-->Hydrocarbon Man
The Daily Reckoning
Paris, France
Wednesday, 23 April 2003
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*** All is forgiven...let the healing begin!
*** The problem with tax cuts...gold up...dollar down...
*** Inflation, reflation, deflation...a $1.4 trillion loss to
homeowners?...eBay...drought...the war...and more!
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It is all behind us now.
The war...the hard feelings...the bear market -- all is
forgiven.
The American proconsul arrived in Baghdad, proclaiming his
coming as a great day for Iraq. (Really...we read it in the
paper.) The Iraqis are going back to whatever it is that they
do. The stock market is rising. And now, in the spirit of
letting bye-gones, be bye-gones, George Bush has given Alan
Greenspan a slap on the back, letting the world know that as
long as the Fed chairman keeps the money flowing, he can stay
on the job until he drops dead.
The Fed chairman resisted Bush's tax cuts the way he first
resisted the stock market bubble."Irrational exuberance," he
called the bubble. We can't remember what he said about the
tax cuts, but whatever it was, it sounded like he neither
expected nor wanted to be re-appointed Fed chairman.
But the Fed chairman is nothing if not a get-along, go-along
kind of guy. And he seems ready to go along with almost
anything.
The problem with the tax cuts is that the federal government
is already running deficits of somewhere between $1.2
trillion and $4.5 trillion over the next 10 years. And the
tax cuts make them even worse.
One of America's structural economic problems is that it
doesn't save enough money so it has to rely on foreign
lenders for capital. Despite the rising personal savings rate
-- recently running at 4% per year -- the federal government
has moved from surplus to deficit, taking the net national
savings rate down to an all-time low of 1.3%. Even throughout
the devil-may-care '90s, the rate averaged about 5%.
So now, the U.S. relies on overseas lenders as never
before...and is exposed to a sudden decline in its standard
of living -- if the foreigners ever decide to stop accepting
its little green I.O.Us.
Gold rose again yesterday. The dollar fell. The Australian
and Canadian dollars both hit 3-year highs. The euro
continues to gain ground too; it's now above $1.09. The
euro's great strength is that its backers can't agree on a
foreign policy...so it has no military adventures to support.
And Europe, as a whole, is a net lender of capital, not a net
consumer, like the U.S.
But Alan Greenspan has once again decided that no matter what
is best for the nation, it is best for Alan Greenspan to look
the other way.
And here's Eric, with more news from Wall Street:
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Eric Fry in New York...
- The Dow Jones Industrial Average soared 156 points
yesterday to 8,485, while the Nasdaq gained nearly 2% to
1,451. Sparking the market's advance was the news that
President Bush would like to keep Alan Greenspan on the job
for another term. If Bush has his way, Greenspan will
continue to head up the Federal Reserve until death - or a
dollar crisis -- do us part.
- The 77-year old Greenspan originally took office as
chairman on Aug. 11, 1987. His current four-year term runs
through June 20, 2004. More than any other government
bureaucrat, Greenspan personifies the bubble-era bull market
in stocks. He nurtured it and applauded it as the natural
outgrowth of our"productivity miracle." Incredibly, the fact
that the productivity miracle turned out to be a fraud has
not diminished the chairman's popularity or esteem...or self-
image. If the bubble is to be successfully re-inflated, there
is probably no one better suited to the job.
- But what if share prices don't re-inflate? What if
expensive stocks don't become even more expensive? What then?
- The more that one considers what to do with one's
investment capital, the more that one might be inclined to do
nothing at all. 2000 years ago, Jesus heaped scorn upon the
metaphorical servant who"buried his talents" in the ground.
But we suspect that if Jesus were preaching on the corner of
Wall and Broad today, he'd praise SELECTIVE talent-burying,
or at least not frown upon it. Like Warren Buffet, he might
praise the virtue of inactivity at certain times and in
certain market environments.
- Today's investor faces the triple terror of a richly priced
post-bubble stock market, a bubble-like bond market and a
bubble-like housing market.
-"Once you get to below 4% on the 10-year note, and you've
got the beginning of a bull market in government - explicitly
aimed at reflation - you ain't going to get double-digit
returns in bonds," says PIMCO's Paul McCulley. And it's true,
the current custodians of the US dollar are promising to
print as many as necessary to reflate the conomy.
-"Because modern central banks date from the 17th century,"
says James Grant,"virtually every monetary policy has been
tried before, many more than once. Inflation has been given
an especially thorough test run."
- A central bank that promises reflation is like a spouse
that promises infidelity...The promise is a guarantee. And
that guarantee is trouble for bondholders, as Grant
illustrates:"We should try to imagine ourselves in the
shoes of a foreign holder of the 10-year Treasury...We have
rubbed our eyes and performed a calculation. If the 10-year
rallied to yield 2.5%, the implied 150 basis-point rally from
the now-prevailing 4% would deliver a 13-point price rise in our
holdings. We are, provisionally, delighted. But the dollar is
not our native currency. We decided it is the part of
prudence to sell some dollars to hedge our exposure. And
we're not alone. Many other people reach the same decision.
The selling snowballs and the dollar exchange rate slips. The
gold price shoots up. Interest rates not under the thumb of
the Fed begin to lift (as do prices of imported merchandise,
reflecting, after a short lag, the weakened dollar exchange
rate). All at once, a latent deflationary crisis becomes an
actual inflationary crisis."
- Very well, if inflation is resurgent, shouldn't real estate
provide a kind of safe haven? Indeed, it may prove to be
exactly that, assuming inflation flourishes like a bamboo
grove. Even so, the housing-bubble contingent is not without
legitimate cause for concern.
- Merrill Lynch economist David Rosenberg notes that
"residential real estate has quickly become the asset class
of choice," making up 31% of household assets versus 23%
three years ago. (Of course, the big jump has as much to do
with falling stock values as with rising home values.) If
home prices hold steady or appreciate, no harm, no foul. But
Rosenberg estimates that a 10% drop in home prices would
shave about $1.4 trillion from household net worth, or
roughly 20% of disposable income...and that WOULD be a
problem!
- Furthermore, as Alan Abelson reports in this week's
Barron's, Rosenberg sees a number of red flags. Namely:
"Inventories of unsold homes are rising quickly and, measured
in months, are now at their highest level since December
1996; The median number of months a home has been on the
market has jumped to 4.8, from 3.8 last fall and the highest
in nearly a year; New home sales have fallen sharply since
the start of the year and are growing at the slowest run rate
since August 2000."
- Hmmm...maybe it's time to get out the shovel and start
digging a hole for your talents!
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Bill Bonner back in Paris...
*** EBay sells for 81 times earnings. TheStreet.com
calculates that earnings would have to rise 40% per year for
the next 5 years to justify the price. How likely is that?
*** From Denver comes news that the housing boom may be
blowing up -- at least in the Rockies. Apartment vacancy
rates are over 10% -- the worst figure since the '80s housing
bust in Denver.
*** The sun has been shining for weeks with scarcely a let-
up. It has been so eerie, so unnatural...and so hard for us
to maintain our normal gloomy vigil when the weather has been
so nice. But now, we have found the cloud in all this silver
lining. Yesterday's paper told us that Europe is as dry as a
Texas teetotaler. Drought and late frost threaten this year's
wine and tree-fruit crops.
***"Well, why don't you just admit you were wrong? The war
went fast...the victory was relatively easy...and now the
threat has been removed...what is the matter with you people,
anyway?"
The above comment amalgamates those of hundreds of Daily
Reckoning readers who have written with questions, insults,
and kvetches. And more insults. We write today not to
apologize to them...but in keeping with the mood of post-war
healing, we write to thank them. Despite serious questions
about our loyalty or our sanity, during this wartime period,
they have kept reading.
Here at the Daily Reckoning headquarters in Paris, we are
glad the war is over....and glad that it ended with so few
casualties. But we still wonder if it was worth a single
life. And maybe we are just born worryworts...or maybe it's
from reading too much military history....but we note that
people learn less from victory than from defeat....and the
gods of war rarely grant an army or an investor a swift, easy
victory...unless they intend to destroy them later.
The Daily Reckoning PRESENTS: Dwindling supply...
skyrocketing global demand... and"price hawks" at the helm
in major OPEC nations, could mean benchmark crude at $50 a
barrel in the not too distant future. Oil expert John Myers
reports.
HYDROCARBON MAN
By John Myers
Just because the US Army has pitched its tents in the Iraqi
oil fields, that doesn't mean that Iraqi oil will soon be
flooding world markets or the price of oil is heading to $12
a barrel. Quite the contrary.
Indeed, one of the biggest post-war surprises is that the oil
price has jumped back over $30 a barrel. I can't say we're
surprised. We have stated repeatedly that the bull market in
oil has little to do with Iraq specifically. Although, the
politically volatile Middle Easy certainly plays a big role
in the oil price trend.
Removing Saddam Hussein from power doesn't change the
fundamental fact that the world is drawing down its oil
reserves at a record pace. Nor does it change the fact that
politically volatile Middle East nations continue to control
the lion's share of the world's oil supplies. Since most of
the rest of the world is rapidly depleting its domestic
supplies of oil, the world has become more dependant than
ever on Mid East oil. Forward-looking investors should be
looking to invest in oil and gas companies with substantial
North American reserves.
To predict what will happen to the world's oil supply, you
need only look at a single oil field. Whether you are talking
about Prudhoe Bay in Alaska or Leduc in Alberta, maximum
production of a given field is achieved some years after
initial discovery as the field continues to be developed with
additional step-out wells. But, after half the recoverable
reserves have been pumped from a field, there is a rapid
decline in the field's oil reservoir. It becomes less and
less economical to pump oil from the field until a breakeven
point is reached - a point where the expense of operating the
oil field equals the revenues produced by the field.
The physics that apply to a single field also apply to a
region or an entire country. Consider the continental United
States. The rate at which new oil was discovered hit its peak
in 1957. By the early 1960s, the nation's total proven
reserves reached its all-time high. Less than a decade later,
U.S. production peaked. Production was relatively stable
until the mid-1980s and then began to fall precipitously.
Year after year the Americans have made up the shortfall in
oil production by importing foreign crude. But what happens
when the world's output begins to fall?
Unless we find oil on Mars, there will be no outside source
to make up for dwindling production. It will be then that the
price impact of dwindling supplies will meet surging demand -
a formula for incredible profits in oil and gas stocks.
Global oil reserves have not increased since 1990. In fact,
over the past four decades, wildcatting has yielded fewer
results. In the 1960s, the industry discovered 375 billion
barrels. In the '70s, 275 billion barrels and in the '80s,
150 billion barrels were discovered. Fewer barrels yet were
discovered during the 1990s.
At one time, the world was blessed with somewhere between 1.8
trillion and 2 trillion barrels of oil. But beginning with
the first flowing oil well in April 1861, that endowment has
been consumed. By the end of 2002, humankind had pumped and
burned about 900 billion barrels of oil, or about half of the
total amount of oil the world has to offer.
Perhaps this year - and certainly no later than 2005 - world
production will hit its apex. That means that over the second
half of this decade world oil output will begin to decline -
just as global oil demand is surging.
Each year the world pumps and burns 26 billion barrels of
this non-renewable resource. That means that every four
years, more than 100 billion barrels of oil-five times the
total reserves of the United States-are consumed.
But world demand for petroleum is expected to soar by 56
percent, or 43 million barrels per day (bpd), over the next
two decades due mostly to strong demand for transportation
fuels. According to the International Energy Agency, global
oil demand would jump to 119.6 million mb/d in 2020 from its
current level of 77 million mb/d. But even today, oil is
being burnt at a torrid rate.
The implications are serious for what Daniel Yergin calls a
"Hydrocarbon Society." Despite the advent of the microchip
and explosion of the Internet, petroleum is the primary
economic engine powering the world. And even as world oil
output peaks and then tapers, there is little evidence that
the necessity of oil, and the demand for it, will wane.
"Hydrocarbon Man shows little inclination to give up his
cars, his suburban home, and what he takes to be not only the
conveniences but the essentials of his way of life," wrote
Yergin in his best seller, The Prize."The people of the
developing world give no inclination that they want to deny
themselves the benefits of an oil-powered economy, whatever
the environmental questions. And any notion of scaling back
the world consumption of oil will be influenced by the
extraordinary population growth ahead."
Of course, not all oil-producing nations will experience a
reduction in output at the same time. As I mentioned, in the
United States production began to fall in the 1970s. Mexico
and North Sea production are now in decline, and few expect a
major discovery in those regions.
The only other major non-OPEC oil region is Russia. But new
oil discoveries in the former Soviet Union have been in
decline since the late 1980s. The expectation by most oil
executives is that we are on the verge of declining Russian
oil production.
With reserves of around 650 billion barrels, the Middle East
is the only major oil-producing region in the world that is
not yet close to its oil reserve half-life.
Until recently it has been oil production from non-OPEC
countries that has kept oil prices in check. But as
production in these regions enter into decline, more power
falls to OPEC, particularly Arab OPEC.
In 1988, Saudi Arabia was happy with an OPEC benchmark price
of $20 a barrel. But given the falling value of the dollar as
measured by the CPI, it takes $31 to buy the same amount of
goods and services that $20 bought in 1988. So even if Mid
East OPEC would accept the kind of pricing policy that the
Saudi's implemented 15 years ago, they would insist on $11
more a barrel to keep pace.
Trouble is, Mid East OPEC wants nothing to do with the
conservative pricing that the Saudis instituted in the late
1980s. Here's why: Most Mid East nations expect maximum oil
production to happen within a decade. Under such a timetable
- they want to maximize short-term revenues. That means a
more aggressive OPEC pricing policy.
Fifteen years ago, world crude demand had slowed to a crawl.
At the same time, millions of barrels a day were being
harvested from the Soviet Union and the North Sea. Saudi
Arabia understood that if it set OPEC prices too high, the
cartel was certain to lose market share.
Not much chance this will happen today. World oil demand is
growing by more than 2 percent annually. The only region rich
enough in oil to satisfy this demand is the Middle East.
In the 1980s, Saudi Arabia was getting arms and financial
assistance from the United States. In turn, the Saudis
exercised their influence to keep oil prices affordable.
Following the War on Iraq, that type of goodwill towards the
United States no longer exists in the Middle East, or even in
Saudi Arabia.
Rather than making life easy for the United States, most of
Arab OPEC would like to see things get more difficult... and
that means higher oil prices.
Sincerely,
John Myers,
for The Daily Reckoning
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