On July 26th I wrote a piece about oil and energy which also focused on the speculative battery technology company EEstor and it’s minority owner Zenn Motor Company (ZNNMF). Since then I’ve given more thought and some added research to the matter. On July 29th, I posted a correction to my original pieces as follows:

re: the Zenn investment, it seems the information in my piece was incorrect. According to a 7/2/09 press release you can find at: http://www.emediaworld.com/press_release/release_detail.php?id=623265
the Zenn investment was $5M [not $700,00]. The other noteworthy fact from this press release is that Zenn was able to invest the maximum amount permitted under a prior agreement because other investors (presumably Kleiner Perkins) elected not to invest the amount to which they were entitled.

Nearly every oil observer - Simmons, Maxwell, Jeff Rubin, many others, and least of all myself - see oil prices rising in 2 - 5 years, probably to new heights, if the global economy continues to recover. That’s based on pretty accurate visibility of new oil supply over the next 5 - 7 years, fairly certain rates of decline in old fields, plus assumptions of demand growth rates for OECD, developing, and oil exporting economies. I provided my own version of this vision in my newsletter last month, saying, “I continue to expect oil supply tightness to manifest itself in 2011, as indicated in my March analysis.

This vision of oil supply tightness is not a happy economic scenario. Very high oil prices would likely cause global stagflation and a poor investing climate. It would be particularly painful for relatively poor people and poor economies. It would help only oil exporting countries, many of which are not friendly to liberal humanitarian forms of government. So not really a very happy picture.

This has nothing to with energy but I was amazed to read a recent WSJ report stating that “Executives and other highly compensated employees now [2007] receive more than one-third of all pay in the U.S.” And that doesn’t even include equity-based compensation like stock options which is often a huge percentage of total executive compensation!

It seems to me that American society is being increasingly polarized both politically and financially, and that the two are related. Not that the rich are in one political camp and the just-getting-by in another. Rather, it seems to me, the difference is more how you feel about the financial polarization than what pole you are in that determines your political outlook. People who think this trend is just fine (and some who feel that way don’t make the big bucks) tend to be Republicans and some who feel that it’s a problem and that taxation aught to be more of an equalizing force tend to be Democrats.

The stock market and the oil market both seem to engender feelings much like summer vacation time when I was a kid. Kinda boring, not much happening, a time to wander around, allow your attention dwell on whatever news of the day happens to come along and rest your mind before getting back to the “real world” some time around Labor Day. So we can be distracted by Gov. Sanford’s bazaar behavior, the political drama of health care reform, Berlesconi and his babes, or Wimbledon - all of which are equally unlikely to have any real economic importance.

One comment on a current event related to oil: I feel so sorry for the reform politicians and demonstrators in Iran who are not likely to change anything in the short term and in many cases will pay a very high personal price for trying. Obviously, many already have; 20 are reported dead so far. The seeds of Middle Eastern democratic reform sprouting in Iraq, Lebanon, and now Iran are like putting small deposits into a savings account. If you keep adding to the account over time and it keeps accruing interest, it could amount to something significant some day. But in the short term there will be no change I think and the oil market seems to agree as it basically ignores the news from Iran.

As numerous observers have said of late, the causes of oil’s substantial climb from about $40 to $70 were primarily the weakening dollar and purchases by investors and speculators (if there is a difference) to hedge their inflation fears. I’ve noted these causes ever since oil broke $50.

More recently I offered the view that some fundamental supply and demand pressures may be building on U.S. oil inventory levels due to the combined difficulties of four of America’s five largest suppliers, Mexico, Venezuela, Nigeria, and Canada, to maintain, much less increase, their supplies, perhaps accounting for recent inventory declines. Nonetheless, inventories are above the seasonal average and I am not suggesting there is anything like a supply squeeze developing; there are ample global reserve levels, including about 4 mb/d of spare OPEC capacity.

Venezuela has provided about 11% of U.S. oil imports, roughly 1.2 mb/d. Two trends are putting that supply at risk. The first is Venezuela’s increased commitment to sell its oil to Cuba, to China, and to other non-Japanese Asian countries. This commitment may be partially one of political comradeship, but it also is based on Venezuelan debt to certain Asian countries.

The second is the decline in Venezuelan production that has come from the increasing financial chaos and expropriation activities caused by its virtual dictator, Huge Chavez. I think Chavez and his plan are imploding. Continuing oil production declines of perhaps increasing magnitude can be expected to result from the continuing take-over by Chavez of foreign owned and operated drilling and supply companies. Chavez has neither the capital nor the expertise to operate this industry himself. Here is a recent report from Bloomberg:

Ever since oil lifted over $50 I’ve been saying that speculation is the cause. Actually, the lower dollar (caused by speculation) is a good part of the cause and inflation speculation is the rest. What is not driving oil up, it seems, is actual supply and demand. That’s the assumption in the market, anyway, and it’s probably correct.

But there are some fundamentals influencing oil to the upside that are worth noting. One is Nigeria and the other is Venezuela. Both have collapsing governments and economies that have been well noted in the press but I think the combination merit some consideration as a bit of fundamental winds to the upside for oil pricing.

In response to my recent post suggesting that the forces of deflation are fighting those of inflation (mostly weak housing, growing unemployment, and compulsory reductions in state and local budgets vs. the easy Fed and large federal deficit spending), one reader chastised me for even considering the possibility of deflation. He and many other commentators say “it can’t happen”. They assume we must be entering a period of inflation because that’s the only way the gigantic projected federal deficits that will create mountains of federal debt - both in the U.S. and even more so in Euro-land and Pound-land - can possibly be serviced. Besides, that’s always how it’s comes out, they say. Print a lot of money, you get inflation.

Inflation fears seem to have started to drive the dollar down which is keeping oil high despite ample supply. And gold is looking a little frisky too. If you think inflation is the future, sell anything denominated in dollars - or any fiat currency the value of which will be inflated away. Buy gold, oil, Brazil, China. Even copper. The last thing you want to own is a bond.

In the conclusions to my latest newsletter I noted that, “Nearly every analyst is saying the market has come too far too fast and needs a pullback. Great, let’s have one.” Now I want to consider the pullback scenario further. While it’s true that when “nearly every analyst” says something, that thing is probably wrong, still I think it might be reasonable for investors to take steps to protect the portfolio gains of the past couple of months in preparation for a potentially serious pullback.

Let’s hope that it is truly “always darkest before the dawn” because the real economy to which the stock market is eventually linked is looking fairly dark right now. U.S. consumer spending, employment and business cap. ex. are all still falling, the auto industry contraction has further to go [it’s not clear to me that GM and Chrysler won’t ultimately be liquidated], and in Europe things actually look worse than they do here. In the northeast real estate agents tell me the standard bid for a house is 20% - 30% under the asking price, which bodes poorly for a leveling off in housing prices any time soon. The only positive indicator I know is the rising Baltic Dry Index - plus recent stock market gains.

There is reportedly $4 trillion parked in U.S money market funds and other cash equivalents getting a return of approximately zero. That’s a large cash allocation. Breaking even seemed great a few months ago when most investors were being crushed by falling equity prices. But now pessimism is waning and the last couple of months’ returns have been record-setting. So cash is now starting to feel under-appreciated, pun intended.

One principle of investing always holds true: funds must land somewhere. So cash funds will either be re-invested where they are - or they must move into another asset class. On the surface, the vastness of the cash pool and the potential for movement which it represents seems bullish for stocks. But there are alternative asset classes into which it could be channeled instead of stocks. Let’s look at the relative attractiveness of owning equities vs. owning other asset classes. The major basic asset classes (all of which have sub-categories) are:

Oil prices are ascending in concert with a rising stock market and an expanding sense of non-pessimism about the global economy, yet the supply of cheap oil remains far greater than demand. Huge amounts of $5 cost oil is being moth-balled by OPEC and there is no shortage of oil inventory above ground, much of it floating at sea. So the fundamentals of near term oil supply and demand imply lower prices but they are being overpowered by speculators who want to own oil as an investment category.

There are, however, some “green shoots” of real oil shortage. Iraq and Nigeria are both looking dicey. In Iraq security operations for the oil exporting infrastructure will soon be handed over from the U.S. to Iraq, putting them at increased risk. Meanwhile terrorism is increasing on the ground as the “surge” tactics of enlisting Sunni support are being abandoned by the Shiite government. More recently the Kurds announced they are planning to begin exporting oil without Federal permission, not a tactic likely to be accepted peacefully. In Nigeria there are new protests against the government for rigging the last election and for widespread corruption.

Here is very good news: The U.S. Department of Energy will stop researching hydrogen fuel cells for cars. Hydrogen fuel cells might be feasible if there were gigantic supplies of cheap wind and solar power available to make hydrogen. It was never a near term concept. In fact, when George Bush proposed a “moon shot” in transportation technology based on hydrogen, my take at the time was that it was being trotted out because of the desire of both Bush and some Detroit executives to defer the inevitable transition to electric power for cars. So hydrogen became a red herring - an excuse for not doing anything with a realistic chance of having a near term impact on the internal combustion engine.

Team Obama is putting an end to that fairy tale promptly. That doesn’t mean the Energy Department will prove greatly effective in defining a practical new energy future for cars. For example it is still mired in the illusion that corn based ethanol can be useful - it cannot. But getting rid of the hydrogen boondoggle is at least a decent start in the right direction.

A report in The Australian newspaper (affiliated with The Wall Street Journal) provides an insight that is worth considering. It suggests a some key ideas that could be important in evaluating the investment prospects of both Lynas (LYSCF.PK) and Arafura:

1. China’s exports of Rare Earth Elements (REE’s) is slipping significantly.

Lynas Corp (LYSCF.PK), the Australian rare earth element mining company, announced it will accept an offer from China Non-Ferrous Metal Mining Co to provide A$252 million of equity capital in exchange for a 51.6% equity position in Lynas. As part of the deal, China Nonferrous will provide guarantees to help Lynas secure financing from Chinese banks for two loans worth $104 million and $80 million. Lynas said the second loan is not needed immediately but is to be made available at the request of its board.

According to this report, while the majority of the stock would be held by the Chinese apparently the entire arrangement will be governed by a contractual agreement which, among other things, specifies that there will be 4 Chinese directors on an 8-person board with a ninth vote being held by CEO Nicholas Curtis, whose title is Executive Chairman.

Stocks continue to recover from their panic bottoms of last November, many of them having doubled or more from then (case in point: General Electric). All this seems very healthy to me given the lack of real world data indicating any sort of resumption in economic growth. We get only data indicating a slowing in the rate of decline. On top of that, we know there are more shocks to come: huge default rates in loans on commercial real estate which lags the economy, the likely bankruptcy of both Chrysler and General Motors (GM) with the unknowable risks which bankruptcy entails, and an open ended risk of a global pandemic of Swine Flu. Given those well know negatives facing us “down the pike”, recent market strength seems impressive.

Meanwhile some specific stocks are grabbing my interest. Lynas (LYSCF.PK), the Australian rare earth element mining company about which I’ve written several times has made some recent eye-popping advances including a nearly 50% move (to $0.35 per share) just Thursday. Trading has been halted in Australia pending news of a new financing - which is obviously seen by insiders as positive. Lynas is one of those little companies that could represent a potential opportunity for many multiples of gain over the next year or three. It should begin shipping product in Q1 or Q2 of 2010 from its world-class deposit. Increasing numbers of analysts are noting the potential supply shortfall for rare earth metals given their use in many high-tech products - not least of which is batteries for hybrid cars. I haven’t bet the ranch on Lynas but at this point I would be more inclined to be a buyer than a seller. I started buying the stock around $0.50 a share and my positions have just today turned net profitable for the first time.

Oil and stocks seem to have bottomed as I suggested last month. Since that March 16th post, stocks are up another 8%, a scorchingly hot run on an annualized basis. Since March 6th the S&P is up over 21%. Meanwhile the price of oil has risen almost 35% since February 18th, not quite two months ago.

More Gains to Come

I continue to expect further gains for both stocks and oil - and eventually for natural gas - but each is a different case. I see stock market gains as a bounce back from an oversold condition caused by the great banking collapse and subsequent recession. More stock price recovery will come before the market is fairly priced for a mildly resurgent economy that most economists now predict for 2010. Businesses are writing off 2009, throwing all their problems into this year’s P&L. Earnings will be awful. But that sets up 2010 for pleasant surprises.

Was last Tuesday’s 350-point rally the beginning of the end of the bear market or just a false “bear trap?” And a related question: “Did oil bottom at $33 and will it get re-tested?” Let’s see what we know.

Some things we know

Sometimes the objective observable facts can yield fairly clear conclusions. Usually that’s not the case. Usually you can use the available facts to make a decent argument in either direction. But sometimes the facts seem fairly clear.

I’m very enthusiastic about the potential for Plug-in Hybrid Electric Vehicles (PHEVs) to provide a big piece of the ultimate solution to America’s “oil addiction” problem. The PHEV will have an extended-range all-electric capability and a small gasoline engine that will re-charge the battery when it begins to run low, thus providing ample total range on a tank of gas.

A PHEV with a 20 mile electric-only range will allow many drivers to do all their normal daily chores while using only minimal gasoline, if any - thus getting virtually infinite mpg. Meanwhile the car’s range per tank of gas for long distance travel will be as good as any conventional car and extended-range efficiency will probably be in the 50 mpg area. All-in average mileage for such a car might well be over 100 mpg.

Six month ago - when the world economy looked significantly rosier - I posted an analysis of projected supply and demand for oil going forward to 2015. The analysis was based on the assumption of continued demand growth, continuing decline of old oil fields and expected new production from announced oil megaprojects. I adjusted the magaprojects estimates for delays and I concluded that: “if these estimates are at all closely correlated with reality we should expect oil markets to be tighter than at present through 2012 followed by even more need for demand destruction from 2013 through 2015.”

I also offered an alternative scenario that included an unadjusted but smoothed curve of the Wikipedia expected annual megaproject supply which showed very substantial new projects coming on stream in 2008 and 2009. Based on this scenario for new oil supplies I concluded: “These “unadjusted” numbers show ample supply of oil through 2009 followed by shortfalls in 2010 and very important shortfalls starting in 2011 - possibly even catastrophic shortfalls in 2012 and thereafter if decline rates are more severe than 4.5%.”

My recent post on “Battery Wars” was a broad overview of the ongoing global struggle to develop one or more cost-effective batteries to power a commercially viable electric or hybrid vehicle. Follow-on commentaries to that post have added more substance and I invite readers with knowledge to add their views on the viability of lithium-ion vs. current NiMH batteries - or any other alternatives.

Because lanthanum, a rare earth element, is essential to the NiMH battery, the business of mining of rare earth elements and related investments has become a sub-text of the battery investment question, as has the mining of lithium in the case of SQM, of course. In regard to REEs, I mentioned two Australian companies that are gearing up to mine REE’s, one of which, Lynas Corp., experienced a financial blowup last week that cut its stock price in half. Some readers have asked if Lynas is an attractive investment here.