A cursory review of the details is worth a minute of your time. This compliments of The Oil & Gas Journal…

“WASHINGTON, DC, May 20 — The U.S. House passed, by a vote of 324 to 84, a bill that would create a new oil antitrust task force within the Department of Justice. Supporters of HR 6074, which also would give DOJ authority to sue foreign oil cartels for violating U.S. antitrust laws, included 103 Republicans, according to its sponsor Rep. Steve Kagen (D-Wis.).

“‘Until we finally have an energy policy other than drill-and-burn, this bill will begin to set things right for the American people. We cannot drill or grow our way out of this energy crisis. We must begin to think differently in America. That includes loosening the stranglehold other nations have on our economy and exploring new forms of energy,’ he said following the vote.

“The new ‘Petroleum Industry Antitrust Task Force’ would be charged with determining the existence and extent of gasoline price gouging, anticompetitive price discrimination by refiners, actions to inflate prices by constraining supplies, and possible oil price manipulation in futures markets, Kagen said.

“The bill, which would amend the Sherman Antitrust Act, also requests a Government Accountability Office study on the effects on competition of prior oil industry mergers and divestitures, he indicated.

“‘This legislation will address the loopholes and exemptions that oil companies exploit at the great expense of our citizens,’ Kagen said. ‘By passing the Gas Price Relief for Consumers Act, the House agrees that it is time to give US authorities the ability to prosecute the anticompetitive conduct committed by international cartels that restricts supply and drives up prices.’”

Now, unless you were informed upon entering your sixth year of grammar school at the age of 21 that you’d have to stay back another year, you’ll recognize this latest bit of pandering as stupidity so profound as to bring a sane man to his knees.

For one, oil is a global market and the members of OPEC include the world’s largest suppliers to that market. In a world of increasing demand bumping up against flattening global production, these are not the people one wants to alienate — that is, if we want to drive our cars and tractors and heat our houses with something other than broken bits of heirloom furniture.

Threatening to sue them, or worse, actually suing them, is unlikely to bring a warm response. Can you imagine the oil sheiks being made to present themselves in the docket in a U.S. Court? (If Homeland Security would let them through the airports, that is). Oh, what a fine media circus that would be! Frankly, if subpoenaed, I think they’ll just refuse to show. And what then?

Secondly, it also reinforces the fiction that the members of OPEC can actually do something to increase their production, as opposed to just talk about it. It reminds me of Saddam’s pledge to unleash the “Mother of All Wars” against the U.S. Forces…which turned out to be more like the “Mother of All Foot Races to the Rear.”

The way the OPEC quotas are assigned, the bigger the reserves a member state reports, the more production the member is allowed to sell. Which is why, since the upward reserve adjustments of the late 1980s – made in anticipation of the revision to the OPEC quota system — there have been virtually no reserve declines reported by OPEC members. It’s as if a magic oil genie resides under the ground, providing oil in unlimited quantities with a twitch of the nose or a nod of the head over crossed arms:

Put more directly, the current reserves are a fantasy, and the ability of OPEC to actually raise production is greatly constrained.

But there is more in this legislation to dislike. Much more. For one, it contains the implicit assumption that all levels of the energy business are corrupt, and the executives of all these firms spend long hours in cigar smoke-filled rooms plotting and scheming to take every advantage of hard-working Americans.

In other words, it declares legal open season on every layer of the energy distribution network. That, of course, means millions of dollars of legal fees, wasted time and, worst of all, more hand-tying regulation…the net result of which will be fewer, not more, energy resources being made available to North American markets.

Do I have a problem with the large energy companies making “obscene” profits?

Not at all. They are going to need all the money they can muster to replace their declining reserves and to fight off fierce competitors from the rest of the world. Competitors, it must be pointed out, unhindered by the perfect-worlders and political panderers that are now playing so effectively to democracy’s weak suit.

Twenty years ago, which was seven years after the link between the U.S. dollar and gold was severed in 1971, oil was selling, on average, for $13.38 per barrel. Adjusting for inflation — using the Shadow Stats and not the government’s laughable CPI — in today’s dollars that same barrel of oil would cost $124.

That it is trading for slightly over that amount, at $143 per barrel, is entirely explainable based on supply/demand constraints, war in the Middle East and the fear of a widening conflict.

In other words, blaming evil-eyed Middle Eastern potentates or bloodless speculators is attributing blame in the wrong direction. If you want to hit the right target, start with the fiat currency system which has systematically reduced the purchasing power of the U.S. dollar and all of its similarly unbacked peers to the level of Monopoly money.

Unfortunately, I don’t see any new legislation on the horizon calling the Fed and the Treasury to account for their role in the higher prices now getting so much attention.

Regards,
David Galland,
Casey Research
July 3, 2008

Oil Company Legislation was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Oil has finally reached $100 per barrel, yet few people on the distant end of oil supply lines are aware of how fast the status quo can change. The status quo tells us to expect more oil when we want it. That market forces always bring ample oil supplies to market. That oil producers will always accept a fixed amount of paper money in exchange for concentrated liquid energy.

But the status quo view of the oil market has been wrong for years. Many still use speculation and geopolitics, rather than supply and demand, to explain rising prices. These pundits never question whether the exchange of paper money for black gold is sustainable. In the old days, when oil prices rose, big exporters like the Saudis recycled most of their oil money into the U.S. bond market, giving rise to the term “petrodollars.” But those days are long gone. Middle East oil producers now pump lots of money into local economies and oil price subsidies. These policies have led to much higher oil consumption in OPEC countries and will keep lots of oil from ever reaching the export market.

The oil trade has radically changed, and investors need to understand these changes. So it helps to look at a model of a hypothetical oil exporting country.

Jeffrey Brown’s Export Land Model accomplishes this. It shows how dramatically exports can decline when two things occur at the same time: Domestic consumption increases while production declines. Brown, an independent petroleum geologist who writes for The Oil Drum, presented his Export Land Model at the ASPO-USA conference in October. When you really think about this model, the debate over how much oil is in the ground becomes trivial. Rather, we should think about how much oil could be available for export in the coming decade.

Brown’s model is easy to understand. It makes sense. Several historical examples validate it. Yet this line of thinking is totally outside the mainstream. As Brown explains, his model represents:

“A hypothetical country with ultimate recoverable reserves of about 38 billion barrels… The model showed the effect on net exports of a country that hit peak production and started declining at 5% per year. The exporting country consumes 50% of its production, and that consumption is increasing by 2.5% per year. The 5% decline rate is loosely based on the post-peak Texas decline rate of about 4% per year.”

The red line in this chart shows that “export land” starts off exporting one million barrels per day. Because production, the black line, is declining at 5% per year and consumption, the gray line, is increasing at 2.5% per year, exports plunge to zero in less than a decade. Brown mentions two other important points about the model. First,

“Only about 1.7 billion barrels, or 10%, of remaining post-peak recoverable reserves would be exported.

“Second, the overall exponential net export decline rate, about 29% per year over the eight-year net export decline period, is much more rapid than the production decline rate of 5% per year.”

The following chart shows how Brown’s model compares with two recent case histories: Indonesia and the United Kingdom. Indonesia, depicted in black, reached peak production in the late 1990s and has almost become a net oil importer. The U.K., depicted in gray, peaked around the turn of the century and became a net oil importer in just a few short years. U.K. North Sea production declined rapidly because offshore fields tend to have very high decline rates:

The top five net oil exporters from 2000-2005 were Saudi Arabia, Russia, Norway, Iran and the United Arab Emirates. Oil consumption in these five countries grew 3.7% per year over this period. Since 2005, consumption growth has accelerated in a few of these countries, so net exports from the top five may decline at a much faster rate than the market expects. We may have seen only the early stages of oil price increases.

Geopolitical Power Will Shift to Oil Exporters

How will the U.S., so reliant on imported oil, cope in an environment of tightening world oil exports? Most U.S. consumers have been sleepwalking on the march to $100 oil. Instead of understanding where oil comes from and altering consumption habits, the public seems more interested in taxing “greedy” oil companies. The longer this happens, the more painful the adjustment will be. Most of us don’t realize that the U.S. no longer has a monopoly on the world’s oil exports…let alone the implications.

Hugo Chavez just announced that Venezuela will export 500,000 barrels per day of crude to China in 2008, up from the current level of 350,000 barrels per day. He wants to increase shipments to one million barrels per day by 2012. Whether he achieves this goal or not, one thing is clear: Venezuela will soon be shipping lots more oil to China than it will to the U.S.

Mexican oil production is declining so fast that it will likely become a net oil importer within a few years. Kazakhstan is unilaterally renegotiating contracts with foreign oil companies to increase the government’s share of growing oil revenues. African countries like Nigeria may do the same with companies like Exxon Mobil.

For years, China has aggressively pursued contracts to secure reliable oil supplies, especially in regions like Africa. As it currently stands, the U.S. has no energy security plan other than to remain friendly with Saudi Arabia and hope that country meets its production goals. But even if OPEC can keep production high enough to meet insatiable demand, it’s unlikely that it will ship oil in the same quantities to the same customers.

Another thing to keep in mind, which we saw unfold in early November, is Ben Bernanke’s dilemma. With oil and gold at record highs, can he really afford to slash short-term interest rates to help save housing? Though he likes to bluff, he can’t afford to push rates down to 1%, as Greenspan did in the last easing cycle. If he did, another round of dollar weakness would drive international investors to gold and tangible assets even faster. It would also make oil less expensive in stronger foreign currencies, which would draw more oil supply to foreign markets.

Under a worst-case scenario, within a few years, much of the world’s tradable crude oil could be withdrawn from futures markets and locked up under long-term supply agreements with “favored” customers. And current trends point to the U.S. losing its favored customer status, even among longtime reliable suppliers from the Middle East.

Middle Eastern Wealth Looking Inward

I maintain regular contact with a private equity fund manager. He just returned from a trip to the Middle East to gauge the local interest in alternative investments. He wrote:

“The gulf is earning $1 trillion every two years, assuming $80 oil. We met with one of the ruling families in the region, and it anticipates no fall in oil prices anytime soon. One question I asked on the trip was how long we should expect the U.S. dollar/Middle East currency pegs to last. I expected a lot of strange looks and party line answers about how they’d be shooting themselves in the foot, since the U.S. is their largest customer, but almost uniformly, people thought a major move away from the dollar is 18-36 months away. But rather than a completely free-floating currency, they believe the ‘basket’ approach of Kuwait is likely to be the outcome.”

Since the dollar is about half of the Kuwaiti currency basket, the impact has been somewhat muted. My contact also noted an unmistakable trend common to all Middle Eastern sovereign wealth funds — they are moving away from U.S. Treasuries with two specific goals in mind. First, they are looking for higher returns in alternative asset classes like hedge and private equity funds. And second, they want to shift portfolio exposure from the West to their home markets — particularly in local infrastructure. This includes roads, utilities, schools and hospitals. Growing Middle Eastern wealth is leading to higher living standards, which leads naturally to higher oil consumption.

This isn’t the behavior of investors seeking to maintain their end of the status quo “oil for U.S. dollar” trade. So the writing is on the wall for the petrodollar trade.

What does this mean for the U.S. and other oil importers? It means the global drilling rig fleet will grow in importance. The rig fleet must become more productive, because target oil and gas reservoirs are becoming smaller and more scattered. The recent spike in drilling activity has strained the industry.

If spikes like these continue, the equipment will become worn out quickly and oil prices will then continue to rise.

Regards,
Dan Amoss, CFA
January 10, 2008

P.S.: The U.S. isn’t the only country in the world that desperately needs oil. What we keep hearing from our government and our media is that it is all the oil companies’ fault. What they aren’t telling us is that perhaps the world is simply running out of oil. What else aren’t they telling us?

P.P.S.: While I will continue to work diligently for all my readers of Strategic Investment, starting Friday, January 18, we will be offering my brand new service, the Strategic Short Report. Stay tuned, and look for details coming very soon.

A Truth About Oil Exporting was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.