Energy Will Lead the Next Commodity Shortage

This article originally appeared in the July, 2009 edition of the Casey Report.

In 2008, prices of oil, natural gas, gold, silver, copper, corn, wheat, and most other commodities reached multi-year, and in some cases multi-decade, highs. They’ve fallen sharply since then, but commodities aren’t going out of business. Another peak is coming, and it will be far higher, especially for oil.

The price run-up to 2008 came as a debt-induced economic acceleration in the developed countries sucked in imports from the emerging economies of Asia. Virtually all the world was gobbling up commodities, but supplies were still choked by the preceding decades of underinvestment in mine development, processing plants, pipelines, railroads, and other elements of the industrial infrastructure needed for producing and transporting raw materials.

Faster consumption and static production capacity had an unsurprising effect -- prices rose. Then they rose some more and kept on rising. And in the later stages of the commodity price boom, investors, especially hedge funds, joined the bidding as a way to bet on a growing world economy. More bidders, more price push.

But not forever. When the credit bubble that had been overstimulating just about every industry became unsustainable and financial markets everywhere collapsed, commodity prices collapsed along with them in anticipation of a deep recession or worse.

The recent bout of low commodity prices and the continuing weakness of the financial system are setting the stage for another, even bigger commodity boom. For a short while, high commodity prices had been drawing capital into commodity production, but that stopped when prices fell. Now, while government bureaucrats are funneling hundreds of billions to weak banks, sick insurance companies, clueless automakers, and the politically well connected, the capital needed for new mines, pipelines, drilling projects, refineries, and crops has dried up. There will be consequences. When the economy crawls out of the current recession, today’s paucity of investment in commodity infrastructure will leave us with meager supplies and roaring prices.

There will be a shortage of commodities in general, but the shortage won’t be uniform. Energy will be the stand-out for tight supply and rising prices.

The decades of low oil prices shown in the chart meant minimal exploration and little investment to develop existing fields. The price surge in 2007-2008 did give an enormous boost to drilling, but the boost was short-lived. This year’s collapse in oil prices to $35 a barrel compelled oil companies to cut the number of rigs in service, consolidate operations, lay off workers, and delay or cancel projects. The atrophy in production capacity and the credit crunch's impact on exploration are setting the stage for a dramatic price rise.

That’s oil, but you could say more or less the same about most commodities. For oil, however, there’s more to the story. Four factors are now at work to make oil the price leader in the next commodity boom.


Factor # 1: Peak Oil

William Cummings of ExxonMobil (XOM) tells us, “All the easy oil and gas in the world has pretty much been found. Now comes the harder work in finding and producing oil from more challenging environments and work areas.” That’s about as cheerfully as the harsh reality can be put. After 150 years of harvesting the Earth’s “low-hanging fruit,” new supplies of oil are going to be progressively more difficult to find, and most of what is found will be expensive to exploit. That by itself means higher prices.

Mexico is a stark example of Peak Oil. Virtually all Mexican output comes from Cantarell, in the shallow waters of the Gulf of Mexico. It’s the second largest oil field in the world and is run by the state-owned Pemex.

When Cantarell was discovered in 1977, it held 17 billion barrels of oil. Since then, the Mexican government has been spending the oil revenues for the benefit of the “right” people and for the all-important project of holding on to power. Pemex isn’t a sideline for the Mexican economy; it provides 40% of all revenue the government collects.

The state is so dependent on oil revenue that Pemex built a nitrogen-injection project to push the oil out faster. It worked, but at a price. In 2004, production rose to 2.5 million barrels per day. But it’s now declining at a rate of 15% per year, and the decline is irreversible. Mexico won’t be an oil exporter for long.

Mexico, like most other oil exporters, is merely retracing the history of the U.S. oil industry. Because it was the one place where easily exploitable petroleum resources, a ready market for petroleum, and respect for property coincided, the U.S. was early in the oil business. Early to start, and early to peak. Its production history is a preview of how Peak Oil works.

In 1973, the United States imported 30% of the crude oil it used. By 1977, imports had risen to 44% of consumption. Then, following a mini-boom in the development of marginal fields that had been made practical by the high oil prices of the late 1970s, imports dropped off to just 25% in 1985.

Since then, imports as a percent of domestic use have been in an almost steady uptrend. They now account for 66% of total domestic crude oil consumed. If the trend were to continue at the rate of the last two decades, in 2028 the U.S. would be totally dependent on imported oil.

Of course, the import trend won’t continue in a straight line to 2028, because production is now declining in the rest of the world. In 2004 the U.S. imported 600 million barrels of oil per year from Mexico. By 2012, total Mexican production will have declined to only 180 million barrels per year, and none of it will be available for export to the U.S. or anywhere else.

Factor # 2: The Big Green NO

If oil is destined to be scarcer, common sense tells us to look for alternatives. But for the Green extremists, only certain “clean” alternatives are worth considering.

The Greens demand that fossil fuels be abandoned in favor of sources that are cleaner and renewable. That immediately excludes coal, which is a giant exclusion. At current consumption rates, the U.S has more than 250 years of the dirty black stuff. That’s more energy than the entire world reserves of recoverable oil. But the Obama administration plans to phase out coal, because it’s been tagged as a global warming villain. The cap-and-trade bill that recently squeaked though the House of Representatives is part of that plan. Approval by the Senate would push the U.S. deeper into the energy scarcity hole.

The Green agenda favors solar power, wind power, geothermal energy, and hydropower (provided no fish are inconvenienced). The Greens also like ethanol, even though producing a gallon of ethanol eats more energy than a gallon of ethanol will produce. In the last decade, 160 ethanol plants have been built in the U.S., but only because of expensive subsidies from taxpayers.

The Green agenda isn’t looking for marginal changes, improvements here and there, or a mere tidying up of the energy industry. Given the prominence of fossil fuels as energy sources, what the Greens are seeking is a wrenching revolution.

Here’s where we are now:

Energy Source	% Usage
Fossil fuels (oil, natural gas, coal)	87%
Nuclear	7%
Hydropower	3%
Ethanol	1.5%
Windmills, solar, geothermal	1.5%
Totals	100%

The Green agenda calls for the “87%” to be replaced by “%.”((0%?)) It’s not going to happen, but part of the Green effort to move things in that direction is political opposition to the development of fossil fuel sources. That opposition will worsen the scarcity of oil.

Meanwhile, it will take decades for alternative energy sources to even begin to offset the decline in oil production. T. Boone Pickens argues that by investing $1 trillion to build wind facilities in the corridor from Texas to North Dakota between now and 2020, we could produce 20% of the nation’s electricity. And that, he contends, would free up our vast natural gas resources to be used as fuel for truck fleets and ultimately automobiles. Perhaps he’s right. Perhaps he’s completely right. But it will take eleven years to prove it.

And nuclear? Even though it substitutes for fossil fuels, don’t expect the Greens to allow nuclear energy to come to the rescue. Currently, 104 nuclear reactors generate 20% of the electricity in the U.S. But they were all built before 1982. Because of a slow and brutally expensive regulatory process and because of latent political hostility, any undertaking to build a new plant and bring it on line would take ten years. There are some dissenters on this point among the enviro-fundamentalists, but for Greens generally, nuclear power is forbidden fruit.


Factor # 3: Neglect of Infrastructure

The infrastructure for producing petroleum products is rusting away and falling apart.

Not a single oil refinery has been built in the U.S. since 1976. The number of U.S. refineries has dropped to 149, less than half the count in 1981. Because of operating improvements and expansions at the surviving refineries, shrinkage in capacity has been held to only 10%. Meanwhile, however, gasoline consumption has risen 45%.

As new sources of easy-to-refine light oil become harder to find, the world will become more dependent on its abundant sources of difficult-to-handle heavy crude. One-third of Saudi Arabia’s 260-billion-barrel reserves are heavy crude. Worldwide, about 40% of oil resources are heavy or extra-heavy crude, and another 30% are in oil sands and bitumen, which are even more difficult to refine.

The U.S. isn’t ready for heavy crude. Only 30% of U.S. refineries can process it. And the U.S. isn’t doing anything to get ready. It won’t invest in anything that doesn’t look like a sick bank. Refinery capacity is already a bottleneck, and the bottle’s neck is narrowing.

The U.S. is clearly a laggard in refining. Canada, where 95% of reserves are in oil sands, has seen a rush of investment into producing and processing the super-dense resource. Saudi Arabia has promised billions of dollars in the next five years to expand its refining capacity to 6.5 million barrels per day, from the current 3.7 million, which will make them one of the largest refiners in the world. Meanwhile, the U.S. twiddles its thumbs and mumbles NIMBY.

The human element of the energy infrastructure is also in decline. Matt Simmons, the author of Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, warns that the best-qualified petroleum geologists and engineers are now retiring, with no one to take their place.

Factor # 4: Growing Demand for Oil

The world’s population will continue to grow, and developing countries will continue to grow more prosperous. Both trends will add to the demand for fossil fuels.

China and India are sucking up oil at an ever-increasing rate. China has seen oil consumption grow by 8% per year since 2002; it now exceeds 8 million barrels per day. China’s middle-class population is nearing 300 million people. While U.S. auto sales were plummeting in 2008, China's auto sales rose 6.7%, to 9.38 million units. Sales in the first five months of 2009 are 14% above a year earlier.

India’s automobile sales are on pace to exceed 10 million in 2009. By 2020, the country’s oil imports are expected to more than triple from 2005 levels, rising to 5 million barrels per day.

It isn’t just China and India that are adding to demand for oil. Others, notably Russian and Brazil, are doing the same. The non-OECD countries now have surpassed the OECD countries in energy usage. This trend will accelerate as the citizens of these countries grow wealthier and buy cars, TVs, and refrigerators.

Get ready for some loud but useless noise. When oil reaches $200 a barrel in the next few years, Congressmen will yell, posture, expound, skewer oil executives on TV, and get red in the face. They will do everything but admit the truth. We will be paying for decades of underinvestment in commodity infrastructure, malinvestment in ethanol, and lack of realism in answering the complaints of Green extremism.

The Department of Energy was created by President Carter in 1977 for the stated purpose of advancing the energy security of the United States. The Department now employs 109,000 people and spends $24 billion of taxpayer funds every year. The accomplishments of those well-funded 109,000 people have been few. We are about to learn in a way that no one will be able to overlook just how few.

Comments

[A Barrel Full:]

There is no doubt in my mind that we face a difficult future because of rising oil demand. However, I tend towards the view that the problems are political not geological.

1) Most of the world's leading oil producing countries positively chase away foriegn investment, whilst state owned companies mismanage reserves.
2) Huge numbers of consumers do not face the true cost of energy, due to subsidies. Therefore price signals do not work.
3) Some significant areas of production are off limits.
4) Politicians act like natural gas doesn't exist.
5) Politicians pretend that action on global warming will be free, stopping them from introducing effective measures (carbon taxes) whilst shovelling cash at useless projects supported by lobby groups.

If logic were king in capitals around the world, we could expect oil to remain below $100 for the foreseeable future. Unfortunately once the recovery has used up Opec's cuts, we are back on track for a massive oil price rise.

Oct 06 04:33 AM

[omega:]

This author's general thesis of upcoming shortages in fossil fuels is quite plausible. Too bad he let's his reactionary political ideology get in the way of a dispassionate evaluation of our predicament. To rail ad nauseum against the environmental extremists is to completely miss the point of why we're in our present day fix. We could only wish that greenies had anything like that much power in our large-corporation dominated political system (almost as true with the Democrats as with the Republicans). If we'd only taken Jimmy Carter's environmental foresight seriously instead of tossing him out of office in favor of Reagan's deregulation of big business and decoupling of federal spending from any semblance of control, we'd be most of the way off foreign oil dependence and onto a variety of renewable energy sources at this juncture -- and probably without the Iraq & Afganistan foreign entanglements as well as the wrenching collapse of the house-of-cards American banking system selling ponzi scheme worthless paper to the rest of the world.

Anyway, all political biases aside, the US might as well bite the bullet now in our time of distress and upheaval and get onto a sustainable energy track. Anything less is just delaying the inevitable day of paying the piper. There's nothing radical about investing in an infrastructure based on technologies and systems that are sustainable, local and independent for the foreseeable future. Natural gas certainly fills some of the bill, but we're likely to discover very shortly that global climate change is not a shrill alarmist cry but an enormous issue that will dominate our struggle to survive as a species. Virtually every scientist in the world who isn't beholden to corporate entrenched interests via having their research funded by an energy company has come to that hair-raising conclusion. I'm always bemused that so many Americans are repeatedly brainwashed so easily by corporate special interest marketing. You'd think that in light of the widespread anger these days toward the big banks and the Fed in collusion with the politicians for ripping the rest of us off to line their own wallets, most Americans would be suspicious of other similarly powerful big industry groups. But no, we continue to buy into their self-serving disseminations as they paint their enemies (ie those who want to free the people from their choke holds) as extremists or worse. Wake up and start to think for yourselves, people!

Various sources of renewable energy are currently extremely cost competitive with new developments of non-renewables, whether we're talking oil, natural gas, coal or nuclear. And that's without even considering the enormous subsidies these entrenched industries are enjoying, from infrastructure buildouts to taxation policies, and from taxpayer funded liability insurance to our fighting foreign wars. The challenge with renewables is they require a mental shift: they have to be site specific -- what works in the Southwest sunbelt is different than what works on the windy great plains or the geothermally active mountains of Alaska. Once the initial capital outlay is made (and for example, wind energy is cheaper than even coal in this regard), the fuel is free and it's difficult for the existing big energy companies to rake in the same profits. So of course they're doing their level best to discredit this whole trend with massive disinformation. Remind anyone of the tobacco companies?

Oct 06 07:20 AM

[O-B-WON:]

omega...

Excellent comment..!! +++

Oct 06 08:04 AM

[pockyclips ...:]

If Americans were charged the price of the war on terror, and the defense of the shipping lanes to get that terrorist oil back to the homeland, other forms of energy would not appear so overpriced.

"Green energy" is not an expense, it's an opportunity. As long as we show the rest of the world that we can't or won't change, they have no reason to either.

If the "free market" works so well, why are we in this mess?
We can see the handwriting on the walls, but refuse to read.

Oct 06 08:40 AM

[Dirk McCoy:]

Peak Oil is kinda like Peak Britney Spears- there's only so much to go around, but at a certain point there are better alternatives. Checking our highways, you'll see 80% of cars with just one passenger, getting 25mpg. At $150/barrel, 1/3 of those cars will be off the highway, substituted with either smaller cars, fuller cars, or cars left in the garage as workers telecommute.

And at $150/barrel, the rest of the world will not develop transportation infrastructure like we have. They weren't at $30/barrel oil. So coal (lots of it, because it's increasingly clearer that the wheels are falling off the AGW wagon) and natural gas will do the heavy lifting for the emerging electric car industry over the next 30 years while solar technology is further developed and can come in at $.05/kwh (in current dollars) to power the world for centuries to come using silicon made from sand.

And we're not running out of sand, or people to convert and install it, anytime soon. Meanwhile, shale and lots of other sources of oil become quite viable at $100/barrel. So while there may be short term shocks (even Britney Spears still sells some albums at higher than I think rational prices), I don't see $200 oil and massive push cost inflation, especially given the excess labor floating around the world.

Oct 06 09:09 AM

[bindlepete:]

If there is a presumtion that tickles me it is that the US, it's driving habits and economy are the domiant function in determining demand for oil.
Maybe this was so a few years back but it is now a world market. Yes we are a player but our influence in terms of conservation and alternatives to oil use are becomming far less important.

What ever we do will unlikely shake the market and reduce the price from it's current range of 66-72$ /bbl.

We no longer have the leverage.

Oct 06 09:57 AM

[thotdoc:]

"Anyway, all political biases aside, the US might as well bite the bullet now in our time of distress and upheaval and get onto a sustainable energy track."

From your mouth to God's ear.

I fear this is not going to happen.

It's funny. The people I talk to are willing to go through what we need to in order to straighten up our house. There is no political will. That may reflect the larger picture, but it may not.

Oct 06 10:09 AM

[Jimbo:]

Omega's comments prompt me to ask this question: If the environmental movement is so free of conflict, why are they opposing a solar energy farm in the California desert? They have even recruited a Senator from California to oppose it. Sorry, but my take on the majority of Enviros is that they want to take us back to the 18th. Century where human and animal power prevailed on land and wind power prevailed on water. This kind of regression is conducive to chaos and disorder. An electric grid based on Thorium reactors would be a much better alternative. The Greens need to make a choice: cooperate for a sensible solution or settle for nihilism.

Oct 06 11:49 AM

[Genesis:]

This article does nothing to prove we will have a shortage of "energy" before we experience a shortage in some other commodity. The title itself is absurd since "energy" is not a particular commodity but consists of a basket of commodities as well as renewable resources like sunlight, wind, and hydroelectric power. The author is talking about the long term, not the "next" big thing. This was a horribly inaccurate and misleading title.

Oct 06 02:15 PM

[woodsey:]

We settled for nihilism long ago.

Oct 06 02:32 PM

[woodsey:]

Genesis, anyone ?

Oct 06 02:35 PM

[James Quinn:]

SA made up the title. The original title was Bet on Stuff.


On Oct 06 02:15 PM Genesis wrote:

> This article does nothing to prove we will have a shortage of "energy"
> before we experience a shortage in some other commodity. The title
> itself is absurd since "energy" is not a particular commodity but
> consists of a basket of commodities as well as renewable resources
> like sunlight, wind, and hydroelectric power. The author is talking
> about the long term, not the "next" big thing. This was a horribly
> inaccurate and misleading title.

Oct 06 03:24 PM

[realold:]

You rail against politics then present yours. Not credible.

On Oct 06 07:20 AM omega wrote:

> This author's general thesis of upcoming shortages in fossil fuels
> is quite plausible. Too bad he let's his reactionary political ideology
> get in the way of a dispassionate evaluation of our predicament.
> To rail ad nauseum against the environmental extremists is to completely
> miss the point of why we're in our present day fix. We could only
> wish that greenies had anything like that much power in our large-corporation
> dominated political system (almost as true with the Democrats as
> with the Republicans). If we'd only taken Jimmy Carter's environmental
> foresight seriously instead of tossing him out of office in favor
> of Reagan's deregulation of big business and decoupling of federal
> spending from any semblance of control, we'd be most of the way off
> foreign oil dependence and onto a variety of renewable energy sources
> at this juncture -- and probably without the Iraq & Afganistan
> foreign entanglements as well as the wrenching collapse of the house-of-cards
> American banking system selling ponzi scheme worthless paper to the
> rest of the world.
>
> Anyway, all political biases aside, the US might as well bite the
> bullet now in our time of distress and upheaval and get onto a sustainable
> energy track. Anything less is just delaying the inevitable day of
> paying the piper. There's nothing radical about investing in an infrastructure
> based on technologies and systems that are sustainable, local and
> independent for the foreseeable future. Natural gas certainly fills
> some of the bill, but we're likely to discover very shortly that
> global climate change is not a shrill alarmist cry but an enormous
> issue that will dominate our struggle to survive as a species. Virtually
> every scientist in the world who isn't beholden to corporate entrenched
> interests via having their research funded by an energy company has
> come to that hair-raising conclusion. I'm always bemused that so
> many Americans are repeatedly brainwashed so easily by corporate
> special interest marketing. You'd think that in light of the widespread
> anger these days toward the big banks and the Fed in collusion with
> the politicians for ripping the rest of us off to line their own
> wallets, most Americans would be suspicious of other similarly powerful
> big industry groups. But no, we continue to buy into their self-serving
> disseminations as they paint their enemies (ie those who want to
> free the people from their choke holds) as extremists or worse. Wake
> up and start to think for yourselves, people!
>
> Various sources of renewable energy are currently extremely cost
> competitive with new developments of non-renewables, whether we're
> talking oil, natural gas, coal or nuclear. And that's without even
> considering the enormous subsidies these entrenched industries are
> enjoying, from infrastructure buildouts to taxation policies, and
> from taxpayer funded liability insurance to our fighting foreign
> wars. The challenge with renewables is they require a mental shift:
> they have to be site specific -- what works in the Southwest sunbelt
> is different than what works on the windy great plains or the geothermally
> active mountains of Alaska. Once the initial capital outlay is made
> (and for example, wind energy is cheaper than even coal in this regard),
> the fuel is free and it's difficult for the existing big energy companies
> to rake in the same profits. So of course they're doing their level
> best to discredit this whole trend with massive disinformation. Remind
> anyone of the tobacco companies?

Oct 07 12:22 AM

[realold:]

Yes, many keep making the same mistake. The U.S. is not the world. We can cap and tax, and China and India can build cars, coal fired electric plants at one a week, etc. We are a small part of the future and are doing are best to legislate ourselves toward zero.


On Oct 06 09:57 AM bindlepete wrote:

> If there is a presumtion that tickles me it is that the US, it's
> driving habits and economy are the domiant function in determining
> demand for oil.
> Maybe this was so a few years back but it is now a world market.
> Yes we are a player but our influence in terms of conservation and
> alternatives to oil use are becomming far less important.
>
> What ever we do will unlikely shake the market and reduce the price
> from it's current range of 66-72$ /bbl.
>
> We no longer have the leverage.

Oct 07 12:26 AM

[ArtfulDodger:]

Very well written, James. Clear and crisp.

Love those short, info-packed paragraphs!

Oct 07 01:02 AM

[rawhamburger:]

I worked as an expat engineer in Saudi Arabia for 17 years. When I started, water cuts(how much water/oil percent comes out of the hole) were about 20-30%. When I left in 2004 water cuts were choking the processing plants at a rate of 80%(20% oil). We couldn't process all the water so the plants could not even process the oil at design limits. Its only becoming worse and not much more to be found in the Middle east. WE ARE PAST PEAK OIL in my first hand view...

Oct 07 03:39 AM

[SeekingTruth:]

It seems to me we could all benefit greatly by reducing dirty and imported sources of energy some significant percentage a year without having to drive the amount of consumption all the way down to zero % as the author remarked as the goal of the greenies.
With a well coordinated national effort ,we could reduce them maybe 2 to 6% a year at least until we got it down to about half of what it is now, ie. 43% instead of 87%, that's still a long way from 0 %, but the relief would have enormous and extraordinary impact in a positive direction.
I once worked with a group of people that were extremely pro nuclear. Well , as their luck and fate would have it , a nuclear facility was later proposed to be built near their homes.
The outrage that went up and the extreme personal threats and threats of violence by these same community people against the proposed facility and the proponents involved caused the proposed facility to be totally canceled.
Shows how dramatically people can change their tune when they become directly impacted by danger to themselves and negative impact on their home and property values.
This happened near Durham in North Carolina, and can easily be researched if one has the inclination.

Oct 12 10:38 PM