The Rude Awakening
Wall Street, New York
Tuesday, October 4, 2005
------------------------- - Welcoming Chris Mayer to the peak oil debate,
- Exactly why did Al Gore invent the internet? And,
- The arduous task of wireless Internet hunting in
Florida.
------------------------- [Joel's Note: A quick apology is in order before we get
into the final installment of the E-day! debate in today's
issue. We have spent the best part of this blustery Florida
morning chasing a wireless Internet connection. Finally the
good people here at this quaint coffee shop have allowed us
to plug into their own cable so we can deliver your Rude
Awakening to you. We hope it is worth the three stress-
filled hours and the $35 in cab fares. You can write in to commend any of our valiant editors on
their comments, or just complain about your belated issue,
by dropping me a line at aussiejoel@rudeawakening.com Now, a quick note from Eric… ------------------------- These guys just won't shut-up!
Your editor's colleagues continue debating the implications
of $70 oil. Despite debating the consequences of "peak oil"
for several days, these guys have failed to exhaust either
themselves or their supply of worthwhile investment
insights. AS I mentioned last week, these guys don't seem to realize
that the Internet in general, and email in particular, is
the domain of useless conversation and inane jokes. (Isn't
that why Al Gore invented the Internet?) And yet, my
colleagues persist in rebelling against convention. They
use email to exchange and to debate investment ideas…It's
embarrassing, really. Chris Mayer, editor of the Fleet Street Letter, kicked off
the debate's second round by firing a salvo toward Dan
Denning, editor of Strategic Investments. Dan defended his
position, after which Justice Litle, editor of Outstanding
Investments, attempted to bridge the divide. So without further ado, please allow us to present the
third, and positively final, installment of the debate over
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By Eric J. Fry "Dan, Peak Oil, as you've described it, will be wrong,"
Chris Mayer badgers Dan Denning, "because energy will not
get more expensive - in the long-run, say, over the next
decade or less. The long history of energy prices is that
they go down - because of technological innovation, because
of changes in consumption patterns, substitutes, etc. There
are lots and lots and lots of examples of this. Many are
already happening.
"So, the physical argument is not convincing to me at all."
"Hmmm. Good point," Dan replies. "But off the top of my
head, Chris, I can't think of a lot of replacements for the
energy density of a barrel of oil. And I have a hard time,
the Saudis and ExxonMobil notwithstanding, believing that
oil reserves are growing and that production is increasing. "So the physical limitation of easy-to-find oil supplies is
an inescapable reality. Even so, you could be right.
Technology could somehow overcome this geological reality. "But before trusting too smugly in the omnipotence of
technology, I would suggest considering another reason why
the inflation-adjusted cost of energy has tended to fall
over the preceding decades: The availability of cheap and
abundant energy may be related to the availability of cheap
credit and liquidity to finance the exploration and
discovery of new energy. "It's true, of course, that the development of every
industry requires some kind of investment, usually a
combination of equity- and debt-financing. So credit and
industrial development are inseparable. That said, I'm
wondering if excessively easy credit, coupled with fiat
currency, has accelerated the rate at which the world has
developed and depleted its energy reserves…. Meaning that
these influences revved the engine of growth for a good
fifty years…. but may be redlining, as oil production
declines.
"This I know: Printing dollar bills is easier than
extracting barrels of oil. And yet, we have behaved as if
the oil supply is as inexhaustible as the supply of
dollars. Oil's $70 price tag suggests, belatedly, that oil
is not inexhaustible. Easy credit, no matter how hard it
tries, cannot extract/coax from Mother Nature what she no
longer possesses. "In summary, I suspect that easy credit and fiat money have
been underwriting more of our energy costs than has
technology. And I wonder how oil will get cheaper as the
most abundant source of it (petroleum) reaches declining
production." To which Justice remarked: "It seems to me, Dan, that the energy industry is subject
to the same violent cyclical patterns that many industries,
economies and nations face, with or without easy credit and
fiat money. "Think back to the Texas oil boom and bust of the
1980s…In a nutshell: Evil OPEC flexes its muscles in the
1970s, price controls lead to panic, oil industry profits
go through the roof, E&P investment skyrockets. The
ensuing production boom, coupled with OPEC quota-cheaters
produced a supply that easily outstripped demand for the
balance of the century. Enter $10 oil, the genesis of
today's $70 oil. "The oil bust of the 1990s put a stranglehold on
exploration and instilled in every oil CEO a deep-seated
fear of being suckered by high oil prices - a fear that
endures to this very day. Meanwhile, the developing world
ramped up oil demand and changed the big picture forever. "I guess the key notion is that energy is still a
commodity, perhaps the most important one, and is thus
naturally prone to boom and bust cycles, with heavy
infrastructure and production investment coming at the peak
of the booms and thus sowing the seeds for following busts.
I would argue that even more than easy credit, the rapid
emergence of the developing world is what caught us asleep
at the switch. Pre-China/India, the delivery system had
ample slack. Post-China/India, no more slack. "Cheap credit is like a performance-enhancing drug in that
it can speed up the investment cycles (or kill the investor
via overdose), but methinks the basic nature of the
commodity cycle would be the same with or without it. The
dynamics of progress are inherently violent and unstable. "Now that we're awake, the key question is how fast a
combination of innovation, investment, conservation and
substitution can fix the problem. Unless technological
progress is halted, energy will definitely get cheaper
again--it's just a question of when, how, and how soon. "While credit bubbles definitely create mismatches,
commodities have their own natural boom and bust cycle
independent of credit cycles. Hefty investment mismatches
and forecast blunders are an inevitable part of the market
landscape, especially with commodities. Credit bubbles
just compound the error by adding leverage to the mistake. "Cheap credit definitely drove excess energy consumption in
the Western world while the getting was good, but today's
problems have arisen primarily through a long-running
neglect of infrastructure and a sharp spike in developing
world demand. In fact it's interesting to wonder what the
energy situation would be like today if China and India
were still communist/socialist backwaters. We probably
wouldn't be talking about oil at all right now. So far,
the issue has only been one of capacity limits, not
depleted reserves. If Asia weren't pushing demand at the
margins, oil would probably still be in the $20s. "So maybe credit hasn't played much of a direct role in
this story after all… when you think about it, the
effects of peak oil haven't really kicked in yet. Not
saying that it isn't coming, just that our issue right now
is capacity constraints - a lack of slack rather than lack
of reserves. "The free market can't act fast enough to implement a short
or intermediate term fix at this point, even if the oil
majors were committed to a massive outlays (which they
aren't). We'll probably see a major recession and a
coordinated government intervention in energy markets
before our infrastructure is up to snuff again. "Regarding oil and dollars, we are basically betting the
ranch that the world has no practical means of abandoning
or replacing the dollar as the world's reserve currency.
Dollars grease the wheels of world trade; there's no easy
way to get around that fact without bringing the entire
engine of global commerce to a halt. That's basically what
we're betting on: that America has carte blanche to enact
banana republic fiscal policies with impunity. When our
President says the rebuilding of New Orleans will cost
"whatever it costs" in a conservative channeling of LBJ's
ghost, he's smugly relying on that precedent. We will
continue to stress-test the system until breaks. If and
when our energy suppliers stop accepting greenbacks for
whatever reason, shooting wars could start soon thereafter. "More than likely though, we'll muddle through with some
form of globally coordinated triage that keeps appearances
intact. The dollar and the stock market get propped up from
behind the scenes, gold and oil march resolutely higher,
the CPI stays magically flat, and the disappearing middle
class grows snarling and desperate as Republicans and
Democrats unite to impose ever more stringent measures in
the name of maintaining social order." Thanks Justice, at least we have THAT to look forward to! [Joel's Note: Did Justice just say "…as Republicans and
Democrats unite"? We shan't hold our breath for that one.
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Please look here: http://www.agora-inc.com/reports/RTA/WRTAFA00 ------------------------- And the Markets… | Monday | Friday | This week | Year-to-Date | DOW | 10,535 | 10,569 | -33 | -2.3% | S&P | 1,227 | 1,229 | -2 | 1.2% | NASDAQ | 2,155 | 2,152 | 4 | -0.9% | 10-year Treasury | 4.39 | 4.33 | 6.00 | 4.35 | 30-year Treasury | 4.63 | 4.56 | 7.00 | 4.58 | Russell 2000 | 671 | 668 | 3 | 2.9% | Gold | $465.95 | $469.30 | -$3.35 | 6.5% | Silver | $7.41 | $7.46 | -$0.05 | 8.7% | CRB | 333.22 | 332.97 | 0.25 | 17.4% | WTI NYMEX CRUDE | $65.17 | $66.24 | -$1.07 | 50.0% | Yen (YEN/USD) | JPY 114.11 | JPY 113.48 | -0.63 | -11.3% | Dollar (USD/EUR) | $1.1915 | $1.2021 | 107 | 12.1% | Dollar (USD/GBP) | $1.7552 | $1.7641 | 89 | 8.5% |
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