Where Nuclear Failed, Oil Succeeded
In a continuation of our series on the state of the oil
industry we look at some of the other ramifications of what we are labeling the
Oil Renaissance in the US, and around the world for that matter. This phrase was first proposed regarding the
potential Nuclear turnaround here in the US, where companies like NRG Energy,
Toshiba and many more players all along the supply chain were positioning
themselves for the Nuclear Renaissance of cheap, and abundant Nuclear energy
for the next 50 years.Well, the natural disaster in Japan changed that movement in the span of a week of just untenable radioactivity readings coming out of Japan. An already uphill battle for changing public sentiment towards the dangers of nuclear energy became an impractical fight from an investment standpoint that relied upon large DOE loan guarantees to attract private investment.
It is ironic, but all these companies spent a lot of time
and effort from lobbying to developing strategic partnerships with each other,
and in the end, most of that 7 year effort had to be written off by firms. It
really shows how firms have to get the industry right; Oil was so much the
smarter play. Higher margins, better technology, much easier safety hurdles,
and even the environmental fight is much more manageable.
Not to mention the number of jobs created is far more with
an Oil Renaissance as opposed to a Nuclear Renaissance, even with a complete
buildup of the entire nuclear supply chain. Nuclear projects are just not
scalable like oil projects are from a numbers standpoint due to the regulation,
lead times for components, inspection, build times, and many more constraints.
No DOE Loan Guarantees: The Free
Market at Work
We are going to have a Renaissance in this country, it just
happened under everyone`s nose. The free market of high oil prices for the last
10 years made it happen all on its own without government subsidies, and part
of the reason that things are going to get real tough for the alternative
energy folks over the next 5 years as those government subsidies wind down.
They will not make sense from an economic standpoint once oil prices come down
considerably, and from a budgetary perspective we can no longer afford this
propping up industries that cannot sustain themselves on their own merit in the
free market. A 16 trillion dollar debt and climbing means the environmentalists
will now be facing an uphill fight on Capitol Hill to have their cause funded
by the American taxpayer.
Technology Changes: Heart Surgery
meets the Oil Patch
The technology changes alone in the oil industry are amazing;
just watch a horizontal drilling or fracking video and it is like all the
advances made by the medical community for endoscopic procedures and advanced
heart surgical techniques have been applied to the oil industry. And the cost
is far more manageable than the medical field with all the added insurance
costs, out of control bureaucracy, and government intervention all but
eliminating any sense of free market principles.
Sure these constraints exist in the oil industry, but the healthcare industry is on a planet of its own and worse from a cost efficiency standpoint by a factor of at least a 100. There is not an ounce of free market in the healthcare industry!
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| Fracking Diagram |
We haven`t seen anything yet as this new technology being
refined and implemented here in the US will then be fully scalable around the
globe, and the amount of new projects that will come online globally with this
new technology over the next ten years has yet to be priced into any market intelligence
models.
Natural Gas Industry as the Model
The natural gas industry is much smaller than the oil
industry, and because of the new technology firms were actually continuing
production with $2 natural gas because of much lower overall project costs
relative to the size of the gas exploitable and other derivative products made along
the way enabling these projects to be
profitable.
The oil industry is much more scalable from a cost
standpoint, and once these upfront costs have been committed, the size of the
industry and scalability means that projects can continue and be highly
profitable even with much lower oil prices.
I previously have thought that this technology would suffer
as prices drop, but I am rethinking this assumption with natural gas as my
guide in a much less scalable industry. So I now believe that this technology
and these projects will continue and be cost effective even with oil dropping
to $45 a barrel for both Brent and WTI.
.gif) |
| Slant & Horizontal Drilling |
It won`t happen overnight, but under one scenario prices
will just steadily trend down like natural gas prices, and before we realize it
we have the equivalent of $2 natural gas prices for the oil industry.
The China Factor: Use less
Commodities for Next Decade
My assumption about the trajectory of oil prices also relies
on the China factor that many analysts have been toying with for the last
couple of years, but the IMF and others have done some nice research on and
applied some hard numbers to the conceptual idea that China has overinvested
for the last decade by a large degree, and most of the previous forecasts for
China`s growth trajectory from an infrastructure standpoint for the next 10
years are far too optimistic.
My conclusion is that China will use far less commodities
than they did the past decade going forward for the next decade. They are
coming into the constraints of large numbers where you have built for the sake
of building, and you can no longer build another large new city every year
because the demand just isn`t there. Basically, the easy, low hanging fruit has
been eaten. Most of the new project benefits will not justify the cost based
upon infrastructure constraints, logistical incongruities, and actual demand &
societal need for said projects.
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| Ordos, China |
The societal costs outweigh the societal benefits and the
projects evaluated in total become a net drag on growth and GDP in the overall calculus.
China can go ahead with these projects but the law of diminishing returns,
means the country will pay a heavy price to do so. China will continue to grow,
but they will grow in a more sophisticated way from a social perspective from
within, i.e. in a metaphorical Maslow`s – Hierarchy of Needs manner, and less
of a brute, infrastructure driven manner.
Ergo, the lower utilization for commodities by China is
another factor that will put downward pressure on Oil and other commodities
over the next 5 to 10 years.
More Storage Capacity Needed Globally
Make no mistake these oil and commodity projects are going
to go full stream regardless of price due to sunk costs, more efficient
operations, job creation, and overall profitability.
One of the takeaways out of this analysis is that storage
facilities will have to be upgraded and new ones coming online for all
commodities. For example in Oil, my analysis concludes that Cushing will need
to upgrade capacity to over 100 million in the next couple of years, and over
150 million by 5 years’ time.
My new analysis determines the need for even more pipelines
being built out of Cushing as well. There will need to be at least 5 million
barrels per day outflow from Cushing to refineries by five years’ time; can
anyone say job creation opportunities here?
The next substantial upgrade besides the paltry 300,000
per/day upgrade this year will not come online until mid-2014 and only improve
capacity to 850,000 barrels per/day outflow from Cushing which is not going to
be enough to counter an exponential measure of domestic production coming into
the Cushing energy hub by 2014.
But I am forecasting that not only will Cushing be above 100
million in storage in three years’ time, but the US will need capacity to store
over 600 million barrels by four years’ time, and China who is building storage
currently, will need to meet their own need for storage due to a massive
oversupply in their country.
China was building storage initially for strategic purposes,
but my analysis concludes that because of an oversupply issue similar to copper
today in China, they are going to need this additional storage for excess
supply issues.
Therefore, if you’re
in the storage facility business, times will be good for the next five years,
plenty of business for these firms. As I think storage facilities will have to
be built all around the world from Iraq, Saudi Arabia, Africa, and the
Scandinavian countries.
A New Price Model for Oil
So how low can prices go? Let`s just say that the
Renaissance in oil is going to be good for the global economy, just back in
2003 gasoline prices were $1.60 a gallon in the US and oil was trading around
$30 a barrel.
It is not unreasonable to think if the Oil Renaissance takes
the path that it is capable of that Oil globally trades all the way down to the
$45 area.
What Price do the Saudi`s Really
Need? Need & Want Confused
And those that think that OPEC would need $75 to keep up
production, remember that OPEC still kept pumping oil only four years ago with
$33 oil in 2008. Furthermore, OPEC countries still need the overall revenue not
the price per say.
Accordingly, you could very easily have a scenario where
prices go lower and they pump more, violate reduction quotas because they all
want the revenue net of volume and price, not just less volume but slightly
higher prices.
I think the world
will be surprised how the talking your book rhetoric of “we need $75 oil to
justify production” is replaced with the actual, “we need the money and our
real cost is so much lower than you could ever imagine” reality on the ground.
This is their one asset in these countries, some revenue
stream is better than no revenue stream, and with global production picking up
OPEC `s relevance, power, and influence on prices is diminishing by the day.
Great OPEC you can reduce production, your global
competitors will love that, less competition for them. The only problem is that
these countries need the money, every country needs the money these days, and
that`s the market place you take what you can get on the market! The market
goes in cycles, just as the housing market re-priced itself, so will the oil
market!
The ironic point here is that often the lower prices go, the
more oil that is produced trying to make up in volume for the lower price to
get as much revenue as possible.
$45 Oil & $2 Gasoline: Consumers Love
this New Era
In conclusion, we are entering a new Renaissance in the oil
market, not just in the US, but globally as well.
New technology, slower growth in the emerging markets over
the next decade, and an era where a decade of high prices will finally bear
some fruit with market dynamics working as their supposed to leading to more
supply, and an eventual reduction in prices.
Expect this new era to manifest itself in giving the entire
world a tax break, and small businesses and consumers worldwide will have more
disposable income, and sectors such as retail, entertainment, transportation,
and global travel will benefit as a result of this sea change in the oil
industry.
I could even envision the manufacturing industry in the US
getting a large piggyback effect as the US will have some of the cheapest
energy costs of anywhere in the world for starting a business with an abundance
of natural gas, oil and petroleum products for the next decade at a low and
stable price.
How does $45 a barrel oil and $2 a gallon gas sound?
Something the peak oil folks thought was an outright impossibility just 5 years
ago.
But a lot of things can change real fast, once technology
gets involved, impossible things become possible. Just look at smartphones
versus 4 years ago, and the fact that I can deposit a check into my checking
account via my smartphone, actually surf the net, get usable navigation
directions, and watch Netflix movies on my smartphone.
The world history of scientific innovation being applied to
markets is remarkable to say the least looking back, it’s now time for the oil
market to have its second renaissance. Expect $45 oil in the future of this
renaissance.
Further Reading - Oil & Gasoline Markets End 2012 with Swollen Inventory Levels
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