Disasters… Both Natural and Unnatural


Looking at history, there are often major international economic declines after big natural disasters. The example I like is how the San Francisco earthquake of 1906 led to the bankruptcy of many insurance carriers and to an outflow of cash from London and New York money centers. This led directly to the Panic of 1907 – and eventually to the creation of the US Federal Reserve. So in a sense, you could say that a natural disaster produced an unnatural disaster.

Getting back to the present, the earthquake-induced drop in oil prices is just a short-term blip. Oil prices are on the way up because many nations are increasing not just demand, but oil stockpiles – due to uncertainty of supply from the Middle East.

In the Philippines, for example, the government recently required that refiners keep a 90-day oil supply, versus, the former 30-day supply. Other countries and large oil-using firms are doing similar things, in terms of building stockpiles.

So which news trumps the other news? Will generally rising oil demand keep pricing strong? Or will unexpected events continue to keep a lid on that oil demand, and thus hold down prices?

Bottom line is that this earthquake oil-selloff is likely a short-term phenomenon. There’s strong upward momentum built into oil prices due to fundamental supply issues, not the least of which relate back to political unrest in the Middle East. We could see a quick rebound in oil price strength due to concerns over supply.

Looking further ahead, China only has enough oil in its strategic reserves to cover one month’s consumption, according to Wang Qingyun, head of the State Bureau of Material Reserves. Mr. Wang says China is working towards building a 90-day reserve, but the energy bureaucrats are still working on selecting the storage locations and constructing facilities.

Oil availability and pricing is certainly a matter of growing concern for China, whose daily oil imports, as a fraction of total consumption, now exceed that of the US. China now imports about 63% of its daily oil consumption – double the percentage of ten years ago.

As China’s consumption grows, the prospect of “permanently high” oil prices also grows. And that will mean investment dollars will continue pouring into the oil exploration industry.

For example, in the past five years we’ve seen (net) about 100 new jack-up and deep-water drill ships float away from the shipyards of the world. These vessels reflect over $40 billion of new capital expenditure. Then there’s the multiplier effect of new-build vessels on the vendors, equipment builders, steel mills and all the way back to the iron mines.

Meanwhile, a hiring craze is on at Halliburton (NYSE:HAL), which has just announced that it will hire about 5,000 new geologists and engineers, worldwide. Heck, even I – your humble editor – routinely field calls from headhunters, seeking geological talent.

It all sounds like positive investment news for the oil industry. But there are other things to consider as well. What’s the payback for all of this investment and hiring? Are we seeing an “energy return” for all the new capital outlay?

Let’s compare some recent numbers. Between 1995 and 2004, the global oil industry spent $2.4 trillion on various capital expenditures. This $2.4 trillion helped increase crude oil production by 12.3 million barrels per day, to about 85 million barrels of output per day by 2005 (and hold that thought). This is just the raw, historical data set.

Coincidentally, between 2005 and 2010, the world oil industry spent another $2.4 trillion on capital expenditure. Yet for the same amount of money – $2.4 trillion – global crude oil production actually fell by about half of one percent.

What does this mean?

There are many implications, of course, but one key point is that the world’s overall daily oil supply is not growing. For all the stories you see about “new” supply coming online from deep-water fields, from onshore discoveries, from enhanced oil recovery, from oil sands, from gas liquids out of tight gas deposits, etc., these are only replacing other oil supplies that are vanishing in the form of depletion.

It’s fair to say that oil output is flat, worldwide, and prices are not really being set or moderated by efficiency, conservation or even by adding capacity.

No, the key control over oil prices in the past couple of years has been the recession. The recession has set the price of oil. And had it not been for the recession, the world might be consuming upwards of 93 million barrels of oil per day…and might be paying much higher prices than $100 a barrel.

Looking ahead, wherever things go with the world economy, we’re in an environment that’s supply-constrained. We’re not going to find any “new” Saudi Arabias or Russias – although it’s good to know the story of what’s happening off shore Brazil.

Peak Oil is here, except right now we’re experiencing it solely as an issue of affordability ($100-plus oil), versus lack of day-to-day supply.

Eventually – well, maybe – the world economy will begin to move out of recession. And maybe we’ll even have a period of time without international crises (Middle East comes to mind) or large-scale natural disasters. Then we’ll see what true supply constraint looks like – and prices will rocket upwards.

How does one deal with all of this? Well, begin by investing in companies that hold real assets in the form of oil and natural gas, as well as uranium and other resources of value – gold, silver, etc. That, and the energy-technology players of the oil service sector – the usual suspects of Schlumberger (NYSE:SLB), Baker Hughes (NYSE:BHI) and Halliburton.

Stay tuned and we’ll figure it out together.


Byron King
For Daily Reckoning Australia

Byron King
Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments.

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5 years 7 months ago

Interesting article, but it contradicts many views presented by Dan Denning on DAILYRECKONING, for exsample this one: http://www.dailyreckoning.com.au/japan%e2%80%99s-crisis-and-the-energy-question/2011/03/15/ or this one http://www.portphillippublishing.com.au/research/AWG/mltesti.php?code=W9AWM104

Also – you suggested USA companies: Schlumberger (NYSE:SLB), Baker Hughes (NYSE:BHI). But this article is for Australian readers and investors, isn’t it ? So what good does it do to direct our attention to US market. Better suggest local companies. But this would be rather difficult as most of them have very limited oil reserves and all really struggle to maintain production at constant level. But coal and LPG suggestions would be easier to find.

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