Dodging Crucial Energy Choices

You know the adage, "Follow the money." When looking at energy issues, we like to pay attention to what the money people are saying--specifically the investment types. Their insights provide an interesting view into America’s energy situation.

Our favorite energy investment advisor is Byron King whose work is published in the Whiskey and Gunpowder Newsletter and the subscription newsletter he edits, Outstanding Investments. (If you have not read any of his previous postings here, we encourage you to check them out too.) For our purposes here, we have edited out all of Byron’s investment advice as we have no business offering such information. However, we do believe you will find his review of history and energy to be very helpful to your understanding of today’s energy situation.

This posting is a bit longer than what we typically post here. You may need to print it out to read at your leisure. Whether you read it here or on paper, we do hope you’ll post your responses. Do you agree with Byron’s assessments? Is his history correct? We always enjoy Byron’s input. We hope you do too!

Will Americans have to read by candlelight and bike to work?
We will if the country dodges crucial energy choices--and time is running out
Remember how President Obama bowed to King Abdullah of Saudi Arabia? That was bad enough. This is worse: Abdullah is playing Obama for a fool.

That bow Obama made to Abdullah at a summit in London says everything about how the Saudis have made us their oil slaves. Think about it, the American president, bowing and scraping to a foreign monarch--the king of a country where women can’t drive and criminals are beheaded in public. Worse, we’re becoming more dependent on the Saudis for energy, because Obama wants to close off even more of the USA to oil exploration.

If some well-informed experts are right, Saudi Arabia's oil reserves are a fraction of what they've been telling us. Why does it matter? Because everyone has believed for decades that Saudi Arabia's oil supply is virtually unlimited. That's what the Saudis have said over and over again for more than 30 years. If an oil shortage threatens to cause a recession or a market crash, we can count on the Saudis to come through. So people think. But one of America's top oil experts warned that the Saudis don't have anything near the oil reserves they claim. They already pump less oil than most "experts" think. Here's the real kicker, Saudi oil production is about to drop sharply. And it will keep going down for good. Other experts have analyzed the numbers and come to the same conclusions. If the charges are true--and I believe they are--we could be facing oil at $150 per barrel and gasoline at $6 a gallon or more. The oil is running out. It's as simple as that.

That's not what you hear from so-called experts. If you ask government officials, our intelligence agencies and even powerful Wall Street financiers, they tell you the opposite.
They say the Saudis could quickly double their oil production from the current level if they wanted to. And given a few years, they think the Saudis could produce four times as much oil as they do now.

The intelligence agencies and the conventional "experts" are dead wrong. The oil isn't there. The oil and gas shortages we've seen lately are nothing compared with what's on the way.
When the truth comes out, it will send shock waves through the world economy. Everyone will find out too late--when gasoline soars to $5 or $6 or more per gallon.

Americans used to run Aramco, the huge oil company that manages the Saudi fields. But in 1979, the Saudis booted us out and took over. And then a funny thing happened, The Saudis started keeping everything a secret. No one knows for sure how much oil they've got in the ground, or how much they produce each year or how much they could produce if they wanted to push it to the max. It's all secret. Experts try to figure out how much oil the Saudis sell by monitoring tanker traffic in and out of the world's ports. That's how little we know for sure.

After the Saudis took over, their figures for proven reserves kept going up and up and up--even though they didn't find any major new oil fields! In 1979, the Saudis adjusted proven reserves upward by 50 billion barrels. Then eight years after that, their proven reserves magically grew by another 100 billion barrels. Their estimated reserves increased by 150% in nine years--to a total of 260 billion barrels. And they didn't find a single major new oil field!

For 16 years, from 1979 through 2005, they've claimed they own 260 billion barrels of proven oil in the ground. The figure never goes down, even though they pumped out 46 billion barrels during that period. Let me see...260 minus 46 equals 260. Saudi math!

Based on these bogus figures, the Saudis claim they can produce as much oil as the world wants for the next 50 years. As recently as 2004, they claimed their reserve estimates are actually conservative. That's why most of the world's governments and intelligence services believe the Saudis could pump 20 million barrels of oil a day if they wanted to. Trouble is, we've got no proof except their say-so. If it were true, we wouldn't have a thing to worry about. But it's not.

Before Aramco's American owners were shown the door in 1979, they told Congress that Saudi Arabia had proven reserves of 110 billion barrels. There have been no major new discoveries, so 110 billion barrels was probably about right. And since then, about half of that has been used up. So why do the Saudis insist everything is just fine and they have 260 billion barrels of reserves? One reason is they wanted to discourage non-OPEC nations from looking for more oil or switching to alternatives. It was a devious plan, and it worked perfectly.

But that wasn't the only reason the Saudis lied about their reserves. They did it because everyone does it! Everyone in OPEC, that is. In the 1980s, OPEC's claim of total reserves magically leaped from 353 to 643 billion barrels without a single major discovery. Industry experts call it the quota war. You see, OPEC had to limit how much oil each member could sell, because prices were too low. The quotas were based on... each member's oil reserves!

That's right: The amount of oil OPEC would let a member pump depended on how much that member had in the ground. So it paid for OPEC members to claim the biggest reserves they could. And that's what they did.

The Saudis alone jacked up their estimate by about 100 billion. Kuwait added 50% to its reserves in one year, 1985. Venezuela doubled its reserves in 1987. Iraq and Iran doubled their estimates, too. What's more, OPEC members did like the Saudis and kept their reserve estimates the same year after year, as if no oil were being pumped out and sold. Everyone claimed to have a bottomless well.

Now, if you're like me, you believe America should base its energy decisions on the real world, not on a fantasy.

Let's Look at how Much Oil There Really Is
In the 1970s, when Western managers were still in charge, they believed for a time that Saudi output could reach 20 million barrels a day. But by the time the Americans lost control in 1979, they figured the peak would be 12 million. They also predicted that peak production would last only 15–20 years. 1979 plus 20 is 1999. We're past the peak, if these men were right. But we already know they were too optimistic. The truth is that Saudi production never got to 12 million. "In all probability, output peaked in 1981 at an unsustainable level of about 10.5 million barrels per day," according to Matthew R. Simmons, a leading oil industry authority.

In 2004, Saudi officials claimed they boosted production to 9.5 million barrels per day and maintained that level for five months. It's almost sure they were lying. The International Energy Agency is the group that keeps an eye on these things for the developed, oil-importing countries. The IEA could find no sign the Saudis were selling more oil. As far as anyone can tell, they pump only around five million barrels a day, and that's all they've pumped for years.

In spite of being lied to at least once, the IEA, the US Department of Energy and other forecasters believe the Saudi claims. ALL their projections of our energy future ALWAYS assume the Saudis could produce 15–20 million barrels a day.

The lies have worked. Not only do Western politicians believe them, but so do many oil industry experts and investors with huge amounts of money at stake. They've been had.

Our whole economy is at risk. America was so prosperous the last couple of decades, a lot of people forget what the energy crisis of the '70s was like. Let me remind you: The price of a barrel of oil shot up 400%. Long lines formed at gas stations practically overnight. Folks had to pay four times as much for a gallon of gas, and there came a week when one out of every five gas stations in the United States had no gas to sell at any price. The US had three major recessions within 10 years after the first oil crisis in 1973. And those recessions were deep, with double-digit unemployment, double-digit interest rates and double-digit inflation. Think 10–12% unemployment. Think 15–18% mortgage rates. Got the picture? That was the ‘70s. Not fun.

My take is that a similar crisis will rock the nation before we solve our problem with clean coal, liquefied natural gas, oil from tar sands, high-mileage cars and safe nuclear plants. More than likely, the politicians will quarrel for years before they do what has to be done.

The Great Coal Rush
While the oil runs out, there's still plenty of coal. The world has enough coal to last for 300 years at current rates. Coal already accounts for more than half of our electricity. But coal is dirty, right? And there's no way it can power cars, right? Wrong, and wrong again. Coal can be cleaned up AND it can power your SUV. However, it's not cheap to do. It's only worthwhile when a barrel of oil costs more than $30.

The US and China both have a growing problem with the price of oil and with the unstable countries they have to buy it from. Meanwhile, the US and China both have HUGE reserves of coal. Add in Australia and Canada and you've got four countries that you could call the OPEC of coal. They own just about all the coal there is.

The US alone has 254 billion tons of proven coal reserves, or about 25% of the world total. Compare that to Saudi Arabia, with 24% of the world's oil (if you believe it).
Meanwhile, the Chinese economy is doubling every 10 years and has a lion's appetite for electricity. The Chinese will have to give up that growth rate or build hundreds of new power plants, one or the other. They have no choice.

Electricity could be China's biggest roadblock to growth. Already, blackouts and brownouts happen every day all over the country. Factories by the thousand are forced to shut down from time to time. Many are allowed to operate only during off-peak hours. Children in some cities do their homework by candlelight. With an economy that grows 8% or 9% every year, and electric usage soaring at the same rate, the Chinese have no choice but to build hundreds of new power plants. And most of those plants are going to run on coal.

In the United States, we have a power crisis of our own. We're at the limit of our generating capacity. We have our own brownouts during peak-demand times. We, too, need to build hundreds of new power plants. Yet the public still doesn't want nuclear power.

You do the math: We face a crude oil shortage, nuclear power gives people the willies, we've got plenty of coal in the ground, we've got a choice between more power plants or deep recession and unemployment. Everything points to coal.

How Oil Could Go Beyond $150 in 24 Hours
If you want to bury your head in the sand and pretend Saudi Arabia has plenty of oil, be my guest. However, very shred of evidence points to no Saudi buffer for world oil markets. And that's a real problem because oil consumption soared from 52 million barrels a day to 82 million in the last 19 years, and it's expected to grow to 120 million in the next 20--if the oil can be found. Very doubtful.

There are three ways oil could race past $150 a barrel: It may get there gradually, or on a faster pace of a year or two, or overnight, literally within 24 hours. Pick any one of the three. No matter how you look at it, it's a sure thing the days of cheap oil are over. We're never going to see $30 oil again, and we may never even see $50 oil. Soon oil in the $100s may very well return to stay.

"You never really run out of oil," says a Houston energy consultant named Henry Groppe. "But many years ago we ran out of $2 a barrel oil, then we ran out of $25 oil, and now we're running out of $40 oil."

Saudi production could fall over a cliff almost overnight. There could be a deep, sharp reduction in Saudi oil production literally any day. It's guesswork, but energy expert Matthew Simmons says, "It will take energy forecasters and policymakers by total surprise. Not a single serious energy plan devised in the past three decades has envisioned such a scenario." He's told interviewers that Saudi output could drop 30–40% from the already low level of just 5 million barrels. Simmons doesn't claim to know for sure, but I believe he's right.

In the big oil crisis of 1973, oil went to $100 in current dollars. Back then, the problem was just political. Angered by US support for Israel, the Arab oil producers cut our supply. After things calmed down, there was plenty of oil. This time the problem is real and there's no quick fix. There's a sword hanging over our heads, and most people don't even know.

I've spotted three trends to watch that could crash markets and cause a recession.

Hurricanes
You already know that the 2005 hurricane season was the worst on record, and the one before that was almost as bad. In 2005, there were 27 tropical storms. Weather experts could hardly believe it, but the last one formed in December, a month after the "end" of the hurricane season. It's not as weird as a blizzard in July. But it's close. Worse, the storms are more powerful than ever before. It seems that a tropical storm is more likely now to become a deadly Category 4 or Category 5 hurricane.

Two reasons for the monster storms: The first reason is there's a normal cycle of low hurricane activity followed by a period of high hurricane activity. Each phase can last for several decades. Clearly, we're in the high phase, and it will probably go on for years. That's bad enough, but it's normal. But now you have to add the danger of climate change.

Bear in mind that climate change can be caused by either human activity or natural causes. And either way, the jury is still out. Despite what you may hear from the mainstream media, the case for global warming is far from closed. But global warming believers are already blaming the monster hurricanes on climate change. They may be right. The level of hurricane activity we're seeing has no precedent in the hundred years or so that scientists have been counting and categorizing storms. Meanwhile, a big chunk of our energy industry is located in the worst possible place.

Americans have largely banned oil and gas drilling and liquefied natural gas ports from the Atlantic and Pacific coasts. They don't like oil refineries, either. Plus, it's well known that the Gulf of Mexico is energy rich. So America ended up with a huge part of its energy infrastructure located on the Gulf Coast. A lot of it was knocked out by Katrina and Rita. As I write this, the Gulf coast energy industry is still not back to normal.

If there is a hurricane season like 2005, it could be the end of some 20% of America's oil and gas industry. And it could all happen in 24 hours.

It's hard to picture that oil companies are going to keep on investing in a region where they get knocked out every year. And the onshore plants can't be moved to Boston and San Francisco, where they're not wanted anyway. We could be staring at a permanent loss of a large part of our energy industry.

War and Revolution at the Chokepoints
World oil supplies are so tight the price could go through the roof if we lose just a couple of million barrels of daily production out of the world total of 82 million. Production is running full tilt and consumers snap up every barrel that comes out of the ground. There's no buffer (despite what the Saudis claim). A sudden leap to $150 a barrel, not to mention $150+, could tip us over the edge--and into a deeper recession. The immediate cause could be war or revolution in an oil-producing country.

Toss in another bad hurricane season at the same time and it could be the end of our way of life.

Saudi Arabia itself is a prime candidate for revolution. You might think al-Qaida's main target is the United States, but in fact the main target all along has been control of Saudi Arabia. The World Trade Center was just a stop on the road to Riyadh, as al-Qaida sees it.
But my own pick for disaster is Nigeria. This African country is the world's No. 12 oil producer, and a big supplier to the United States.

Nigeria is seething with revolution. The government--if you want to call it a government--admits that thieves steal as much as 200,000 barrels of oil a day and sell it on the black market. Off the record, experts put the bootleg oil as high as 650,000 barrels a day. That kind of oil generates huge sums of cash, and a lot of the money is plowed into arms for the rebels. There's no shortage of poor, hopeless young men willing to use the weapons. Three Nigerians out of five live in poverty.

Caught in the middle of all this are big oil companies like Shell and Chevron. In some parts of the country their facilities have been shut down and they've been kicked out. If you want to get punched in Nigeria, just tell a native you work for Shell.

Terrorism
You won't be surprised to learn terrorism is the third wild card that could create an instant crisis. In fact, a former CIA director recently joined some former oil executives and government experts in a risk-analysis exercise. They forecast three very likely events that could bring the roof down on our heads. One of them was civil war in Nigeria. The other two were both terror incidents.

Intelligence agencies know the terrorists have especially targeted oil facilities and infrastructure. It's an international game of cat and mouse in which the terrorists are looking for a weak point day and night, high and low, while we try to find them and stop them in time. It's only a matter of time until they succeed. It's like a thief checking every door in the neighborhood every night. One night, he'll find a door that's not locked.

Are you getting the picture? The good scenario is that the oil price will merely hover around $150 over the next few years. The worst scenario is that it will go there--then much higher--next week, or next month or next year.

The Natural Gas Bottleneck
When oil started getting pricey during the 1970s, America switched to natural gas in a big way. Natural gas now supplies about 24% of our total energy needs, including a big chunk of our electricity. The move made sense. We had plenty of natural gas, and what's more, it's a clean-burning fuel that cuts down on pollution. But like any kind of fossil fuel, there's only so much of it. Now we're running out.

After the big hurricanes of 2005, everyone can see the US is vulnerable. We didn't have the gas supplies we needed when we needed them. That was a cold, expensive winter for a lot of Americans.

America has placed vast areas off limits to drilling. Not only millions of acres of federal lands, but also most of the offshore areas on the Atlantic and Pacific coasts. These gas-rich regions are off-limits even though natural gas doesn't create spills. If there's an accident, it just escapes into the air. And drilling rigs are mostly out of sight of the resort properties on the beach. The regulations have left only the Gulf of Mexico, aka hurricane alley, for offshore drilling and natural gas production.

If you saw your heating bills shoot up this winter, you'll be frustrated to learn there's plenty of gas worldwide. It's a byproduct of oil wells, and if an oil field isn't close to a big population center or a pipeline, the gas is just flared off. The rest of the world burns off as much as 2.5 trillion cubic feet of what is called "stranded" natural gas. That's equivalent to 1.7 billion barrels of oil totally wasted every year! The problem is that gas, unlike oil, is hard to transport. You can't build pipelines across oceans. And big oceans separate North America from the cheap gas that's now going to waste.

Because of the bottleneck problem, the price of natural gas is much higher in North America than in the countries that are swimming in the stuff.

There's an easy solution to our natural gas shortage, and it's been around for years. It's called liquefied natural gas, or LNG. If you turn natural gas into a liquid by supercooling it, you can transport 600 times as much gas in the same space. One LNG tanker can carry as much as 600 ships hauling natural gas in vapor form. And despite what you may have heard, LNG is safe. With 40,000 LNG tanker voyages spanning the last 45 years and crossing 60 million miles of ocean, there hasn't been a single major accident. Not one. No explosions, no fireballs, no gruesome casualties. Sorry, Hollywood.

As things stand now, the US gets only 1.5% of its natural gas in the form of LNG, but with the energy crunch, things are going to change. The government's Energy Information Administration believes LNG will provide about 17% of our total gas supply by 2030. That means a 11-fold increase in LNG. Better yet, that's going to be a higher percentage of a bigger market, too. The EIA projects total gas consumption — LNG and vapor combined — will boom 30% in the next 10 years. And meanwhile, a fierce bidding war has broken out among Europe, Asia and the US for every available ounce of LNG.

The boom was actually under way before the current energy crunch hit. LNG trade soared 55% in the 10 years ending in 2004. This little market is growing like crazy. Some analysts even predict LNG will surpass King Crude to dominate the world's energy markets. The CEO of Shell says within 10 years, gas will be a bigger part of the company's business than oil. Natural gas is quickly becoming the energy of choice internationally. Natural gas demand will also become a cheaper and more viable energy source.

The Worldwide Boom in Nuclear Power
After a couple of freak accidents several decades ago, Americans decided they wanted nothing to do with nuclear power ever, anywhere. The accidents at Chernobyl and Three Mile Island killed nuclear power in the United States. We're just about the only people with that attitude. The rest of the world took a look at the safety problems, solved them and forged ahead. France now gets 77% of its electric power from nuclear plants. Japan and South Korea get 39%--and the two of them have more than 20 new plants on the way.

Belgium, Sweden, Finland--they've all gone nuclear. It seems like everyone but us is building nukes.

China plans to boost its nuclear power capacity by 500%. In fact, for the past 40 years, nuclear has been the fastest-growing power source in the world. And now it's really taking off. What's more, all the hundreds of plants worldwide have logged thousands of reactor years without a single accident. You see, Asians and Europeans have discovered something Americans refuse to see: Nuclear power is safer, cheaper and cleaner.

The Chinese are charging ahead with a new type of nuclear power plant. I predict utilities will build hundreds, and maybe thousands, of these new plants all over the globe. Electricity will become super-cheap. And eventually we'll see an economic boom worldwide like we've never seen before:
*The new plants will be walk-away safe. A meltdown is not just unlikely, it's impossible.
*There's no danger of radioactivity venting into air or water.
*There's no chain reaction involved.
*No need for huge cooling towers or water. No billion-dollar pressure dome.
*Almost no waste, and what waste there is can be stored safely on the premises.
*No need to fear a terrorist attack.

The technology uses an alternative way to harvest the energy of the atom--a way that Americans discovered and then rejected decades ago. The Chinese plan to mass-produce the reactors. The plants will be modular and factory made, built to last 40 years, ready to ship anywhere in the world and assembled like Legos. A Chinese scientist boasts, "Eventually these new reactors will compete strategically, and in the end, they will win. When that happens, it will leave traditional nuclear power in ruins." The man has reason to be cocky. They've already tested the prototype by turning off the coolant and letting the plant cool down by itself. That would be totally unthinkable with a conventional reactor.

Byron King earned his Juris Doctor from the University of Pittsburgh School of Law, graduated cum laude from Harvard University, served on the staff of the Chief of Naval Operations, and is a regulator contributor to the Whiskey and Gunpowder investment newsletter.