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First, let me applaud T. Boone Pickens for putting all this energy, time and money into a very important issue. His plan is to use wind power to replace 20% of the US electric grid, freeing up natural gas to be used in the US transportation fleet. First lets recap a few points of Pickens' to ponder:

  • US oil production peaked in the 1960s and 1970s.
  • US oil production is now at 5 million barrels a day, the lowest output in over 50 years despite record real prices - the US consumes over 20 million barrels per day.
  • The US consumes 25% of the world's oil, with only 4% of its population.
  • The US will send $700 billion dollars out of the country per year to buy oil.
  • Projected over the next 10 years, the cost for oil imports will be $10 trillion — the greatest transfer of wealth in the history of mankind.
  • World oil production peaked in 2005 at about 85 million barrels per day.

Much of the $700 billion the US spends to buy foreign oil does not go to unstable countries. Canada and Mexico are two of our largest suppliers. But billions of dollars do go to countries that may fund anti-US activities. Bottom line: $700 billion is leaving the US economy.

How has the US boxed itself into this nasty oil corner? The answer is the power of the monopoly. Over the past 100 years the US has built (with tax payer dollars), an enormous vehicle transportation infrastructure based on only one energy source - oil. This oil infrastructure monopoly will not allow competition, as the barrier for entry is just too high.

Free market systems no longer work with a publicly funded monopoly in place. We already have many cheaper alternatives to the oil based vehicle. One can fill up a natural gas vehicle for under $2 a gallon. Electric vehicles cost less than $1.50 to charge.

Eventually economics will force the US energy vehicle infrastructure to move away from oil, but during this time we are putting ourselves at a huge national security and economic risk. A small conflict in the Middle East could close the Straits of Hormuz for months. This would not only create huge price jumps in oil products but create fuel shortages and rationing that would send the US into a long-lasting depression.

We can not dig or drill ourselves out of this problem. T. Boone Pickens has been saying this for over a year. The only result will be a bigger to crawl out of.  Almost every drilling rig is in use. Drillers can't find workers to work on their existing projects. Listening to many energy conference calls, I hear the same thing: There are no workers available for this type of work. Here are some recent comments from Stacy Locke,  CEO of Pioneer Drilling, a San Antonio-based contract land drilling company:

The labor market is extremely tight for all energy personnel. It is extremely challenging. You can't just hire a truck driver and make him a tool pusher.

A tool pusher, the top hand on a drilling rig who supervises the crew, is the worker most in demand. In the past,  it could take a rig worker 10 years to rise to the tool pusher's job. Working up from floor hand to derrickman to driller could take five years.

The crux: more oil exploration, or real investment in alternatives for oil?

We are now at the crux. The US could try and build new rigs, train new workers, and spend huge amounts of money for more oil infrastructure, or the US could spend that money and focus to move vehicles away from oil, and create the infrastructure for renewable energies such as solar, wind, biofuels, and non-oil infrastructure creating American jobs and stop sending $700 billion to foreign countries.

Should the US open up more offshore areas for oil and gas exploration? This should be on the table as part of a REAL US energy policy. But as discussed above, this will have almost no effect on global oil prices as we do not have any more spare oil infrastructure to increase supply. Another reason more drilling in the US will not effect pricing are the concepts of net reserves, and well to wheel efficiencies.

Concept of net reserves

This is very important. Everyone should watch the move "There will be blood". It depicts how digging for oil works in a free market system. The easy oil gets sucked dry first. Back then, oil would just explode into the sky. Now we need to pump millions of gallons of water down the hole to bring up an ever shrinking amount of oil. It takes a lot of energy to pump water around.

60 years ago, it may have taken 1 boe(barrel of oil equivalent) to bring up 100 barrels of oil. That a 99% energy efficiency drill ratio. So the net reserve of that well would be 99% of the total recoverable amount. Now to get that 100 barrels out of the ground it may take 50-100 boe to extract, a 50% or less ratio. So actually reserves figures are meaningless, its the net reserves after you calculate the boe to extract the oil.

I am actually worried about negative energy drill ratio's. It is very possible we will see more energy used than the energy content of what is extracted. How can this be? Simple - natural gas is used to drill, and pump for oil. Since the price of NG is less than 50% of the price of oil based on energy content, we could be losing energy and still making economic profits. This scenario is devastating for the US energy picture, as we could be throwing away a precious US resource - natural gas.

Well to wheel efficiencies

This is an important concept when discussing a comprehensive US energy policy. In most studies, the electric engine is twice as efficient(full cycle) as the oil based combustion engine. This means the US will use half as much total energy, and reduce pollution by half if we move to electric engines. With the above economics of net oil reserves discussed above, this huge efficiency benefit from alternative engine types(electric, and NG) will continue to increase, as oil extraction requires more and more energy.

Pickens' plan implementation

His plan calls for natural gas vehicles, but electric vehicles may be an even better idea. From a free market approach, the US should not try and pick which alternative engine will be used. The US should just make it so the current oil based engine is not used, and let economics decide which is the best replacement. There are two methods that could work in a 10-15 year time frame.

US mandate

A simple mandate could be as follows. By the year 2015, no new  vehicles with oil based propulsion systems, are sold in the US. By the year 2022: no vehicle oil based fuel at filling stations. During this time, the US could start a vehicle recycling program to help lower income drivers switch to the new vehicles.

The energy consumption tax approach

Shift away from income taxation into energy taxation. This would actually be a tax reduction plan. Income tax avoidance is growing, and now is 20% of the economy in my opinion. This 20% illegal underground economy currently pays very little in taxes. These tax cheaters will now pay more taxes.

By shifting to gasoline taxes - US workers will have more disposable income after paying these new energy taxes, since their wage taxes would be reduced by more then they pay in new consumption taxes. The US could set the gas tax as follows:

Set minimum gasoline prices:

  • 2009 - $5.5
  • 2010 - $6.0
  • 2011 - $7.0
  • 2012 - $8.0

To offset the regressive nature of consumption taxes, the US could change the wage tax structure. Currently, low income earners pay 15.3% SS wage tax, and since the tax stops at around 100K, high wage earners pay a much smaller %. A new structure could be the first 12K of w-2 with a zero SS tax rate, then 15% up to 150K of w-2 income. With the above consumption tax revenue, the income tax rates could be lower at all levels.

I think the US should use both methods concurrently. With the new minimum gas prices, the alternatives would finally be funded from the private sector. The fear of the oil infrastructure, and lower oil and gas prices once these alternative get funded has stop any real funding in the past, and will continue to do so in the future. By setting the minimum price to the consumer, new companies will be funded, and stimulate the economy.

Investors insight

This plan will benefit the natural gas stocks. If we use natural gas vehicles - demand goes up. If we use electric vehicles, the grid would need more feedstocks like natural gas, so demand goes up. Also wind farm production would help steel stocks that sell into the power generation area. My favorite equities based on the Pickens plan are:

  • Apache (NYSE:APA)
  • Devon (NYSE:DVN)
  • Chesapeake (NYSE:CHK)
  • Provident (PVX)
  • Enerplus Resources (NYSE:ERF)
  • XTO Energy (XTO)
  • Universal Stainless (NASDAQ:USAP)

Disclosure: The author currently owns USAP.

Source: Implementing Pickens' Plan for Public Energy Policy