As Russia Tests the Waters, Oil and Gas Showdown Looms 16 comments
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Investors who think oil and gas will stay cheap should think again. Already Russia is putting President-elect Obama to the test... and an inevitable oil and gas showdown looms.
Mark my words. It will not be six months before the world tests Barack Obama like they did John Kennedy. The world is looking.
- Vice-President-elect Joe Biden
Just a few weeks ago, Vice-President-elect Joe Biden (back when he was plain old Senator Joe Biden) promised the world that Barack Obama will be "tested" by America's enemies.
"Remember I said it standing here," Biden told his Seattle audience, "if you don't remember anything else I said. Watch, we're going to have an international crisis, a generated crisis, to test the mettle of [Barack Obama]. And he's going to have to make some really tough - I don't know what the decision's gonna be, but I promise you it will occur. As a student of history and having served with seven presidents, I guarantee you it's going to happen."
Say it ain't so, Joe...
Russia: "I'm Your Huckleberry"
With no time to waste, it seems Mr. Biden's words have already come true. Within 24 hours of Obama's historic victory, Russia elected to stir the pot. As the Financial Times reports:
Russia's president Dmitry Medvedev on Wednesday became the first world leader to throw down a gauntlet to U.S. president-elect Barack Obama, declaring that the Kremlin would station missiles in the tiny Russian enclave of Kaliningrad, which borders Poland, in response to U.S. plans for an anti-missile system in Eastern Europe.
Your humble editor is a big fan of old spaghetti westerns - Clint Eastwood westerns in particular. The Good, the Bad & the Ugly... The Outlaw Josey Wales... Unforgiven... and so on.
But one of the best westerns ever, in part for its cheek and cheesiness, has to be Tombstone, with Kurt Russell, Val Kilmer, Bill Paxton, and a few other notables.
One of Tombstone's best lines is when Doc Holliday (Val Kilmer) tells Johnny Ringo, "I'm your Huckleberry." Meaning, "I'm the man you want to fight."
In acting so swiftly to station missiles on the Poland border, Russia is in effect saying to the U.S. President-elect: "I'm your Huckleberry. Let's see what you're going to do."
What's more, this plan does not feel like something Medvedev could have cooked up all by himself. To the contrary, it has Vladimir Putin's fingerprints all over it.
So is it really a further surprise, then, to hear the Russian newspaper Vedomosti predict that Putin could retake his post as Russia's president (with the current occupant stepping aside) sometime in 2009?
I have no idea how President Obama will respond to a newly-hostile Russia. My guess is that he will prove much less the "dove" than some expect... that the pragmatic Chicago operator in him could find the means to take a very hard line.
Dove or hawk, we'll get a chance to find out either way...
A few weeks ago we noted in these pages that "falling oil is a geopolitical time bomb." That notion holds true as ever, I believe. We just can't be sure when or in what fashion the bomb will go off.
OPEC Still a Factor
Meanwhile, the Saudis aren't exactly sitting on their duffs. Crude oil prices saw a ten percent jump earlier this week on news of the Kingdom's production cuts.
There is an open question as to just how effective OPEC really is. Some believe there is so much "cheating" going on that changes in the official quotas amount to little more than hot air. And with budgets getting tighter, the Saudis are one of the rare OPEC producers with enough "swing" capacity to really make a difference in day-to-day crude supply.
With that said, though, the long-term trend for oil prices remains up, not down... and that means a greater concentration of power for OPEC.
The IEA (International Energy Agency) is expected to release its "World Energy Outlook," an annual report of sorts detailing the state of energy production around the globe, very shortly.
In that report (according to those who have seen advance copies), the IEA will release a forecast of $200 per barrel oil by 2030. The IEA expects a tripling of OPEC's revenue in the coming years, from $700 billion in 2007 to more than $2 trillion down the road.
The IEA further notes "a real risk that underinvestment... will cause an oil supply crunch," and that we will see "persistently higher levels of consumer spending on oil." No surprises there.
Direction, Not Destination
How much stock should we put in a forecast for oil prices more than 20 years out? Not much, obviously. I have no idea where the price of oil will be in 2030. (If it was honest, the IEA would admit it doesn't either.)
But there is still value in this type of forecasting, because rigorous analysis of the data helps uncover the likely direction of the long-term trend.
We may not know how high or how fast oil's price will rise in future... but we do know that the long-run direction for energy prices is still UP - not down - in spite of the recent price implosion.
The credit crunch and ensuing panic have put global growth projections on hold for a time - but it is only a pause, not a halt. Nor has the reality changed that all the "easy" oil is gone... that remaining oil supplies are getting ever harder to find... and that the NOCs (national oil companies) are increasingly hoarding the spoils for themselves, forcing the western oil majors to pursue ever tougher and riskier projects.
(Eventually) Back in Black
As far as the global economy goes, the worst case scenario for 2009 is one in which the powers that be screw things up so badly that we wind up with Great Depression 2.0.
Barring that tragic outcome - and it's a pretty low-probability scenario I might add - a real problem we will face is lack of preparedness when demand trends come back on line.
As outlined in our explanation of why the commodity supercycle isn't dead, a lack of capital spending now will likely lead to even bigger production bottlenecks in future.
And so, in short, I believe that while the price of oil got "crunched" along with everything else - the dollar's sharp rise playing a role too - energy prices will bounce back with even more velocity and vigor when global growth returns.
And when that happens, we'll have the same problems to deal with that were temporarily back-burnered by the credit crisis... and as a result, natural gas will play an expanding role.
Jumpin' Jack Flash It's A...
When we talk about oil and gas, we typically forget about the "gas" part. This is largely due to the varying roles that the major fossil fuels play. Oil is the big dog because we use it for transport. Coal is king because we use it for heat and electricity.
Natural gas has many uses too, but it's a less critical piece of the energy puzzle in comparison to its bigger, dirtier fossil fuel brethren.
Oil and gas have big troubles though. The trouble with oil is that we are running out of it (or the easy stuff at any rate). The trouble with coal is that we hate it. America and China have more coal than they know what to do with, but coal is viewed as public enemy number one from an environmental standpoint.
The reality of rising demand is that oil and coal won't go away - but alternatives will become all the more important. We'll keep burning all the oil we can, and on a global basis, we'll see new coal plants firing up every week for the next twenty to thirty years.
But natural gas still has room to be a much bigger part of the mix because coal is so undesirable as a primary electricity source, and the available oil just won't be enough.
Natural gas is hard to transport across oceans now. But it will become much easier to transport as more LNG (liquid natural gas) facilities get built. In the same vein, it's not very common these days to think of natural gas as a "transport" fuel... that is to say, something you put in your gas tank. But that mindset will change too, as Western countries move towards the mutually supportive goals of cleaner energy sources and less oil dependence at the same time.
We are nearing the stage, for example, when electric cars become truly viable on a mass scale. Technology, political will, public sentiment, and investor capital are all finally converging on this idea simultaneously.
When we see it really take off, chances are many of these next-gen cars could draw their electricity from natural gas-fired power plants. That's just one quick example of how natural gas, the cleanest and least offensive of the major fossil fuels, can grab a march on oil and coal. There are plenty more.
Rumblings of GOPEC
As one might expect, the world's major oil exporters tend to be the world's natural gas powerhouses too. Last time I checked, Russia held an estimated 25% of the world's known gas reserves.
As an aside, there has been a lot of excitement around natural gas shale finds in the US, but the "decline rates" on shale are extraordinary - as high as 70% in the first year. Thus if natural gas truly catches on in terms of consumer heating and transport trends, North America will be back in its same old position... running to stand still as new gas production barely keeps up with the old production's decline.
This creates an opening for the big gas players - Russia leading them - to band together and form a sort of "GOPEC," or "natural gas OPEC."
In fact, the GOPEC idea has already moved beyond the "maybe we should ponder this" stage and progressed to serious implementation. As the UK Guardian reported recently:
Western concerns about global energy markets hit new heights [in late October] when Russia, Iran and Qatar said they were forming an OPEC-style gas cartel.
The move by the three countries, which control 60% of the world's gas reserves, was met with immediate opposition from the European commission, which fears the group could drive up prices.
Alexey Miller, chairman of Russia's Gazprom, said they were forming a "big gas troika" and warned that the era of cheap hydrocarbons had come to an end.
"We are united by the world's largest gas reserves, common strategic interests and, which is of great importance, high cooperation potential in tripartite projects," he explained. "We have agreed to hold regular - three to four times a year - meetings of the gas G3 to discuss the crucial issues of mutual interest."
Don't Get Fooled Again
In conclusion, investors who think cheap oil and gas will stay cheap should take a lesson from Pete Townshend and the Who. They should get on their knees and pray they don't get fooled again.
"Meet the new boss, same as the old boss" might not apply to President-elect Obama, who is most decidedly not the same as President Bush. But it does apply to the same old realities of supply and demand.
The world's oil and gas reserves are still a scarce resource, relative to the global demand that will eventually be coming back on line. The fact that Wall Street has temporarily lost sight of this creates short-term opportunity to scoop up well-run, well-capitalized energy players at insanely cheap valuations.
I'll confess, too, that I like the little guys here a lot more than the big guys.
The big, well-muscled oil majors like Exxon (XOM) and BP (BP) are bursting with cash and profits right about now - a sign of stability and comfort for nervous investors. The trouble is, all that stability may well be priced into the shares... and at the same time, the hidden troubles that the oil majors will face in finding replacement reserves do not feel adequately priced in.
Exxon is heralded for its cash and ledger-busting profits, for instance, but few talk about the troubles the big behemoth will have replacing depleted reserves down the road... a task that is getting harder by the day.
Many of the little guys, on the other hand - smaller, more nimble energy companies that are often good takeover candidates - are in an opposite position to the oil majors. Their values are being discounted by Wall Street due to an irrational fear that the financing of current operations won't hold up.
In other words, we're in an environment where investors are perhaps paying up too much for the perception of safety, while shying away from the opportunity to pick up great assets at a discount because of an overcompensated aversion to risk.
That's the kind of discrepancy great investors love to exploit all day long.
And, last but not least, there's a bonus factor in regard to the "big boys" being stuffed with cash right now - their big cash positions and tough replacement challenges make it easier for them to buy new production versus going out and finding it. (This is sometimes known as "drilling for oil on Wall Street.") In other words, it's all the more likely for an Exxon or a BP to spend some of its hoard snapping up smaller names at a fat premium to the going share price.
The Best of Times, the Worst of Times
Charles Dickens opened up A Tale of Two Cities with the famous line, "It was the best of times, it was the worst of times."
That's a good summation of how I feel about markets right now. We just went through some of the worst carnage in a hundred years... but at the same time, the fact it's been the "worst of times" is also what makes it the "best of times" in terms of here-and-now opportunities.
Exploiting the wide disconnect between public perception and the inevitable reality of the looming "oil and gas showdown" headed our way is exactly how sharp-eyed contrarians get rich. It's a textbook example, right in front of our eyes, of how new fortunes are built in the aftermath of crisis.
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This article has 16 comments:
1) it was the idiotic Bush policies of a) backing the puppet in Georgia and b) announcing missiles in Poland that have directly led to Russia's response. Russian "experts" in the administration such as Condo Rice should have known this.
2) the IEA has been consistently wrong in their long-term projection of oil prices, $200 by 2030? please. with any kind of decent economic activity, you will see $200 by 2015. that is the year that CEO's at conocophillips, hess, and shell see worldwide supply simply not keeping up with worldwide demand. the IEA is controlled by the oil companies to in order to keep the world addicted to oil. it is working, especially in the US because we have lost 8 years under bush.
3) the twin american time bombs (fiscal deficits and 70% addiction to foreign oil), long term must cause a weakening of the US dollar, which will push US dollar denominated oil higher
4) electric cars are not only viable now, if you add up the cost to the economy of not having them, they have been viable since GM killed the EV1.
5) natural gas powered transportation solutions are simply a no-brainer, and we must have them. see my related article SA published today: we should DEMAND nat gas powered vehicles in return for tax-payer subsidizing of the manufacturers of Hummers and SUV's who now want the middle class US taxpayer to bail them out.
It will rebound, and spectacularly fast as demand in China and the oil producers will not sink to anything like the extent in the West.
This rules out recovery and makes years of recession inevitable, in fact until oil and gas is substituted.
The IEA is ridiculously optimistic in it's projections for the finding and developing of new oil sources as old fields deplete.
They are projecting totally different trends to the last 30 years.
Of course, they are an agent of Governments, and hence have to 'look on the bright side of life'
The depletion rates for oil fields of around 9% are accurate though.
It boils down to sinking supplies by 2012, getting worse all the time as demand in China and elsewhere rises.
The way the two will be reconciled is by permanent depression and falling living standards in the west.
Couple that with the unwinding of the debt position and of the vastly inflated house prices and you are looking at the next 20 years at least being hard times.
Because of the lag time in revving up production in oil and gas production new supply will be bid thru the roof....May 2009 oil @ $110..by July it's again around $140..and it won't be because of speculation..The story on nat gas is even better...It will by Fall 2009 start to be used on a much greater scale as a vehicle fuel..In fact, my guess is that the "saving" of the motor morons will be tied to this "enlightened" new approach.
Ethanol will also be back..but it will be from Brazil in the sugar based form..Corn will go back to what nature intended..feeding people and serving as a critical animal feedstock.
In the seventies it wasn't thought there was any use for it. In the eighties we figured out how to extract it. In the nineties we began drilling for it in Alaska and in 2000 Clinton signed the Methane Hydrate Act. Over the last eight years the infrastucture to go into production has been placed and next year they will come on line in Alaska and off the coast of India.
Oil should go back to its former levels soon as the world really only has a decades worth of the stuff left till the last drop is gone, and alternative energy infrastructure won't all be in place by then, but starting next year methane hydrates will be in the pipeline.
Missile defense..as many things are with Russia..a marker of how committeed the West is to standing up to the Moscow thugs.
The most promising thing on the distant horizon – in my opinion – is algae. It is 1000 times more efficient for producing fuel than ethanol, and it does not compete with a food source. Take a look at some of the amazing things being done by Valcent-dot-net with Algae. I think there is some real hope here.
> jack
Surely the supply of oil is finite, but even at todays $65 it will inspire many alternatives and MUCH conservation. Extremes in prices as we have just experienced (like we did in the late 70's/early 80's and demand collapsed by.... 25% IN THE USA!!!!!) are not good for long term oil/energy prices.
The huge imbalance of priorities between producers and suppliers makes it inevitable that other less economic alternatives will be found before the supply of oil runs out... the suppliers are just too unreliable - consumers cannot run their economies that way.... and won't.
Naturally, it's not easy to agree with everything. "Standing up to Moscow thugs", for example. Standing up to them for what? Standing up to Soviet thugs gave me a marvelous 5 year vacation, mostly in Japan and Germany, preparing for a war that was never going to come - couldn't come in fact given the realities of nuclear missles. Is it really true that there are people who want us to go down that road again? Of course, doing pushups on concrete covered with spit and snot provided some nice memories.
Ignore Geo, if it wasn't his idea and he doesn't understand it, he always demeans it. His views are infallible, to himself.
Sadly Putin has joined with Chavez and Ahmadinijad in playing international politics for every petrodollar it is worth. Hopefully Mr Obama will not take the bait. We need a return to previous efforts towards nuclear disarmament and missile reduction, something the Bush administration did much to undermine.
2) Ah, geopolitics thrown into a lot of the comments. The prize of the international monetary peg is considered 'up for grabs'. This is the stuff of wars and higher oil and gas prices.
3) The hostile regimes, put Russia Iran and YES China into that camp see Israel as a strategic barrier to some of the GCC countries that supply us. This point should weigh in on your investment strategy in regard to energy. Let's not forget the US printing effect and the devaluation of the dollar ready to assume it's ugly march and in the short term.But I do disagree with Biden we'll see widescale hostilities in the Middle East in the short term. We might see what a practice run looks like but I suspect it will be 3-4 years at this point before you see hostile regimes make an all out move to remove Israel. And when they do, they'll wind up with the Sampson Option, a very bad thing for the globe and these nations underestimating Israel's desire to survive as a nation.