Thursday, April 28, 2005

oil refining

Saudi Crown Prince Abdullah said that high gas prices in the US are the result of of lack of refining capability in the US.

This may or may not be true right now. I am wondering if something similar to the California electicity crisis of a few years back is going on in oil refining, with oil companies deliberatly letting refineries suffer breakdowns in order to profit from a shortage.

But long term will be different. There will be refining over-capacity, which is why even huge multinational oil companies (which make huge profits refining oil) are reluctant to build new plants. My point is that there are going to be oil shortages as many oil exporting countries' output peaks. Indonesia, Mexico, and the North sea nations may choose to use their remaining oil domestically, instead of sending it abroad (according to Richard Heinberg, author of The Party's Over, this may be in violation of WTA rules and may spark intense trade disputes). China may gain control, economically or militarily, over some Indonesian oil, much as the USA has been doing for decades.
So, some refineries will be sitting idle becuase they can't get the oil they they were built to process. More capacity may be needed to process heavy oils, but this will require huge investments. It is a lot harder to refine heavy oil, and a lot more polluting.

America's oil supply

The Bush and Cheney show have gone into damage contol mode trying to bring down the price of oil in the past week. Bush had a high profile meeting with Saudi Crown Prince Abdullah.

Abdulla pledged to produce enough oil to keep the US gas guzzlers filled to the brim at all times. He did not make any promises about the price. The Saudis now sell some of thier highest quality oil (light sweet crude) to China. This is the oil that is easiest to refine, and produces the most gasoline and jet fuel, and yields the highest profit. Few countries are priviliged to receive these shipments, so this is an indication of how highly the Saudis value the Chinese market. The Saudis now have two major markets for their oil, the US and China, and they are happy to see who is willing to pay more on any given day. It is called a seller's market.

With drilling in the Arctic, making deals and threats around the globe, and new "unconventional oil" technology, America may be able to keep the supply coming in for a few more years, maybe a decade. The question is: at what price? Wars to protect oil supplies are incredibly expensive (and immoral). Deepwater drilling, and unconventional oil is available but it too is very expensive, and yields a much smaller "energy profit". For example, it takes about 3 barrels of oil equivalent to produce 4 from the tar sands of Alberta. This is a far cry from the days when oil gushed out of the Texas earth at high pressure. The mammoth oil gushers of the past may have been history's greatest ever energy profit. Those days are now gone and they are not coming back.

America is a already far over-extended financially, and if we keep paying ever increasing costs per barrel for increasing numbers of barrels, this will drive our currency further down. This is because most of these barrels of oil are imported. And even domestic oil is costing us more to produce, now. We can drill for our own oil and gas in the arctic, bring the gas down in a huge pipeline through Canada, and yes, we will have achieved a little bit of energy independence. But this will still be expensive fuel for a deeply indebted nation. If we use it wastefully it won't do us any good at all.

Note also that there is positive feedback in this process: since oil is priced internationally in US dollars, as the dollar weakens due to our poor balance of trade, this also will increase the price of oil, independant of any supply and demand issue. Even our out-of-balance trade with China, which has been weakening the US dollar, is, in effect, driving up the price of oil. The US clearly has a choice here: it can turn to conservation to ease its mounting energy crisis, or it can go broke trying to maintain its supply-only energy policy.

Tuesday, April 19, 2005

the 'core' rate of inflation?

When I read in the paper that there has been .7 percent inflation in March, but only .1 percent in the ‘core’ rate, it makes me laugh. And when the business writer then declares that inflation is not a problem I am stunned.

They seem to think that the core of the economy is the price of cars, shampoo, cruise ship tours, etc. Not electricity, transportation fuels, and food. As if these were things we purchase if we have a little cash left over at the end of the month. This is completely backwards! The core of ANY economy is it’s energy base. The energy we consume makes everything else possible. For example: suppose we heated and cooked with wood, and used horses to get around? Then the economic activity we could generate would be limited to the amount of wood and hay we had. Oil has been so plentiful for so long, and it is such a concentrated and easily storable and transportable energy source, that we have forgotten that energy is the single and all-important limit to growth. Energy price inflation will be relentless and unstoppable soon, no matter how high governments push up interest rates.

the goldman sachs commodities index

I am still long one goldman sachs commodities index contract. I have lost a bunch of money, but I like this investment, and it turned around today, which shrunk my loss a lot. It had been going down last week, but today it went back up substantially. The index consists of 24 commodities, weighted by annual volume traded. This index is 70% energy, with the remaining sectors being grains, livestock, and industrial metals, and precious metals. The way that futures accounts are set up, they make it easy to get into a contract on very low margin requirements, but the account is highly levereaged, and very volitile. I made an error, in buying into this when energy was near a peak. But in the long term, say the next two decades, I think all of these commodities will rise in price, some of them a lot. I like the fact that the index is 70% energy, because energy is the most fundamental commodity class, and will be subject to increasing shortages going forward. So that is why I want to be long on Goldman Sachs contract all the time.

While I’m on the subject of commodity inflation, I’ll just point out the very high energy input of industrial agriculture. The high yields which give us cheap corn and soy are the result of intensive fertilization. Our grain comes from intensive fertilization with nitrogen, which comes from ammonia based fertilizer, which is made from natural gas. If natural gas increases in price, this will result in increases in the cost of food production.

At some point, I predict, grains will rise in price, and then livestock will rise faster, because of the large amount of grain it takes to produce meat. Grains periodically have surpluses due to good crop yields, which has caused the price to fall, but now these surpluses can be converted to fuel (gasahol and bio-diesel) profitably. Thus grains now have a natural floor price, and won’t be able to drop. Because everyone needs grains, grains will become a larger percentage of the index, and food will become more expensive. But because meat is (at least in historical terms) a luxury item, people will consume less, and then producers will raise less livestock, and this sector will shrink. This is as it should be: meat is far too cheap in the USA.

china and the price of energy

Crude oil is now around $50/barrel. There is debate over whether this is a very high price, a low price, or fairly valued. IMO, the reason the price is not high is because of Chinese purchasing. I keep reading that the Chinese have become very aggressive energy bidders in the past few years. Americans seem to react to this shift in trading power with a mixture of outrage, surprise, and disbelief. A few weeks ago, after a day in which oil had risen substantially, NPR interviewd an oil futures trader. He says, with frustration, that oil is way overpriced because Chinese buyers are willing to pay more than market rates for oil. I’m like what planet is he on? Hasn’t he heard of the free market? This is a new era, and the United States will no longer get to pick which oil fields it would like, what grade of oil at what price, etc. China now has the cash to outbid us for the oil that both countries desperately need. This will be even more true for natural gas, which requires gargantuan capitol investments that dwarf even the huge sums spent developing oil fields (mainly because gas is vastly more expensive to transport than oil). Because the balance of trade favors China, they will be more easily able to finance natural gas projects. China will get much of the gas that American utility companies would like to use to generate our electriciy from. I often read that Canada is making long term energy deals with China. This is especially worrisome to America. america has taken it for granted that all the oil in North America would certainly go into our own SUVs. With Canada right on our border, and having a surplus of gas and oil, shouldn't that surplus naturally flow straight down to the United Stares? But it seems that Canadian companies can now make more money selling to the Chinese, even though the gas and oil has to be shipped across the Pacific ocean. So, I don’t think energy prices can drop much.

The biggest question with this scenario is what would happen in a global resession, or depression, one of which is probably going to occur in the next ten years. It seems that China generates most of its wealth and grows its economy by selling manufactured goods to America. But US consumers would not buy as many goods in a recession or depression. At some point China’s rapid exponential growth will have to slow. All rapidly growing economies experience booms and busts. China could have history’s largest bust.