IS THE WORLD RUNNING OUT OF OIL? -- World Affairs

In the early 1850s, Samuel Kier, a Pittsburgh druggist, began selling bottled oil, an undesirable by-product of his father's brine wells as "Pennsylvania Rock Oil". (Brine wells were created by pumping water down a well and pulling up a salty solution, which was processed to extract salt, bromine, then used as a pharmaceutical, and calcium hypochlorite -- a form of bleach -- among other less-familiar products.) By 1855, he was advertising the scarcity of the oil: "Hurry, before this wonderful product is depleted from Nature's laboratory!" it read. Modern-day Pollyannas have been using this quote and others like it to denigrate the idea that we will run out of oil.

Modern-day Cassandras, on the other hand, find ample “evidence” that the world’s out-of-control overpopulation will strip the earth of every twig, blade of grass, and molecule of oil during our lifetime.

Both are wrong. But the Cassandras are closer to the truth. And they will be closer to the truth until and unless someone abrogates the laws of supply and demand. If you doubt the ability of manunkind to destroy his environment, take a look at this week’s headlines about Haiti and the Dominican Republic. Add grinding poverty to someone’s misconception (pun intended) that “Be fruitful and multiply” meant “be fruitful and multiply exponentially. Multiply like rabbits unchecked by predators until you have destroyed everything else I created.” The result is the mud-flowing, eroded, barren, wind-swept terrain known as Haiti. Wonderful people. Mis-conceived notions.

How does this apply to the amount of oil our children will have? Think China and India. If you think 7 million Haitians need to stay warm, might want illumination at night, or need to get from point A to point B, try 10 times that many -- or 100 times -- or 300 times, which is the number of people we’re talking about just in China and India. Shanghai alone has more people than all of Haiti.

To understand why this is a demo-trend that transcends today’s price per barrel of oil or tonight’s evening sound bites, this month we’ll devote virtually our entire issue to the history of fossil fuel production; an overview of all fossil fuels (not just oil); China, India, and the supply-demand equation; and the effect politics, wars, and alliances have on the mix; and what it all means to investors.

History

Contrary to what some US textbooks might have you believe, oil was not discovered by “Colonel” Edwin Drake in 1859, though he was a key player in the evolution of oil drilling. We’ve used oil for centuries. Oil wells were drilled in China, at depths of up to 800 feet, using hard bits attached to bamboo poles, for at least a couple centuries prior to the birth of Christ. Over the next couple thousand years, cultures all over the world collected seep oil (oil that oozed out of the earth at various points in the surface) to light their street lamps and more.

Marco Polo recorded his observations in 1264 in what is now Baku, Azerbaijan: "..on the confines toward Geirgine there is a fountain from which oil springs in great abundance, inasmuch as a hundred shiploads might be taken from it at one time." In 1264, Europeans and Asians knew about oil. So did American Indians, who collected it in seeps all across the country. Lest we think this industry is a fledgling, even the “new” technology of separating oil from oil sands was done as long ago as 1735 in France.

Before the American civil war, a Canadian geologist figured out how to distill kerosene from oil, thereby saving the world’s whales. That’s right. The next time some eco-Nazi tries to tell you you’re an evil person for using electricity or traveling in an airplane or staying warm in the winter, remind them that, prior to the 1800s, artificial light was provided by fire torches, tallow candles, and foul-smelling, atmosphere-polluting lamps that burned animal fat. In the early and mid-1800s, whale oil, with less odor and smoke than most fuels, became the fuel of choice. A powerful whaling industry developed to provide (mostly sperm whale) oil for lighting and other species of whale oil as lubricants for the machine parts of factories and trains. Some species were driven to the brink of extinction. The right whale was killed in the early 1800s at a rate of about 15,000 per year. (By comparison, Norway, the most eco-friendly nation you’ll ever visit, is reviled by environmental groups today. That nation kills about 700 whales a year, all for eating, from a species that reproduces at the rate of about 3 times that many each year. Norway considers this a renewable resource like lobsters and shrimp. Some eco-Nazis think it’s a sin to kill food to eat OR to use fossil fuels. Go figure.)

When a truly clean-burning kerosene lamp -- the first mass use of fossil fuels in America -- hit the market in 1857, its effect on the whaling industry was devastating. Kerosene (known then as coal oil) was cheap, abundant, easy to produce, smelled lots better, and didn’t spoil like whale oil did. The public abandoned whale oil lamps almost overnight. If petroleum products, such as kerosene and machine oil, had not appeared in the 1850s as alternatives to whale oil, many species of whales would have disappeared long ago. Population and economic growth in the 1800s and 1900s would have deprived us of the leviathans of the sea.

...which brings us back to “Colonel” Drake. A New York lawyer heard about druggist Kier's Pennsylvania Rock Oil and hired someone to see if Kier’s oil (more widely called Seneca Oil because members of the Seneca Nation collected it from seeps in Oil Creek in Pennsylvania) could yield lamp oil. It worked and lawyer Bissell obtained financial backing to form the "Pennsylvania Rock Oil Company", -- later the "Seneca Oil Company."

By coincidence, an out-of-work railroad conductor -- Drake -- was staying at the same hotel as Bissell and his partners in New Haven, Connecticut. Edwin Drake had a free railroad pass as a severance from his last job. With this as his sole apparent qualification, Drake was hired in 1857 to go to Titusville, a town on Oil Creek. His employers passed him off as a colonel to give their venture an air of respectability -- although he had no military service.

Drake’s contribution was to use steam-powered equipment used to drill brine wells for oil, as well. Although no gusher came in -- it was more of a seeper with oil brought up from about 70 feet down -- Titusville was transformed into an oil boom town, the first of many from Pennsylvania to Texas to California to Alaska, and today from Azerbaijan to Zaire and nearly everywhere in between. Names legend to oil wildcatters -- Adams Canyon, Shamrock, Blue Goose, Lakeview, Spindletop, Prudhoe Bay, the North Sea, etc. The hunt goes on.

Just What Is It We’re Hunting For?

Call it what you will -- black gold, Texas tea, dead dinosaurs, or whatever, “oil” means more than just “oil”. The term is used incorrectly but generically and frequently to mean any and all hydrocarbons -- the fossil fuels, so named because they are the agglomeration of dead bodies, diatoms, trees and plants that died and sank to the bottom of the swamps and oceans. There they formed layers of a spongy peat-like material. Over many millennia, the peat was covered by sand and clay and other minerals, which turned into sedimentary rock.

More and more of these layers piled on top of each other. As its weight increased, the excess water oozed out. Over many millions of years, the remaining biomass turned into coal, oil, or natural gas. At Investor’s Edge, we most certainly do not use the three terms interchangeably. There are times when we want to be buyers of coal, other times natural gas, and other times oil. Sometimes we want to own all three. And for the very long term (generations, not years) we want to always own at least some of each, as well as alternative energy companies in the solar, wind, biomass, and fuel cell areas. We refer to “energy” companies, not oil companies, when we label companies that seek to find, extract, refine, and distribute any of these fuel sources.

Supply, Demand, Politics, and Wars

I said above we are not influenced by the daily upticks or downticks in the price of oil. Most people buy energy stocks when they see oil prices rising and sell when they see them falling. While I believe we can time cyclical moves in the stock markets, there is no way anyone can foresee with accuracy over time the shifting sands of politics, wars, alliances, and encumbrances. I think I am an astute student of international relations, politics, enlightened national self-interest, and warfare. I have an undergraduate degree in the first and a Masters degree and a few decades experience in the last. I read voraciously. And yet, like most, I did not predict the violent overthrow of the Shah and his replacement by a theocracy in Iran, I missed just how much collusion there was between Saddam and those with whom he traded oil for guns, and did not prophesize the decision by Khadaffi to bring Libya into the 21st century as a more responsible nation.

Yet every one of these events had the potential to radically alter the supply and demand parameters of the world’s oil and natural gas. Just using these three nations as an example, Iraq has more proven reserves of oil than any of the nations on the earth except Saudi Arabia (about 260 billion barrels) and Canada (with whom, at 120 billion barrels) Iraq (115 billion barrels) is about tied.) When it comes to their (likely but not proved) reserve base, however, Iraq beats Canada and even Libya's vast natural gas reserve. Counting the tar sands, which are currently being profitably produced in Canada, both Canada and Iraq may yet prove to be bigger than Saudi Arabia.

You’ll hear terms like these thrown around on TV by know-nothings trying to impress. Just remember: In the energy business, “proven reserves” are that portion of total oil resources that have been (1) found, (2) developed, and (3) for which wells are drilled and some equipment is in place.

The “reserve base” is that part of a resource that meets certain industry-standard criteria related to current production practices (like grade, quality, and depth of a field.) It may include resources that have a reasonable expectation of becoming economically viable when more advanced removal technology and/or a better economic environment accrues. Some texts use the term “probable reserves” interchangeably with “reserve base.”

Finally, “‘reserves” or “resources” are used and mean whatever the heck the writer wants them to mean -- loosely, the amount of oil the writer can quasi-plausibly speculate exists. When the writer is an oil company’s accounting department, this leads to the final oil patch term, a “no-no.”

In addition to all that oil, Iraq has proven reserves of 110 trillion cubic feet (tcf) of natural gas. (Libya has proven reserves of 46 tcf and Iran, with 16% of the world’s supply, has 815 tcf of natural gas.)

Iran isn’t far behind in the oil category, either, with 88 billion barrels of proven reserves, and Libya, Africa’s biggest oil producer, brings up the rear with 29 billion barrels of proven reserves. To put this in perspective, the US has 30 billion barrels of proven reserves which, at current production levels, will last 10 years. Russia has 44 billion barrels in proven reserves. That’s 21 years worth. Both dates reflect zero new capacity.

Taking the macro geopolitical view is key to deciding how much, as an investor, to rely upon the price and direction of the price of a barrel of oil to make your buying decisions. Did you predict the revolution in Iran in 1979? If you didn’t, and you were out of energy stocks, by the time you blinked, they had skyrocketed. Did you predict the Iraqi invasion of Kuwait? The 1973 Yom Kippur War that led to OPEC drastically reducing the supply of oil? The Libyan decision to eschew its WMD program? If so, the US intelligence community and about a hundred oil companies would like to hire you! If not, you could have been badly whipsawed by each event.

I don’t discount the short-term impact on oil and gas prices of these events, but I prefer to invest based upon larger factors. Supply will come and go in the short term. OPEC will get in a snit and lower production, resulting in higher prices. A revolution occurs in Iran and the temporary disruption of world supplies sends oil higher. Libya rejoins the world and invites oil companies to use their money to explore and oil prices may fall. Saudi Arabia pumps like crazy in an election year and prices decline. But, like the chart in the lower left (used to describe the market itself in a previous issue), those are all merely sine curves around The Big Trend.

Will we run out of oil? Well, not right away. Supply will expand. We may get a big boost from new discoveries in the Arabian / Persian Gulf in natural gas, the Baku fields for oil, or new unexplored areas in previously despotic and relatively unexplored areas like Iraq. Oil sands and shale oil will add, at higher expense (but still wildly profitable with oil anywhere north of $45 a barrel), significant proven reserves. Coming to our senses and using nuclear, wind, and solar will help hugely. But the demand is growing even faster. The equation is simple: more bodies on earth, more motor scooters, more cars, more factories, and more travel = greater demand. Greater... than the supply.

[This article originally written in Investor's Edge (R) (June2004) and posted at www.investorsedge.us]