Analysis of Present Oil Crisis

How the New Oil Crisis Affects You
by Sean Brodrick 06-11-08

In ancient times, when mapmakers came to uncharted territory, they would scrawl: "Here There Be Dragons."

Flash-forward to the 21st Century; oil markets went into uncharted territory on the charts last week. Friday's dramatic spike up was the biggest one-day move EVER. Morgan Stanley now predicts that oil prices could hit $150 per barrel by the 4th of July.

The dragons are coming to dinner. Are Americans on the menu? More specifically, are you? Today, I'll answer those questions and more.



Let's start with ...

How This Crisis Differs
From Past Oil Spikes

If you remember the last two oil crises — in 1973 and 1979 — you might be thinking: "well, these things end eventually."

Maybe so, but there are big differences between then and now.

SUPPLY ...

U.S. production peaked in 1970 at about 9.6 million barrels a day. In 1973, we imported about 3.1 million barrels a day. So when the Arabs cut off our imported oil, it hurt, but we could adjust.

Today, the import/domestic production ratio has flipped — we import about two-thirds of our oil.

So when President Bush said we are "addicted to oil," that's only part of the problem. The real problem is we're addicted to foreign oil — much more so than in the past.

U.S. oil inventories have dropped 35 million barrels since March — our margin of safety is getting painfully thin. The most recent trend is particularly ominous. Crude oil stocks are down 5.8% in the last three weeks compared to an increase of 2.5% at the same time a year ago.

And U.S. gasoline inventories are falling off a cliff — down 11% since early March. They should have built up right before the summer driving season, but that didn't happen this year.



And DEMAND ...

In the 1970s, OPEC slapped an embargo on oil shipments as punishment for U.S. support of Israel (in 1973, Israel and Egypt fought the Yom Kippur War). The reason for oil stoppage was political — artificial. However, it caused real conservation in the U.S. By 1979, virtually all the big "full size" American cars were downsized. When the Iranians turned off the taps, it didn't hurt nearly as much as the first oil crisis.

And it went beyond cars. Conservation became the buzzword across America. President Jimmy Carter installed solar panels and a wood burning stove at the White House. Carter's energy saving measures were promptly trashed by Ronald Reagan when he took office, as the energy crisis receded in the rear-view mirror.

But America's conservation proved OPEC's undoing. When they wanted to sell oil again, we didn't need as much of it. And without American demand, oil prices plummeted.

This time around, the demand growth isn't limited to the U.S. or even the Western world. There are 10 million new cars and trucks hitting the road this year alone in China, and millions more joining traffic jams in India, and other emerging markets. OPEC is starting to realize that because of this new demand, they need us a lot less than we need them.

Asia is why global oil demand is growing stronger even though the U.S. economy is slowing down. In previous oil crises, a weakened U.S. economy dragged down the global economy and global oil demand.

But the International Monetary Fund just projected that even with higher oil prices the global economy will grow at 3.7% this year and 3.8% next year. Oil supply is growing at 1% annually at best. It's simple math ... and it points to higher oil prices.

The stark differences between supply/demand then and now explain only part of the uncharted territory we are now navigating. Here are the other three dragons coming to dinner ...

1) Accelerating decline in net oil exports. Over the next couple months, I think you're going to hear a lot about something called the "Export Land Model", or ELM. This is a theory proposed by Jeffrey Brown and others associated with TheOilDrum.com, an excellent site for information on the oil crisis. Unfortunately for American consumers, more and more evidence is showing the ELM oil prophecies to be painfully true.

The ELM says that, after a country's oil production peaks, it will decline at a 5% annual rate (the blue line) at the same time that local consumption increases by 2.5% (the green line). Add blue and green together and you get the red line, which shows the decline in a country's next exports will reach zero nine years after peak production. After that, the former exporter becomes an importer.

We've seen this model hold true in the U.S., China, Great Britain and Indonesia. For example, China went from a net exporter in 1993 to importing four million barrels a day today ... with those imports projected to rise another 50% over the next 10 years.



The real problem is that many of the world's exporters are now at their peaks. Recently, the U.S. Department of Energy said the amount of petroleum products shipped by the world's top oil exporters fell 2.5% last year, despite a 57% increase in prices.

And that means much higher prices are on the horizon.

2) Catastrophic decline in Mexico. I know I keep pounding the table about Mexico. But the facts South of the Border keep getting worse and worse.

In April, Mexico's oil output fell to a nine-year low of 2.8 million barrels a day, mostly because of a decline in its giant Cantarell field. At current rates of decline, Mexico will become a net oil importer by 2016, and maybe sooner, according to Mexico's Energy Ministry.

And just last week, Pemex, Mexico's state-run oil company, said its oil exports would drop to an average of 1.40 million to 1.45 million barrels per day (bpd) this year. That's about 15% below last year's level.

Mexico is America's #3 supplier of imported oil. This is not only a crisis for Mexico — it's a crisis for us.

3) Resource Nationalism will tighten the screws. Americans sometimes act like other countries are sitting on "our" oil and they have a duty to provide it to us as fast and cheaply as possible. But more and more countries are realizing their oil is a national treasure, and they're starting to sell as little of it as possible at the highest prices they can. It's called Resource Nationalism and it is bad news for American consumers.

That's why ...

In Venezuela, President Hugo Chavez's nationalization crusade has forced out two of the world's largest energy companies and the OPEC nation is preparing a "windfall" oil tax to boost its share of profits from its fields.

In Russia, Vladimir Putin has used hook and crook to bring more than half of that country's oil industry under state control, grabbing properties and projects from large foreign oil companies.

Even our "good friends" in the Middle East — Saudi Arabia, United Arab Emirates, Iran, Kuwait, Iraq and Qatar — curbed their output by 544,000 barrels a day last year. At the same time, their domestic demand increased by 318,000 barrels a day (there's that Export Land Model again!), so, their next exports dropped by 862,000 barrels. In fact, net exports from Saudi Arabia, the world's biggest oil producer, have actually dropped by a total of nearly 1.2 million barrels since 2006.
Saudi oil executive Sadad Al-Husseini said last June: "There has been a paradigm shift in the energy world whereby oil producers are no longer inclined to rapidly exhaust their resource for the sake of accelerating the misuse of a precious and finite commodity. This sentiment prevails inside and outside of OPEC countries, but has yet to be appreciated among the major energy-consuming countries of the world."

The reality is national oil companies control 94% of the world's conventional oil and gas reserves. And they'll want more control in the years to come.

When it comes to bargaining chips, America is sitting at the table with a pair of twos, and there are others at the table with full houses, aces high. And they AREN'T our friends.

All in all, it's a recipe for much higher prices. Oil at $100 a barrel was a shock, and now $150 seems inevitable. I'd say at the torrid pace we're on, oil may hit $200 sooner rather than later. After that, could $300 or even $400 per barrel be in the cards?

Yes! As long as the world's civilization runs on oil, we'll pay whatever it costs. There are alternatives to oil, but they aren't ready yet. So how might your life change in the next year or two? And what should you do with your money? Here are a few ideas ...

Get ready for $5 gasoline. The average price of gasoline in the U.S. has already pushed past $4 a gallon, and if oil rises to $150 per barrel and higher, $5 gas isn't far behind.

Get used to bumpy roads. Roads are paved with asphalt, and that requires oil. The hike in oil prices so far has pushed paving bills up by about 25%, so cities and states are cutting back on needed road work. That means more potholes as you drive back and forth to work ... if you still have a job. When we hit $150 oil, it almost certainly means the U.S. will careen into recession.

Your neighborhood will have a lot of empty homes. About 1 in 11 American mortgages were past due or in foreclosure at the end of March, according to a report released last week. And it's not just the "high-risk" loans that are going belly up. The problems are across the spectrum. Heck, even Ed McMahon is facing foreclosure.

Higher fuel prices are going to squeeze consumers mercilessly, worsening this problem, and perhaps even doubling the number of Americans kicked out of their homes.

Prepare for heating oil shock. Heating oil prices could DOUBLE by the time next winter rolls around. If you heat with natural gas, you won't be spared — the price of natgas is going much higher as well. If you haven't already, you might spend this summer insulating your home as much as possible. There are probably even tax credits for doing so in your state.

Prepare for rolling blackouts. Our national power grid runs on natural gas and coal (and some nuclear power), so it might sound safe, but think again. Our natural gas supply is under threat, and it could be devastating for the American way of life.

Brace yourself for higher food prices. Globally, food prices increased 43% in the past year, and the IMF says about nearly half of that is due to biofuels. The effect was much less in the U.S. — 4% last year — but it's ramping up fast. Some estimates put U.S. food inflation at 9% currently and accelerating. Higher fuel costs are going to shift food prices into overdrive.

These are just SOME of the changes you may face as oil spirals higher. But you can protect yourself, and profit, by making the right investments.