-->The Crude Awakening
The Daily Reckoning
Baltimore, Maryland
Thursday, 24 June 2004
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*** Have you seen Bill?
*** N.I.M.B.Yism... a new gas refinery...
environmentalists...
*** Gold at $400... stocks up, oil down...
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Your Paris-based editor is missing-in-action. So strong are
Bill's evasive techniques, that we can't even ascertain
where, if or how he went missing. In fact, when we called
Paris, we couldn't get so much as a Parisian-shoulder shrug
or a"Je ne sais pas."
If you have seen him, or even if you have a likely
hypothesis as to where he might be, email the Baltimore HQ
at tom@dailyreckoning.com...
Not to worry. We go straight over to New York, for news
from Eric Fry...
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Eric Fry, from the corner of Wall and Broad...
- The Nasdaq scampered through 2,000 again for the first
time in two weeks, leading the Dow and S&P 500 to new highs
for the month of June. No readily identifiable catalyst
produced yesterday's rally, although the falling price of
crude oil seemed to grease the stock-buying machinery.
- During the first few hours of trading yesterday, the
stock market meandered aimlessly, just as it has been doing
on most days this month. But shortly after Wall Street
traders returned from their two-cappuccino lunches, the
stock market lurched higher. By day's end, the Dow had
tacked on 85 points to 10,480, while the Nasdaq had jumped
more than 1% to 2,021.
- The price of crude oil tumbled nearly one dollar around
midday, after the American Petroleum Institute reported a
hefty 4.9 million-barrel climb in crude inventories for the
week ended June 18, boosting supplies to their highest
level in nearly two years. While supplies surged, demand
barely budged. The API reported a negligible year-over-year
rise in demand for gasoline - the third straight week of
little or no demand growth.
- A rising oil supply that swamps stagnant demand is not
the sort of condition a crude oil bull wants to see.
Nevertheless, oil stocks registered some of the stock
market's biggest gains yesterday. The S&P Oil & Gas
Refining Index jumped more than 1% to an all-time high.
Even though the oil price has dropped nearly $5 a barrel
since oil topping out at $42.33 on the first day of June,
most oil stocks keep chugging higher. The Philadelphia Oil
and Gas Index has gained more than 10% since early May,
while the oil price has been falling.
- Divergences like these always arouse our
curiosity... who's got it right: the crude oil sellers or
the oil stock buyers? Since ignorance does not preclude
guessing, we'd guess that the oil price will pull back a
bit, before resuming its climb a few weeks later. In other
words, the bull market in oil lives, but it might take a
little snooze.
- Meanwhile, the fear of future energy shortages is
beginning to shift the balance of power between industrial
America and the N.I.M.B.Y. (not in my back-yard) crowd.
Throughout the energy-abundant 1990s, conservationists,
environmentalists and N.I.M.B.Y.s thwarted innumerable
attempts to build any sort of industrial complex larger
than a lemonade stand. Case-in-point, the last oil refinery
built in America was completed during the Reagan
Administration. But late last week, The Federal Energy
Regulatory Commission approved a $500 project to build a
complex in Quintana Island, Tex., capable of unloading 200
shiploads of liquefied natural gas a year.
-"The project, known as Freeport LNG, is among the first
of its kind to win federal regulatory approval in the
United States in more than two decades," the New York Times
reports."It is a major development in the debate between
environmental advocates and energy companies over the
safety of large liquefied natural gas terminals...
-"It is one of several projects proposed for Texas and
Louisiana, where resistance from environmental advocates
and community groups is not as strong as in places like
California, New England and Florida. Opposition to gas
terminals on both coasts has already led energy companies
to cancel nearly half a dozen similar projects for large
gas terminals."
- Has the bull market in NIMBYism finally ended? Has the
bull market in environmental activism finally reached its
denouement? And should we expect a renaissance in
regulatory approvals for everything from oil refineries to
coal-fired power plants to nuclear power facilities? Watch
this space.
- We just noticed... gold at $400. Will we ever see $300-
gold again, dear reader? Possibly...
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The Daily Reckoning PRESENTS: Wow! According to 'The Guru's
Corner' of CBS MarketWatch, Outstanding Investments ranked
#4 in a list of top performing newsletters over the last 12
months, with a 68% return on its picks. Today John
discusses the oil supply market...
THE CRUDE AWAKENING
by John Myers
"The days of cheap energy are gone."
— Michael Hershey, president, Landis Associates LLC
The only shock about the surging price of oil these days is
that Wall Street is shocked by it. If professional
investors didn't see this one coming, they must have either
been locked up in an Iraqi prison or in a coma. We
certainly saw it coming.
For as much as we have talked about the impact of growing
demand for petroleum from China, India and a cavalcade of
SUV drivers in North America, the biggest reason for the
bull market in oil is a shortage of supplies. From
bottlenecks caused by aging refineries and a supertanker
shortage to depleted production from non-OPEC producers,
the price of crude is being pushed higher because of one
simple fact: There isn't enough of it.
One of the biggest bottlenecks — one that can't be overcome
quickly or easily — in the industry, is the lack of
refining capacity in Canada and the United States. The U.S.
Energy Department reports that refining capacity in the
United States has grown by just 2.4% since 1977, while
demand for gasoline has risen 27% during the same period.
And the cruel fact is that no major new oil refineries have
been built in the United States or Canada since the early
1980s, and many of the ones that used to exist have been
shut down. That's left the continent's existing refineries
stretched to capacity, just as North American gasoline
markets are heading into the heavy demand summer driving
season. According to one estimate, U.S. refineries are
running at about 97% capacity.
In fact, many of the refineries that disappeared in the
past 20 years were closed because it would have been too
expensive to upgrade them to meet new environmental rules.
It's not a coincidence that no new refineries have been
built since the U.S. Environmental Protection Agency
brought in its Clean Air regulations, which placed limits
on refinery emissions.
How expensive is expensive? Just meeting the various local,
state and federal environmental and planning requirements
for a new refinery could cost as much as $100 million,
according to some estimates — if a site could even be
found. And if the permits were acquired, the U.S. Senate
Committee on Environment and Public Works estimates the
cost to build a new refinery at a whopping $2.5 billion.
And, oh yes, it could take seven years to complete.
If you want to understand the world's oil supply problem,
simply look at what happens to a single oil field. Whether
you are talking about Prudhoe Bay in Alaska or Leduc in
Alberta, the life cycle of an oil field is the same. It
takes several years after an oil basin is discovered to
achieve maximum production as the field continues to be
developed with additional step-out wells.
As a good rule of thumb, 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 break-
even 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 their 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? The price impact of
dwindling supplies will meet surging demand — a formula for
incredible profits in oil and gas stocks.
What is so bullish for oil is that, while world discovery
rates peaked in the 1960s, global oil reserves have not
increased since 1990. In fact, over the past four decades,
exploration efforts have yielded a diminishing return.
In the 1960s the industry discovered 375 billion
barrels... in the '80s, 150 billion barrels were discovered.
Even fewer barrels were discovered during the 1990s.
Perhaps this year, and certainly by 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.
And each year, the world pumps and burns 26 billion barrels
of oil, this nonrenewable 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.
Of course, not all oil-producing nations will experience a
reduction in output at the same time. As I mentioned, U.S.
production began to fall in the 1970s. Mexico and North Sea
productions 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 of most oil
executives is that we are on the verge of declining Russian
oil production.
Oil production from non-OPEC countries has kept oil prices
in check until just recently. But nowadays, oil supplies
outside OPEC don't gush to the surface the way they once
did. The really plum oil fields are in the Persian Gulf.
In 1973 — the eve of the first oil crisis — there were 15
giant oil fields in the world producing over 1 million
barrels per day. They accounted for almost 30% of the
world's daily supply. Moreover, their average age was only
23 years.
Today 13 of these 15 giant fields are still producing,
though their average age is now 50 years. Only two of these
original fields still produce over 1 million barrels of oil
per day, and the 11 remaining fields each have an average
production of around 200,000 to 300,000 barrels per day.
Today, only two fields in all non-OPEC countries produce
over 1 million barrels per day. Another three produce about
500,000 barrels per day.
As production in these regions enters into decline, more
power falls to OPEC, particularly Arab OPEC. Already
countries around the Persian Gulf produce one-third of the
world's crude oil and
control two-thirds of the world's reserves... and make up
the only major oil-producing region in the world that is
not yet close to its oil reserve half-life.
Turning to our ally in the Middle East — Saudi Arabia —
brings up a new question: Just how effective can Saudi
Arabia be in easing the supply crunch?
Put aside for a moment the frightening terrorist activities
in that country — like the recent killing of 22 people in
Khobar. When you look at the issue of supply versus demand,
you have to recognize that not even Saudi Arabia has the
oil capacity to ease the world's supply problems.
Twenty-five years ago, Saudi Arabia stood ready to pump 14
million barrels per day. Currently, the Saudis say that, if
necessary, they can raise oil output over time from 8.35
million barrels per day to 12 million barrels per day.
But a Calgary geologist, who has spent extensive time
working in Saudi Arabia over a career that has spanned 25
years, told us that while the Saudis could raise production
to 12 million barrels per day for a time, they certainly
couldn't keep that output going for long. Oil simply
doesn't flow the way it did 20 years ago. Not even for the
Saudis.
All this just tells us that oil prices aren't ready to
stabilize, let alone retreat... even though much of the
world doesn't believe prices will stay at these levels. The
conventional thinking is that oil prices will fall, but I'm
certain they'll go just the opposite way... higher!
Regards,
John Myers
for The Daily Reckoning
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