Chris Nelder - Angel Publishing

Shadowboxing the Apocalypse

(An homage to John Perry Barlow)

If it weren't such a desperately serious situation, watching our fearless leaders trying to grapple with the energy and financial crises would be hilarious.

Anyone with more than $100,000 in their bank accounts must be having some sleepless nights right about now, as the failure of overextended financial institutions continues its brutal cascade. The federal seizure of IndyMac, and the potential federal intervention into Fannie and Freddie, have somewhat dampened the fallout, but Congress' response on Monday to Sec. Paulson's plan was tepid. As I have discussed in previous articles, by the numbers there is still a long way to fall before we hit bottom.

Merrill Lynch warned yesterday that the flagging faith in US financial institutions may hasten that long-dreaded day when Asia, Russia and the Middle East start dumping dollars and refuse to continue buying $700 billion of our debt every year to keep our listing ship afloat.

According to Brian Bethune, the chief financial economist at Global Insight, the situation is even worse: If the US Treasury does not push through a rescue of Fannie and Freddie within a mere two or three days, he said, it risks a financial crisis that spirals out of control. "We can't dither," he warned. "The markets can be brutal. We have to break the chain of contagion before confidence is destroyed."

Free-market champions like Larry Kudlow have argued that a $1.4 trillion Fannie and Freddie bailout would only increase the "moral hazard" risk, by allowing an unsound mortgage business to go even deeper into a hole of lending to try to rescue itself. Far too few of their holdings could be called a piece of moral land, they say, and I am inclined to agree on that. On the other hand, I don't think the economy can tolerate the risk of letting them fail.

In response to the crisis, Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson have been vigorously waving their magic wands before a weary band of bankers, but the Street seems unconvinced. The Dow Jones U.S. Financials Index has fallen 15% over the last week alone. (Of course, if you have been buying SKF, as I have recommended several times this year, you're up 30% over the same week, and using that to hedge your losses elsewhere in your portfolio.)

Meanwhile, President Bush continues to complain that he doesn't have a magic wand to make gas prices go down. I don't know who advised him to keep hammering on that talking point, but every time he says it, it just sounds dumber. We don't need magic wands, or for that matter bloody and costly attempts to secure by military means our access to foreign oil. What we urgently need is a sensible energy policy for the long run, and by that I mean a 100 year plan.

Unfortunately, I see very little of the kind offered from our energy cretins on the Hill. For your amusement and horror, I offer this little selection of their vast, bipartisan failure to come to grips with reality.

A Parade of Bad Ideas

I begin with Newt Gingrich's soft-money PAC, American Solutions for Winning the Future, which is largely funded by Las Vegas billionaire Sheldon Adelson, a major Republican donor and fundraiser. Their flashy new web site panders to the patriotic breast shamelessly, while promoting a "Drill Here, Drill Now, Pay Less" message. Apparently, they have gathered over a million signatures in short order on their petition to Congress, asking them to "act immediately to lower gasoline prices" by "authorizing the exploration of proven energy reserves" off our coasts.

Nice try, Newt. I assume that none of my readers were among your signatories. They know that any new drilling off our coasts could not produce any significant new stream of oil for at least 10 years, and would only slightly affect prices at the pump. Even the EIA has acknowledged that "any impact on average wellhead prices" would be "insignificant" after 2030.

For his part, President Bush lifted the moratorium his father placed on offshore drilling, saying that "as the Democratically controlled Congress sat idle, gas prices have continued to increase. The failure to act is unacceptable." Apparently he has forgotten that the Republican controlled Congresses that preceded this one, on his watch, also watched gas prices increase without actually doing anything about it.

Since Congress has its own moratorium in place, Bush knows that the gesture is purely symbolic, just as he knows that new offshore drilling would have no effect on prices until well after his successors are out of office. But it might reassure the gullible that he's trying to do something about oil supply, and score a few political points.

Seeking to score some points of her own on the issue, Senator Barbara Boxer (D-CA) expressed her "outrage" over the presidential reprieve, saying that the oil companies should drill on the leases they've already got. (We'll discuss the energy illiteracy of that claim in a minute.)

Next we have a strange and oft-repeated claim by a handful of Republican senators (and Dick Cheney) that we must start drilling in offshore Florida because the Chinese are already drilling off the coast of Cuba, and taking "American oil." In fact, there are no Chinese firms drilling off Cuba's coast, but according to the Washington Post, the claim is "just too juicy not to repeat."

The hype about oil shale must also grace our list. Bush and other boosters are trying to whip up public support for a new run at turning low-grade shale into liquid fuel (the fifth such attempt in our nation's history), touting the deposits as being three times the size of Saudi Arabia's reserves. As my readers know, such assertions are extreme exaggerations. The oil shale resource, while large, has never proved to be commercially viable and is unlikely to ever deliver more than a trickle of very expensive, synthetic fuel, which will have very little impact on American supply or prices while incurring as-yet-unknown environmental damage. Unfortunately, the appalling ignorance about energy that burdens most of America makes such wild claims useful political fodder.

On the other side of the aisle, House Speaker Nancy Pelosi struck her own pandering pose, claiming that the current economic "emergency" justified releasing oil from the SPR. Clearly, Pelosi is no more up to speed about the realities of the oil business than anyone else on the Hill. As I have explained before, the SPR is already far too small an emergency reserve, and should only be tapped in the event of severely disruptive actual shortages. It's bad enough that the Democrats were able to stop the filling of the SPR some months ago. Anyone who isn't in total denial about peak oil knows that trying to use the SPR to moderate prices is a terrible idea.

The Democrats, of course, have a growing list of terrible ideas on how to address the energy crisis. I'm sure it scores political points with angry voters to say they'll crack down on oil price "gouging" and excess speculation, but as I have written repeatedly, I don't believe either of those things are a significant factor in today's prices, if they're happening at all.

But the crowning idiocy of Democratic suggestions must remain the legislation that makes it possible for Congress to sue OPEC for price gouging, an idea so stupid that whoever conceived it should win a Darwin Award. In a way, I hope they actually try that some day. Maybe the blowback will slap some sense into them.

And so the shadowboxing continues, with both sides of the aisle feinting and jabbing against straw men, and getting us exactly nowhere in terms of real solutions. Each side blames the other for being in this predicament, while none dare whisper the one word that ought to be the first on the list: conservation. Our addiction to oil is too great to even talk about.

A silent war rages within the very breast of America. Will we continue to insist, with the mentality of a two-year old, that all the oil we want should be ours, that we have some birthright to endless growth and cheap energy? Or will we grow up, and realize that we're neither immortal nor wise, and that the world has real limits we have to live within?

Enough, Already!

While politicians do their level best to ensure that America is as confused as possible about energy, spreading their spins and racking up pander points, there are at least a few experts in the energy industry who are telling the story straight.

John Hoffmeister, former CEO and president of Shell Oil's US operations, told CNBC yesterday why he supported lifting the ban on drilling the outer continental shelf (OCS). Recognizing that OCS production is "not gonna make any material difference" in the short term, he noted that America has resisted developing those areas for 30 years, and that we're now "paying the price" for that.

He went on to explain that all of our options—including drilling for more oil and gas domestically, swapping out 200 million liquid-fuel burning cars for ones that run on electricity, and growing the 2% share of renewably generated energy up to a much more significant level—will take decades to achieve. But politicians, with their short term motivations, simply can't grapple with the long time horizons of the energy business.

Our 30-year failure to develop a sensible long-term energy policy, a period that has seen both Republican and Democratic presidents and majorities in Congress and a long history of shortsighted solutions, is ample demonstration of his point.

Regarding the Democratic assertion that the oil industry isn't using its existing leases, Hoffmeister remarked, "The industry is pursuing the leases it has, but to be blunt, the prospective nature of many of those leases is very low. And you don't go drill oil where you know it doesn't exist." That, I believe, is a true statement.

Hoffmeister explained why he chose to leave the oil business and found a nonprofit group called Citizens for Affordable Energy: to start "doing what's right in America." "Doing what's right in America is listening to the citizens that are in great pain," he said, "making the tough political choices to go after more oil and gas, and—and, as T. Boone Pickens would say, all those other forms of energy that are out there, and do it all."

That has been my position all along, because the way I tally the numbers, even if we do it all, and do it well, we're still likely to come up quite a bit short.

Decrying the "politics of partisan paralysis," Hoffmeister said "It's not helping the American consumer or the American economy one iota. We really have to look at this as an American problem. It's not a Republican problem, a Democratic problem...It's an American problem, and I wish the two branches of government would work together." He went on to say, "The great American public has said ‘enough, let's quit the political rhetoric, and get on with solutions.'"

I only hope that's what we're saying.

(To those of you who caught the references: hey now!)

Until next time,

Chris

Peak Oil Confusion - A Game Whose Time Is Up

Pain at the pump is finally putting energy on the front burner in this election season, but media coverage of the issue has been fraught with misinformation.

I hate to say it, but I am beginning to think some of the confusion is intentional. From the news that Cheney's office has interfered with reporting on climate change science (what a shocker!), to the assertions of some pundits that there are 12 trillion barrels of oil yet to recover out there, to assertions by politicians that we can drill our way to energy independence, it's tough for the average person to get a real grip on the issues.

Confusion breeds apathy, and that's not something we can afford anymore. I believe that the impending energy crisis is too urgent to allow misinformation about peak oil to go unanswered.

So I am attempting to set the record straight.

For this week's Energy and Capital column, I am publishing a formal rebuttal to a May editorial on peak oil in Investor's Business Daily, which got the facts about peak oil-as I understand them-badly wrong.

It refers to a companion piece which has just been published, a "Peak Oil Media Guide" that I developed for the Association for the Study of Peak Oil - USA.

I hope my readers will find these two pieces helpful in separating fact from fiction about peak oil.

Until next time,

Chris

To the editors of Investor's Business Daily:

I feel compelled to respond to your editorial of May 28, 2008, entitled "Peak Oil: An Idea Whose Time Is Up." For a respected financial publication such as yours, I found your coverage reprehensible and rife with errors. I have to wonder if it was deliberately designed to confuse the public, or if the authors were merely deeply misinformed.

Our nation urgently needs to get up to speed on the realities of energy before we can have any sort of intelligent conversation about reforming energy policy. Articles such as yours do the public a grave disservice.

First, peak oil is a study, not a "theory." That is why the name of the world's top authority on peak oil is the Association for the Study of Peak Oil (ASPO), not the Association for the Theory of Peak Oil. The peak oil study is simply a scientific analysis and modeling of available data. More data might correct existing models, but there is no theory to prove or disprove. Likewise, politics plays no role in the scientific assessment of the ASPO's respected petroleum geologists.

Second, peak oil is not about "running out of crude," it's about the rate of oil production. You are correct "that one day the crude supply will effectively dry up," but that day, perhaps 100 years in the future, is not what the study of peak oil is about.

I will refer to the "Peak Oil Media Guide" as I address your remaining statements.

To begin with item 1, "It's not the size of the tank which matters, but the size of the tap."

Talking only about the number of barrels of oil that might exist somewhere, without also talking about the rate at which that oil can be produced, and when, is utterly meaningless.

You stated:

U.S. production is trending down again, but it's not because there's no oil. It's due to shortsighted policies that prevent the industry from drilling for the almost 100 billion barrels of crude known to be under Alaska's Arctic National Wildlife Refuge and beneath the oceans just off of America's coasts. It's because politics and political correctness block the development of Big Sky state oil shale fields, where as much as 2 trillion barrels of crude, by some estimates, sit idle.

Here's the reality.

Right now, the world is producing between 86 and 87 million barrels per day (mbpd) of oil, just 2 mbpd more than it did in 2005. The world has reached a bumpy production plateau, and will likely continue on it for another three to six years before beginning the terminal decline of global oil production.

Your numbers on oil are also questionable:

But the impact of those nations on crude prices in recent months is suspect. Global oil consumption grew 2% in the first quarter of this year over the first quarter of 2007, while production increased 2.5% over the same period. On a daily basis, roughly 85 million barrels of oil are consumed across the world, almost exactly matching the amount produced each day.

You don't state your sources, but according to the IEA Oil Market Report of May 13, the most recent publicly available global data I am aware of, the numbers are quite different:

Global oil consumption grew 0.81%, not 2%, from 85.9 mbpd in Q1 2007 to 86.6 mbpd in Q1 2008.
Global oil supply in the grew 1.81%, from 85.6 in Q1 2007 to 87.2 mbpd in Q2 2008. However, April supply fell 0.4 mbpd to 86.8 mbpd, due to declining output from OPEC and the FSU, plus North Sea outages.
Average demand in 2008 is projected to be 1.2% higher than 2007.
According to this data, supply is a scant 0.6 mbpd higher than demand.

If you will refer to "Figure 3 - US Oil Production 1900-2005," which shows the historical peaking of U.S. oil production, perhaps you can explain why you would dismiss the U.S. peak with a comment like "Yes, domestic output has peaked. But it peaked at a level 13% above what Hubbert predicted. And the peak wasn't followed by a falling-off-the-table decline. Output rose after a temporary slide."

Yes it did...and then resumed its downward course on a relentless, 38-year history of decline, as the chart clearly shows. Who are you trying to fool?

As for the fact that U.S. production peaked 13% above Hubbert's prediction, I say, "close enough." Hubbert also found that if the recoverable amount of oil in the U.S. were increased by one-third, it would only delay the Lower 48 production peak by five years. A similar calculation for world production would produce similar results. Again, when it comes to the question of peaking, flow rates are far more important than reserves.

The decline of U.S. oil production was not the result of politics, nor can any political decisions now significantly alter its future course. It is simply the nature of petroleum extraction that it ramps up to a peak and then declines, in a rough bell-curve shape. This observation has been made in thousands of oil fields (and oil producing nations) worldwide, which is why Hubbert's model continues to be respected.

If you will refer to item 2, "We are now at, or ‘close enough' to the peak," you will note that global oil production has plateaued. It may continue to rise at a negligible rate for the next couple of years, but no major increases are possible.

You seem to be among those who are laboring under the mistaken belief that the U.S. can somehow drill its way out of dependency on foreign oil, and that increased domestic production could the relieve today's "high" prices.

Nothing could be further from the truth.

In fact, the U.S. uses about 20 mbpd of petroleum, and produces about 7 of that. The other two-thirds is imported because there is no possible way that we could produce another 13 mbpd domestically, even if we drilled every single place that might have oil.

Regarding the potential of oil shale, please refer to item 4, "Oil shale: the fuel of the future...and it always will be." After four decades of fully authorized, commercial, even subsidized attempts to develop oil shale into a usable fuel, no one has ever been able to make it economically feasible. Part of the reason for that is that it's not even really oil-it's kerogen, an immature precursor to oil, and it takes an enormous amount of energy to turn it into something usable.

It remains to be seen if the energy returned on the energy invested (EROEI) for oil shale is high enough to even make its production worthwhile. Even if it does prove to be viable, it is unlikely to ever produce more than a modest flow (though perhaps a very long-lived one) of extremely expensive, synthetic oil. It is not some quickly available "two trillion barrels" of "crude," as you asserted, and it will require an enormous amount of energy, probably from coal, to produce.

As for the oil reserves of ANWR and the continental shelf, please refer to item 5, "ANWR and the continental shelf are no panacea." The flow rates from these resources cannot be known until they are produced, but we can make ballpark estimates.

Preliminary estimates by the USGS indicate that ANWR would likely only produce around 750,000 barrels per day at peak. More importantly, it would take 10-20 years to achieve that peak production level.

If all limits on domestic drilling were removed, including ANWR, it could only increase US oil production by a maximum of 2-3 mbpd. It would come online slowly, and given the loss in global oil production by the time it arrives, the additional production from these remaining domestic reserves will be underwhelming. Together, they could amount to perhaps 12-15% of our daily usage today, or about 3% of world production.

However, if we are currently on the peak/plateau of global oil production, and production starts to fall within the next five years, then 10 years from now, at a reasonable average 2.0% rate of net depletion, world oil production will be down 11 mbpd-about 12%-from where it stands today. Therefore any additional domestic production could only offset perhaps one-quarter of the global production that will be lost!

It should be obvious, after a close look at the data, that at the rate that the U.S. currently uses oil, the chance of producing all of our own needs domestically is zero.

The potential impact of increased domestic drilling on oil prices is also minimal. Since oil is traded globally, and the U.S. imports about two-thirds of the oil it consumes, the price of the oil we produce will always maintain parity with global prices. With the global supply and demand balance as tight as it is for oil, natural gas, and coal, increased production in the U.S. would make a negligible difference in U.S. gasoline prices.

The U.S. Department of Energy estimates that drilling in ANWR would only reduce the price of gasoline by less than four pennies per gallon-20 years from now!

The slight declines in petroleum consumption over the past year in the U.S. and Europe have been more than offset by the increasing consumption of countries in Asia, South America, Russia, and the Middle East. Net global consumption is expected to increase another 1 mbpd this year.

Indeed, we should recognize, as the Saudis have, that the oil we still have will only become more valuable as time goes on, and it makes sense to save some for future generations. Oil is incredibly useful and energy dense, and we use it altogether too profligately today. Burning every last bit of what remains as quickly as we can makes no sense at all. I further submit that it is irresponsible and immoral to attempt it.

One of the most glaring errors in your analysis was in misunderstanding depletion. I refer your attention to item 7, "Depletion is relentless."

The concept is simple: Oil production first must make up for the depletion of mature fields before any net additional oil can be counted. It's like pouring water into a bucket with a hole in it. The background global decline rate is generally accepted to be 4.5 - 5%.

Anyone familiar with a balance sheet should understand this concept, but you missed it when you said:

Production over the next two quarters is projected to continue rising (3.3% and 4.1%, according to estimates from Citigroup), while demand is expected to grow at a slower 1.6% pace over the next six months.

A net global production increase of 3-4% has not occurred in several decades, nor is it conceivably possible in the future, let alone the next six months, given what we know about the projects that are under way.

Clearly, you confused "production" with net production. The world's net production over the next six months would be lucky to manage a 0.6% increase, after accounting for the background decline rate.

You point out: "World output is expected to rise from 85 million barrels a day today to 110 million barrels by 2015, according to the International Energy Agency," but your information is out of date.

Surely you are aware of the Wall Street Journal's article, "Energy Watchdog Warns of Oil-Production Crunch," published on May 23, 2008, about a week before yours? It previewed the IEA's upcoming report in November, which will announce the results of their first detailed study of the depletion rates of the world's top 400 oil fields. That study has prompted them to reduce their estimate to 100 mbpd by 2015.

I should also point out that the IEA has lagged well behind other knowledgeable analysts who have consistently demonstrated why the IEA's past projections could not be obtained, and who are now of the opinion that global oil production is unlikely to ever exceed 90 mbpd.

I must emphasize that no political considerations, or faith-based economics, are needed to understand the available data and the models. The mathematics are quite clear.

Finally, I must address your quote from Peter Jackson of CERA, who said, "The 'peak oil' argument is based on faulty analysis which could, if accepted, distort critical policy and investment decisions and cloud the debate over the energy future."

I respond that CERA's projections of future oil production have been far off the mark for about the last five years straight. If anyone's analysis is faulty, it is theirs. The ASPO's has come much closer to reality. ASPO-USA has directly challenged CERA to back their projections with real money; so far, they have declined to respond.

CERA is correct, however, that faulty analysis could "distort critical policy and investment decisions and cloud the debate over the energy future." I beg you to consult more reliable authorities than CERA for that very reason. They have a lovely story to tell; unfortunately, it's wrong.

I hope you will explore the information I have provided here, and avoid making such fundamental errors in your future coverage of the oil markets, and of the study of peak oil.

Sincerely,

Chris Nelder
Energy Journalist

A New Paradigm

It was a wicked, wretched June for the Dow, which posted its worst performance for the month since the Great Depression.

Oil prices setting record high after record high, while the dollar sinks ever lower, have put the hurts on the whole economy—except for commodities and energy, which are the only two asset classes I have promoted in these pages.

It's not that I'm a genius investor or anything—I assure you, I'm not. All I do is read the writing on the wall, and tell you what I think. It's a surprisingly rare thing to do among Wall Street pundits, who seem to prefer the safety of historical patterns and chart analysis to actually looking around them.

So you have to look past the talk about how all those beaten down stocks in tech, retail, and luxury items are good buys.

They sure are: Good bye house, good bye car...

What we have here is a new paradigm. It's time to throw out the old investing playbook and make a new one.

Rather than being safe ways to play the market, index funds, diversified portfolios, momentum trading strategies, and technical chart analysis are now more likely to lose you money than increase it.

Want some proof? Here are the top-performing diversified U.S. stock-fund categories, according to MarketWatch:

Category	Q2 Avg. Return	YTD Avg. Return
Midcap Growth	5.2%	- 8.3%
Small-Cap Growth	4.2	- 11.3
Midcap Core	4.1	- 6.0
Multicap Growth	2.0	- 10.5
Large-Cap Growth	1.8	- 10.0
U.S. Diversified	0.6	- 9.7

Yes, that's right, the top performing stock funds are down 6-11% on the year. As for the major averages, they're down 12-14% this year.

A typical Wall Street pundit, trying to paint a happy face on an abysmal market, might write up the headline as "Funds beat the indexes in 2008!"

But that's not the kind of gruel we serve around here.

A Perfect Storm

Regular readers of my column know the real score: We've got a perfect storm on our hands.

As more and more of one's income is eaten up by the basic needs of food and energy, it leads to further dependency on credit, which increases the likelihood of credit and mortgage default, which further hurts the financial sector, taking down the broader markets and putting the economy in an increasingly worse position.

Oil prices are causing inflation across the board, from food to everyday goods, and by "inflation" I mean prices for everything going up, not some geeky Austrian-school definition of it.

Part of the reason oil keeps going up (apart from simple supply and demand) is that the Fed has devalued the dollar in order to stave off a financial crisis resulting from the subprime meltdown. But if the Fed tries to prop up the dollar now, and raise rates, it could bring an already-down economy to a standstill. So by averting a crisis of confidence in the banks, they brought on a crisis of stagflation for the entire economy. As the old saying goes, if the only tool you have is a hammer, the whole world looks like a nail.

The fact is, the Fed is whistling past the graveyard. Or sticking their finger in a leaky dike. Or whatever metaphor you like.

While most investors are shaking their heads in confusion and dismay over a recession that just won't go away, it all makes perfect sense to those who really understand the implications of peak oil.

I hold a very simple thesis: Without an ever-growing supply of cheap and plentiful energy, the old investing strategies simply don't work anymore, because the markets don't behave as they should.

In fact, record high oil prices have clearly failed to bring adequate new supply to market. Consequently, oil and commodity prices stubbornly refuse to revert back to the mean, as a technical analysis says they should.

A Very Nasty Period

The trends should be clear enough to anybody who reads the news.

Transportation is on the ropes. The Big Three automakers are posting huge losses after being asleep at the wheel for years, continuing to pin their futures on big trucks and SUVs even as global oil production flattened out and the peak oil story started to unfold. Now new and used car dealerships are saddled with row upon row of gas guzzlers nobody wants, and American-made vehicles with European fuel economy are nowhere to be found. It's no surprise to me that Chrysler just shut down an assembly plant, and I expect more bad news yet from the American automakers.

The airline sector is going down in flames, with fuel prices destroying the bottom line. (See my article of last month, "Peak Oil and the Rail Revolution - Say Goodbye to Cheap Air Travel.")

Truckers are trying to strike their way out of losses due to skyrocketing fuel costs, but if they can't pass on the higher cost of their fuel to the buyers of the goods they haul, which is hard to do in a declining economy, then they're going to simply run out of road.

The financial sector is down 20% on the year, and it ain't over yet, not even hardly. Hedge fund manager John Paulson believes that we're only $360 billion of the way through a $1.3 trillion writedown from the credit crisis.

Oh, yes. The subprime mess was just the beginning. Now we're getting into the option ARM resets, where borrowers have a choice about how much to pay off each month. Merrill Lynch estimates that the losses from option ARMs could add another $100 billion to the $400 billion in mortgage and subprime related losses. And after that, we'll likely see another wave of personal credit defaults, leading to yet another fat writedown for the banks.

On June 18, the credit strategist for the Royal Bank of Scotland said, "A very nasty period is soon to be upon us - be prepared," and warned that the S&P 500 could tank to 1050 by September—a 28% drop since the beginning of the year. That means that all of the gains made by the index's component companies since the end of 2003 would be wiped out.

Retail, luxury goods, tech, travel, entertainment...all in the dumper. Want a good way to hedge against recession? Pick the weak companies in any of those sectors, and short them.

Yesterday, the Dollar Thrifty car rental company blamed its poor 2008 performance on "tough operating conditions" as if this were some unexpected, nasty bump in the road, but I call it an entirely predictable result of peak oil.

Likewise, it should have been no surprise to anyone who's paying attention when Starbucks announced that it will close 600 stores, cut 12,000 jobs, and halve its expansion plans. When people can't afford to fill their tanks just to get to work, a $4 cup of frothed coffee-flavored milk just doesn't rank on the priority list.

But energy and commodities? Ahh...now there's a different story.

Energy Stocks: The Only Way to Make Any Money

In a CNBC interview on May 29, Matthew Simmons, one of the world's top energy investment bankers and a proponent of the peak oil study, explained his investing strategy. "I have a very significant portfolio that I've built up over the last 25-30 years in energy stocks," he said, "because I think it's the only way that anyone's going to make any money."

I couldn't agree more.

The investing game has changed, and those who realize it now have an opportunity to jump on the greatest investment event of the century. The growth potential for renewable energy in particular, and the associated technologies of the future, seems nearly limitless. After decades of investment and research into renewable energy, it currently accounts for only about 1% of the global energy mix, but by the end of the century, it will have to be closer to 100%.

We should expect prices for our most basic of needs, food and energy, to continue to rise until the supply and demand equations are back into balance. And it looks to me like that will be achieved mainly by demand destruction, which could take years to play out. This bear is going nowhere.

Meanwhile, energy and commodities, including agricultural commodity ETFs, are doing very well this year even as the rest of the market goes south. (For my previous recommendations in these sectors, see the Related Articles section at the bottom.) Along with traditional safe havens like gold and silver, bonds, T-bills and the like, they're really the only place to be right now.

But if you want to do really well, then you need to have a stake in some of the choice energy picks we have selected for the $20 Trillion Report.

Until next time,

Chris

Energy and Capital

The Big Picture on Q2 2008, Part 2

In part 1 of this series, we reviewed the trends in financials, fossil fuels and electricity. This week, we take a look at renewables, food and fertilizer.

Renewable Energy

The picture for renewable energy just keeps getting better, as more of the world begins to realize that we are having a real problem maintaining our traditional energy supplies. I have no doubt now that a big revolution in energy has begun. Mark my words: This is the time to go long on renewable energy, for the long term.

Consider this chart of a few of my favorite renewable stocks against the S&P 500:

After being beaten down harshly in the first quarter, along with just about everything else, renewable energy shares bounced up like spring flowers, handily beating the indexes by 20% or better.

Meanwhile, the chatter about controlling carbon emissions has only gotten louder, particularly as bad weather hits everywhere (which we'll get to in a moment). I expect this trend to continue, and would not be at all surprised to see some sort of binding legislation passed within the next year.

As I have detailed in my book, I favor a carbon tax over cap-and-trade schemes, for a variety of reasons, but I would be happy to see any sort of binding controls established. When that happens, you will definitely want to be holding some solid, reputable renewable energy companies in your portfolio, because it's going to put new fire under the whole sector, even as it puts the hurts on oil and coal.

Agriculture

Food production has come about even with energy as the world's top concern since my review of the first quarter. Riots, hoarding, and intermittent shortages became more common, and everyone from the UN to the Saudis put it on the front burner.

My observation was borne out in an unexpectedly harsh way:

Not only are food and energy closely interrelated, but weather is right in the mix too. The increasing use of fossil fuels contributes to global warming, which reduces food production, as was the case with the Australian wheat harvest. At the same time, weather impacts our ability to produce energy...and back around the wheel we go.

Flooding in the Midwest this spring has ruined an estimate 5 million acres of land, and harvests have been delayed because the fields were too wet to work. While parts of the West like California had the driest spring on record, parts of southern Indiana, Illinois and Missouri have endured the wettest spring on record. (Inversely, China's agriculture ministry instructed wheat and rice farmers in southern China a few weeks ago to harvest as much of their crop as possible before another wave of rains arrived.)

With fields too wet to sow corn, many farmers opted to plant soy this year instead of corn. The corn harvest this year is expected to be 10% lower than last year, and soybean plantings are running about 16% behind last year.

Consequently, corn shot from $5.82 at the end of Q1 to a record $7.92 last week. The spike in corn prices was due to the torrential rains that soaked the Midwest starting in late May, and in a mere two and a half weeks, corn prices went up 28%.

Ethanol production is expected to increase 25% over last year, and consume about 4 billion bushels of corn out of the 86 billion that will be sown this year. In the face of record corn prices, the cattle and poultry industries have been lobbying the EPA to cut the nation's ethanol production mandate in half.

They're not the only ones. Policymakers are realizing that corn is a very inefficient way of trying to produce biofuel, and might not be worth it. (That has been my position on corn ethanol since the beginning.) The corn ethanol plays have suffered the fallout:

The one bit of good news for grains is the worldwide wheat harvest, which is expected to be about 8% higher this year than last. The expectation brought the price of wheat down from a record $13.50 per bushel on Feb. 27 to $8.70 today, about where it started the year. Still, wheat remains about 50% higher than it was a year ago, and the harvest below average levels.

The big picture for agriculture is clear enough: demand is higher than ever, and supply is faltering. (Reminds you of anything?)

The flooding of the Mississippi had another unexpected consequence: The levee breaks shut down transport on the river, stranding 100 barges. Mississippi barges are the primary mode of transport to get grain from the Midwest to export terminals in the Gulf of Mexico. Grain giant Cargill alone had 200,000 bushels of corn sitting on the dock, unable to get a barge.

If you took my recommendations on fertilizer at the beginning of Q2, you are smiling now:

FEED has clearly sold off a speculative bubble, so I wouldn't touch that one now (and I hope you got out with some nice gains, as I did). But Mosaic and Potash Corp. are still good bets to hold, because I don't see any reason to think the food supply situation is going to radically improve any time soon. In fact, this looks like a nice little buying opportunity.

As one would expect for a diversified play, the more general agriculture ETFs I suggested have performed more modestly than the fertilizer plays, but who would complain about a 10-30% gain in a quarter, especially when the S&P actually fell a few percent?

I remain bullish on the ag ETFs, at least until we get a significant change in the supply and demand balance.

Metals

The metals group I suggested hasn't done quite as well, but if you picked the better stocks over the ETFs, you made out alright:

My read of the metals group is that it's probably ripe for a recovery, as the last couple of weeks are showing. Considering that the building boom is still going strong in Asia and the Middle East, and that shortages of basic building materials like iron are still happening regularly, I think this is a good time to jump into metals if you're not in already.

On the whole, as bad as the news has been in energy, agriculture, finance, and the economy in general for the past quarter, I have to say I saw it all coming. I banked on it, and I'm still banking on it.

With an economy on the ropes, the financial sector going down in flames, food prices skyrocketing, oil prices causing widespread inflation and the Fed helpless to do anything about it, a lot of investors will end this year with a lot less money than they started it.

But not us. In fact, we expect to turn some nice gains, by reading the signs rightly and playing them smartly.

Gains like the ones you'll make from our energy picks, when you sign up for the $20 Trillion Report.

Until next time,

Chris

Energy and Capital

The Big Picture on Q2 2008, Part 1

The second quarter of the year is almost over, so it seems like a good time to zoom out and look at the big picture again (especially after my last few articles, which were pretty technical).

The trends I indentified in my big picture update for the first quarter (Part 1, Part 2, Part 3) have only intensified. The events in Q2 continued to be negative for the economy, but excellent investment opportunities for those who took advantage of a few of my tips.

Let's run the bases again...

Financials

The big story in Q1 was the implosion of Bear Stearns, and the beginning of the continuous mudslide of bad news for the financial sector this year. In the second quarter, the poster child for the credit market's woes has been Lehman Brothers, down 62% for the year. And it looks like Morgan Stanley might be next on the block.

In both of these financial bear runs, I picked up a quick 10% here and a quick 10% there by playing the UltraShort Financials ProShares ETF (AMEX: SKF). It's important to get the timing right with a play like this, but it's not that hard if you pay attention. I watch the news carefully, looking for the early whispers of distress from the financial sector. I buy it when the market is up (which is when SKF is cheap), then after the bad news is plastered all over the front pages, I look for a particularly bearish day to get out.

For those inclined to play a little speculative money now and again, I think it's a good hedge against the sickening jolts that have hit the markets with increasing frequency this year.

The fundamentals of a recession are firmly in place now. The whisper on the street is that the really bad news is yet to come, as broad swaths of the consumer credit markets buckle and break under the strains of steadily higher food and energy costs—the two things that the oft-quoted Consumer Price Index (CPI) explicitly leaves out—and a collapsing housing market.

If the whisper is right, and I think it is, then the markets are in for another downturn. So watch the news on the financials, and keep your powder dry for their next "good" day.

Oil

The volatility in the oil markets has increased quite dramatically in the second quarter, where a $5 to $11 swing in the price over a single day is now becoming more the norm than a rarity.

As I discussed in my piece two weeks ago ("It Takes Two To Contango"), we should expect to see such volatility increase, as the reality of the supply and demand balance really sinks in, and the market seeks to find the new, proper value for oil.

A chorus of analysts have popped up in recent days to claim that oil prices are in a speculative bubble, and their fervor only increased when oil hit a new record just shy of a $140 on Monday.

My favorite piece was an article in Fortune last week titled "Why oil prices will tank," which speculated, "It's even possible that, a few years hence, we could see a sustained period of plentiful oil supplies and low prices, meaning $50 or below." All I could do was shake my head in wonder as the author carried on about how a "new abundance" would come from shale, tar sands, coal, and "an OPEC desperate to regain market share."

If that last bit didn't make you laugh out loud, read it again.

Investor's Business Daily, another venerable financial publication, went just as badly awry in its article three weeks ago, "Peak Oil: An Idea Whose Time Is Up." I was aghast at the parade of wrong information and blatant ignorance in that one. I intend to debunk it formally, but it's going to take a whole ‘nother article to do that job.

So if you thought everybody was already on the same side of the trade in this seemingly endless bull run for oil, think again. Some of the most-read financial journalists in the country still don't understand what "peak oil" means, don't comprehend the numbers, don't understand the crucial differences between oil shale, tar sands and crude, and apparently, some even think oil is overvalued by nearly 3x!

For smart investors like you who do understand these things, though, all the confusion out there simply makes for a good trading environment. When the noise is all wrong, you buy, and when everybody comes around to the way you see it, you sell.

If you took my suggestion in my article two weeks ago, subtitled "Pullback in Oil is a Buying Opportunity," and bought the United States Oil Fund LP (AMEX:USO) that day, at the bottom if oil's most recent dip, you'd be up about 10% on that position now. Not bad for a two-week gain!

Oil prices continue to have an inflationary effect on everything, from food to gasoline to everyday products (thanks to transportation costs). We'll get into the food aspects in the next part of this series.

The next major cue on oil will come from a Saudi-hosted summit meeting of oil producers and consumers this coming Sunday. The kingdom is worried that instability in the markets and high prices will undermine the oil market and encourage alternative energy. King Abdullah has reportedly instructed his ministers to pursue any solution to skyrocketing oil prices.

It is expected that the Saudis will announce a 200,000 barrel per day increase in production starting in July. My bet is that even if they do announce it, it won't affect prices much, or for very long.

They may also decide to raise their discount on crude. That might actually assuage the markets for a while, because it would help restore the profitability of refiners, and should eventually bring down the price of gasoline and diesel.

But in a few weeks or months, even such measures would lose their impact as the markets realize that the world really has no ability to increase production from here. Saudi Arabia has announced that they only intend to add about 1 million barrels per day (mbpd) of production capacity through the end of 2009. That increase still seems highly unlikely to me, but just taking them at their word, they are currently producing about 9.45 mbpd out of a claimed capacity of 11.4 mbpd, with expectations to raise it to 12.5 mbpd, and after that, nada mas.

So while the world waits for the next Saudi announcement, just remember: it's just more short-term noise along the long-term signal of ever-higher oil prices.

The Dollar

The influence of the dollar on commodity prices, particularly oil, continues to be underestimated. I'll dispense with the charts this time, but my observation in the Q1 update, that oil prices moved opposite to the dollar, continues to hold. According to calculations by Bloomberg, the dollar as valued against the euro has moved in the opposite direction from oil 93% of the time this year.

That's a very strong correlation, and should not be overlooked when we hear the latest from Mr. Bernanke. He seems to have successfully jawboned the dollar into a stabler pattern since it crashed to the late-April low, but the recent rally now appears to be losing steam as the expectations of a rate hike in August start to look overblown.

Without a strong rebound in the dollar, which seems extremely unlikely given the Fed's current position somewhere between the rock of inflation and the hard place of recession, oil will have to remain at or above its current heights. So don't go running for the exits the next time you hear some "expert" saying that oil prices are going to crash—instead, buy on any weakness.

Gasoline and Diesel

Gasoline and diesel both shattered all previous records (even the inflation-adjusted ones) in Q2. The national average price of gasoline is now over $4 for the first time, and diesel is trading at the highest premium to gasoline in 15 years, 16% more than gasoline at $4.69.

Diesel is the world's most popular transportation fuel, and refiners simply haven't been able to make enough of it. Not only is it by far the preferred fuel in Europe, most of the rest of the world is currently experiencing shortages of it due to enormous demand and limited supply. China, for example, imported 34 times as much diesel in May as it did last year, partly in preparation for the Olympic Games. Across the Third World, diesel is increasingly being used to run generators as their grid power fails, due to shortages of natural gas and reduced hydropower.

By comparison, 43% of the world's gasoline is consumed in the U.S., where demand is falling as prices rise. Although the sticker shock of gas over $4 has been hard on Americans accustomed to cheap gasoline, we're still paying very low fuel prices compared to Europe and elsewhere in the industrialized world, where gasoline in the $8-12 range is the norm. As I have said before, we should really be grateful to the rest of the world for keeping our gas prices so low by not competing with us for it!

Here in California, a 20-gallon fillup now costs me about $90, and I have no doubt that my first $100 fillup is just around the corner. Believe me, I'm not looking forward to it, but also believe that investing wisely in oil is your best defense against those ever-increasing prices.

While some destruction of diesel demand will take place eventually as vehicles are switched over to run on natural gas, electricity, and other alternative fuels, those transitions will take years to complete. I expect the current imbalances between gasoline and diesel to remain firmly in place for quite some time.

Natural Gas

The trend in natural gas is unchanged from Q1: prices have beat a straight line upward all year, rising from $8.30 on January 10 to $12.95 today. This trend also shows no sign of slacking, for there is very little net excess capacity for gas production.

Consequently, 2008 has been a sweet year for natural gas producers, with some of my favorites delivering better than 60% returns so far:

Coal

Coal has was full of surprises in the second quarter. My Q1 observation that coal didn't have the signs you would expect from a growth industry was based in reality, but no sooner had I published that article than a massive spike in coal prices began.

In Q2, prices for domestic coal went through the roof:

Average Weekly Coal Commodity Spot Prices
Business Week Ended June 13, 2008

Source: EIA, Coal News and Markets

The explosion in prices was reflected in some of the industry's better coal stocks:

Despite this performance, the EIA expects domestic coal consumption to be lackluster, posting less than 1% growth this year after only 2% growth last year, and a lousy 0.6% growth next year.

On the production side, EIA expects a 2.9% growth in production this year, and increasing inventories with coal consumers.

So if it wasn't domestic consumption, what drove prices up?

You guessed it: exports.

Exports of coal posted a sharp jump at the end of last year, and they are continuing to drive demand:

Source: EIA, Quarterly Coal Report, Oct - Dec 2007

The primary region consuming all that exported coal is Europe, where a very limited and uncertain supply of natural gas has been driving up grid prices. The outlook for electricity in Europe is increasingly dim, and they're trying to make up the difference with coal. Flagging Australian coal exports to Europe, along with competition for supply with the emerging nations of the FSU, have really stretched the supply-demand equation.

Exports of coal from the U.S. to Europe jumped 19% from the third to the fourth quarters of last year, and were 52% higher at the end of 2007 than a year earlier.

Again, I do not see anything resolving the tension in this very tight market any time soon. It looks to me like another major bull run has begun for coal. The three stocks in the above chart should continue to do very nicely.

Electricity

The price spikes for natural gas and coal have translated directly to increasing prices for grid power. According to the 2008 Short Term Energy Outlook, June 2008, the Energy Information Administration (EIA) expects average U.S. residential electricity prices to increase by about 3.7% in 2008, and 3.6% in 2009.

The average rate of those historical price increases from 1997-2007 is 2.26%.

In other words, the EIA has just predicted that for the next two years, your bill is going to rise at a rate 63% higher than it has in the past!

For the communities who haven't been aggressively seeking to deploy as much wind and solar and geothermal generation as possible, it spells a long march to ever-higher prices.

But for solar and wind generators, this is great news, because it means that the breakeven point on their projects just got bumped up a couple of years. It's also great news for those who make solar and wind equipment, like the many companies we have recommended in the pages of Green Chip Stocks.

Don't Panic, Profit

As the fallout from rising energy costs, particularly fuel shortages in the Third World, starts to settle around us, it's causing a great deal of pain and unrest and confusion. People are starting to panic.

We understand their fear, but panic isn't helpful. What's important is to be able to understand the trends, play them wisely, and put yourself in the best position you can to weather the even harder days ahead.

That's why we created the $20 Trillion Report—to spot the plays that will bring you profits while everybody else panics.

Next week, I'll update you on the outlook for renewables, food and fertilizer.

Until next time,

Chris

Energy and Capital

The Impending Oil Export Crisis

Just shy of a year ago, I wrote an article for Energy and Capital entitled "Canary in a Data Mine," in which I examined the global scenario for oil production and demand, and concluded:

So the upshot is this: There is clearly a yawning gap, possibly as much as 2%, opening between production and demand in 2007 for those of us who depend on imports.

It looks to me like the loss of export capacity will prove to be the canary in the data mine. It doesn't really matter if the peak is technically a few years off if we can't satisfy our ever-growing thirst.

That canary has now keeled over.

The problem is simple: Net oil exporters are awash in the cash from their oil exports. As they grow up and continue to industrialize, they consume more of their own production, which cuts into their exports.

There is also the factor of subsidies. With such extraordinary income from their oil sales, net oil exporters don't need the income from domestic consumption. They'd rather invest it in building infrastructure and stimulating their economies, so they subsidize the cost of fuel. Fast-growing economies like China would screech to a halt if consumers had to pay the market rate for fuel, so instead the Chinese pay about $2.80/gal for gasoline, and in the countries of the Middle East, gasoline generally goes for under $1.50/gal.

It should be obvious that as time goes on, the export problem becomes a vicious circle. As export supply falls, the price of exported oil goes up, which sends even more money to the producers, who will use it to build more and consume even more energy, which will further cut into their exports. A growing sentiment among net oil exporters to save some oil for future generations will further limit their output.

For a country like the U.S., which imports about two-thirds of its oil, the most immediate problem isn't peak oil, but peak exports. The gradual loss of imported oil has hit us first, and will cost us more than the mere global supply peak would.

So this week, I take a closer look at the vicious circle of declining exports.

The Export Land Model

Dallas-based independent petroleum geologist Jeffrey Brown and Dr. Samuel Foucher (aka "Khebab"), a Ph.D. expert on signal processing, have been working for about two years now on a model to demonstrate the net export problem, which they call the Export Land Model (ELM). Progress on the model and its implications have been regularly discussed on TheOilDrum.com, including the recent update "Is a Net Oil Export Hurricane Hitting the US Gulf Coast?"

The model proposes a hypothetical oil exporting country called "Export Land," and makes the following simple and reasonable assumptions about it:

Peak production rate: 2 mbpd
Rate of decline post-peak: 5%/year
Internal consumption: 1 mbpd
Rate of consumption increase: 2.5%/year

Here's their model in graphical terms:

Source: The Oil Drum

The results of this analysis are startling:

Exports cease in only nine years, far faster than overall oil production.
Exports decline at an accelerating rate, starting at about -13% and ending at about -48%, averaging about -29% per year over the 8 years of decline.
Only about 10% of the oil produced after the peak is ever exported!

Applying the concepts in the model to the world's actual oil production, they focused on the world's top five net oil exporting countries—Saudi Arabia, Russia, Norway, Iran and the UAE—which together account for about half of the world's net oil exports.

The results were ominous:

In their middle case scenario, these top five exporters will approach zero net oil exports around 2031, starting from an average net export decline of about one mbpd per year in 2006. In a recent post, Brown notes, "net exports by the top five net oil exporters dropped by 800,000 bpd in 2006, from a 2005 peak of 23.5 mbpd, and I estimate that they dropped by about one mbpd in 2007."

According to a recent article in the Wall Street Journal, data from the EIA did indeed show about a one million barrel per day decline in exports in 2007.

Exporters to the U.S.

Since "peak exports" is what we really should be worried about in the U.S., let's take a closer look at our imports.

Here are the top 10 sources of U.S. crude oil and petroleum product imports, as of March 2008:

Top 10 Suppliers of U.S. Oil Imports and Their Fuel Costs

Rank	Country	Thousand Barrels	Domestic cost of gasoline (US $/gal, 2006 prices)
1	Canada	78,814	$5.49
2	Saudi Arabia	47,806	$0.45
3	Mexico	42,111	$2.35
4	Nigeria	36,381	*$1.94
5	Venezuela	32,009	$0.19
6	Iraq	23,967	(no data, probably about $0.25)
7	Algeria	13,674	$1.21
8	Russia	12,466	$3.97
9	Angola	12,043	$1.90
10	Virgin Is.	9,002	(no data)

Sources: Oil Import data: EIA. Gasoline prices: German Technical Corporation
(* corrected from previous version)

According to EIA, the total crude oil and petroleum product supplied to the U.S. market in March was about 612 million barrels. Total imports were 389 million barrels, or 64% of our total consumption. (Considered on an annual basis, and looking only at crude oil, our imports are probably closer to three-quarters of the total than two-thirds.)

By way of example, if it were all priced at $130 a barrel, the oil we imported last year would have cost $638 billion, which is probably in the neighborhood of what we'll spend this year for imports. That's over four times as much as we are spending annually on the war in Iraq.

The economic fallout from oil prices has arrived in the form of a widening trade deficit. According to a report from the Commerce Department yesterday, both the price and the volume of imported oil hit new highs in April, which contributed to overall U.S. imports reaching a record $216.4 billion. The trade deficit now stands at $61 billion.

No economy can survive such a drain on its finances. If we don't do something to stop that flow of money to oil exporters, it will kill us. Consider this: The price of oil has approximately doubled over the last year. If it doubles again in the next year, that fiscal wound will be bleeding at the rate of about $1.3 trillion per year, or about 10% of our total GDP!

Charts for Our Top 9 Suppliers

To see how the export decline problem might affect us here in the U.S., we now look at the net exports of our top 9 suppliers in turn. Normally, I wouldn't have attempted this sort of data analysis for a weekly column, but I just discovered that Jonathan Callahan of Mazama Science has released a very handy little online tool called the Energy Export Databrowser that makes it easy. (The tool uses data from the BP 2007 Statistical Review, which has no data for the Virgin Islands, so their production not shown here.)

Here are his charts of oil consumption, production, exports and imports for each country, with the net percentage change from 2005-2006. (Note: for countries with no consumption data, only production is shown.)

Canada: Exports +16.4%

Fortunately for the U.S., oil exports from Canada are actually rising, due to a boom in production from unconventional oil and gas, and tar sands. Canada's production is truly the only significant bright spot in the outlook for oil imports to the U.S., and we have focused on it intently in picking stocks.

Saudi Arabia: Exports -4%

The situation for the world's top oil exporter is quite different, where exports decreased 4% from 2005-2006, and 7% from 2006-2007 (EIA). At Saudi Arabia's level of production, this is an enormously worrisome development.

Mexico: Exports -4.2%

Mexico's export decline is of particular concern, since they are one of only two suppliers who can reach us by pipeline. Their supergiant field Cantarell has gone into collapse, declining at the rate of about 14% a year. By the end of 2009, it is projected to be producing only half of what it was producing at the end of 2004.

Nigeria: Production -4.6%

Nigeria continues to be beset with civil unrest and strikes, which have shut in between 800,000 and 1 million barrels per day of capacity for the last two years, and dampened hopes for a significant increase in its production. In fact, its production actually fell from 2005-2006:

Venezuela: Exports -5.5%

Venezuela's exports have been in decline for a decade, and the rate appears to be accelerating. According to the latest EIA data, Venezuela's net export decline rate now stands at -7.6% a year.

Brown notes that the combined net oil exports from Venezuela & Mexico to the US dropped at the whopping rate of -32% per year over the six months between last October and this March.

Iraq: Production +9%

Production data from Iraq is notoriously unreliable, due to a robust black market and deliberate reporting of incorrect data. We also have no consumption data for Iraq in this database. In my considered opinion, the extremely slow progress that the Iraqi congress has made in establishing revenue sharing and production agreements between the various parties, and the continuing violence and sabotage in that country, makes it an unreliable hope for increasing exports substantially, at least in the foreseeable future.

Algeria: Exports -1.1%

Algeria is one of the few African oil producers where the environment is relatively stable, and where oil production might hope to be increased. It is also utterly dependent on its oil revenues, which make up nearly all of its export income, and that should serve to make it a compliant participant in the global oil markets. However, it is still a small producer, accounting for only about 5% of our oil imports.

Russia: Exports +1.5%*

I put an * after that number because Russia's export situation has changed since 2006, where the dataset used to generate these charts ends. I included this chart for the sake of completeness, and to keep with the same dataset as the other charts.

According to Brown and Foucher, Russia's exports declined 6.7% from December 2006 to December 2007. Their projected 10-year net export decline rate for Russia is -8.2%/year, ±4%, with a middle case scenario approaching zero net exports in 2024.

(For a good detailed look at Russia's oil production, see Foucher's recent analysis, "Russia's Oil Production is About to Peak.")

Angola: Production +14.2%

Angola has just surpassed Nigeria for the first time in 50 years as the top African oil producing nation. The country produced 1.87 million barrels per day in April, according to OPEC, vs. Nigeria's production of 1.81 million barrels per day. As previously mentioned, this is mostly due to the shut-in capacity in Nigeria. Angola's production—accounting for about 5% of the U.S.'s imports—might be increased a little in the coming years, but in the absence of consumption data the exportable portion is unknown, and in any case is fairly insignificant in the big picture for the U.S.

Looking at those charts, one thing should be very clear: Many of the big exporters on whose output we most desperately rely aren't going to be reliable for much longer. Most of the production gains are from small producers in Africa, which are fraught with conflict and relatively inhospitable to foreign investment, so we shouldn't count on them too much, either.

A Sobering—and Profitable—Thought

The impending export crisis is a very sobering realization. When oil imports simply aren't available, we will be forced to live within a smaller energy budget, and the adjustment could be painful.

So never mind the fact that the world will still be consuming a wee little bit of oil by the end of the century.

Never mind that we're only about halfway through the total amount of oil that the world will ever produce.

In fact, never mind peak oil.

The real questions are much more urgent:

Will the world be ready to deal with zero next exports from the top five exporters in a mere 25 years or so? World net exports appear to be declining at about 2.5% per year already, and according to the ELM model, we should expect that rate to accelerate.

Closer to home, will the U.S. be prepared to replace the two-thirds of its lifeblood that is imported, before it goes off the market? High oil prices and a struggling economy have already reduced our imports by 6% over the last year, but how close to the bone can we cut?

This is why we here at Angel Publishing have sought out the best fossil fuel plays we can find in North America. As the old Billie Holiday song goes,

Money, you've got lots of friends
Crowding round the door
When you're gone, spending ends
They don't come no more

Rich relations give
Crust of bread and such
You can help yourself
But don't take too much
Mama may have, Papa may have
But God bless the child that's got his own

The unconventional oil and gas plays we have uncovered in the U.S. and Canada may not be able to make us fossil fuel independent, but they will be the resources we count on as the export curtain falls.

Amid the panic, there will also be profit...and a piece of it can be yours when you subscribe to the $20 Trillion report.

Until next time,

Chris

It Takes Two to Contango

A few readers have asked about the meaning of a term I used in my last column: "contango." So this week, we'll delve into the murky world of oil futures trading.

A crude futures contract, for those who are unfamiliar, is simply a contract to buy or sell a certain amount of crude oil, of a certain specific gravity (ranging from "light" to "heavy") and sulfur content (ranging from "sweet" to "sour"), delivered to a specified place, at a specified price, on a certain day in the future. The contract can be settled in one of two ways:

Upon expiration, the holder of the contract—normally, a refinery—takes delivery of the oil and pays the specified price.
Prior to expiration, the holder of the contract can either sell a long position (effectively liquidating an earlier purchase), or cover a short position (that is, buying a new contract to cancel out an earlier sale), to close out the futures position and its contract obligations that way.

The price of oil futures contracts normally follows a curve, where the price for delivery in the near term—say, next month—is higher than the price for delivery far in the future—say, eight years from now. This condition is known as "backwardation."

Conversely, when the price in the future (a "deferred" contract) is higher than the near-month price, the curve is said to be in "contango."

Traders generally look at inventory levels and anticipated production when bidding on contracts. A tight inventory situation now is expected to be resolved by the market in the future, so prices usually fall off in a long backwardation curve over time. But they might also show a short period of contango for the near future, reflecting the current tightness of the market, as demonstrated in this chart:

Normally, periods of contango are relatively short-lived, as buyers take advantage of near-term weakness, which eventually restores the backwardation curve.

In May, however, an unprecedented change occurred: the futures contract went into a long-term continuous contango, as shown in this chart by "jeffvail" from his post on the subject two weeks ago at TheOilDrum:

The sharp upward move of the curves between May 16 and May 20 into continuous contango not only happened faster, but rose farther, than they ever had before.

Analysts were quick to point the finger at speculators for the sudden change, calling oil futures a "bubble" and offering lots of complicated explanations to support their arguments.

"Speculation," or Normal Market Behavior?

As I argued on Neil Cavuto's show on Fox Business on Monday (video forthcoming), I think the speculation argument has been really overblown. Likewise, I think the hunting expedition this week in Congress, where they grilled oil market-makers and investors to see if the oil markets were being unfairly manipulated, was a waste of time.

Ultimately, when the contracts are settled, as Scott Nations pointed out in a humorous discussion on CNBC a week ago, "the price is what the price is." It's the refiners who have to take delivery of the black gold who ultimately decide what the fair price for oil is. Upon expiration of the contracts, as Rick Santelli said, "there is no speculation."

The fact that we really haven't seen a wide divergence in price between the middle of a contract and its expiration belies the argument that oil's rise is all about speculation. Although speculators do play a role in that process, the fact that oil is a commodity that will be physically delivered really limits the opportunity to manipulate the contracts—they're not like cash-settled futures.

I firmly believe that what we are seeing in the oil markets now, where crude has rocketed from $100 at the start of the year, to a peak around $135, then falling rather quickly to $122 today, is primarily the simple result of traders trying to figure out what the proper value of a barrel of incredibly useful, energy dense, finite, and diminishing oil should be.

So yes, speculation does play a role in the short-term fluctuations-when oil is up $2 one day, then down $3 the next day, then up $2 the next-but over the long term, it's just the market doing its thing.

By the way, the swing to contango also means that the aggressive oil price hedging strategies that enabled Southwest Airlines to pull the only profit of all the major airlines in Q1 (see my recent article, "Say Goodbye to Cheap Air Travel") relied upon the historical norm of backwardation. If this contango pattern persists, it's going to put the screws to the airlines even harder...and offer some great investment opportunities in rail.

Today, the curve is showing a little backwardation at the front, but is still in a long-term contango:

Source: NYMEX

The dip is probably a response to today's inventory report, which showed an unexpected drop of 4.8 million barrels, or 1.5%, where analysts had expected a gain of 2.7 million barrels, according to a survey by Platts. It was the third declining week in a row, and puts inventories about 12% below where they were a year ago, according to the EIA.

Refinery utilization is currently 89.7%, which is lower than where I expected it to be at this time. If inventories are dropping, and refiners are still running at a relatively low rate of utilization at the beginning of the summer driving season, then refiners are probably betting that the market is softening in the short term, so they'd rather draw down inventories and wait and see.

A Simpler Explanation

There may be a simpler explanation, though, than all this gen-u-ine Wall Street gibberish about dancing the contango backwards, or whatever.

It's axiomatic that two primary sentiments rule the markets: Fear and greed.

When the markets are greedy, backwardation rules, and traders can play games like selling the front-month contract and buying the long contract to make money on the difference.

But when the markets are fearful, and the future looks dim, we get contango.

And it just so happens that the startling shift to a long-term contango began in the week of May 19—the same week that the financial media seemed to finally embrace the concept of peak oil. (See my article of last week, "The Tipping Point in the Peak Oil Debate.")

It really might be that simple.

Global demand for oil is still greater than supply, and we believe that it will continue to remain so (with perhaps a few short periods of easing), so we think we'll be dancing the contango for a good long time to come—at least until global demand destruction sets in.

As for the conventional wisdom on the Street, Lehman Brothers and others are convinced that prices are now "anomalous" and that oil is an asset bubble. They believe that global supply will increase faster than expected in the next few years to resolve the tension, and for a while that will probably "talk down" the price of oil.

But I think they're wrong. Non-OPEC supply in particular looks terminally broken to me, and any growth in OPEC supply is dubious, at best.

That means you've got a buying opportunity developing here, while the market is underpricing the future of oil.

Whether you're the kind of investor who might play the United States Oil Fund LP (AMEX:USO), an ETF on oil futures, or a more traditional investor who might seize the opportunity to jump on some of the oil plays we have recommended for the $20 Trillion portfolio, this is the kind of pullback you're looking for during a long term bull run for oil.

Until next time,

Chris