Beating a Dead Horse and Other Mental Constructs

Source: EIA

OK, superimpose over the above a second mental chart showing crude oil prices. (Hint, two spikes on either side centered on 1980 and 2005 and a deep valley in the middle). Now go back to the long production slide and decide whether the dual peaks, which made a tremendous difference to lots of non-petroleum things in the world, made any difference at all to US oil production. Answer: they didn't. The market was willing to reward marginal increments in domestic production up the wazoo, but no amount of revenue and profit, big or small, made any perceptible difference in US production. It made a difference only in the size of producer and consumer wallets at the time, and you already know which wazoos got rich and which didn't. True, it was, and will remain for another week or two, a singular time for commodity speculators as inflation takes off. And it is also true, as purists will argue, that all those profits may have had some minor effect on the relative rate of production decline, which you may either accept or deny as you see fit. But however much you flog the nearly dead horse, there is no get up and go left, so why keep paying for more of what is not there and never will return?

Message to Congress: with near zero supply elasticity, it makes no sense to let the domestic oil patch capture all the oil rents. Those funds are needed elsewhere: no, not as a sop to the people to pay for a couple of fill-ups just before the election -- please take note Mr. Frisk and the rest of you congressional idlers responding to The Chant and hoping to be reelected.  They should be recaptured and redirected in a massive way toward the first phase of The Transition Away From Petroleum. [And what is that? More to come.]  But before leaving, spare a thought to poor Mr. Bernanke.  He has admitted that he was shocked by the market's misreading of his opening gambit -- they seemed to think he was a wuss on inflation and proud of it.  It will be his attempt to prove just how wrong everyone was that will end up confirming that the average American (or average anyone else) can't live that well for that long with $75 dollar oil and serious interest rates. By the normal measures, oil is overpriced anyway. Lookout below once the farce in Iran and the tragedy in Nigeria have played out.*

*Pete's had a chance to rethink this rash statement and realizes oil could trade at well over $100 if Iran succeeds in quickly stampeding others into paying for oil in something other than dollars, as may be happening at the moment or about to happen soon. (Pete favors partial non-dollar oil pricing, provided the implementation is slow and gradual and over a number of years).  The Bush faction, having once again cut taxes in the face of major deficits, with an economy overheating, the fed on pause, and commodities exploding have it coming, but it will make life in the US pretty difficult if the current stampede away from the dollar leaves it a smoldering pile of rubble. As it has fallen from about 1.20 dollars for a euro to about 1.29 in a week, the carnage has already been severe but could be just beginning.

Pete's View of the Present

Every two hours or so a new wave of hypocrisy skims in from the hinterlands, roars over the beltway, and hisses to an end somewhere near Chevy Chase Circle. The Volk are clearly upset. $3 gas has them scared and angry.  Their winter heating bills haven't yet been fully paid and now the gougers down at the local pumps want them to kiss away $60 for each fill-up. They're right to be alarmed. They're wrong to be mad - it's a democracy after all and they and the freebooters they elect have been in charge. Everyone could see it coming for a generation; no one did anything useful. It's their own damn fault. Let them suffer the consequences for being such rash fools. 

Except that's not the way democracies work. The denizens of the beltway now have to scurry around and find some lamb worth sacrificing to assuage the anger. This part of the game is well understood: it's called The Chant. The Chant tends to get started over in Virginia, somewhere near Great Falls. What'll work? Let's see: heads must roll? No, not bloody enough.  Heads of assistant secretaries on pikes along Pennsylvania Avenue might do, hard to say, but it still may not be enough.  Another pride of oil company executives forced to sit quietly and listen to Nancy Pelosi at her illogical best? No, frightening indeed but not theatrical enough. Windfall profit taxes? From Dubya? not in this life. But don't worry. Once The Chant gets going, it gets loud, really loud really quickly, and the crew on Capitol Hill will get it frighteningly well.  They'll do something, however temporary and ineffective, but it'll be enough to bring quiet for a while.

And then what? We're left with $75 oil, a planet in trouble, the fourth or fifth failed presidency in a row, leaders who are worthless, and an economy distorted by hideous pretzel-like structural problems while chugging merrily along toward the wall.

Come on, lighten up a bit. There's a whole transition away from fossil fuels to start to puzzle out. If you want to drown your tears in your beer, try ethanol instead. Works better and faster anyway, if you can get some.

EIA's View of the Future

... is never right or even particularly close when it comes to prices, but usually is not too far off on consumption, as most demand forecasting is just more of the same writ larger.  So where is all the petroleum coming from?  Apparently the trip from 40 quads to 50+ quads of oil every year will be just as easy as the trip from 30 to 40.  EIA probably keeps three or four new Saudi Arabias hidden in their computers, and must think the Chinese and Indians prefer bicycles. And either the sequestration of carbon dioxide from coal will be proceeding apace and then some, or all that stuff about climate change must have turned out to be a hoax. Nice work if you can get it....

The Cost of Capping Greenhouse Emissions

EIA has issued a preliminary analysis of the cost of various proposals to limit greenhouse gas emissions. q.v. Unfortunately, the proposals analyzed key off of intensity reductions as opposed to actual reductions, and include an interesting provision for a 'safety' valve, presumably in case the doyens of K street become worried whether saving the planet is really worth it.

O Exxon

Exxon has run full page ads in the Washington Post and New York Times in recent days that attempt to show how much it has been doing to promote petroleum development.

A quick review of Exxon's balance sheet, with color emphasis supplied and profits/net income shown for reference, confirms that it has been spending a lot of money in absolute terms for energy development, but 'a lot' must be understood in relative terms. It is a lot in absolute terms: who could argue that $10-20 billion is not a lot of money? But Exxon hasn't been spending a lot in percentage terms compared to a hungry company that is actually out to find a lot of oil.  Exxon has been successful for many years in replacing the petroleum it uses and then some.  It invests just enough to do that, and then spends the rest on purchasing treasury shares to keep investors* happy through higher stock prices, and by returning money to them in the form of dividends. Its actual investment in property, plant, and equipment fell in a year when it made $10 billion more in profit, as did its long-term debt.  Indeed it is so well capitalized that long-term debt is a minor annoyance that could be paid off at any time.  Although not shown above, it finances the relatively small amount it does invest looking for new oil from its internal cash flow with little need of outside finance.  However, it could afford to borrow and invest many tens of billions more if it chose to do so. In fairness, when it does decide to invest in petroleum, it chooses exciting, very large projects and executes them with unmatched competence. If only it would do more.

The problem is that it does only what it has to, and a just a little bit more. This is not the balance sheet of a company that is lean and mean and looking hard for oil and gas.  It is the balance sheet for a firm that grew rich off investments made in previous decades that is quite content to treat its shareholders very well as it continues to grow its petroleum assets at a moderate and even stately pace.  Had not the spike in energy prices showered it with (undeserved?) money, it wouldn't have the pleasant and only mildly embarrassing task of trying to explain to the public why it was so very rich in financial assets.

*Including Pete.

O Canada

With considerable fanfare, the governments of the US, Mexico, and Canada have just released a report on the energy economy of North America qv1 qv2

The point is to demonstrate the importance of North American production to the world energy picture and the decision to include Canadian oil sands makes the point very well. But is it a realistic view? A far more interesting and arguably more realistic picture of the situation has been prepared by David Hughes of the Geological Survey of Canada in a very recent presentation to the Ontario Petroleum Institute. q.v. (see page 14 et seq.) And on the issue of realism, Roger Blanchard offers a brief critique of the US government's forecasts of Canadian oil production. q.v.

*Caveat lector: Pete sometimes takes positions in the stock of Canadian energy companies.

Nostro Nostrum

Since the early 90s, when it was just getting started, the derivatives market and the zoo of risk transfer mechanisms it spawned has simultaneously managed to evolve, settle down, and explode in size. But, most importantly, it hasn't crashed. It remains untamed and unmeasured and under-regulated, but it has worked well to transfer risks, even when some unworthy counterparties such as Enron had to be thrown out on their ear. The system swallowed hard but went on working. Still, what central banker hasn't lost sleep thinking about the myriad bad things that could happen? Here are a few of the recent remarks of Timothy Geithner, head of the NY Federal Reserve Bank, at a conference of the Global Association of Risk Professionals:

• The scale of the over-the-counter derivatives markets is very large. Although the notional total value of these contracts, now approaching $300 trillion, is not a particularly useful measure of the underlying economic exposure at stake, the size of gross exposures and the extraordinarily large number of contracts suggest the scale of the unwinding challenge the market would confront in the event of the exit of a major counterparty. The process of closing out those positions and replacing them could add stress to markets and possibly intensify the direct damage caused by exposure to the exiting institution. ... Credit derivatives, where the gaps in the infrastructure and risk management systems are most conspicuous, are less than 10 percent, and perhaps less than 5 percent, of the total OTC derivatives universe, but are growing much more rapidly. Large notional values are written on a much smaller base of underlying debt issuance. The same names show up in multiple types of positions-singles-name, index and structured products such as CDOs. These create the potential for squeezes in cash markets and greater volatility across instruments in the event of a default, magnifying the risk of adverse market dynamics.
• The net credit exposures in OTC derivatives, after accounting for collateral, are a small fraction of the gross notional values. The ten largest U.S. bank holding companies, for example, report about $600 billion of potential credit exposure from their entire derivatives positions, the total gross notional values of which are about $95 trillion. This "credit equivalent amount" is approximately 175 percent of tier-one capital, about 15 percent higher relative to capital than five years ago. This measure of the underlying credit exposure in OTC derivatives positions is roughly a fifth of the aggregate total credit exposure of the largest bank holding companies. This is a relatively conservative measure of the credit risk in total derivatives positions, but, for credit derivatives and some other instruments, it still may not adequately capture the scale of losses in the event of default in the underlying credits or the consequences of a prolonged disruption to market liquidity. The complexity of many new instruments and the relative immaturity of the various approaches used to measure the risks in those exposures magnify the uncertainty involved.
• Internal risk management systems have improved substantially since the mid-1990s, but most firms still face considerable challenges in aggregating exposures across the firm, capturing concentrations in exposures to credit and other risks, and producing stress testing and scenario analysis on a fully integrated picture of exposures generated across their increasingly diverse array of activities. The greater diversity of institutions that now provide demand for credit risk, or are willing to hold credit risk, should make credit markets more liquid and resilient than would be the case if credit risk was still held predominantly by banks or by a smaller number of more uniform institutions, with less capacity to hedge those exposures. However, we still face considerable uncertainty about how market liquidity will behave in the context of a major deterioration in credit conditions or a sharp increase in volatility in equity and credit spreads, and this uncertainty is hard to quantify and therefore hard to integrate into the risk management process.  ...
• The post-trade processing and settlement infrastructure, particularly in credit derivatives, is still quite weak relative to the significance of these markets, although the major dealers and buy-side investors are making a substantial effort to address these problems. The total stock of unconfirmed trades is large and until recently was growing considerably faster than the total volume of new trades. The time between trade and confirmation is still quite long for a large share of the transactions. The share of trades done on the available automated platforms is still substantially short of what is possible. Until the adoption of a new protocol last fall, firms were typically assigning trades without the knowledge or consent of the original counterparties. Nostro breaks, which are errors in payments discovered by counterparties at the time of the quarterly flows, rose to a significant share of total trades. Efforts to standardize documentation and provide automated confirmation services has lagged behind product development and growth in volume. Although the risk controls seem to have done a pretty good job of capturing the economic terms of the trades, the assignment problems create uncertainty about the actual size of exposures to individual counterparties that could exacerbate market liquidity problems in the event of stress.

 Petro Flows and Other Imbalances

Source: US Treasury

Since 2000 nearly a trillion dollars have flowed through OPEC's purses. What have they done with it? The US Treasury has issued a paper explaining. q.v. 

A few of its conclusions might seem, uh, interesting, such as, "If oil prices remain elevated, large oil exporters should consider the role that the choice of foreign exchange regime can play in the adjustment process." Policy Pete has long thought that it is time to price at least a portion of the oil moving in international trade in currencies other than the dollar, and is glad to note the authors' apparent concurrence.*  Even so, given recent events, it only fair to warn that the eventual public clamor to follow from choosing a 'different foreign exchange regime' will make the Dubai port management issue look pretty tame by comparison.

*The paper is more a trial balloon than an official pronouncement, coming with the warning: "These papers are not statements of U.S. Government, Department of the Treasury, or Administration policy and reflect solely the views of the authors." All very well, but, if so, then why note the paper's existence on the main web page and issue a press release?

The Rich Get Richer and the Poor Poorer

Source: Federal Reserve

Background - Real Wellhead Natural Gas Prices

Source: EIA

Background - Saudi Drilling Activity

Source: WTRG Economics, Energy Economist

Used to be the Saudi's managed to keep up their 10 million b/d production capacity (or thereabouts) with just 20 rigs active.  But they have announced plans to put as many as 80 rigs up and working in the near future.  Keep in mind that even 80 rigs is a tiny fraction of the number required to keep US production from declining faster, but it suggests determination to have enough capacity to help avoid future price spikes. 

Going Deep

Roger Blanchard reports on developments in the deep water petroleum, with particular reference to the beginning of sharp declines in the North Sea, counterbalanced by projected growth in the other areas. q.v.

The North American Gas Situation

Source: Graphic adapted from Canadian Potential Gas Committee

Although now more than a year and a half old, David Hughes' authoritative and troubling overview of the North American gas situation should not be missed. q.v.[pdf] Not a pretty picture, especially for Pete who was counting on Canadian coal bed methane qv1 qv2 to come to the rescue.

Coal and Human Mercury Levels

One of the nastier aspects of coal combustion is that minute amounts of mercury trapped in the solid coal are also released into the atmosphere during combustion. In time the mercury particles often enter the water supply where they may be transformed by bacteria to a toxic form of organic mercury called methylmercury. If consumed by fish or shell fish that humans later consume, the mercury is concentrated as it moves up the food chain and may show up in humans in perceptible, possibly even dangerous, levels. The health risk from elevated mercury levels is thought to be greatest for fetus development in pregnant women. There are several other possible sources of mercury in humans, including the amalgams used by dentists to fill cavities and flu shots, in addition to consumption of fish.

A recent study determined that fish consumption was by far the most significant source of human mercury levels in excess of the EPA's reference level.  The study also found that more than one person in five over16 years old exceeded the reference EPA standard, with men having higher levels than women. q.v.  A second conclusion was that mercury concentration levels varied regionally, with the Midwest having the lowest levels, while a few large cities had notably high levels, such as New York, where nearly half the participants had mercury levels in excess of the EPA reference level, and Seattle, Miami, San Francisco, and Washington, DC where more than one person in four was above the level.

The study itself was not based on a random but a self-selected sample of 6,583 people who submitted hair for analysis. The basic EPA analysis of the issue was published in 1997 q.v. and a multi-year EPA research plan exists. q.v. The impetus for the latter includes the fact that "as of December 2002, 2,140 fish consumption advisories in 45 states [had been] issued in part due to mercury concentrations." The Electric Power Research Institute has also been undertaking studies of the issue. q.v.

Warmest US January Ever

Source: NOAA

How warm was it? NOAA says:

Pete had to summon his haruspex -- the one who kept issuing dire warnings of impending doom based on too much hurricane damage to the natural gas delivery system -- back inside the beltway for a refresher course on entrail reading. Given a half-way decent winter, he might have been right, but fortunately he wasn't. It seems the US has lucked-out once again, which is a very good thing.

Background - US Trade Balance & Per Capita Income By State

Source: Bureau of Economic Analysis

Let's see, with a few exceptions, dark blue states are liberal, while conservative states tend to be white or gray. Deference rules?

The Dogs That Didn't Bark

Pete listened intently to the energy portions of president's speech q.v. on the state of the union, and finally heard them - the dogs that didn't bark.  He was quite content to listen to the normal blather about the importance of alternate fuels, reasonably priced energy, and so forth. Good safe stuff.  An 'advanced initiative' on alternate fuels? great, bring it on. Switch grass? what the hell is that? qv1 qv2 But if you think it's worth mentioning, Mr. President, then he does too. Hybrid automobiles? right on! OK it's a little hard to think that 'technological breakthroughs' like hybrids and switch grass are going to allow us to '...replace more than 75 percent of our oil imports from the Middle East by 2025... ,'  but no one is ever honest with numbers in Washington and there's no reason to start now. Maybe we really are on the threshold of 'incredible advances.'  Perhaps right now some uber scientist is rejiggering the first and second laws of thermodynamics in our favor.  It could happen. You never know. It never hurts to catch a few lucky breaks.

But then the dogs that didn't bark started getting a little loud. Zero emission coal? Oh you must mean the game where we pretend that carbon dioxide is not emitted by combusting 'zero emission' coal. Only the Bush administration and the Exxon boardroom believe it doesn't matter if we make progress on slowing global climate change, and yet not a word was spoken on the subject. The next dog was energy addiction. The president lamented oil dependency without mentioning that he is in the process of creating a serious and far more dangerous natural gas addiction. By 2025 future presidents will be using their state of the union speeches to lament the LNG problem created during the George W watch. And it is likely to be one of the few achievements for which he'll be remembered.

Exxon Breaks The Bank

ExxonMobil Corporation eclipsed its own past record by making more than $10 billion in profits during the final quarter of 2005. q.v. Coincidentally or not, GM, formerly a car company of some note, managed to lose $4.8 billion. q.v. Oh well, what's a car company here or there? Exxon for its part pointed out that the money didn't seem like wretched excess when measured as a percentage of total revenues. True, but as Exxon didn't manage to produce any more oil or gas, the results just show how nice it is to be around when it starts raining money. What will Exxon do with the money? The majority will be given to shareholders either as dividends or by supporting the price of Exxon shares through company repurchases. Now there's energy policy at its market-driven best.

Natural Gas Winners and Losers

The moral is either that it's an ill trio of hurricanes that blows no good, or a simple admonition to stay lucky if your assets sit in harm's way, but some petroleum firms won big in the natural gas stakes, while others lost big.  Here are a few of both:

Quick Guide to Regional Changes in US Natural Gas Reserves

Source: EIA

The OPEC Income Constraint

Source: EIA

Leaving aside questions of mal distribution internally, even record energy price levels have not produced record per capita revenues within OPEC. However, the current situation is a reminder that internal distribution of oil revenues is always an issue, and one that foreign consumers may end up paying for, given the apparent upward reaction of world oil markets to internecine conflict in Nigeria.

The US Income Constraint

Source: Morgan Stanley

As one might expect, the income constraint comes at a time when American household debt service payments and financial obligations are hitting new records as a percentage of disposable personal income. q.v.

The Ringing Energy System

A long-time PP reader, who prefers anonymity, writes as follows: