Twilight in the Desert, and 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, Simons 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. The interview turned to a discussion of peak oil.

Peak Oil: Peak oil is the notion that the world has produced about half its producible reserves, and that implied demand will soon outpace available supply.

Kinnear begins in a humourous way. “You usually see a peak in oil prices in the spring, and the low point for oil demand is usually in December.” It is not clear whether he understood the question until he adds this: “In the second half of last year something very interesting happened. Look: we have $90 oil, and most companies are still missing their production targets. Maybe the oil just isn’t there.”

He warms up to the topic. “It took about 250 million years to create all this oil, and we have used about half of it in the last three generations. It’s amazing. Whether you do or don’t believe in peak oil, there just 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 of their cash on new development and buying back stock to increase shareholder value. Some major companies 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 alien companies 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.

Kinnear echoes a century-old refrain: “It’s 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, Kinnear points 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 returns 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 is an irony in this. Trusts like Pengrowth do not take large exploration risks or develop such megaprojects as oil sand plants. Instead, they acquire producing assets from other firms, and often operate them directly. For firms with that business model, the risk of peak oil can create an ideal business environment. Under peak oil, energy trusts would generate increasing cash flow as a result of rising energy prices. Those funds would come from existing operations, and they would fund future distributions and expansion. While not involved much in the hunt for new fields, trusts like Pengrowth provide an efficient way to harvest known reserves. This is a profitable business model.

Colin Campbell and the Cracks of Doom

By Peter McKenzie-Brown
For many peak oil believers, this is the scariest chart you can imagine. The blue lines show historical oil discoveries. The gold lines project discoveries into the future. The line that looks like a rising serpent shows annual production up to about 2005. The chart was created by peak oil guru Colin Campbell in 2004 for a deliciously ironic article titled "The Heart of the Matter". The chart looks like a road map to the Cracks of Doom, and it has been quite influential.

In this column I have frequently provided arguments in favour of peak oil theory, and I am an unabashed admirer of Campbell and his work. However, I believe this chart, though directionally accurate, is simplistic and alarmist. It needs to be nuanced. We can do that in three ways.

• First, note that the blue lines essentially track the world’s new-field discoveries of light and medium oil. The chart suggests that these volumes are the world’s oil reserves. It doesn’t nearly reflect the reserves additions that come through infill drilling, enhanced oil recovery and other standard oilfield practices. By applying simple math to the chart (subtracting production from discoveries), you will come up with world oil reserves far short of the roughly 1.2 trillion barrels that the Energy Information Agency and other authorities have booked.

As they are developed, most discoveries prove to be much bigger than the estimates at time of discovery. This is partly because reserves are a function of economics. When you find a new field you calculate its reserves based on present conditions and price forecasts – say, in 1970, $2.50 per barrel into the foreseeable future. As prices rise relative to costs, you will get more oil out of that field – of that you can be sure.

The thinking by which M. King Hubbert forecast the year of peak oil production in the United States was incredibly successful. What is rarely discussed, though, is that Hubbert underestimated by about 50 per cent the amount of oil that would be available in the US after it reached the peak. To a large extent this was because new reserves became available through changing technologies and more favourable petroleum economics.

• Second, give heavy oil, bitumen and oil shale the credit they deserve. Because of the nature of the beast, these unconventional resources are not booked as reserves until they become economically and technically producible.

Alberta’s huge oil sands are a classic example. In 2005 America’s Energy Information Agency booked Canadian oil reserves as second in the world (after Saudi Arabia) because of the impact of higher prices and improved technologies on the oil sands. If that amount of oil – 174 billion barrels (174 gigabarrels) – were added to the gold-coloured reserves lines on Campbell’s chart, it would require a line that would tower over the rest of the chart by a factor of three. Campbell’s methodology does not account for this kind of event. And in all likelihood, much more of the oilsands will eventually be booked as reserves.

That point takes me to this chart (click to enlarge), which is also from Campbell’s article. The black wedge – characterized as “Heavy, etc.” in the legend – is his estimate of the contribution of heavy oil to the global energy liquids picture. Eyeballing suggests that he expected these unconventional resources to be about 4.5 million barrels per day by now, world-wide.

Heavy oil, synthetic oil and non-upgraded bitumen represent about two million barrels of production per day in Canada alone, and Venezuela and Mexico are also big producers. What’s more, Canada’s oil industry is working hard to develop export markets for heavy oil, because there is a great deal more production yet to develop. Indeed, Canadian producers are selling their heavy oil at a discount because they cannot get it to world markets.

According to one excellent and credible report, seven years from now Alberta alone will be producing about three million barrels per day of “Heavy, etc.” That estimate risks production for economic and environmental obstacles, so it is probably low.

• Third – and this is my main point – let’s acknowledge that the serpent-like production line in Campbell’s chart, while it is not a happy sign, is not the spectre of doom it appears. The world’s unconventional resources will greatly blunt the blow – relative to the steep declines described in Campbell’s chart, in any event.

One amazing feature of the oil sands is their incredible energy density. Imperial Oil’s Cold Lake bitumen plant, for example, is a tiny dot on the map of Alberta, yet it produces 6 per cent of Canada’s oil. The resource density of these unconventional resources is immense, and that density is what makes it such an important resource. The world is heading toward capital-intensive, technology-intensive, pollution-intensive and energy-intensive energy - bitumen from Cold Lake, for example.

The greater the capital intensity, though, the lower the geopolitical risk must be. Keep that in mind when you consider development prospects for Venezuela’s Orinoco heavy oil belt, which is so huge it rivals the resources of Canada. The geopolitical risks in that country are enormous, so the likelihood is small that new Venezuelan supplies will soon hit world markets.

Strongman Hugo Chavez is increasingly unpopular in his own country, however, and the economy is in disarray. Oil production is in decline even though the the country has the largest conventional reserves in this hemisphere. Given that situation, it is possible to imagine a post-Chavez Venezuela which will develop those resources and become a resurgent supplier to the world. If that happened, it would lead to another super spike in booked reserves.

I share the view that a global Hubbert’s peak is nigh. The world is facing serious energy supply problems, and they are related to peak oil. To too great a degree, however, the discussion has failed to recognize the immensity and importance of the world’s unconventional sources of oil. Those vital resources will radically change the shape of the chart as they are plotted into it.

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.

A Shell Game of Coal Dust and Green Olympics

I present to you a vision of the future: China has already leapfrogged to where we in the West will be within a decade, using coal to power our economies and cities as conventional worldwide oil production continues to decline. The pollution could be the sight and smell of economic growth in such an environment.

By Dave DuByne

There are only 270 days left until the opening ceremony at the Beijing Olympics. Between now and the time the torch is lit and the Green games start, 38 new pulverized-coal fired power plants will open.

Statement after statement about how this Olympiad will be environmentally friendly and the amazing lengths China is going to with regard to alternative energy power generation in Beijing is plastered around the news media daily. That is the truth – well, half of it. Media releases seem to conveniently leave out the other half of the information: While there is tremendous focus on this single city in Green development, the remainder of the country is left behind in a haze of contaminants and smokestack particulates settling on nearly every square centimeter of land except a few isolated pockets in remote mountainous areas.

On one hand, China claims to the world it is going green to help us all against climate change and pollution control. But read the newspaper s – for example, “Nation not a Threat to World Energy” in the China Daily. That article boldly claims that coal accounts for 70 per cent of the country’s energy needs and with proven reserves of one trillion tons, these reserves can satisfy Chinese demand for the next 100 years. It also paints a different picture.

We need to look deeper into the mind frame of Chinese society to understand why this is happening and why coal use is set to intensify as our planet experiences a further drop in conventional crude oil production.

Making Face: Chinese society is complex in ways Westerners overlook or do not understand. “Mianzi” or “face”, for example, is the biggest stumbling block to our understanding consumption patterns of commodities and electricity usage in modern China. “Mianzi” is best explained as reputation, social standing or how others see you in their eyes. The Chinese are pre-occupied with “mianzi” to the point that decisions made in life are all about appearance. This includes government and business decisions. In order to continue with a roaring economy that pollutes along the way,

China has to “make face” with Western governments showing that they are committed to help solve their own pollution problem from within. This is their front face, what lies behind is the true face. There are always two faces to everything in China.

Construction of hundreds more pulverized-coal-fired power plants assure coal will likely remain the fuel of choice for many decades in China. Despite economic, social, and environmental problems coal creates, it is the fuel that will allow the Chinese energy sector to continue expanding along with coal affiliated mega-corporations involved in power generation, u