Some Consequences if Oil Prices Stay High

Director of Zacks Equity Research Dirk van Dijk, CFA has long considered the affects of sky-high energy prices for an extended period of time on the overall global economy. Today we have him spell out a couple scenarios that may be plausible in the months and years ahead.

What do you foresee if oil prices remain at high levels?

Well, the downside could be massive wars over resources and a major collapse of the world economy. However, let’s focus on a more middle of the road case, one where in real terms the price of oil remains where it is today.

For the most part, these are changes that will occur due to market forces, with relatively little need for changes in public policy. Stable real prices for oil would imply ongoing demand destruction in the OECD [Organization of Economic Cooperation and Development] countries combined with some slowdown in the growth of consumption in the emerging economies. The magnitude and the shape of the demand response to changes in price differs greatly if the change is seen as permanent, or just a temporary spike. So far most of the responses we have seen to higher oil prices seem to reflect the view that high prices are just an aberration.

What sorts of changes would we expect to see, say a decade from now?

Well first and foremost would be the “great slowdown.” We will probably see the return of the dreaded “double nickel” speed limit. However, more significant than this would be a slowdown in freight shipments, most notably by changing the mode of transportation, not the slowing of each mode.

As a general rule of thumb, each mode shift results in a five-fold improvement in energy efficiency. Fewer goods would move by air freight, particularly if there was no ocean to cross. This will mean that firms like FedEx (FDX) and UPS (UPS) should be considered like the airlines are today, firms you only rent for a tactical trade, not as something you seriously consider investing in for the long term.

Those goods would be shifted to the next slowest mode of transportation, trucking. A large percentage of the goods that are now carried by trucks would be shifted to rail. Truckers who concentrate on full truckload cargos would be at more risk than those that do a large amount of less-than-truckload business.

Since most of the population lives near the coast or on a navigable waterway, we may see a return of inter-coastal shipping. The amount of energy conserved by each class of shipping taking one step slower would be enormous. To pull this off would require quite a bit of investment in infrastructure, in particular refurbishing (or creating) ports and upgrading the carrying capacity of the rail system.

Firms that made rail cars would benefit while makers of big class eight trucks will suffer. Where rail was used, it would be primarily for the long haul, with trucks still used to go the last 50 or 100 miles. This would mean that businesses would have to keep larger inventories on hand, since they could not count on the part to be there exactly when they needed it anymore (not to mention the greater amount of inventories in transit).

Warehouses could make a comeback. This will result in a need for more working capital, and will reduce returns on assets, but hardly to a crippling degree.

Some things we have grown used to have become simply unavailable, but they are not particularly critical to the running of the world economy. For example, it is no longer feasible to fly cut flowers from the southern hemisphere to the U.S. in the middle of winter. Valentines Day will be much more expensive. There will be less fresh fruit available off-season. Given the energy-intensive nature of modern agriculture, food prices in general will be higher than we have been used to over the last several decades.

It sounds as if many things we’ve taken for granted, like air travel, would be considered luxuries.

In terms of personal transportation, air travel has once again become more of a luxury good. It is still widely available, but there are fewer flights, they are more crowded and it is significantly more expensive. Business travel is down as more firms use teleconferencing for routine meetings, although if it is important enough, businessmen still travel. Up until this point, telecommuting has largely been a question of lifestyle (i.e. more time with the kids), and sort of considered a perk by most firms. Look for a much larger percentage of workers to be doing so from home.

Elsewhere, with broadband Internet connections, there is little real need for most office workers to actually be in the office. This trend will not be good for commercial real estate. With more people working from home the demand for office space will fall, and with it office rents.

It also implies that major hardware suppliers for the Internet, firms like Cisco (CSCO), will continue to be well positioned. Working from home will be particularly attractive to those people who live in the exurbs. Telecommuters may be the only people who can afford to live in communities 40 miles from an urban center with no good public transportation. Housing prices will recover much more quickly in the cities and the inner ring of suburbs than in the outer suburbs. Many McMansions built in those communities may never sell for the prices they went for when first built a year or two ago.

Do you see this affecting the auto industry in any profound ways?

Cars are still in use, but by this time the remaining auto firms have shifted most of their production to smaller, more fuel-efficient vehicles. Plug-in hybrids have picked up a significant – but still far from dominant – share of the new car market, but are still about as common as a Prius is on the road today. Large SUVs and pickup trucks have become niche vehicles largely used for commercial (or agricultural) reasons. This mix shift, while very bad for profitability, will certainly help the auto firms meet the new CAFE standards.

People will consider it normal to rent a truck for those occasions that they need to tow something. Taking public transportation to work is no longer frowned upon (never really the case in a few large urban areas, such as New York and Chicago, but very much the case today in many areas). Ethanol has become a major source of liquid fuels, although most of the production is derived either from cellulosic sources like switch grass or wood chips, or from algae.

Are electric cars a major consideration?

The ongoing shift towards plug-in hybrids increases the importance of electricity in the overall energy mix. If the Chevy Volt can be produced in a large enough quantity soon enough, it might be the savior of GM (GM).

How about other forms of alternative energy?

Wind has become a major energy source with a band of wind farms running up the Western Great Plains. The manufacture of wind turbines is one of General Electric’s (GE) biggest business units, both for domestic use and for export.

Hopefully by that time, the engineering challenge of how to deal with radioactive waste will have been solved, and a large number (say 30 to 40) nuclear power plants are either under construction or have come on line. However, if that challenge cannot be solved, it seems foolhardy to be creating and storing large amounts of waste above ground in a post-9/11 world. We will probably have to relax the standards for the length of time the material has to be absolutely safe, from the current 100,000 years to something a bit more manageable, but still very long term, say 10,000 years (which going back rather than forward reaches beyond even the earliest villages on Earth).

Dirk van Dijk, CFA is the Director of Zacks Equity Research.

Comments

[BudH]

The nuclear waste issue was on the verge of being solved. Then Harry Reed became majority leader of the Senate. He said "No way, not in Nevada."

[Anthony Ettaro]

I didn't see mention of CSPs - Concentrated Solar Power stations--utility grade solar-steam-turbine electricity generators, such as those built by Ausra. Will these be a factor in energy production?

[Barry's Pharmacist]

What's wrong with loading up a rocket and shooting radioactive waste out into space? Isn't pretty much everything radioactive out there? Kinda like throwing sand on a beach.

[User 169775]

@ Barry's Pharmacist:

I think the chief objection to using a rocket to shoot nuclear waste into space is that rockets are only 98% reliable. Which means for every 50 launches, there is going to be 1 failure where the rocket blows up in the atmosphere during its booster stage.

A rocket filled with nuclear waste blowing up during its booster stage would not be good for the folks living in Florida. :-)

[Wadhamite]

I don't see anything about bicycles in your article. They have been used for a century in much of the world. I predict a significant return to them in the United States out of economic necesssity.

[BudH]

Also, regarding shooting nuclear waste into space via rocket; Nuclear waste is extremely heavy, heavier than lead. Massive rockets would be necessary. Along with the risk of scattering nuclear material if there were a rocket explosion as said above. Burying it in a deep hold under Yucca mountain, or similar place, seems the best solution at this point.

[sad-old-git]

Actually I think burying deep into the lithosphere on the edge of a convergent tectonic plate is the best bet. That will eventually send it into the Earth's core where it came from. Plus it will give all the out-of-work drilling companies something to do when we run out of oil.

[john s. gordon]

we have known since 1973 (or earlier) that there is nothing more efficient than a steel wheel on a steel rail. nevertheless - thanks to d.d.eisenhower and the trucking industry lobby we use rubber tires. remember the 1920's in los angeles - they had the best interurban light rail system in the country, then these were bought up by union oil, genaral motors & firestone acting in concert, the rails were torn up & sold for scrap (the nipponese needed the iron to make bombs for china) & the system was replaced by stinky diesel buses. in 1967 we had the w&od railway in my neighborhood, a nice little freight carrying commuter railroad, but then the rails were torn up & sold for scrap & the right of way became a powerline r.o.w. so - shortsightedness never ends.
> jack

[RogerScott]

The market is already reacting. PCAR is down about 30% and BNI is up about 10% YTD.

[blink0404]

As the market continues to go down, shipping, which used to be a safe haven, now looks like it may be subject to a downward trend. Here's a pretty good podcast that discusses what to during this down market and what's going on with coal, steel, bulk shipping, and agriculture.

the main idea is that individual investors dont have to act like institutional investors and this market and may be better holding cash than trying to beat the market.
www.greenfaucet.com/sh...

[Frankie62]

Sad Oil Git - Re Nuclear Waste - Do you realize there are often volcanos in that ring of fire around the techtonic plate edges? And mountain building goes on around techtonic plates - it could end up on top of or inside a mountain - what a great waterfall that would be. And do you really want to gamble that the waste will have made it down to the magma before a volcano erupts? Now that could be an interesting volcanic eruption if it included nuclear waste. That volcanic ash cloud could circle the globe in a short time. And those old familiar claims that we can bury the waste deep enough not to reappear in the ground water - I don't want to drink any of the "spring water" from that area - do you?

[librlman]

Yucca Mountain has too many faults to gaurantee containment integrity for the radioative lifetime of the waste. While the prospect of radioactive waste leaching into the water table in 10000 years (plus or minus) may seem an unreasonable concern to many of those living now, some people prefer to deal with our own problems rather than passing them to future generations.

As for burying it along a convergent plate boundary (CA, OR, WA... NIMBY, anyone?), there are several factors that make this prohibitive: 1) dewatering of subducting plate may allow waste materials to leach upward along the plate boundary and thru faults; 2) the volumes of waste material (much of which is solid) can't be piped down 10's of 1000's of feet thru a well-sized hole... it would require a massive pit (issues with structural collapse from overburden of rock, flooding of the shaft requiring a massive pumping system, and what happens when earthquakes hit while you're digging thru hard and soft rock layers... and they will); and 3) if you somehow get it all down there and buried, there is no gaurantee it won't integrate into magma that's headed toward the surface in a few hundred or thousand years (what happens if it sprays into the air as part of an ash cloud?).

Bottom line, Yucca Mountain is too expensive a boondoggle for a temporary storage solution (100 years +/- until a better solution should be found), one that politicians might choose to turn a blind eye to later. The mine shaft to Hades is a non-starter (more expensive and unpredictable than Yucca Mtn.). Far better to try and reprocess/recycle/repu... what there is, and limit the new waste being produced (phase out nuclear reactors in favor of wind, wave, pv, solarthermal, and geothermal). If you insist on using nuclear power, pour money into developing thorium-based reactors (theoretically safer, fuel is more abundant, and produces far less radioactive waste) to replace the uranium reactors.

[librlman]

EDIT: "reprocess/recycl... from above post should be "reprocess/recycl...

[librlman]

EDIT, part II:

that is, "reprocess, recycle, or otherwise repurpose"

let's hope is doesn't get mangled a third time in publishing

[Deweyp]

#1 Solar.
#2 Wind.
#3 Hydro (dams, tide movements, river currents, water falls)
#4 Earth Mining (shale oil, yellow cake, oil drilling off shore)
Sound familiar? Been around for centuries. Problem is we have bought into the theory that anything we humans do is destructive to the environment and therefore should be eliminated. Some would go so far as to include all of us, as we, they conclude, contribute to the problem.
It seems to me that it is time to show these bozos, who have used our system of freedom to advance their repressive ideals, that they are truly
out of step and in the minority and we will not allow it to happen. Ours is the very best system in the world and we should do all possible to protect it. We should not allow offshore companies to delude the American public into believing that they are superior, and therefore should replace our own highly efficient and high quality products, that in most cases the American company was the inventor of. Let us begin to explore and use, the wonderfully developed products that American industry has provided, and show the world that ours is the template of freedom that most desire, rather than the quirky society that the press seems to love to show the world. We are so much better than that!!

[Vilhelm Black]

In 10,000 years, we went from chucking spears at mammoths to the atom bomb. In less than 100 years, we went from adding numbers with pencils and paper to the internet. It's safe to say that in 1000 years, we'll have figured out how to neutralize radioactive waste, or at the very least annihilate it.

In 10,000 years, assuming humans are still alive and hanging around on this planet, it will be a non-issue.