Agora Financial’s Rude Awakening

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Dubai, UAE

• A $117 bargain – oil eyes the record books from afar,
• Gustav and Hannah loom large in the Gulf,
• Great expectations, stark revelations and plenty more…

Joel Bowman, reporting from Dubai in the Persian Gulf…

At $117 per barrel, crude was considered astronomically expensive. Now, it’s just an uncomfortable reality.

“Where will it end?” traders asked themselves back in April, when the world’s grease was on a seemingly unstoppable, record-breaking trend line. Then came May and the price per barrel was up into the mid-$130s. June saw it nibbling on the heals of $140 and then, in July, the world winced as oil hit an all-time high of $147 per barrel.

“It’s only July, but it might be time to start loading up on blankets and sweaters,” reported the Associated Press at the time.

Airlines saw their profit margins disappear. Truck drivers took to the streets around the world in protest. Oil execs were hauled in front of politicians to explain the situation and people started to think that maybe flying in strawberries from half way around the world would no longer be economically feasible.

Since then oil, and the whole commodity complex, has retreated. Energy and metals have entered into a bear market and crude is back to where it was in April. What was once considered “astronomically expensive” is now, as we mentioned, seen as more of an uncomfortable reality.

So, are the days of record-breaking oil prices behind us for good? Is $117 the new $147? Could the reality suddenly get “less-comfortable?”

In a word: Yes. In two words: Very Easily.

This is hurricane season, for one. Every year around this time traders cast a nervous glance down towards the Gulf of Mexico to see what troubles are a brewin’. So, how is the weather fairing? Poorly. Hurricanes Gustav and Hannah, behind it, are right on course for the goods.

Several thousand of the 20,000 workers on offshore platforms in the Gulf have been evacuated, according to Bloomberg. That’s about a quarter of the number needed to maintain production.

“There’s going to be disruption in oil production next week in the Gulf of Mexico, especially the rigs off Louisiana,” AccuWeather’s Walker told the newswire. “Even in Texas they’re going to have to take protective measures.”

That’s on top of the strained friendship between Russia and Europe. Reports have begun to filter through that the Kremlin has ordered Russian oil companies to cut supply to Germany and Poland through the “friendship pipeline.”

“They have been told to be ready to cut off supplies as soon as Monday,” a high-level business source told the UK’s Daily Telegraph.

In the long term, the simple supply demand equation dictates much higher prices for oil. Put simply, the earth is not refilling the basins it took billions of years to prepare. (Even if it is, as some reckon, it’s certainly not doing so at a rate of 85-90 million barrels per day.) Nor are we finding any new “elephant fields” to replace the old ones we are draining.

Perhaps even more worrying, however, is that there may not even be that much left to pump. An oil expert friend of ours here in the Middle East provided us with the chart you see below.

 

As you can see, industry estimates differ vastly from that of the United States Geological Society. The real figures on what might be found are, of course, mostly guesswork. But some guesses are better than others. Even if the truth lay somewhere between the two estimates, that would seem to put the
kibosh on many “just pump more” plans.

With Russia, Mexico and the North Sea already entering into terminal declines, we might have to seriously consider the possibility of NEVER getting those imported strawberries…at least delivered on hydrocarbon powered jetliners.

In the column below, Byron King, our own oil expert and editor of the Outstanding Investments newsletter, takes a more educated look deep into the well. Please enjoy and send your comments to the address below…

—- Outstanding Investments Oil report —-

Urgent Investment Special Coverage:

The Full-on Oil War of 2008: Bloody New “Backlash” Set to Rocket Oil Past $150… and Send Gas Soaring to Over $6 per Gallon. Details on how best to play this wild upswing in the enclosed report.

Click Here to Access Your Copy

(Fri Aug 29 10:44:17 2008. US/Eastern)

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“NOC-Out” Oil
By Byron King

Western nations - the U.S., in particular - are now experiencing the bow wave of a profound change in the current and future availability of oil. According to recently published data, oil output from all major Western oil companies is on an ominous decline trend. Exxon Mobil, for example, announced that its average oil output has fallen by 614,000 barrels per day in 2008.

Western oil majors like Exxon are finding it harder than ever to identify new prospects and successfully complete new oil projects. This comes despite the fact that the oil industry is flush with profits from upstream operations, and is eager to expand.

BP’s Thunder Horse project in the Gulf of Mexico, for example, is finally coming online in 2008, with an anticipated output of nearly 250,000 barrels per day. But this one project has taken almost 20 years to complete, at a cost in excess of $6 billion.

And Chevron’s recent success with its Jack 2 project in the Gulf came at a cost of over $240 million for just one test well. And this prospect is still years away from being a successful oil-producing prospect.

These sorts of developments have implications far beyond the Peak Oil argument, as valid as that thesis may be.

One of the key reasons for the decline in oil output from major Western companies is world politics. In the 1990s, the key strategic development in the wake of the fall of the Berlin Wall and the decline of communism was the trend toward globalization. Much of the world opened up to the West figuratively, as well as literally. And the oil industry was one beneficiary, making significant investments in unexplored or underexplored regions from South America to the Caspian Sea.

But the key strategic development in the first decade of the 2000s has been, arguably, the concept of “resource nationalism.” That is, in the many nations that were formerly friendly toward Western companies, the attitudes toward foreign investment have fundamentally changed. Western oil companies have found themselves squeezed in resource-rich areas.

Western companies have experienced outright nationalizations, such as what occurred with Exxon Mobil and ConocoPhillips in Venezuela. Or Western companies have been shown the door through intimidation and bullying legal tactics under the guise of “tax laws” or “environmental enforcement,” such as what happened with Shell Oil Co. at its Sakhalin project in Russia.

Even Brazil has shown its nationalistic teeth to foreign investment. Recently, Brazil withdrew numerous areas from prospective lease sales after it became apparent that the odds of finding oil were quite good. Why not just save it for Petrobras?

Whatever the case might be, Western companies have been shunted aside or, in the best cases, forced to renegotiate contracts on less favorable terms. The traditional model of resource development, in which Western companies obtain legal title and control over oil and gas deposits in the ground, is fighting a losing battle. Assertive host governments are gaming the rules to favor their state-owned national oil companies (NOCs).

As recently as the late 1970s, Western oil companies controlled well over half of the world’s oil production. But now the NOCs - such as Saudi Aramco, National Iranian Oil Co., Kuwait Oil Co., Petroleos de Venezuela, Petroleos Mexicanos (Pemex), etc. - control over 85% of the world’s oil resources. Western majors control about 7% of the world’s oil resource base.

All the while, oil output from mature regions is in decline. From the North Sea to the Alaska North Slope, the Western oil companies are faced with lower volumes from existing oil holdings. And there is a much thinner book of potential business elsewhere in the world. According to Amy Myers Jaffe, who studies the oil business from her chair at Rice University, “This is an industry in crisis.”

This sense of crisis also helps explain why Western oil companies are fighting to expand their options for offshore drilling in the U.S., as well as to expand access to areas like northern Alaska. The U.S. offshore, and other frontier areas such as the Arctic National Wildlife Refuge (ANWR) are among the few options remaining for Western oil companies.

So one key point that the Western oil industry makes is that its resource base and reserves are in decline. And over the medium to long term, this means that the economic importance of the Western companies will erode. Despite any plans or efforts at conservation and efficiency, as well as a large-scale shift to alternative energy sources, the Western world will become increasingly dependent on NOCs for oil.

From the standpoint of energy and strategy, this will not be a good thing for the West.

[Joel's Note: In addition to being a trained geologist Byron is also the editor of the most successful commodity-focused research services, Outstanding Investments. If the future of energy is something that interests and/or concerns you, this is the one investment newsletter you simply cannot miss. Here is a link to a special oil report that Byron put together for us. Access it right here: The Great Oil Grab of 2008.

—- The Strategic Short Report —-

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[Rude Endnote: If you have any comments to make about today’s column, be they oil-related insights or otherwise, please send them along to us. For now, we’re off to the emirate of Ajman to stock up on a different type of fuel – think 500ml cans and 750ml bottles – to last us through the month-long fast of Ramadan.

Until next time…

Cheers,

Joel Bowman
Rude Awakening

aussiejoel@the-rude-awakening.com