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Oil Shock

Whiskey & Gunpowder
August 2nd, 2005 by Sean Brodrick
South Florida, U.S.A.

THE DISCONNECT BETWEEN what oil experts are saying and what oil is actually doing is widening to Grand Canyon proportions.

Recently, the Organization of Petroleum Exporting Countries cut its forecast for growth in demand in the third and fourth quarters of 2005 by 600,000 barrels per day...the International Energy Agency lowered its fourth-quarter demand for OPEC oil by 700,000 barrels per day...and Morgan Stanley economists have flat out called oil a "bubble."

Sounds bearish for oil prices, right? Not so fast. What we can observe happening in the oil markets is actually very bullish for oil prices.

For example, bookings of supertankers for oil exports from the Middle East soared to the highest monthly level this year in July -- and shipping costs doubled along the way, according to Bloomberg. Oil production in Norway -- usually the No. 3 global exporter, behind Saudi Arabia and Russia -- has hit an 11-year-low...and China's oil-thirsty economy is humming along at 9.5% growth, shrugging off any and all efforts to slow it down.

These don't sound like the ingredients for lower demand or too much supply for me.

What's more, speaking of OPEC, the Saudis also recently told the world's leading industrial powers that OPEC will not be able to meet Western oil demand in 10-15 years. This was the first time -- ever -- that OPEC has made such an announcement.

Now consider this: What if OPEC is lowering its forecast in preparation for cutting its production quotas at its next meetings. Why would OPEC do that? Well, either it wants higher prices, or it sees difficulty in meeting current production levels starting as early as the third quarter. Either way, that's bullish for oil.

And if you think we'll be able to take care of our own energy needs ourselves without some drastic changes...think again. U.S. strategic oil reserves are equal to just 70 days of supply.

In fact, despite ratcheting back demand growth, the IEA still expects oil demand to rise to 85.9 million barrels a day by the fourth quarter of this year. That's higher than global refining capacity of about 84.5 million barrels per day. But the IEA has a history of being too optimistic -- the squeeze could come a lot sooner than Wall Street is willing to believe.

It's as if we're finally heading toward the end of the oil era. And the transition -- as we've seen at the pump recently -- may be a brutal one. The oil gauge is slowly moving toward empty...and the world's largest suppliers say they won't be able to fill us up again.

This is a core economic shift that will be an underlying trend in the financial markets -- and your daily life -- for decades. It is crucial that you understand the implications, the dangers, this shift represents.

We've seen oil crises before -- the last one most people remember is the 1973 oil embargo. But history is dotted with energy emergencies that make the oil shock of the

'70s look tame. Heck, Britain was hit hard by an "energy crisis" some 400 years ago. At the time, wood provided basic energy plus the charcoal needed to smelt iron. But the forests were quickly disappearing. Shortages got so bad that laws were passed restricting woodcutting.

Luckily, Britain made the switch to coal. Coal had been in limited use since Roman times, but when the wood shortage hit, coal was adopted to provide heat. Still, it took another century to learn how to make coke to smelt iron. The result helped spark the Industrial Revolution. In short, an energy crisis forced a seismic shift in the economy and society.

Today, we're facing another kind of energy crisis...

The largest declines in oil production last year occurred in the U.S., where output fell by 160,000 barrels a day, and in Britain, where output declined by 230,000 barrels a day. We're near the bottom of the barrel for many of America's oil fields.America imports 58% of its oil -- and we import more and more oil all the time. In fact, U.S. oil imports jumped 5.3% last year over 2003, versus a 5% rise for the world. So our dependency on oil from people who'd like to kill us is increasing, and increasing faster than the global average. The world's energy use is increasing rapidly. Global oil consumption grew by nearly 2.5 million barrels per day last year -- more than DOUBLE the 10-year average rate.Oil already pushed past the $60 mark recently, and financial markets initially plunged on the news. How will they react when oil breaks $70...$80...or Goldman Sachs' recently predicted $105 per barrel?

Most economists pull the 1970s oil crisis out as an example of how rising prices eventually crimp demand and send prices lower. But let me give you two reasons why it's different this time: China and India.

Over the last three years, China has accounted for over a third of the global increase in oil demand. As GDP increases, so does a country's oil use. And Chinese President Hu Jintao says China aims to quadruple its GDP, to $4 trillion, by 2020.

Already, China's and India's economies are roaring, and their energy use is ramping up, as their citizens are making the switch from bicycles to scooters to cars. Last year, more than 1 million cars were sold in India. Car sales there are roaring along at a 20% growth, and sales are expected to surge for another 10 years. Meanwhile, China is seeing auto sales grow by 16% a year, with 2.79 million cars and light trucks sold in the first half of this year alone. Newly mobile consumers in both countries will need oil and gas -- and lots of it.

Both these countries have roaring economies that use more and more oil every month. They are competing with the United States for global energy resources. This wasn't the case back in the last oil crunch. It could make this one drastically different.

Today's energy crisis is transforming the world -- from geopolitics to the financial markets to the gas pump to the price of 75% of everything you consume on a daily basis.

I'd like to be able to tell you that the U.S. government is doing everything it can to prepare for the coming energy emergency...but I can't. In fact, when I think about how little prepared this country is for the changes that are about to hit us, my hands automatically clench into fists.

Sincerely,
Sean Brodrick
Investment Director
The Sovereign Society

*****Here are some supplemental information links from Sean:

Seems like just last month (hey, it was last month!) that the Saudis said they'd pump all the oil we could want and then some. Now the Saudis are admitting there are limits.

Oil isn't the only energy source. Natural gas, nuclear, coal -- we'll need them all to get through the tough times ahead. We'll also need to learn from history. Here's a book that combines history and energy, Coal: A Human History.

Norway's oil output falls to an 11-year low. Norway's attitude: "What, me worry?".

The IEA says oil demand is to fall in the fourth quarter,

and to rise in 2006.

Morgan Stanley economist Andy Xie thinks oil prices may "collapse soon." He's basing it on slowing Asian demand. Good luck with that one, Andy...

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