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$200 Oil Revisited – And Still Looks Good

Written by Steven Hansen

I am deviating somewhat from my weekend think pieces on sectors of the economy and returning to my past life in global infrastructure development. I am at a  convention of sorts of energy industry professionals who are at the front lines of implementation of energy processes – not the fat cats viewing the world from the 40th floor.

The consensus is that the world is far from peak energy if cost is ignored. The difference between professionals and politicians is that professionals explore all options – and are only removed from the table for technical issues (such as process reliability, costs). Environmental issues play second fiddle to professionals – not because environmental issues are not important – but because environmental issues are solved through the design and process improvement cycle.  Even after processes come on line, they are constantly reformed for a variety of issues – including cost and environmental.

This natural flow is called continuous improvement. No successful organizations limit development of options or block continuous improvement cycles.

I listened to field tests being done in oil / gas extraction, nuclear and renewables. No one believed any one form of energy had the potential to dominate based on cutting edge technologies on the drawing boards. However, as a group – we believed when viewed as whole, there is no reason for a net importation of energy into the USA.  Instead of forcing stricter regulations (such as done with auto industry fuel consumption) – government policies literally have removed coal and nuclear from the table, while significantly restricting expansion of gas and oil “mining” and pipelines.

  • I am not a big fan of coal, especially the big lignite fueled power stations in the West based on current methodology. Wasting 1/3 of the potential energy output on environmental systems (bag-houses and precipitators) means we are wasting much of this resource ahead of its time when technology could prevent this waste.
  • The current crop of nukes had a 40 year design basis – and they need to be replaced with the new “fail safe” technologies. To most of us building this past generation of nukes, the concept of suppression pools to contain a loss-of-coolant (LOC) accident was viewed as peeing on a forest fire.   Current state-of-the-art plants are exponentially safer as LOC situations are theoretically prevented.

Based on current technology and price structures – the reason the USA is not energy independent is only political. The USA could not be energy independent at spot oil prices of $38 per barrel.   At $100, massive hydrocarbon reserves which are now commercially extractable within USA property lines.   Combine this with “fail safe” nuke power generation, natural gas, renewables, and continued emphasis on conservation.

Interesting on the above graphic that the EIA sees a falling share of GDP consumed by energy.

Back in August of 2008, I posted a piece at Seeking Alpha arguing $200 oil may be a good thing for the USA (note: I have re-posted in its entirety below). Long term, high energy costs favor local made products.  No question high energy prices are disruptive, but over long spans so are trade imbalances.

Politicos criticize China for developing an export centric economy, yet roughly half of the current USA trade deficit is oil. It seems politicians not only do not explore options, but are good at transferring blame of conditions they cause to others.

Other Economic News this Week:

The Econintersect economic forecast for April 2012 shows a less good growth. There has been a degradation in our government and finished goods pulse points.

ECRI has called a recession. Their data looks ahead at least 6 months and the bottom line for them is that a recession is a certainty. The size and depth is unknown but the recession start has been revised to hit around mid-year 2012.

This week ECRI’s WLI index value declined for the second week in a row to 0.6 – after the previous twelve weeks of index improvement. This index continues to indicate the economy six months from today will be marginally better than today.

Initial unemployment claims essentially increased from 386,000 (reported last week) to 388,000 this week. Historically, claims exceeding 400,000 per week usually occur when employment gains are less than the workforce growth, resulting in an increasing unemployment rate (background here and here). The real gauge – the 4 week moving average – rose from 374,750 (reported last week) to 381,750. Because of the noise (week-to-week movements from abnormal events AND the backward revisions to previous weeks releases), the 4-week average remains the reliable gauge.

Data released this week which contained economically intuitive components (forward looking) were rail movements, trucking, and CFNAI. Rail movements this week were good if one ignores coal.  Both trucking and CFNAI were weak but clearly expanding.

Weekly Economic Release Scorecard:

1Q2012 GDP: Shows Soft Economy but Consumer Spending OK
Preliminary April Michigan Consumer Sentiment: Slight Improvement
March 2012 Pending Home Index Shows Strengthening Real Estate
March 2012 CFNAI Shows Economic Expansion Less Good
A Mortgage Turncoat Who is No Hero
Austerity: How is as Important as How Much
Another Ugly Data Release: Durable Goods March 2012
What is Kirchner Doing in Argentina?
Funda-Metals
Summary for Week Ending 23 April 2012
Will On-Line Higher Education Impact the Economy?
April 2012 Conference Board Consumer Confidence Little Changed
March 2012 New Home Sales Volume Trend Still Improving
February 2012 Case-Shiller Home Price Decline Less Badly
Wall Street 101 for Progressives, Academics and Career Politicians
The Market: Is It 30 Seconds to Midnight?
The U.S. Has a Low Corporate Tax
Boomtje en Bustje
President Obama Doesn’t Understand Oil Markets
The Week Ahead: Will the Fed Disappoint the Markets?
States and Structural Unemployment
The five devastating storms in summer 2012 at the heart of the world geopolitical swing
Trefis: Week in Review 20 April 2012

Bankruptcies this Week: None

Why $200 Oil Is Good for US Markets

(published 24 August 2008 at Seeking Alpha)

Goldman Sachs last week stuck with its oil price prediction of $147 per barrel by the end of 2008. I pray for oil at $200.

$200 oil with its knock-on effects would drive the CPI up at least 20% initially from today’s levels, and would place the world into a recession bordering on depression. It would cause major upheavals in the financial markets. The Fed would be close to powerless to soften the impact of the impacts of this high oil price. There would be blood on the streets and it may be a good thing.

“For all practical purposes we are at currently at war.”

This was a quote from the Tom Clancy book, Debt of Honor. The USA has been at war for some time but few recognized it as war. Terrorism was not the real enemy – economics was. America is under attack from:

  1. The US government leaders with ever mounting debt servicing due to inefficiencies, lack of fiscal restraint, and using weapons which spill blood and cost a lot of money to fight wars;
  2. Certain trading partners who believe trade is a one way street;
  3. Europe with the Euro;
  4. Commodity rich countries; and
  5. US residents credit lifestyle and search for the fast and easy buck.

The US Economy is in Bad Shape

Within the last year, trillions of dollars of real and imagined wealth was destroyed. It is tough going now as this debt has damaged the US economic engine. It will take many years to work off the losses and recapitalize. Additional losses will continue to unfold as the dominoes of the housing and commercial properties markets continue to fall. The government will be short revenue from tax base deterioration and this will exasperate the government debt.

The Differences between the Great Depression and Now

The Fed. The Fed today has mitigated the potential over reaction to the sub-prime mortgage crisis, and the ensuing credit crisis which will be unfolding for years to come. During the Great Depression, the government and the Fed stood around and let the market forces destroy the economy.

We are currently in the Great Indescribable. It is indescribable because there are issues of inflation, deflation, unemployment, debasement, expansion, contraction…… For sure there is a lot of bad debt and over valuation which cannot be absorbed in the short term. The Fed will continue to fight to ease the damage being done. It is defending economic valuations which will not be sustainable for years to come. The very effort of trying to create a soft landing may be working against a smooth recovery. Politically they have no choice, unless an event occurs which even the Fed is powerless to mitigate.

A Major Event to the Rescue – $200 Oil

Without a major event, it will take decades to work out the effects of the Great Indescribable. The Great Depression needed the Second World War to terminate its grip on the economy. The massive R & D and economic priming necessary during and shortly following this war supercharged the US economic engine while the rest of the world was in ruins.

$200 oil would hurt the US economy, but would destroy the economy of pretty much everyone else other than an oil exporting country, China and India. The situation in the US would be very bad for many years, but when viewed twenty years from today we would see:

  • Quantitative analysis of shipping costs favored local manufacturing. Mini factories were built all across the US. The cost of labor became a very small percentage of the retail price of industrial and consumer goods.
  • Massive R&D into alternative energy favored US technology base. New technologies will be born in the USA and exported.
  • Politically, there would have been no way to lessen the USA dependence on oil unless oil until it became so expensive that the middle class could not afford to drive their cars or heat their houses or watch TV.
  • This massive R&D investment, subsequent retooling, and then manufacturing & construction of non-oil using cars and power generation installations revitalized the economic engine.
  • The Treasury and the Fed were far more important than the Departments of Defense and Homeland Security. The US can only be safe if it is strong economically. All wars are economic.
  • It forced the US markets valuations to contract to a level that long term and sustainable growth could be achieved.
  • There were several constitutional amendments which included the line item veto to get the budgeting process under control, and political campaign regulations which outlawed any fundraising or political action groups.

In the long run $200 oil may be a very good thing.

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One Response to $200 Oil Revisited – And Still Looks Good

  1. Derryl Hermanutz says:

    Steve really nailed it in August/08, even before Lehman triggered the crash,

    “We are currently in the Great Indescribable. It is indescribable because there are issues of inflation, deflation, unemployment, debasement, expansion, contraction……”

    Nearly 4 years later we are stiil in a great indescribable with no clear direction of inflation, debasement, etc.

    Good call, Steve!