Oil Defies a Correction…

by BWK ~ June 25, 2008

The returns are coming in from the distant precincts of the oil patch, and the winner is……… Oil!

The price for oil has barely budged based on the Saudi Summit. There has been no summer sell-off, and I’d be surprised to see a significant pull-back as the summer driving season kicks into gear. (Followed by hurricane season, and then the buildup for winter heating stocks, followed by winter.)

What’s going on? Well, what the Saudis give — in proposed, future increased production… the Nigerians take away — with ongoing oil patch carnage that forces the likes of Shell & Chevron to close vast pipeline systems. Apparently the present trumps the future, even in the futures markets. Everything is connected to everything else, isn’t it?

Here is may take on the exit polls from the Saudi Summit…

Consumers and their representative governments are desperate for an oil pullback. This $135 oil is draining budgets. The poor & working poor are already marginalized in this cruel world of ours. Now it’s the turn of the middle classes to get kicked into the cellar of the modern age. People are working time-and-a-half just to put food on the table and gas in the car. Retirees and others on more-or-less “fixed” incomes are impoverishing slowly.

Unless they are impoverishing fast. Bankruptcy filings among the older and elderly demographics in the US are soaring. The bottom line is that the conventional image of a “decent standard of living” is rapidly receding for many tens of millions of households. The 20th Century is truly over. (I think this has much to do with the meteoric rise of Sen. Obama as well… He offers nothing new — mostly just classic, populist Democratic Party bromides — but he offers it in such a sweet and beguiling, teflon-coated manner…)

And it will get worse before it gets better. To be perfectly blunt, it might not even get better. Over the next year, and into the forseeable future, in the developed world people will go broke buying motor-fuel, heating oil and natural gas. (Wait until next winter… WOW!) In the less-developed world, people will go broke buying bread. And then the poorest amongst us will starve. Any way you look at it, it’s bad for business.

Fast-rising energy prices are decapitalizing entire nations. Energy prices are destroying wealth faster than people can re-create it. Entire segments of the world economy have hit the iceberg and are filling with cold seawater. Some industries are becoming obsolete in a matter of months. Much of the airline industry is drowning in red ink before our eyes — almost every flight in the sky is losing money, no matter how much they charge to check your suitcase or how few peanuts they put in the small package.

And down on the ground, most motor transport is just plain uneconomic any more… “Dead Rigs Driving.” Farewell to the “Warehouse on Wheels.” Sic Semper Globalization.

Large swaths of the auto & truck building industry have become capital-wastelands. Eg, GM is closing SUV factories and planning to ditch the Hummer brand. This cascades down to firms that make everything that goes into a set of gas-guzzling wheels. You name it: hot-coiled strip, axles & tires, wire bundles, paints & coatings, window glass and seatbelts, and so much more. Billions of dollars worth of past investment is just gone… ‘bye-’bye, poof! And the good-jobs-at-good-wages? History.

What about those totally cool “Green Jobs” that everyone talks about? Sure, if you are nimble. If you have certain technical skills. If you are willing to relocate. If the winds of fate are blowing your way. Maybe you too can become a rooftop-solar installer, or a windmill repairman. But you ought to keep in mind that many of those “green jobs” will be working in dirty old hard-steel industries like oil drilling and coal mining, but doing it in an environmentally sound manner.

Really, 87% of the US energy supply comes from burning carbon. Nothing big will change in the next four years, or eight years, or twelve or twenty or thirty-two years. Actually, God help us if it does change “big.” We’ll probably be in trouble — big time.

If you sell oil, of course you are a happy camper right about now. Although some are happier than others.

If you are among the Arab nations of the Middle East, you may just be raking it in faster than you can spend it. Or else how to explain the building boom in UAE and Saudi, where the national bird has become the construction crane? Really — why build a 2,300 foot tall skyscraper in Dubai, unless it is the way of Allah to advise that you have too darn much money?

And as no less an authority than Allah can tell you, too much money can be a curse as well as a blessing. (”Give daily alms to the poor” is one of His commandments.) How bad is it? In the UAE as of late, there are severe shortages of cement. The contents in the holds of the cement-carrying cargo ships are spoken for long before the anchor drops or the vessel ties up at Jebel Ali. Trucks wait at the piers to haul the precious cement cargo direct to the construction sites. No warehouses or storage bins for the gray gold. Just drive to the point of use, add water, and mix with gravel… if you can get gravel.

This just illustrates the inefficiencies that come with having too much cash, and not enough good projects on which to spend it. Hey, does anyone want to buy the Chrysler Building in New York? Well, every time you buy gas at $4.25 per gallon, you are helping someone else do exactly that.

And the high rates of spending are breeding grounds for capital cost inflation. Too much money is chasing not-enough steel and machinery and skilled labor. So whatever you build is costing 50% to 100% more than you planned. Ain’t no way to run a railroad. Or a petrochemical refinery. Or an aluminum smelter complex.

And what of the far-seeing eyes in Riyadh? — And believe me there are eyes in that mysterious and secretive desert-kingdom land that rival the optics of the Hubble Telescope. They are not blind to the potential for high energy prices — especially in the context of a rapid price runup — to shock and weaken the economies of their far-distant customer base. What good is current income from oil sales if the purchasing economies are cast into recession or depression, and the currencies of denomination are wrecked by economic collapse? And what good is it to jettison the “special relationship” with the US that dates to World War II, and under which the Saudi royal family has prospered and multiplied? Is there someone in the wings who can offer a better deal? The Saudis are many things, but they are no fools.

If you are among another rank of oil-exporters, you are very happy with high prices, and you only wish that the prices were higher. You want all the cash you can raise to fund your elaborate social welfare schemes (Venezuela), so as to keep the natives un-restless. Or perhaps your ambitions are more in the realm of particle physics, and you need oil revenues to fund your nuclear ambitions (Iran). Or maybe you have pretensions of returning to great power status (Russia), and you need funds to buy weapons that your industry can manufacture but your government has not been able to afford. Ah! For these nations, the feel of jingle in the national pocket is incomparable. It’s hard to understand unless, perhaps, you ever enjoyed the feeling of whizzing down the street at the wheel of a stolen bicycle when you were young.

In that case, heck, if the price of oil drops, you are in trouble. So you like the high prices, and wish that the prices would continue to climb. Indeed, if the price of oil falls you probably have enough money to go out and engage your own bunch of personal traders to bid the price back up for your own account. Really, why be a price taker if you can be a price maker? It’s like what Mark Twain once said about his early job as a newspaper reporter in San Francisco… “My job was to cover fires. If there were no fires, I was supposed to go out and set some.”

Is there room for optimism here? Yes, in the sense that high prices are concentrating many minds on energy. “Energy” is the most important issue of our time, bar none. That is, people are finally beginning to understand the centrality of energy to our collective existence. Take away the cheap energy, and it becomes clear that mankind has spent the past century building the wrong kind of world.

Another way of saying it is that we’ve collectively built “tomorrow’s ruins” today. And I don’t mean just the physical structures, the bad architecture and stranded infrastructure that is worthless when energy is expensive. Think as well about the social structures that are beyond worthless when energy gets expensive. Tell me when you start to get worried…..

Much of what happens in our time only happens because energy is relatively cheap and abundant. So when energy gets expensive, a lot of what happens is going to stop happening. And what will we all make of that turn of events? Well now…….

On that note, I leave the rest to your imagination.

Best regards, BWK

Note: Byron King is a frequent contributor to the free e-letter Whiskey & Gunpowder. To receive daily insights into energy, oil, commodities and other natural resources sign up here!

Additional Resources:
The Airline Waiting Game…
Energy Q&A Part II: Investing in Oil Refiners and Oil Service Companies
Energy Q&A Part I: Peak Oil and Oil
The Oil “Melt-Up” and Why the U.S. Economy Won’t Run On Windmills Alone…
US Agriculture Supply and the Coming Election
U.S. Factories: Where Did They Go?
The 2nd Fed… Carbon Permits