Energy Update: Coal Use Starting to Dominate

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 |  Includes: KOL, USO
by: Wyatt Investment Research

QE2 has unleashed a raging bull market for gold and silver. But the falling dollar is also pushing oil prices higher, too. Oil is zeroing in on its 52-week high. And oil stocks have been performing very well.

Now, as you now, I was recently at the Association for the Study of Peak Oil (ASPO) conference in Washington, D.C. The main reason I went was to see my friend and Energy World Profits editor Gregor Macdonald speak on the "Rise of Coal."

I will offer Gregor's perspective on coal later. First, I want to tackle some of the bigger issues of Peak Oil, the most important being that global oil production appears to have peaked in 2004.

This chart, from the September 22 issue of Energy World Profits shows the supply situation.

One of the most interesting observations from this chart is the supply response during 2007 when oil prices ran to $147. You might think that oil companies would pump as much oil as possible to take advantage of record high prices. I know I would...

In fact, oil companies probably did pump as much as they could. But it wasn't enough to match peaks from 2004 and 2005.

Again this year, we can see that supply has failed to increase as oil prices have moved above $80 a barrel. In fact, supply has been falling this year.

Many economists, investors and even oil traders have a tendency to use U.S. oil demand as the driving force for oil prices. From the April issue of Energy World Profits, Gregor wrote:

To economists, oil analysts, and political scientists the conditions we face today, just five years later, would have seemed bizarre. And I don't refer so much to the financial crisis. No, I refer to the fact that oil now trades at $82.00 dollars during the worst recession since WW2. And not only is the recession the worst in size and scope, but it's the worst in duration also.

It would have been unthinkable to the Wall Street Journal, Foreign Policy Magazine, The James A. Baker Energy Institute in Houston, The Department of Energy, and many TV pundits that oil could be at $82.00 dollars in the aftermath of a financial collapse. In fact, it was indeed unthinkable to all those organizations and media outlets just mentioned--and they said as much, week after week.

As Dan Yergin wrote in 2005, only "above ground" factors could push oil higher in the years ahead. My comment: any 2005 roundtable on the future price of oil would have agreed that only an attack on Saudi Arabia could place oil at $82.00 dollars a barrel in the midst of a severe recession in the United States. After all, the United States with its outsized demand has historically set the price of oil. During a deep recession in the US, oil should be at $12.00 dollars, not $82.00. How did the US lose control, of the price of oil?

The controlling factor now in global oil prices are the five billion people in the developing world. They use less oil per capita and derive more utility from each barrel. Which is a good thing, as the global supply of oil is now unable to make a sustained response to higher prices.

Ever since the financial crisis of 2008, Americans have been plagued by the feeling that we, as a country, have squandered our surplus wealth and now are a nation in decline.

After all, driving a Hummer was a status symbol just a few years ago. But today, you'd probably get some dirty looks tooling around in a gas-guzzler like that.

On an individual level, Americans may feel as though we took asset prices (like houses) for granted and spent too much money and failed to save.

A similar situation exists for the country as a whole. But Gregor suggests that the root cause is energy prices...

...the West, both in its private balance sheet and public balance sheet, is carrying very high debt levels that are marked to even higher nominal prices. There is simply not enough cheap energy to fund the type of very, very fast growth required to pay back this debt. And it’s no longer just a question of debt-saturation in the private sector, and impending private defaults.

Economists who propose creating a lot more government debt, in order to fund stimulus, clearly do not understand that these new tranches of debt -- which, by the way, become someone’s savings when they purchase that debt -- cannot possibly be paid back given that the world has now reached a plateau in oil production.

Now we can easily see why the world is transitioning back to coal. The bottom line is that it's cheap. And as oil prices rise, and we continue to resist greater investment in renewable energy sources or even natural gas, the only way to maintain a profit margin and grow an economy is with cheap energy.

In the following chart, you can see the path that coal use is on. Gregor projects that coal use will surpass oil sometime in 2014.

If you don't have energy stocks in your portfolio, you should. Oil, coal, renewables, these stocks will only get more valuable as investors become more aware of the true energy situation.