Coal

Oil may hog the limelight these days, but coal has not gone dormant. If anything, today's world relies on coal more than ever before. According to recent figures from the World Coal Institute, 24.4% of primary energy consumption worldwide comes from coal. Coal's share of worldwide electricity generation is 40.1%. In the United States, more than half the country's electricity comes from coal; in China and Australia, the totals approach 80%; in Poland and South Africa, the totals are above 90%.

For perspective on how much physical coal the world eats up, consider this: According to the science Web site, howstuffworks.com, the electricity required to power a single 100-watt light bulb, if left on 24 hours a day, would consume 714 pounds of coal over the course of a year. Most of us do not leave our lights on round the clock, but we tend to have many going simultaneously. (Never mind everything else left on around the house.)

As it turns out, the world's heavy coal users - folks like you and me - don't even know they have a habit. That ignorance is a luxury, provided by the blessings of modern technology. For the majority of its history, coal has been a particularly nasty source of urban pollution. Blackened lungs and reddened eyes go all the way back to the High Middle Ages. In the year 1285, King Edward I - commonly known as Edward the Longshanks - had two great battles on his hands. In Scotland, there was William Wallace; at home in London, there was coal. The King tried, and failed, to curtail London's use of coal on public health grounds. Harsh bans and brutal penalties were put in place, but acrid smoke continued to foul the air. With the city growing rapidly and the forests in retreat, London's pressing need for fuel and heat trumped all else.

Some 500 years after Longshanks, the potent combination of coal and steam had transformed England and kicked off the Industrial Revolution. By the 1850s, Britain was officially urbanized, with 51% of the population living in cities. And what living hells those early industrial cities were, Manchester chief among them: sky black with smoke, ground black with soot, the very air choked with dust. Scores of Manchester children were struck with rickets, a vitamin deficiency malady that softens the bones due to lack of exposure to sunlight. Fifty-seven percent died before the age of five. Those children who survived typically toiled the rest of their lives away in the factories and the mines.

All that misery is gone now (in the Western world, at any rate). Modern coal-fired power plants are paragons of efficiency and discretion. Leviathan jets of flame 10 stories high consume as much as 500 tons of coal per hour, hidden in the confines of gigantic boilers that convert heat into steam and steam into electricity. It all happens behind closed doors, on guarded grounds outside city limits. We no longer see, smell or taste the coal. We only flip on the light switch.

Yet, for all the cleaning up the coal industry has done, we are still paying a heavy toll for coal use. Western coal plants no longer belch black smoke; their emissions have been vigorously scrubbed and filtered, in accordance with the law. But these scrubbed emissions still make a disturbing contribution to the likes of acid rain and other "slow-fuse" environmental concerns like rising carbon dioxide emissions. And in less fastidious jurisdictions - like the entire country of China - "unscrubbed" emissions from coal-fired plants have produced some of the most toxic cities in the world. Many Chinese cities resemble the Manchester, England of old.

The New York Times reports that China uses more coal than the United States, Japan and the European Union combined. China's plants are older, less efficient and produce more toxic emissions than their regulated Western counterparts. China's massive pollution clouds have been known to travel the breadth of oceans, clogging up filters as far away as Lake Tahoe. With India following in China's sooty footsteps, a global pollution epidemic may be in the works.

So should we feel gratitude or disgust toward Old King Coal? It's hard not to feel a mixture of both. On the whole, coal has been very good to us. As a driver of the Industrial Revolution, however hellish initial conditions were, coal brought about the rise of manufacturing and the high standards of living the West now enjoys. As an ongoing source of cheap power, coal now gives China and India a chance at continued rapid growth. But none of this is without cost. China possesses seven of the world's ten most polluted cities, thanks largely to the country's heavy reliance on coal-fired electricity.

Even so, the world will not be going off coal anytime soon. Energy economics tilt heavily in coal's favor, especially in the developing world. New coal plants, still being built at a rapid clip, have operating life spans of half a century or more. It wouldn't make sense to mothball them prematurely. Countless existing plants have decades left to go. Last, but certainly not least, countries like China and India also have to deal with an emerging middle class and the rise of consumption-based lifestyles. They may need all the energy sources they can get their hands on - both dirty and clean - to keep up with demand in future years.

Meanwhile, coal-to-liquids technologies, as well as various "clean coal" technologies, will continue to promote demand for coal throughout the Developed World. Given all these demand factors, $40-a-ton coal seems way too cheap.

It is interesting to note that the price of coal, relative to the price of crude oil, has slumped to its lowest level in a decade. This relationship does not necessarily imply that coal prices are approaching an important bottom, but it does suggest the possibility.

Long-term investors take note.

Justice Litle
for The Daily Reckoning Australia

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• Australia Struggles to Meet the World’s Energy Demands
• Crude Oil: A Long Term Forecast

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To begin with, warm winter weather in the northern hemisphere has resulted in lower seasonal energy use than anticipated. (Global heating oil demand, for example, is estimated to be off by 20-30%.) At the same time, OPEC's production cuts are seen as ineffectual in the face of cheating, and Russia has been hesitant to slash its record output.

On top of this, commodity speculators have become bearish and institutional investors are getting cold feet. When spot crude fetches a higher price than the further-out futures contracts - a situation known as "backwardation" - it becomes profitable to buy the back months and wait for prices to rise as the spot draws closer. The persistence of backwardation in 2006 led institutional investors and commodity index trackers to load up on long-dated crude oil contracts; now that the market is no longer in backwardation, those same players find themselves losing money.

As icing on the cake, the crude oil market is suffering from intrigue fatigue. Like a jaded child desensitized to violence on television, the market has grown bored with overly familiar catastrophe scenarios. (Yet if anything, the geopolitical situation is more precarious today than a year ago: Israel leaking plans for a tactical strike on Iran; Saudi Arabia threatening to aid Iraq's Sunnis if the Shia majority pushes too far; U.S. military morale at low ebb; escalating tensions between Russia and Europe; nationalization on the rise; Iran accelerating its nuclear program; and so on.)

In light of all the recent bearishness, it is worthwhile to ponder the Energy Information Administration's recently released "Annual Energy Outlook 2007 (Early Release version)." Here are the two most interesting sentences out of the whole thing (in your humble editor's opinion):

"Oil, coal and natural gas... are projected to provide roughly the same 86% share of the total U.S. primary energy supply in 2030 that they did in 2005 (assuming no changes in existing laws and regulations...

"In 2030, the average real price of crude oil is projected to be above $59 per barrel in 2005 dollars, or about $95 per barrel in nominal dollars."

Trying to predict anything 23 years out is a foolhardy exercise... but the EIA projections are nonetheless instructive.

For one thing, the projections show just how small the alternative energy base still is in comparison with fossil fuels. It is not that the EIA expects zero growth in alternative energy's slice of the pie over the next few decades; rather, the EIA expects total energy demand to overwhelm all else, with fossil fuels filling the breach. (For this same reason, the EIA expects nuclear power's share of the pie to actually fall in percentage terms, even as more nuclear power plants go online.)

The EIA's second prediction is chuckle inducing. For crude to be just above $59 in 2030 - not far from where it is now - means little will have changed on the whole. And how helpful of the EIA to let us know that $59 in 2005 will translate to $95 in 2030. That's a wonderfully benign inflation rate... just over 2% per annum between here and there.

As you might have guessed, the point here is not to put faith in government agency predictions. Instead, it's to get some perspective on where we stand for the long term.

As a government agency and an offspring of the U.S. Department of Energy, the EIA is congenitally optimistic in its conclusions -- much as the U.S. Bureau of Labor Statistics is congenitally blind to inflation. And with all the data at hand, the EIA's projected long-term price band of $50-60 crude (more or less) is truly the optimistic case.

Such a prediction almost completely writes off the ramifications of Peak Oil, and relies on heavily aggressive assumptions in regard to deep-water drilling and Canada's oil sands. Such a prediction also requires an almost touching naivete in terms of U.S. monetary policy; can we really expect inflation to run just 2.1% per year for the next 23 years? (What happens when the dollar goes down in flames?)

There are far too many variables to make a forecast of crude oil's 2030 price. But we do have enough information to note that, given the piles of data presently available, the optimistic number crunchers at the EIA see crude trading solidly for the duration. In fact, their $50-60 price range represents the shiny happy scenario, leaving out the ugly but all-too-real possibilities looming before us.

The other thing we can gather from the EIA forecast is this: Nobody knows nothin'. Meaning, all the data points in the world can't predict the distant future. To grasp how ludicrous these types of specific predictions are, just observe the fate of those who make them. In the real world, the best you can do is marshal the facts to get a sense of what's possible and what isn't... what makes sense and what doesn't. In this sense, broad observations regarding the possible course of future events should be rooted in the laws of physics. What goes up must come down... that which cannot persist must eventually cease... and so on.

In the short run, a market can do most anything - especially one dominated by speculators with a quarterly, or even monthly, time horizon. But in the long run, as Jesse Livermore noted, the best and truest allies will always be underlying conditions. You'll see all kinds of numbers fly around in the coming weeks and months, feet stampeding this way and that... but through it all, the long-term energy picture won't shift much.

We're dealing with sweeping sea change here, not ephemeral seasonal stuff.

That's why I'm not inclined to worry too much about investing in crude oil based on this recent slide. There's never any money in running around like a chicken with your head cut off. Traders rely on speed and reflex, investors on patience and fortitude; to the best of my knowledge, nervous panic is no help to either discipline. If anything, the short-term roller coaster gives an edge to those with a taste for the long term forecast for crude oil.

Regards,

Justice Litle
for The Daily Reckoning Australia

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A HEALTHY GLOW
by Justice Litle

"The proposed reactors will be of an improved and simplified design,
pre-approved, more amenable to maintenance and operation than the
first-generation reactors designed before 1980... Some studies estimate
that more than 1,000 additional [reactors] will be needed in the next half
century."
 - Retired Los Alamos scientists William R. Stratton and Donald F.
Peterson
"You don't need a weatherman to know which way the wind blows."

- Bob Dylan

Cigar Lake, in Canada's Saskatchewan province, is home to one of the
richest uranium ore bodies on the planet. At 232 million pounds of proven
and probable reserves, the economic value of the find is nearly $14
billion by recent spot price.

Cigar Lake production was expected to save the day for hungry nuclear
power utilities - 103 of which operate in the United States. The plan was
to have 7-8 million pounds of production online by 2008, with as much as
18 million pounds a year not long after. Cigar Lake was expected to supply
50% of all new uranium production within five years.

Then the walls caved in. Literally.

Concrete-reinforced steel doors were in place to hold back the lake, but
an underground rockfall caused the doors to give way. Water rushed in at
1,500 cubic meters an hour; in due time, the mine was flooded.

The flood is a costly setback for Cameco (CCJ: NYSE), 50% joint owner of
the Cigar Lake mine, and a major headache for uranium buyers in general.
Kevin Bambrough of Sprott Asset Management believes American utilities
will be particularly squeezed.

"The delays... will create a sense of urgency for the next few years,"
Bambrough said. "It's almost the equivalent of the oil industry losing
Saudi Arabia."

Uranium prices are surveyed and quoted on a weekly basis by various
industry watchers. The recent move from $56 to $60 a pound was "the
largest weekly increase on record," according to Eric Webb of Ux
Consulting. Long-term forecasts of $75 and even $100 a pound now appear
justified; uranium would have to trade above $111 a pound to break its
inflation-adjusted highs from 1978.

This is more than just subterranean cave-in blues: The uranium spot price hasn't seen a down month since 2001. For years now, uranium producers have met just 60% of total annual demand - the other 40% coming from government
stockpiles and decommissioned nuclear warheads. This can go on for only so long.

The tightness of supply comes at a time of atomic resurgence. Three
large-scale factors have turned the tide in favor of nuclear energy:
geopolitics, global warming and developing world growth.

First, geopolitics: The unpleasant consequences of fossil fuel addiction
splash across the headlines every week. Mahmoud Ahmadinejad predicts the
collapse of Israel, the U.K. and the United States... Hugo Chavez vows to
defeat "the most powerful empire on Earth"... Vladimir Putin waves off
brutal assassinations while cranking up the Cold War rhetoric... and so
on.

All this and more is fueled by an unquenchable thirst for oil and gas.
Nuclear power may not offer a direct path to energy independence - we
can't put uranium rods in our gas tanks, as Peter Tertzakian observes -
but it is a big step in the right direction. (And if hybrid car sales
continue to skyrocket, drivers could conceivably "plug in" at night, when
traditional electricity demand is low.)

Second, global warming: The debate rages on; many still agree with Sen.
James Inhofe (R-Okla.), who called global warming the "greatest hoax ever
perpetrated on the American people." Yet political ideologies aside,
mounting evidence is getting harder to ignore. While China, North America
and Australia are endowed with huge deposits of thermal coal, the
consequences of accelerated coal use could be dire. (Air pollution factors
in too; filters in Lake Tahoe, your editor's beloved backyard, are already
clogging up with Chinese gunk.)

Whether the public accepts global warming or not, Western governments
surely do. The United States was arguably the last holdout, and with Sen.
Barbara Boxer (D-Calif.) succeeding Inhofe as chair of the Environment and
Public Works Committee, that domino has clearly fallen. Politics aside,
this is another feather in uranium's cap: Regime change in Washington,
combined with the urgent need to "do something" about global warming,
works in favor of nuclear energy.

The Democrats would no doubt like to rely more on greener solutions, like
solar and wind, but those industries are still too small to pack a
meaningful wallop. The green technologies of tomorrow hold great promise,
but they have not yet demonstrated an ability to perform at scale. Nuclear
power has already demonstrated its safety, scalability and 90%-plus
reliability, with next-gen technology like pebble bed reactors offering
improved maintenance and safety to boot.

The final factor driving a nuclear renaissance is developing world growth.
The historical correlation between energy use and economic growth is high;
when rapid industrialization kicks in for a developing world country, the
energy consumption path goes parabolic. Asia knows that relying on fossil
fuels to drive the next stage is a mug's game, for geopolitical,
environmental and financial reasons. Besides, there will already be enough
headaches as we try to fill up all those cars (hybrid diesels anyone?) and
enough pollution to deal with aside from new power plants. Fossil fuel use
is going to rise dramatically no matter what; nuclear power will help take
an edge off that pain. Let a hundred reactors bloom.

So where will the uranium to fuel a nuclear resurgence come from? With
government stockpiles covering 40% of present demand, the question looms
large.

For one, Cameco is confident that Cigar Lake will eventually be up and
running. The costs will be high, but that uranium is too valuable not to
be accessed - and Cameco should recoup its recovery costs and more in the long run.

An important future source could be Australia, home to 38% of the world's
low-cost uranium reserves. Surprisingly, for a country so rich in the
stuff, Australia does not operate a single nuclear power plant - yet. The
"lucky country" still relies on coal for 80% of electricity needs. Yet a
government report recommends adding nuclear to Australia's energy mix to
lower greenhouse gas emissions, and Prime Minister John Howard recently
called the rise of nuclear power in Australia "inevitable."

A commissioned study argues Australia could quadruple its export profits
by enriching and fabricating uranium at home, rather than shipping it
abroad unprocessed. Local environmentalists may protest against expanded
uranium trade, but friendly pressure from the United States could win
out... especially when combined with lucrative economic incentive.

Another country keen on nuclear power is Russia. Home to an estimated 15%
of world uranium reserves, Russia could yet go from exporter to importer
in the coming years. The official plan is to dramatically expand nuclear
power's share of the Russian energy mix, to 25% by 2020. Russian uranium
production will have to grow approximately 433%, from 3,000 tons a year to
16,000 tons, if domestic supply is to do the job.

On the positive side, existing government stockpiles of uranium can act as
a buffer against volatile demand. Construction costs make up the lion's
share of investment for a new plant, with ongoing fuel and maintenance
costs relatively small in comparison; the hitch is that a steady supply of
fuel - the uranium itself - should be locked up in advance, preferably via
ironclad contracts. This puts a lot of power in the hands of financiers,
who like to see a reasonably steady production stream before committing
funds. The financiers are thus relieved to know that governments are on
their side, with a willingness to act as swing supplier in the event of
temporary shortages. The U.S. government in particular is doing all it can
to get the nuclear resurgence jump-started, including making generous
offers of "regulatory insurance" to utilities who get the ball rolling.

All in all, the pieces are in place. The rise of safe, clean nuclear power
is in most everyone's best interest... except the petrocrats who want to
keep the world as addicted to fossil fuels as possible. Uranium producers
could have some very good years ahead.

Regards,

Justice Litle
for The Daily Reckoning

• None Found

The broad market appears to be firing on all cylinders. About the only thing getting sent to the wood shed is the U.S. dollar.

The action in the greenback looks exceptionally ugly. Yet if you step back and look at a monthly chart of the U.S. dollar index, we haven't even broken the December 2004 lows.

There is more to come... much more to come. As Jesse Livermore, the greatest speculator of all time, once said: "The speculator's greatest and truest ally is underlying conditions." That about sums it up when it comes to the dollar -- and gold.

Bloomberg columnist Chet Currier thinks equities are getting a boost from the lack of appealing alternatives - a tongue-in-cheek "benign conspiracy" of sorts. In his piece, entitled "Costly Bonds, Real Estate Make Stocks Look Good," Currier observes:

"Yields on government bonds are just plain miserly. Ditto for corporate bonds all up and down the quality scale... Yields offered by money market mutual funds and similar short-term vehicles have flattened since the Federal Reserve stopped increasing its target rate... the housing market is undergoing a much-discussed shakeout in many parts of the country."

Currier goes on to note the "sloshing sea of cash" that is desperate to earn a return, forcing investors to bid up everything in sight.

Meanwhile, private equity players are busy privatizing everything in sight. Raymond James strategist Jeff Saut reports, "Almost 2% of the NYSE's entire market capitalization has been taken private... since the beginning of this year."

Meanwhile Ben Bernanke, the Fed chair, continues to blame the "global savings glut" for this foamy tide that has lifted all boats.

One of Gentle Ben's key directives, I suspect, is looking out for his friends. I may have shared the following excerpt with you before; even if so, it is worth sharing again. Consider this intriguing observation from portfolio manager Chris Dialynas of PIMCO:

"The Clinton and Bush administrations, as well as the Greenspan Fed, have relied upon many internal and external advisers. Without doubt, most of these advisers are of Ivy League vintage. It is particularly noteworthy to understand that the endowments of most of those universities - endowments that substantially accrue to the benefit of the respective professors - are primarily invested in very high-risk assets and high-risk strategies (as are numerous other investors in their quest for high returns in a low interest rate world). It is, consequently, of little surprise that policy advice has tended to aggressive stimulus. A disciplined, 'take-your- medicine/rebalance-the-economy' set of policies would most likely be detrimental to the endowments of many of this country's leading educational institutions. As long as these institutions maintain high-risk portfolios, the policy advice from the ivory towers will be highly stimulative based upon new, bizarre economic ideas. The global imbalances will grow."

"Professor Bernanke is a member of this fraternity... There is an extraordinary challenge for a very high-quality person. My concern is his presumed pro-reflationary bias."

An extraordinary challenge, indeed. So challenging, in fact, that it must be asked: Why "take the medicine" at all, when one can simply wade further into the soup instead?

This is certainly the best choice from a short-term utilitarian perspective: It maximizes the distribution of happiness for an extended period of time. Look at it from Gentle Ben's point of view, and backdoor reflation is the way to go. Your friends are happy... Wall Street is happy... the president is happy... trading partners looking a bit peaked, but are happy nonetheless... no one gets left out except those cussed Austrian types. (And there's no satisfying them anyway, right?)

Bernanke has chosen to be a stand-up guy and keep the taps flowing for his friends. As I type these words, and as you read them, "cash" is being turned into "trash" at a steady pace. The smart money is buying with abandon because it knows the paper bits floating around today will be worth less than the paper bits floating around tomorrow.

How long can this go on? No one really knows. It's sort of like a game of musical chairs. As long as a veneer of psychological stability is maintained - i.e., as long as cash doesn't become trash too quickly - we could continue to see an upward trend in nominal values, even as real values stall out, or even decline.

Sooner or later, gold is going to break its 1980 highs in nominal terms. (This could easily happen in 2007.) After that, it will break its 1980 highs in inflation-adjusted terms -- which will prove a much more noteworthy feat.

It's always been sort of assumed that the conditions in which gold does this would be very ugly. Equity markets will have crashed, all Hades will have broken loose, and so on. That could certainly still be the case.

But it could also be that the Dow marches steadily higher along with gold, calm as a flat and glassy sea; if the fiction of prosperity is maintained, investors might be content to keep riding the merry-go-round, smiling like mildly sedated children.

In this scenario, everyone stays happy except the poor man in the street, who doesn't have enough paper asset holdings to cancel out the steady rise in day-to-day living expenses. A slow debasement of the currency, to the benefit of paper asset holders, is thus a rather ingenious way to rob hundreds of millions of unaware citizens. Not all at once, of course, but in dribs and drabs... a little bit at a time.

Currier's "benign conspiracy" is perhaps not so benign after all.

Since we're laying on the quotes this week, here is one more from Aldous Huxley, author of the dystopian classic Brave New World. The quote is twice as old as I am, but could have been written yesterday:

"There is, of course, no reason why the new totalitarians should resemble the old. Government by clubs and firing squads, by artificial famine, mass imprisonment and mass deportation, is not only inhumane (nobody cares much about that nowadays), it is demonstrably inefficient and in an age of advanced technology, inefficiency is the sin against the Holy Ghost. A really efficient totalitarian state would be one in which the all-powerful executive of political bosses and their army of managers control a population of slaves who do not have to be coerced, because they love their servitude. To make them love it is the task assigned, in present-day totalitarian states, to ministries of propaganda, newspaper editors and schoolteachers... The most important Manhattan projects of the future will be vast government-sponsored enquiries into what the politicians and the participating scientists will call 'the problem of happiness' -- in other words, the problem of making people love their servitude."

The problem of happiness. Hmmm. Sound familiar? Not the most pleasant thought, I know. The world can be a depressing place at times.

But in spite of all the chicanery and deceit, there is much to be joyful for and much to be grateful for. If you see all this madness as a game - a game you are forced to play, but a game nonetheless - it becomes easier to take things less seriously. Best of all, with a little skill and determination, it is a game you can win.

Regards,

Justice Litle
for The Daily Reckoning

• None Found

"In 1930, we found 10 billion new barrels of oil in the world, and we used 1.5 billion. We reached a peak in 1964, when we found 48 billion barrels and used approximately 12 billion. In 1988, we found 23 billion barrels and used 23 billion barrels. That was the crossover when we started finding less than we were using. In 2005, we found about 5-6 billion, and we used 30 billion. These numbers are just overwhelming." - Charley Maxwell 

Less than 20 years from now - not a long time in the big scheme of things - ExxonMobil Corp. (NYSE:XOM) could be flat broke.

Imagine that. One of the biggest, most outrageously profitable corporations in the history of markets... an awe-inspiring behemoth that rakes in tens of billions per quarter in pure profit... broke. Busted. Kaput. Tapped out. Like a poker player down to the felt.

This isn't some whacked-out, nearly impossible prediction. It's based on the analysis of Charley Maxwell, a veteran analyst with Weeden & Co. in Greenwich, Conn in the United States.

In addition to being one of the most respected energy analysts on Wall Street, Maxwell has had nearly 50 years of experience in the oil and gas industry. He got his start with Mobil Corp. - since merged with Exxon - way back in 1957.

After 11 years in the field, Maxwell headed for the canyons of Wall Street in 1968. He quickly established a reputation as the top oil analyst in the business, dominating the rankings for decades. Now he works with institutional traders, meets with top industry execs and OPEC officials twice a year and routinely advises the top dogs in the energy and hedge fund world.

In other words, the guy's opinion is probably worth listening to.

In a recent interview with Barron's, Maxwell marvelled at the utter folly of Exxon's decisions. To understand his line of thinking - and to see why Exxon is in major trouble - we first need to consider the energy industry from a big-picture perspective.

By conservative estimate, 75% of the world's oil supply is produced by national oil companies, or NOCs. This is not good news, as Maxwell explains:

"Most of [the NOCs] were nationalized in the '70s and early '80s, and they have real structural problems today. They bring in a lot of money, but most of it goes to support the national treasuries and the various political constituencies that are in favour in the various countries, whether it's the army or a host of other bureaucratic ministries. In the end, in the political battle for budgetary support, the national oil companies tend to be a constituency with little or no political influence. All in all, the national oil companies have been short-changed and held on a poverty diet for a long time."

Imagine the U.S. Postal Service in charge of America's energy supply. The efficient, well-run oil majors are like FedEx and UPS - they do a good job, but handle a very small portion of the job overall. Now expand this analogy to a global energy scale.

The situation with NOCs is ugly for multiple reasons. On one side of the coin, you have leaders like Hugo Chavez, who turn their countries' oil and gas operations into political fronts and largesse-distribution programs. On the other side of the coin, you have leaders like Vladimir Putin, who see the strategic value of energy as a weapon.

Those NOCs that are asleep at the wheel are making the energy supply problem worse as their operations fall into decay. Those NOCs that are wide awake see the increasing value of their reserves and are increasingly loath to share them. Witness Russia's recent belligerence regarding its Sakhalin and Shtokman fields. Russia rejected all Western partnership offers for development of its massive Shtokman gas field, on grounds that the spoils are simply too valuable to share.

Cynics have their own interpretation of the golden rule: He who holds the gold makes the rules. This is doubly true for energy reserves.

As Russia demonstrates, oil majors in future will have two choices: They will have to pay through the nose for access to new reserves, or be left out in the cold. The first option could eventually disappear altogether. And as my colleague Dan Amoss recently pointed out, the inevitable corruption of paper currencies makes energy hoarding all the more likely. When the world clamours for a refuge from paper, even as the developing world bursts at the seams, NOCs will be all the more aggressive about keeping the goods to themselves.

(By the way, did you hear China will start filling its second oil reserve soon? By the end of this year, we're told.)

Exxon puts on a confident face, but seems to have no plan... other than assuming things will just work out somehow. If Exxon's management is confident that cheap oil will be readily available anytime soon, they are deluded. The NOCs are going in the other direction. They are moving toward hoarding, not sharing.

If not cheap oil, then what about expensive oil?

For the most part, energy optimists don't dispute that the cheap oil is gone. They just assume that technology will save the day, by giving us access to the more expensive, harder-to-reach stuff.

Chevron's deep-water drilling is just such an example of technological triumph. So is Exxon confidently betting on technology, then? Will the great behemoth save itself with skilful application of technology?

Apparently not. Maxwell reports:

"As we understand it, Exxon is not taking on any leases for deep-water drilling after 2008. They haven't leased anything. If you think deep-water leases are going to be very important, and the recent big discovery in the Gulf of Mexico suggests they will be, you would have contracted for the future use of rigs. But if you think the deep-water leases aren't going to be important because the oil found will be more expensive than the common garden-variety Texas oil from 6,000 feet down, and that you will have lots of oil coming from sources like that, then you don't need these high-cost leases down the road. On the other hand, many major oil companies have taken these rigs to 2010 and 2012 and 2014 and are pre-empting Exxon's ability to get these rigs. Exxon is putting itself at a huge disadvantage if there should be a need for this type of deep oil. I find that remarkable."

Maxwell goes on to clarify his belief that Exxon is taking a huge gamble, on the assumption that oil will go back to $30 and none of this high-tech foofaraw will be necessary. He thinks Exxon is "dead wrong"... and I completely agree.

Optimism is good when logic and reason support it. Optimism sans logic is foolhardy and dangerous. I agree with the energy optimists that technology will eventually pull us through... the key word being "eventually." This idea that oil markets will have a Goldilocks soft landing, though, and that the gusher days of yesteryear will roll back around is just plain silly.

This leads to a conundrum: Exxon is an excellent company, with a history of excellent management. How could it make such a boneheaded mistake?

Not to put too fine a point on it, how could it be so... so... dumb?

It makes sense if one considers that Exxon is steeped in a rigid, old-school culture that doesn't respond well to change. It fits in terms of seeing Exxon as a gigantic, tradition-steeped company with a history of dogmatic authority at the top of the pyramid.

It also makes sense that Exxon would have adopted this "nothing is wrong" view early on, as a defence of its larger-than-life profits, and then got stuck in a rut of consistency bias.

For Exxon management to adopt the Peak Oil view, even as it rakes in tens of billions per quarter, would be a public relations disaster. If the world's most profitable corporation were to sound the energy alarm, political heat would increase to unbearable levels. Nationalization would be on the table.

Furthermore, the required investment response to Peak Oil - ramping up capital expenditure like crazy, plunging into high-cost, high-risk deep-water projects with both feet - would be anathema to Exxon's hard-bitten conservative management. So they reject the facts out of hand, and stubbornly dig their own hole.

In sum, Exxon has become entombed by its own success and its own culture. This in itself is not surprising. It has happened plenty of times before, to companies and empires alike.

One last eye-opening word from Mr. Maxwell:

"I estimate Exxon will peak in 2011. BP will peak in 2012. Total in 2012. ConocoPhillips in 2013. Marathon Oil in 2009. Royal Dutch in 2009 and Hess in 2010. But a company like Suncor Energy (NYSE: SU), which operates in the Canadian tar sands, will peak around 2045. It is a completely different world. EnCana (NYSE: ECA), the big Canadian gas and tar sands producer, will peak around 2020."

As you know, we own Suncor and EnCana. Now, can you imagine - just imagine - the valuation boost these companies will get when it becomes clear to the world what is happening? When the Street wakes up to the fact that Exxon and its ilk are set to peak within the next five years and find themselves on a path to oblivion thereafter?

The Suncors and EnCanas are indeed in a "different world," as Maxwell suggests... they are deep in the oil sands, investing in the future, doing it right.

Regards,

Justice Litle
for The Daily Reckoning

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