Why 2006 could see another oil spike
Many people would describe 2005 as 'an ugly year for energy markets,' says Justice Litle on Whiskey & Gunpowder. But the truth is, things could have been so much worse - and 2006 has just begun...
In his groundbreaking work, Consilience: The Unity of Knowledge, noted biologist Edward O. Wilson takes up the measure of what man has learned so far. Imagine a freewheeling conversation with a brilliant scientific mind, touching on everything from the Enlightenment to the arts. Wilson speaks to humanity's future, as well as its past; the final chapters of the book are devoted to ecology and the environment. Consider this foreboding bit of insight:
'Humankind is like a household living giddily off vanishing capital. Exemptionalists are risking a lot when they advise us, in effect, that 'Life is good and getting better, because look around you, we are still expanding and spending faster. Don't worry about next year. We're such a smart bunch something will turn up. It always has.
'They, and most of the rest of us, have yet to learn the arithmetical riddle of the lily pond. A lily pad is placed in a pond. Each day thereafter, the pad and then all of its descendents double. On the 30th day, the pond is covered completely by lily pads, which can grow no more. On which day was the pond half full and half empty? The 29th day.'
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To be more specific, the 'vanishing capital' Wilson refers to is food and water. But crude oil fits just as well. As my fellow colleague and Whiskey contributor Byron King is fond of pointing out, we don't just burn oil in our gas tanks. We eat it too.
Petroleum is a key fertilizer and pesticide ingredient: Without it, crop yields would plummet. Without fuel to run the combines, the crops would rot in the fields. And without fuel for heavy transport, the foodstuffs grown in wide-open spaces would never make it to densely populated cities for consumption - let alone across the ocean.
It is understandable that Wilson left energy off his short list. At the time Consilience was finished (1998), crude oil was trading below $20 a barreland looked to be headed for single digits. The developing world was not yet a blip on the radar screen. Now things look quite different. We have not seen the 29th day for energy just yet - but the clock is ticking.
The riddle of the lily pond dovetails nicely with Peak Oil. Everything looks just fine - right up to the point when cruel reality barges in. Surprise! (Or perhaps, oops!) Of course, some key players dismiss Peak Oil out of hand. The Saudi sheiks and the global oil majors will say that you can rest easy - that there is enough oil in the ground to last another 50 years. What, me worry?
This soothing snake oil is really not surprising. The oilmens' self-interest requires a Panglossian stance; there is really no choice in the matter. If Peak Oil were ever taken seriously by the Western world, a chain of disastrous events would immediately follow. Exxon and BP would be all but nationalized by their respective panicked governments; geopolitical tensions would escalate tenfold; and the sheiks would soon have Day-Glo bull's-eyes painted on their foreheads. So much easier to smile and avoid all that.
If and when Peak Oil kicks in, the endgame will accelerate. But the true rub is this: We are headed for the 29th day whether Peak Oil kicks in or not. Oil in the ground is only half the equation, you see. The other half is getting it out of the ground fast enough. (Imagine 500 cars lined up at a single gas pump.) An oil field has an optimal barrels-per-day output; pumping the black stuff too quickly can cause long term damage, permanently reducing future yields. Whether the Saudis are true to their word or lying through their teeth about reserves could wind up a moot point. Either way, it's only a matter of time before capacity limits become a stranglehold.
Skyrocketing energy demand will bring this stranglehold about. The main driver of that demand will be developing world consumption. Geometric progressions are unwieldy things; most of us aren't familiar with the sums and scales involved.
To get a feel for the numbers, consider the real-world example of MySpace.com, a 'social networking' Web site popular with teenagers the world over (and recently acquired by Rupert Murdoch). According to data from comScore Media Metrix, MySpace.com has been adding users at a rate of 100,000 per day (or more) over the past year. For the first half of November, comScore reported an accelerated pace of 150,000 new users per day. If the new pace holds, that is a ramp from 36.5 million new users per year to 54.75 million.
After you digest the numbers, try to digest the acceleration. It is hard to even imagine such a momentous mass of flirt-crazed, Web-hungry teens. But when it comes to economic changes in the developing world - new entrants in the work force, new applicants for a driver's license or a credit card, new strivers pursuing the middle-class dream - those eye-popping numbers are merely ho-hum.
When the sleepy village with no electricity becomes a bustling industrial center equipped with the comforts of modern life, energy requirements increase by multiple orders of magnitude. The aggregate effects of developing world growth will eventually create a demand tidal wave. In fact, the ocean floor is already trembling: You can feel it from here to China.
All this impressive new technology and rampant global growth comes with a nasty catch. Marginal improvements aside, 21st century energy is still 'old school.' Alternative energy is still in its infancy, not yet ready for prime time. (There are excellent investment opportunities in the alternative space, but mass substitution is still years away.)
There is a large gap between what we've signed up for and what we'll be ready for. With all this technology-oriented growth and relentless progress, the world's fuel of choice is still decomposed dinosaur bones. Something will have to give.
As if Peak Oil and capacity constraints weren't enough, the optimists have yet another problem. As energy demand increases, the margin for error decreases. Market prices are routinely set at the margins: Small changes in supply will have an amplified effect on price. If the supply of crude oil is suddenly slashed by, say, 300,000 barrels per day in a tight market, someone will not be getting the 300,000 barrels they were expecting.
To determine who goes without, end-users must aggressively outbid each other - and continue outbidding each other - until someone cries uncle and drops out. When supply is intact and all is quiet, a consistent 'premium' will be built into the market price, reflecting the risk of disruption. The tighter the market, the higher the premium will be.
Between Hurricane Katrina, crude oil touching $70 per barrel, and natural gas making a run at $15 per million BTU, many would consider 2005 an ugly year for the energy markets. The reality is that the world got lucky. Things could have been much, much worse.
Geopolitical uncertainty is on the rise (as evidenced by Iran, Nigeria, Russia, Mexico, and Venezuela); al Qaeda has turned a desperate eye to the Middle East (as evidenced by recent attacks in Jordan); Peak Oil premonitions are building (Kuwait's Burgan oil field, the second largest in the world, has now been verified past peak); and to top it all off, some scientists believe a new cycle of Gulf-threatening 'super-storms' has begun.
These concerns are neither temporary nor solvable. So far, we have beaten the odds; no single event or series of events have led to the dreaded 'super spike' that puts the price of crude over $100 a barrel. But how long will we stay lucky? In Russian roulette, the unfortunate soul playing the game gets six chambers and one bullet. If he plays only once, his odds of survival are 83%.
But the odds get worse for each additional round: Play five times, and the odds of survival are cut in half. Play 10 times, and they are cut in half yet again. Of course, the global energy situation is not quite as bad as all that. Rather than six chambers and one bullet, it is more like a hundred chambers and half a dozen bullets. That is cold comfort, however, when the world is forced to play a new round every single day.
So what should we do? Time to hit the mountains and take up subsistence farming? Not quite. But nor is it a time for complacency. As Wilson notes, 'To bet on safe passage is a terrible choice, because the stakes on the table are just about everything.'
We are in for turbulent times and dramatic change, no matter what. If the best preparation advice could be summed up in three words, it might be these: Expect the unexpected. To flesh that out a bit, don't be pacified by the sight of crude oil drifting gently downward. Don't be lulled to sleep by the gentle crooning of Pollyanna pundits. And on a bright note, do remember that the biggest profits of all are yet to be made.
By Justice Litle for Whiskey & Gunpowder
Whiskey & Gunpowder is a free, twice-per-week, e-mail service for more from the team, go to https://www.whiskeyandgunpowder.com
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