Why oil prices are in a secular uptrend
Editor’s Note: Edward Harrison will be writing about the logic others feel support he other side of this trade based on views that Deniis Gartman espoused at an investment conference earlier today.
Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and “The Coming Collapse of the Municipal Bond Market” (Aucontrarian.com, 2009)
There is not enough money being invested in energy to hold prices at current levels. It costs a bundle to replace depleted sources of oil and gas. The justification for increasing exploration budgets is hard to come by when countries are (effectively) nationalizing companies’ projects. There is also the problem of actual production not meeting anticipated levels. And the matter – not, by any means, confined to a single industry or country – of companies not investing at all, terrorized as they are by our stark, raving, mad monetary policy.
Andy Lees, proprietor of AML Macro Ltd., has warned the sky is falling for some time, to little avail. Two years ago, in “How to Look for a Job,” I cited Andy’s projection that the cost of energy will increase from 5% of the world’s GDP to 16% of its GDP. Since then, investment has continued to flow into fun and finance, so both the jobs and financial resources needed to replace energy, at least in equal measure to that consumed, have probably expanded. (Fun and finance make a riveting partnership. From the September 25, 2012, Financial Times: “Wall Street financial engineers have devised… an index to add financial instruments that do not exist.” This is where the nation’s investment is going.)
Replacing oil and gas deposits demands new capital investment. Exxon plans to spend $37 billion on exploration during 2012. Exxon’s oil and gas production fell 5.5% in the first half of the year. Its earnings in the second quarter of 2012 were less than one-half of those in the second quarter 2011. Some of this was due to lower natural gas prices. Ergo, gas prices will rise.
Reuters reports Exxon’s costs of exploration are soaring. The weighted price of goods sold is falling. Exxon will cancel exploration. In fact, Exxon decided to forego two of its six Polish shale-gas concessions on September 20, 2012.
This is not much in a $37 billion investment budget, but the burden of costs goes on and on. Quoting myself from 2007: “Cambridge Energy Research Associates (CERA) estimated the worldwide cost to produce oil and natural gas (labor and equipment) had risen 53% since 2004. In some cases the rising costs have led producers to scrap exploration. Exxon estimated the cost of building a gas-to-liquids plant in Qatar at $3 billion in 2004. Current estimates having risen to $18 billion. The joint project of Exxon and Qatar has been dropped.” If anyone has seen a recent CERA cost index, please pass it along.
Exxon, of course, is not the only frustrated driller. Quoting Andy Lees from September 20, 2012: “Highlighting the difficulties of Arctic drilling, Royal Dutch Shell announced that it has abandoned any hope of striking oil this year after the ice moved in. Last week it was forced to unhook its drilling vessel from anchors holding it to a drill site just one day after it started drilling the first hole in the Chukchi seabed. Shell’s activities in the Beaufort Sea have been hit by similar issues which have also meant they have yet to get a drill bit into the seabed. The remoteness, the extreme cold, the threat from ice crushing equipment and the shortened season makes the economics shaky. “The Arctic has a high cost of supply and it is going to take a high oil price to keep it competitive until we can drive down the costs” according to ConocoPhilips. Gazprom has also been reported to have shelved the development of the Shtokman gas field in the Arctic because of surging costs. There were also reports that natural gas bearing rock had been found off the Falkland Islands in the South Atlantic raising the possibility of the most remote LNG plant in the world being built if sufficient further gas reserves are found. Whether it is depths, distances, temperatures or darkness, the environments we have to work in are getting more and more extreme to maintain supplies.”
There seems to be a consistent tendency for energy exploration projections to come up short. In 2006, Canadian tar sands production was expected to rise from one million barrels per day to 2.8 million bpd in 2012. Output has only risen to 1.6 million bpd. Another example is the large Azeri-Chirag-Gunashil oil field in Azerbaijan. After a new leg of investment was completed in 2008, production was expected to reach 1 million barrels per day (bpd). It peaked in 2010 at 823,000 bpd, averaged 684,000 bpd in the first half of 2012, and is declining at a rate of 10% a year.
All the while, the world’s economy is slowing down yet costs are rising. FedEx “an economic bellwether as operator of the world’s largest cargo airline, reduced its profit outlook for the second time this year, citing a slower economy.” (September 20, 2012) Fred Smith, chief executive officer of the company, said: “Exports around the world have contracted and the policy choices in Europe, the U.S. and China are having an effect on global trade.” [Not a good one. My italics. – FJS] Within a day, FedEx announced it is increasing shipping rates an average of 5.9% on January 1, 2013.
The destructive central-banking distortions retard useful investment. This is not an environment in which companies make long-term, capital-investment commitments. Instead, the Federal Reserve has placed a bid under the asset-backed securitization complex in its latest QEEEEEEE. The tapeworms did not need encouragement. International Financing Reviewreported on September 15: “The US structured-credit market exploded with issuance in the past week, as 24 transactions across ABS, RMBS, CMBS, and CLOs sent investors into a feeding frenzy….Twelve ABS transactions, mostly auto-related (including three sub-prime auto deals), were marketed to investors, with several achieving impressive over-subscription levels and the tightest spreads in five years.” On September 7, 2012, Bloomberg posted a headline: “Goldman Sachs, Citigroup Lead CMBS Sales in Most Deals Since ’07.” We need go no further.
The latest round of quantitative easing flows to Wall Street and feeds anxious hopes of a housing recovery. That will not happen. Prices still have along way to fall, although, in the meantime the perversions are straight out of 2007. From the September 19, 2012, Wall Street Journal: “HENDERSON, Nev.-The latest sign that the housing market is bubbling to life: The artificial waterfall at the entryway to Lake Las Vegas is again flowing. Few developments were hit harder in the real estate crash than this mixed-use project in the desert 20 miles southeast of Las Vegas. While overbuilding caused Las Vegas to collapse during the housing crash, Lake Las Vegas was hit even harder. At the height of the city’s foreclosure crisis, one in every 45 homes received a foreclosure filing, compared with one in every 13 in Lake Las Vegas. …. Hedge-fund manager John Paulson’s Real Estate Private Equity Group recently snapped up 530 acres of developable land in Lake Las Vegas for $17 million in cash from lenders…. During a visit earlier this summer, business was brisk at a Ravella hotel bar which has Tuscan-inspired views of manicured hedges surrounding a fire pit, with customers sipping martinis and noshing on pappardelle with veal meatballs.”
To quote the greatest perversion of 2007, celebrated former Federal Reserve Chairman Alan Greenspan offered fin-de-siecle advice in May of that year: “Enjoy it while it lasts.”