Agora Financial’s Rude Awakening

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Laguna Beach, California

• A U.S. energy supplier breakdown: How much from who and how,
• The trouble with heavy, sour oil…and heavier, sourer ex-girlfriends,
• When appetite for energy outstrips caution and plenty more…   

Eric Fry, reporting from the tony hamlet of Laguna Beach, California…

“‘Dirty, insecure and expensive’ are not merely the adjectives that describe most of your California editor’s past girlfriends,” we remarked in the November 9, 2006 edition of the Rude Awakening, “they are also the adjectives that the International Energy Agency (IEA) uses to describe the current state of the world energy market. ‘The energy future we are facing today is doomed to failure,’ warns Claude Mandil, head of the IEA.”

Back then, light sweet crude oil was changing hands for less than $60 a barrel. Today, this precious energy source costs about $140 a barrel. Kudos to the IEA! Rarely has a group of bureaucrats issued such a prescient and timely forecast.

The IEA’s World Energy Outlook 2006 predicted that total world energy demand would “grow from the current 85 million barrels per day to 116 million barrels per day by 2030.” In other words, as our colleague Dan Denning calculated at the time, “World oil production will have to increase by 37% between now and then to meet projected demand. Or, in absolute terms, the world will have to produce 32 million barrels per day more than it is currently producing.”

Even if such a dramatic increase in crude production were geologically feasible, the IEA’s Outlook implied that it would not be environmentally desirable.

“On current trends,” the IEA’s Mandil asserted, “we are on course for an expensive and dirty energy system that will go from crisis to crisis. It can mean more supply disruptions, meteorological disasters or both. This energy future is not only unsustainable, but it is doomed to failure.”

We have often observed that the things that cannot continue, do not continue – bad marriages being the sole exception in the universe. The world’s current energy path is one of those things that simply cannot continue, as our guest contributor, Marin Katusa, explains below…

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Securing the Insecure: U.S. Oil Imports
By Marin Katusa of the Casey Energy Speculator

America’s appetite for energy is stronger than its caution. In the last 15 years, the United States has steadily increased its dependence on imported crude oil by some 60%. Part of the reason is declining production.

Declining production has been matched by the country’s declining reserves. Production is falling despite increasingly ambitious efforts to turn things around, including deep-sea drilling far off the coast in the Gulf of Mexico. Put simply, regardless of America’s strategic concerns over energy security, any large increase in domestic production or reserves is unlikely.

To a superpower that imports nearly 70% of its oil, it’s more than a mental exercise to evaluate the reliability of its sources. Any economic or geopolitical risk with the potential to disrupt supplies could have a destabilizing and even devastating impact on investment markets and the economy. In the pie chart below we’ve separated the countries exporting crude oil to the United States into three categories: friendly, potentially hostile/hostile, and unsure/neutral.

The countries portrayed in black and gray are the allies, countries that have usually shown a willingness to work in concert with the United States on numerous issues. These countries are Canada (geographic proximity), Mexico (geographic proximity), Nigeria (much improved relations over the past 15 years) and Iraq (very close ties with the United States, for obvious reasons).

Countries depicted in shades of red are countries that are either openly hostile or have previously been hostile with the United States: Venezuela (Hugo Chavez… say no more), Algeria (issues remaining from Algerian Civil War), Angola (U.S.-funded anti-government rebels), Russia (lingering Cold War effects) and Ecuador (the new president is a friend of Chavez). We list Saudi Arabia as a wildcard, with the potential to go either way.

Adding up the numbers, a bit less than half of U.S. imports are from countries that are either politically unfriendly or have the potential to be. Now let’s take a closer look at the “allies” of America, since even they have problems providing a stable stream of oil.

In the last 15 years, Canada has taken honors as one of the top crude oil exporters to the United States. However, conventional reserves of crude oil in Canada are in decline, and the only reserves that Canada has in abundance are the oil sands, which are expensive and difficult to extract. Furthermore, Canada already consumes 90% of the crude oil it produces, and this number is growing.

Mexico faces a much larger problem. Its reserves are dropping quickly, with little ability to replace them. For example, production at Cantarell, one of the world’s largest oil fields, is conservatively estimated to fall to half of its 2003 peak by the end of this year.

This problem is exacerbated by Mexico’s increasing domestic consumption. Its population already consumes 60% of its crude. Mexico could become a net importer of crude oil by 2014, according to  Jeffery Brown’s Export Land Model. (That’s only six short years from now!)

[To learn more about the frightening conclusions of Brown's Export Land Model, check out the January 15, 2008 edition of the Rude Awakening]

Nigeria, the African continent’s largest oil exporter, has impressive oil reserves. Unfortunately, the country is marred by not only the misappropriation of oil funds but also the ethnic clashes between the Ibo, Housa and Yoruba tribes. The multinational oil companies are either stuck in the middle or contributing to the mess, depending on your point of view. Ongoing supply unrest mean that Nigeria is less than a reliable source of crude.

Iraq contains large known fields, and the potential for more large fields yet to be discovered.  As long as the United States maintains a strong presence in the area, Iraq should continue to provide a steady supply to the United States. A long-term presence, however, is very much in doubt.  And, should the U.S. leave, the direction of Iraq’s flow of oil could change overnight. So, a big question mark here.

Countries such as Angola, Algeria and Ecuador are obviously willing to sell to America for now. But at the same time, they have been ramping up their exports to other countries. As time goes on, these countries may begin to favor non-U.S. customers.

This trend is evident in Venezuela, a more mature oil-producing country, which, under the leadership of Hugo Chavez, has already begun to reduce exports to the United States. The bad blood between Venezuela and the U.S., combined with increased international competition for Venezuela’s oil, increases the possibility of a Venezuelan oil embargo on exports to the United States.

Russia has the potential to possess one of the most abundant sources of crude oil on the planet. But the tap-twisting that Russia has recently pulled with its natural gas exports strongly suggests it sees its energy supplies as a tool for gaining geopolitical power.

Down in Saudi Arabia, the Saud royal family and the United States have enjoyed a relatively stable relationship for many years. But rising tensions in the region and increasing Islamic extremism could potentially trigger another oil embargo such as in the 1970s, particularly if Israeli-Palestinian troubles remain unresolved. The ruling House of Saud has a tenuous grip on power in the country and, thus, a tenuous grip on oil supplies. An overthrow of the Saud family, dourly predicted for years, would in all likelihood be unfavorable to U.S. oil supplies.

The squeeze on supply is only getting worse as the ascendant economies of China and India ramp up their demands for oil. At some future tipping point, exporters unfriendly toward the United States will be happy to sell their oil to these growing non-U.S. markets. So where can the United States expect to turn instead?

What about the former Soviet Republic countries (the “-stans”)? Offsetting their vast potential and anti-Russian leanings is their geographical proximity to China, a natural buyer. In any case, the possibility of finding new significant reserves of light oil in most of these countries is unlikely.

There is, however, a much better solution – a proven and plentiful resource in an area friendly to the United States and in geographical proximity: the heavy oil fields of Alberta, Canada.  While available in abundant supply, these supplies are not without challenges. That’s because heavy oil is more viscous, more dense (low API gravity), and often has contaminants such as sulfur.

Canada could ramp up its heavy oil production relatively easily, since these reserves have already been proven. Transportation of this crude is also less of an issue since Canada is quite stable politically, and can easily construct new pipelines or twin their existing ones (to reduce the costs) to pump much-needed crude into the United States – provided the price is right.

The oil majors clearly expect heavy crude to play a growing role in the global oil market. BP Inc, for example, is investing $3.8 billion to upgrade its Whiting Heavy Oil Refinery outside Chicago, in large part to handle more heavy oil from Canada; and countries like China, India, Syria and Saudi Arabia are also beginning to build more heavy oil refineries.

So how do we profit from this trend? A logical answer would be to buy into prospective heavy oil companies, those that are cheap producers with good upside potential. We should be looking for well-cashed-up companies that can withstand difficult capital market conditions and have their operations in a jurisdiction that stands to benefit from America’s crude oil shortfall.

Heavy oil is the newest old thing.

[Joel's Note: Your editors will be journeying to Vancouver, Canada next week to attend the Agora Financial Investment Symposium. In the meantime, if you have a Canadian oil play with low density and high profit potential, we’d love to hear it. Send your thoughts to the address at the bottom of this email…

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That’s all for this sweltering Wednesday (it’s over 120 here in Dubai today. Ouch!) We’ll be back with all your regular Rude musings this time tomorrow.

Until then…

Cheers,

Joel Bowman
Rude Awakening

aussiejoel@the-rude-awakening.com