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Tag Archive: Oil

  1. Does $100 Oil Kill All Business Activity?

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    No.  But at least some busi­nesses are hurt less than others.

    High oil prices tend to trig­ger a so-called “neigh­bor­hood effect” where selected man­u­fac­tur­ing busi­nesses that are located closer to their cus­tomers get a price advan­tage over com­peti­tors that are located far away. That is because local busi­nesses have lower trans­porta­tion costs than their out of town, or out of coun­try, competitors.

    It’s loca­tion, loca­tion, loca­tion that dri­ves the rel­a­tive cost of ship­ping cer­tain types of goods. A supplier’s close loca­tion to his cus­tomers will result in low trans­porta­tion costs.

    The rest of this arti­cle can be found at the Huff­in­g­ton Post at  The Small Sil­ver Lin­ing Of $100 Oil.

  2. The Inflation Monster Is Tame

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    Despite the quick run up in gaso­line prices, the U.S. econ­omy isn’t about to be eaten by the infla­tion monster.

    While it is a good bet that some­time in the next few years the Fed will have to deal with ris­ing infla­tion, now isn’t the time to change mon­e­tary pol­icy in an effort to slay the infla­tion monster.

    For the entire post, please fol­low this link to Seek­ing Alpha.

  3. Another Big Win For Energy Economics 101: Demand Destruction Isn’t Good For New Investment

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    On Mon­day the Wall Street Jour­nal ran an arti­cle that described the end of the golden era for oil refin­ers. It is a great arti­cle that, unfor­tu­nately, was pub­lished many years too late to be con­sid­ered news. Just as grav­ity is a force that brings all objects to earth, pub­lic pol­icy that destroys the demand for gaso­line will hurt the refin­ery busi­ness. Not sur­pris­ingly, Pres­i­dent Obama’s pub­lic pol­icy ini­tia­tives that increase car and truck fuel effi­ciency have the side effect of hurt­ing oil refin­ery and dis­tri­b­u­tion businesses.

    Just to be clear, I am not against the Administration’s effort to increase fuel effi­ciency in the vehi­cle fleet. Quite the con­trary, it is a mat­ter of national and eco­nomic secu­rity that we burn less imported fuel.  Increas­ing trans­porta­tion fuel effi­ciency is a “must” for the United States. How­ever, I don’t think that it is real­is­tic to believe that the energy indus­try is act like an old trusted dog that knows when it it time to walk into the woods and die. And, it isn’t fair to the refin­ery and dis­tri­b­u­tion busi­nesses to ask them to effec­tively sub­si­dize the rest of the economy’s shift to more fuel effi­cient vehi­cles and alter­nate energy with­out compensation.

    The Wall Street Jour­nal reported that over the next few years there is going to be global over­ca­pac­ity among oil refin­ers. Not only is demand being reduced for refined prod­ucts (par­tic­u­larly in the U.S.), but there is a lot of new and effi­cient capac­ity that is com­ing on line in Asia and the Mid­dle East. That isn’t a pre­scrip­tion for a lot of new invest­ment in refin­ery capac­ity or for good returns for exist­ing refiners.

    I have a cou­ple of news flashes about the future of oil refin­ery and dis­tri­b­u­tion that I am pretty sure are big news scoops (at least for most major media outlets).

    1. As gaso­line demand drops refiner­ies won’t be the only busi­nesses whose invest­ments are under­per­form­ing. There is going to be a lot of excess dis­tri­b­u­tion and retail­ing capac­ity. So far the Wall Street Jour­nal has only reported on excess refin­ery capac­ity. Dis­tri­b­u­tion and retail­ing are the next seg­ments of the indus­try that will expe­ri­ence over­ca­pac­ity and the end of its “golden era” (to the extent that there ever was a golden era). That means that the U.S. will have too many tank farms, too many truck­ers that move refined prod­ucts and too many gas sta­tions that sell gaso­line and diesel to consumers.
    2. The oil refin­ery and dis­tri­b­u­tion indus­try isn’t going to take an assault on their abil­ity to earn prof­its sit­ting down. They are going to hold back on main­te­nance spend­ing until U.S. refin­ery and dis­tri­b­u­tion capac­ity declines and mar­gins are restored. Restor­ing mar­gins means that prices will rise. There will be a pub­lic back­lash against the oil com­pa­nies for earn­ing too much money and maybe even worth­less Con­gres­sional hear­ings where senior indus­try offi­cials are pub­li­cally flogged. If there are hear­ings, some­one who claims to be smart, but really isn’t, will get on TV and announce that no new refiner­ies have been built in the U.S. in more than 30 years and that this is another exam­ple of the U.S. los­ing its global eco­nomic lead­er­ship. Of course, no one will point out that offi­cial gov­ern­ment pol­icy on fuel effi­ciency has the nasty side effect of destroy­ing the indus­try, that the pol­icy is work­ing and only an idiot would build a new oil refin­ery. Sound famil­iar? It reminds me of the sum­mer of 2007 and the hys­te­ria that took place in the media and Con­gress when refin­ery capac­ity was tight.

    Over­ca­pac­ity and falling mar­gins reported by the Wall Street Jour­nal on Mon­day were eas­ily pre­dictable. In fact, I know that they were pre­dictable because in Decem­ber, 2008, I pre­dicted that oil refin­ers would face over­ca­pac­ity and falling mar­gins. Back in Decem­ber I wrote two arti­cles on energy pol­icy which can be viewed here and here.

    From Three Incon­ve­nient Energy Truths

    …while every­one agrees that cars need to get bet­ter gas mileage, vir­tu­ally no one has thought about what hap­pens to the peo­ple and com­pa­nies that make and dis­trib­ute gas for us to use. Bet­ter gas mileage has a side effect of hurt­ing the refin­ers, trans­porters, whole­salers and retail­ers of gaso­line. Bet­ter gas mileage destroys demand for gaso­line and will cre­ate lower prices and over capac­ity. It isn’t sur­pris­ing that vested inter­ests in the oil indus­try are quiet but effec­tive oppo­nents of energy pol­icy pro­pos­als. After all, how many indus­try lead­ers sup­port fed­eral ini­tia­tives that are the equiv­a­lent of eco­nomic suicide?

    Of course, for every action there is an equal or greater reac­tion and the refin­ery and dis­tri­b­u­tion story doesn’t end with demand destruc­tion and stranded capac­ity and investment.

    …Even worse, it will take years for the U.S. to achieve energy inde­pen­dence. We will need new invest­ment to pre­serve exist­ing infra­struc­ture. For exam­ple, oil refiner­ies need con­stant invest­ment to oper­ate. Dur­ing the sum­mer, with great fan­fare, the media announced that it had been more than 30 years since the last new domes­tic oil refin­ery was built. Politi­cians acted like it was a national crime when the refin­ery indus­try was caught short of capac­ity. But, what ratio­nal investor would put money into a new oil refin­ery know­ing that it is U.S. pol­icy to reduce demand for their prod­ucts and cre­ate over­ca­pac­ity. And, for that mat­ter, why should Saudi Ara­bia invest in pro­duc­tion capac­ity to serve Amer­i­can demand if our stated goal is to leave their infra­struc­ture stranded with­out its best customer.

    The con­cerns of exist­ing energy pro­duc­ers are legit­i­mate and need to be addressed. If Obama’s energy pol­icy for­gets to take care of incum­bent energy inter­ests it will fail. Energy pol­icy needs to make sure that invest­ments in prop­erty, plant and equip­ment that are ren­dered obso­lete or made uneco­nomic because of over­ca­pac­ity are paid for through their use­ful eco­nomic lives.

    The Admin­is­tra­tion means well but needs to get rid of its sim­plis­tic approach to energy pol­icy which ignores how to tran­si­tion the U.S. from a posi­tion of energy depen­dence to one of energy inde­pen­dence. If the Admin­is­tra­tion con­tin­ues on its cur­rent pol­icy path the indus­try will cut capac­ity until mar­gins are restored. It will seem like the oil indus­try is hold­ing the nation hostage to high prices while in fact they will just be act­ing log­i­cally and pre­dictably. It is naïve to believe that Big Oil will merely stand by and watch hun­dreds of bil­lions of dol­lars of invest­ment that is needed to sup­port the rest of the econ­omy get flushed down the drain before the end of its eco­nomic life and with­out com­pen­sa­tion. We need oil refin­ers, dis­trib­u­tors and retail­ers to main­tain the cur­rent infra­struc­ture for the fore­see­able future and will­ingly engi­neer a smooth tran­si­tion to a dif­fer­ent energy par­a­digm. If energy pol­icy keeps on ignor­ing this incon­ve­nient truth the shift will be very expen­sive and extremely rocky.

    The prob­lems of demand destruc­tion, stranded invest­ment and tran­si­tion eco­nom­ics were taught to me in my Energy Eco­nom­ics 101 class 29 years ago. It is just too bad the Admin­is­tra­tion offi­cials didn’t take the class.

  4. Sunshine’s Travel Log Blog — The Chinese Economic Miracle May Be Unraveling

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    The Chi­nese eco­nomic mir­a­cle appears to be unrav­el­ing at an alarm­ing and accel­er­at­ing pace.

    In just 30 years, China was able to trans­form its econ­omy from a Marx­ist bas­ket case to a global man­u­fac­tur­ing pow­er­house. But recent reports of mas­sive plant clos­ings, sky­rock­et­ing unem­ploy­ment, plung­ing exports and grow­ing social unrest are rais­ing seri­ous ques­tions about China’s eco­nomic and polit­i­cal future.

    The prob­lem is that China’s export growth engine was built on four Chi­nese eco­nomic pil­lars — three of which no longer exist and may never return.

    The four Chi­nese eco­nomic pillars:

    1.  Really cheap labor. First and fore­most, the Chi­nese eco­nomic mir­a­cle was based upon really cheap labor. Ini­tially, the cheap­est labor, slave and child labor, drove low export prices. Over time cheap migrant labor from the West­ern regions of China replaced slaves and children.

    But even migrant labor has gone up in price. In the begin­ning of 2008 new laws raised labor costs through min­i­mum wage and other worker ori­ented stan­dards. So, while Chi­nese labor is cheap by West­ern stan­dards, it is no longer the cheap­est for high vol­ume, low-valued-added jobs.

    2.  No envi­ron­men­tal pro­tec­tion. China had few envi­ron­men­tal stan­dards and in some areas has made its water and air vir­tu­ally unable to sus­tain human life. By pol­lut­ing its envi­ron­ment, China was able to gain a cost advan­tage over other man­u­fac­tur­ing countries.

    But China slowly poi­soned its cit­i­zens, and in 2008, new envi­ron­men­tal stan­dards were imposed upon man­u­fac­tur­ers that increased costs.

    3.  Cheap and abun­dant financ­ing. The main mar­ket for many Chinese-produced con­sumer goods is out­side of China. It is expen­sive, though, to ship goods from Chi­nese fac­to­ries to over­seas cus­tomers, and fac­to­ries require financ­ing from banks to cover these costs. For a long time such financ­ing was cheap.

    How­ever, the global credit cri­sis has dried up bank loans and Chi­nese man­u­fac­tur­ers are now scram­bling for liq­uid­ity. Until cheap and abun­dant financ­ing returns, it is going to be hard to finance a high vol­ume of Chi­nese exports.

    4.  Low oil prices and unlim­ited energy. China uses mate­ri­ally more energy per unit of gross domes­tic prod­uct than the United States, West­ern Europe or Japan. China burns approx­i­mately 10 times the amount of energy to pro­duce $1 of G.D.P. than Japan and 3 to 4 times the amount of the United States.

    Energy is used for pro­duc­tion and trans­porta­tion, and when oil topped $140 per bar­rel, the effect on China’s exports was to dra­mat­i­cally increase costs rel­a­tive to other coun­tries. While oil is once again cheap and plen­ti­ful, cur­rent price lev­els may not last for­ever. If oil prices rise again the Chi­nese export sec­tor will become less com­pet­i­tive rel­a­tive to more well-developed economies.

    The elim­i­na­tion of three of four Chi­nese eco­nomic pil­lars has crit­i­cally wounded the Chi­nese economy.

    In just the toy sec­tor up to 2.0 mil­lion jobs may have been lost in recent months. And, the employ­ment car­nage doesn’t stop with toys; pub­lished reports of job losses vary widely but seem to con­verge on up to 10 mil­lion total jobs hav­ing been lost in export related man­u­fac­tur­ing indus­tries such as toys, shoes, tex­tiles, steel, elec­tron­ics and con­struc­tion mate­ri­als. Amer­i­can job losses seem almost irrel­e­vant in com­par­i­son to Chi­nese labor mar­ket destruction.

    The risk is that extreme eco­nomic hard­ship leads to gut wrench­ing and vio­lent polit­i­cal change.

    Unrest is increas­ing in China, but it isn’t being fully reported because of cen­sor­ship accord­ing to media sources. All the while, the Hong Kong West­ern com­mu­nity has been buzzing about rumored eye­wit­ness accounts of troop and riot police deploy­ments in Guang­dong province. And, it is widely antic­i­pated that as plants close this week in antic­i­pa­tion of the Chi­nese New Year which starts on Mon­day a lot of them won’t reopen and there will be worker unrest among the newly unemployed.

    I was recently in China and found that many of the Chi­nese peo­ple I spoke with are scared and wor­ried that China’s best days are behind it, and that the stan­dard of liv­ing for hun­dreds of mil­lions of Chi­nese is about to drop below the poverty line. They fear that mass-starvation will lead to vio­lent upris­ings, per­haps directed at the rich “cap­i­tal­ists” in the coun­try. Images of lux­ury malls in Bei­jing, sky­scrap­ers in Shang­hai and con­spic­u­ous con­sump­tion through­out the coastal region don’t play well to starv­ing peas­ants who are still wait­ing for their turn at the rice bowl.

  5. Low Oil Prices Kill Energy Investments

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    Last week I pub­lished a blog arti­cle that dis­cussed energy pol­icy and sug­gested that an effec­tive energy pol­icy requires fed­er­ally estab­lished min­i­mum oil prices. Low and volatile oil prices destroy pri­vate invest­ment in energy projects because returns become too uncer­tain to attract financ­ing. As oil trades between $40 and $50 per bar­rel invest­ment capac­ity for energy projects is dis­ap­pear­ing. On Mon­day, the New York Times pub­lished a great arti­cle writ­ten by Jad Mouawad that artic­u­lates exam­ples of sup­ply destruc­tion occur­ring from low and volatile oil prices.

    If the U.S. wants to break its addic­tion to imported oil, set­ting and main­tain­ing floor prices for oil, gas and coal must be a cen­ter­piece of U.S. energy pol­icy. With­out min­i­mum prices, “in the real world” investors won’t com­mit enough cap­i­tal to domes­tic energy projects so that the U.S. can become energy inde­pen­dent. Domes­tic free mar­ket cap­i­tal can’t com­pete with for­eign gov­ern­ment spon­sored cap­i­tal and energy pol­icy needs to rec­og­nize this incon­ve­nient truth.

    Also, with­out min­i­mum energy prices “green energy” will remain a mirage on the hori­zon, always there but always beyond our reach. Green energy is more expen­sive than gov­ern­ment spon­sored Mid­dle East­ern oil and, with­out price sup­ports, it won’t attract the nec­es­sary invest­ment dol­lars to com­pete with cheap for­eign oil. Green energy advo­cates fail to real­ize that gov­ern­ment man­dates aren’t the same thing as mar­ket solu­tions. Only min­i­mum prices estab­lished through a vari­able sur­charge will pro­vide the mar­ket solu­tions that are needed to get green energy alter­na­tives into the mainstream.

    Below are some excerpts from Jad Mouawad’s New York Times article.

    From the plains of North Dakota to the deep waters of Brazil, dozens of major oil and gas projects have been sus­pended or can­celed in recent weeks as com­pa­nies scram­ble to adjust to the col­lapse in energy markets…

    …But the project delays are likely to reduce future energy supplies…

    …The pre­cip­i­tous drop in oil prices since the sum­mer, com­ing on the heels of a dizzy­ing seven-year rise, was a reminder that the oil busi­ness, like those of most com­modi­ties, is cycli­cal. When demand drops and prices fall, com­pa­nies curb their invest­ments, lead­ing to lower sup­plies. When demand recov­ers, prices rise again and com­pa­nies start to invest in new pro­duc­tion, start­ing another cycle…

    …Invest­ment in alter­na­tive energy sources like bio­fu­els that had flour­ished in recent years could dry up if prices stay low for the next few years, ana­lysts said. Banks have become reluc­tant lenders, espe­cially to renew­able energy projects that may prove unprof­itable in an era of low oil and gas prices…

    …Accord­ing to research ana­lysts at the bro­ker­age firm Ray­mond James, domes­tic drilling could drop by 41 per­cent next year as com­pa­nies scale back…

    …“We expect oper­a­tors to sig­nif­i­cantly cut their activ­ity in the com­ing weeks due to the hol­i­day sea­son, and many of these rigs will not come back to work,” the report said.

  6. Three Inconvenient Energy Policy Truths

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    Pres­i­dent Elect Obama nom­i­nated his energy team yes­ter­day and empha­sized that energy pol­icy is a national pri­or­ity. Every Pres­i­dent since Jimmy Carter has talked about U.S. energy inde­pen­dence, but no Pres­i­dent has actu­ally bro­ken the U.S. addic­tion to imported oil. In the 1970s, I stud­ied energy eco­nom­ics and pol­icy and learned that man­dates, slo­gans and “feel good” poli­cies based on fads don’t work. Only eco­nom­i­cally and finan­cially sound poli­cies will break the U.S. addic­tion to imported oil.

    A lot is rid­ing on a suc­cess­ful energy pol­icy. National and eco­nomic secu­rity, the auto­mo­bile industry’s future, the cost and avail­abil­ity of food, the future of the envi­ron­ment and the nation’s eco­nomic recov­ery plan are all tied to energy policy.

    Unfor­tu­nately, for as long as any­one can remem­ber the United States has lacked an effec­tive energy pol­icy. Our coun­try has never been more depen­dent on imported oil than now. Hope­fully, $145 per bar­rel oil and our fear of run­ning out of oil all together will move us to a con­sen­sus on energy that will actu­ally work.

    In the past year, a pub­lic con­sen­sus has formed around four prin­ci­pal energy pol­icy goals. These goals are:

    • Min­i­mum depen­dence on energy pro­duced out­side North America;
    • Low envi­ron­men­tal impact from the gen­er­a­tion of energy;
    • Rea­son­able cost; and
    • Preser­va­tion of the Amer­i­can “way of life” includ­ing strong national and eco­nomic security.

    Cur­rent energy pol­icy hasn’t achieved any of these goals and pol­icy fail­ures are becom­ing more and more dan­ger­ous for the United States. A suc­cess­ful energy pol­icy must achieve each of the above objec­tives and be self sus­tain­ing. Ini­tia­tives that spend money on “green” energy, con­ser­va­tion and domes­tic pro­duc­tion but which aren’t sus­tained by the pri­vate mar­ket when the sub­sidy goes away don’t work.

    How­ever, before “good” energy pol­icy can be enacted, three unpop­u­lar incon­ve­nient “truths” need to be rec­og­nized and dealt with. Dis­re­gard­ing any of these three energy truths will result in energy pol­icy that won’t work.

    Incon­ve­nient Energy Pol­icy Truth #1

    There is no magic bul­let that is going to make the U.S. energy inde­pen­dent. Suc­cess­ful energy pol­icy requires a decen­tral­ized multi-strategy approach.

    Large, sim­ple solu­tions to the energy prob­lem don’t work. Break­ing the imported oil addi­tion requires mass par­tic­i­pa­tion in decen­tral­ized energy pro­duc­tion and con­ser­va­tion. Unfor­tu­nately, the Amer­i­can pub­lic has never embraced decen­tral­ized energy solu­tions. Vir­tu­ally every major energy ini­tia­tive gen­er­ates oppo­si­tion from groups that are ded­i­cated to the sta­tus quo and are able to block or slow wide­spread adop­tion of energy solu­tions. Even wind­mills and pas­sive solar pan­els are resisted by inter­est groups that fre­quently kill projects.

    Renew­able energy pro­duc­tion and con­ser­va­tion is decen­tral­ized because renew­able energy sources are incred­i­bly spread out. Wind, tides and sun­shine (some of the more promis­ing renew­able energy sources) aren’t con­cen­trated in one place and require a lot of wind­mills, water tur­bines and solar pan­els to have a mean­ing­ful effect. And, con­ser­va­tion requires the com­mit­ment of every indi­vid­ual to suc­ceed. Energy inde­pen­dence will only be achieved through the accu­mu­lated results of a lot of lit­tle things under­taken by many peo­ple at the same time.

    Energy pol­icy needs to rip down the local bar­ri­ers, soci­etal prej­u­dices and zon­ing rules that pre­vent decen­tral­ized solu­tions. A “kitchen sink” approach to domes­tic energy pro­duc­tion and con­ser­va­tion is needed because every­thing that can be done needs to hap­pen at the same time. Envi­ron­men­tal laws and other reg­u­la­tions need to be imme­di­ately mod­i­fied so that inter­est groups that “don’t want that thing in my neigh­bor­hood” can’t mount irrel­e­vant chal­lenges to pre­vent renew­able energy alter­na­tives. While cheap imported oil was great while it lasted, until every­one decides to be part of the national energy solu­tions, the U.S. won’t be energy independent.

    Incon­ve­nient Energy Pol­icy Truth #2

    Energy pol­icy needs to make every­one a win­ner. Poli­cies that make losers out of exist­ing energy sup­pli­ers, investors and work­ers will fail.

    His­tor­i­cally, the pol­icy debate has been insen­si­tive to the peo­ple, investors and com­pa­nies that man­u­fac­ture, dis­trib­ute and deliver energy. Vir­tu­ally all energy ini­tia­tives have the unin­tended effect of leav­ing large invest­ments to be writ­ten off because of obso­les­cence or lower demand. Pol­icy mak­ers don’t think about the vested inter­est groups that stand to lose from new and dif­fer­ent fuels and con­ser­va­tion and, not sur­pris­ingly, exist­ing energy pro­duc­ers have gen­er­ated silent but deadly oppo­si­tion to change.

    As an exam­ple, while every­one agrees that cars need to get bet­ter gas mileage, vir­tu­ally no one has thought about what hap­pens to the peo­ple and com­pa­nies that make and dis­trib­ute gas for us to use. Bet­ter gas mileage has a side effect of hurt­ing the refin­ers, trans­porters, whole­salers and retail­ers of gaso­line. Bet­ter gas mileage destroys demand for gaso­line and will cre­ate lower prices and over capac­ity. It isn’t sur­pris­ing that vested inter­ests in the oil indus­try are quiet but effec­tive oppo­nents of energy pol­icy pro­pos­als. After all, how many indus­try lead­ers sup­port fed­eral ini­tia­tives that are the equiv­a­lent of eco­nomic suicide?

    Sim­i­lar issues exist for ports, ships and ter­mi­nals that are used to import oil. Energy pol­icy mak­ers are naïve to assume that work­ers and investors haven’t noticed that gov­ern­ment pol­icy is going to kill their jobs and destroy their investment.

    The issue of obso­lete and under­uti­lized resources is the same for own­ers of elec­tri­cal power plants. Solar, wind, tidal and other renew­able resources are a great idea unless you own or work in an exist­ing power plant that isn’t going to pro­duce power when the sun is out or the wind is blowing.

    By the way, for­eign oil pro­duc­ers aren’t too happy about los­ing U.S. busi­ness. This week’s edi­tion of 60 Min­utes fea­tured the CEO of Saudi Aramco and the Saudi Oil Min­is­ter. They were clear that they want to keep the U.S. as their largest and best cus­tomer. Saudi Ara­bia isn’t going to give up with­out a fight and we can expect all sorts of trou­ble from for­eign coun­tries if the U.S. is suc­cess­ful in reduc­ing its depen­dence on for­eign oil.

    Even worse, it will take years for the U.S. to achieve energy inde­pen­dence. We will need new invest­ment to pre­serve exist­ing infra­struc­ture will be needed. For exam­ple, oil refiner­ies need con­stant invest­ment to oper­ate. Dur­ing the sum­mer, with great fan­fare, the media announced that it had been more than 30 years since the last new domes­tic oil refin­ery was built. Politi­cians acted like it was a national crime when the refin­ery indus­try was caught short of capac­ity. But, what ratio­nal investor would put money into a new oil refin­ery know­ing that it is U.S. pol­icy to reduce demand for their prod­ucts and cre­ate over­ca­pac­ity. And, for that mat­ter, why should Saudi Ara­bia invest in pro­duc­tion capac­ity to serve Amer­i­can demand if our stated goal is to leave their infra­struc­ture stranded with­out its best customer.

    The con­cerns of exist­ing energy pro­duc­ers are legit­i­mate and need to be addressed. If Obama’s energy pol­icy for­gets to take care of incum­bent energy inter­ests it will fail. Energy pol­icy needs to make sure that invest­ments in prop­erty, plant and equip­ment that are ren­dered obso­lete or made uneco­nomic because of over­ca­pac­ity are paid for through their use­ful eco­nomic lives.

    Incon­ve­nient Energy Pol­icy Truth #3

    Reduc­ing America’s depen­dence on for­eign oil causes imported oil prices to drop which makes the U.S. want to burn more cheap for­eign oil. Energy pol­icy needs to break this loop which under­mines policy.

    A suc­cess­ful energy pol­icy will reduce oil con­sump­tion which will cause oil prices to fall. Cheap oil kills domes­tic energy pro­duc­tion, renew­able energy ini­tia­tives and con­ser­va­tion. It hap­pened in the late 1980’s and 1990’s and, as prices drop below $40 per bar­rel today, his­tory is repeat­ing itself.

    Low and volatile oil prices are bad for energy invest­ments because investors can’t rea­son­ably expect to make money on new energy invest­ments. When investors fund energy projects, they cre­ate finan­cial pro­jec­tions that assume dif­fer­ent price lev­els for oil, gas and coal. If energy prices drop below a min­i­mum level, the pro­jec­tions show that the invest­ment won’t make money and the project isn’t funded. Highly volatile prices cause investors to cre­ate pro­jec­tions with wide price swings. There are very few new domes­tic energy invest­ments that make money with oil prices at $40 per bar­rel. And, when investors cre­ate a price sen­si­tiv­ity analy­sis and assume that prices could poten­tially drop from cur­rent lev­els, vir­tu­ally no projects make eco­nomic sense.

    The boom and bust his­tory of U.S. energy prices for the last 30 years rein­forces depen­dence on for­eign oil. For­eign pro­duc­ers have lower costs of expor­ta­tion, devel­op­ment and pro­duc­tion and can eas­ily sur­vive large price declines. Even worse, most large for­eign oil pro­duc­tion is gov­ern­ment owned and tra­di­tional invest­ment analy­sis isn’t used to decide upon pro­duc­tion and investment.

    Oil prices dis­tort the auto­mo­bile mar­ket. The cur­rent humil­i­a­tion of the Big 3 exec­u­tives because they didn’t invest in energy effi­cient vehi­cles ignores gaso­line price his­tory and the real­ity of con­sumer demand. Gas was cheap and U.S. con­sumers wanted big vehi­cles. For­eign man­u­fac­tur­ers that appear smart because they pro­duce energy effi­cient vehi­cles were forced to pro­duce those vehi­cles because of energy taxes that drove up the price of gaso­line to con­sumers in their domes­tic markets.

    The U.S. needs gov­ern­ment man­dated min­i­mum guar­an­teed prices for oil, nat­ural gas and coal. Min­i­mum guar­an­teed prices reduce price volatil­ity and pro­vide some mea­sure of cer­tainty to investors and con­sumers. And, it isn’t only renew­able energy and con­ser­va­tion invest­ments that need price cer­tainty; new domes­tic oil and gas invest­ment needs price floors to be com­pet­i­tive. With price floors, investors can con­fi­dently invest in domes­tic energy projects with­out being wiped out by low prices when for­eign gov­ern­ments dump­ing energy into the mar­ket. Energy pol­icy won’t work until prices are sta­bi­lized so self sus­tain­ing energy invest­ments can take place and won’t be killed by for­eign gov­ern­ment price manip­u­la­tion and production.

    Cur­rent “cap and trade” leg­is­la­tion isn’t good energy pol­icy and shouldn’t be relied upon to solve the prob­lem of falling oil prices. Cap and trade leg­is­la­tion is sup­posed to reduce green­house emis­sions and isn’t energy pol­icy. Cap and trade pro­pos­als are envi­ron­men­tal pol­icy ini­tia­tives and that isn’t the same as energy pol­icy. Cap and trade does noth­ing to encour­age domes­tic energy pro­duc­tion and doesn’t address the issue of low and volatile prices.

    A gas tax isn’t the same thing as a min­i­mum oil price. While a gas tax will encour­age con­sumers to drive more effi­cient vehi­cles, that doesn’t do any­thing for the sup­ply side of energy. Only min­i­mum oil prices achieve all of the objec­tives of tax policy.

    Price floors can be enforced by impos­ing a tax sur­charge on energy that is sold below the min­i­mum price. Through tax sur­charges, the effec­tive price to inter­me­di­ate and final users will be the min­i­mum estab­lished price. And the rev­enue that is raised through min­i­mum price sur­charges can be used to com­pen­sate energy pro­duc­ers who are harmed by energy policy.

    The U.S. has too much at stake for a pre­tend debate on energy pol­icy that doesn’t rec­og­nize the three incon­ve­nient energy truths. Fail­ure to deal with real­ity has put the U.S. into the predica­ment of need­ing for­eign and some­times hos­tile inter­ests to sup­port us for our eco­nomic and national sur­vival. This cycle of depen­dency must end. We need a new national con­sen­sus reached for energy independence.

  7. OIL SPECULATORSTHEY AREN’T THE REASON FOR HIGH OIL PRICES" rel="bookmark">OIL SPECULATORSTHEY AREN’T THE REASON FOR HIGH OIL PRICES

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    Today Con­gress announced a great break­through that explains the cause of high oil prices. The cure for the energy crises is now known and sim­ple leg­is­la­tion will cut gas prices, help the econ­omy and raise liv­ing stan­dards. MarketWatch’s head­line said it all: “Gas could fall to $2 if Con­gress acts….Limiting spec­u­la­tion would push prices to fun­da­men­tal level(s)…” But if only it were that easy to solve the prob­lem of high energy prices.

    As the debate on energy begins to resem­ble Lewis Carroll’s “Alice in Won­der­land”, a sur­real work of lit­er­ally non­sense, it is time to wake up and real­ize that our national lead­ers shouldn’t go “down the rab­bit hole” and imag­ine a solu­tion to the energy crises. They should know real­ity is bet­ter than fic­tion when set­ting national pol­icy and “oil spec­u­la­tors” don’t cause high oil prices.

    Con­gress would have you believe that its scape­goats, the spec­u­la­tors, are a “new” type of “hulk investor” that has super­hero pow­ers to move moun­tains of cash into oil futures and thereby dis­tort the fun­da­men­tal supply/demand bal­ance for oil.

    Oil spec­u­la­tors are accused of push­ing up the price of crude oil because they pur­chase oil futures and index funds that pur­chase oil futures. The oil “blame gamers” want to claim that own­ing oil futures is the same as hoard­ing crude oil inven­to­ries (which by the way is really the only way for spec­u­la­tors to affect the price of crude oil). But, pur­chas­ing oil futures is not the same as own­ing crude oil. The goal of an oil future pur­chaser is to resell for a profit their con­tract to some­one who actu­ally wants to own oil, i.e., has fun­da­men­tal demand for oil, and will take deliv­ery of the oil rep­re­sented by the futures.

    No one accuses oil spec­u­la­tors of actu­ally pur­chas­ing oil or hoard­ing oil inven­to­ries, only that they pur­chase and sell oil futures. Since the trad­ing of oil futures doesn’t affect sup­ply or demand, it is hard to see how oil spec­u­la­tors push up the price that end users are will­ing to pay.

    While it is easy for the blame gamers to focus on spec­u­la­tors as the boogey­man, they have a prob­lem since there is no hard sup­port­ing evi­dence. Instead, the fol­low­ing facts destroy the case against speculators.

    • Oil spec­u­la­tors haven’t been hord­ing oil; inven­to­ries are actu­ally down. In order for oil spec­u­la­tors to affect oil prices they need to pur­chase oil, reduce avail­able sup­ply and refuse to sell their oil for a low price. In other words, they need to hoard oil, store oil and keep oil off of the mar­ket. If oil spec­u­la­tors were hoard­ing oil then oil inven­to­ries would be up and not down (as reported by the Energy Infor­ma­tion Admin­is­tra­tion).

       

      Instead, oil spec­u­la­tors are buy­ing con­tracts to pur­chase oil in the future but then sell­ing those con­tracts before tak­ing deliv­ery to “real buy­ers” who take deliv­ery. Pro­duc­ers (sup­ply) and end users (demand) drive price and if futures con­tracts become uncor­re­lated with fun­da­men­tal prices spec­u­la­tors will lose money.

       

    • Futures con­tracts are trad­ing at about the same value as spot mar­ket prices which reflect fun­da­men­tal demand. Oil spec­u­la­tors don’t buy spot con­tracts and don’t affect spot prices. Hmmm…..this is a trou­bling fact for the blame gamers. Spot oil pur­chasers buy to fill fun­da­men­tal demand and reflect cur­rent mar­ket prices. Because spec­u­la­tors don’t own terminal/receiving, stor­age and trans­porta­tion facil­i­ties, they don’t pur­chase in the spot mar­ket. Since spot prices (the fun­da­men­tal mar­ket) are very close to futures prices (the spec­u­la­tor mar­ket) that would sug­gest that if there is any spec­u­la­tive bub­ble in futures prices it is very small.

       

    • Oil spec­u­la­tors pro­vide cap­i­tal to the futures mar­ket which is a finan­cial deriv­a­tive mar­ket. More cap­i­tal leads to nar­rower bid/ask spreads and less price volatil­ity. The pres­ence of more par­tic­i­pants with greater cap­i­tal in the mar­ket is result­ing in lower spreads and less volatil­ity for oil futures. The ben­e­fits of more cap­i­tal is just as true for the oil futures mar­ket as it is for every other finan­cial deriv­a­tive market.

    It is dan­ger­ous for the United States to con­tinue to delude itself as to the real issues sur­round­ing high energy prices.

    When I hear our cur­rent Con­gres­sional and national lead­ers debate this issue I want to quote the Eaglet in Alice in Won­der­land.

    Speak Eng­lish! I don’t know the mean­ing of half those long words, and I don’t believe you do either!”

  8. US Auto Manufacturers Are Becoming Competitive Again" rel="bookmark">Surprise — The US Auto Manufacturers Are Becoming Competitive Again

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    On Tues­day, June 3rd I was on FOX Busi­ness Net­work dis­cussing the US auto man­u­fac­tur­ers and why I think they are poised to regain mar­ket share in the North Amer­i­can car and light truck mar­ket. In par­tic­u­lar, assum­ing GM makes it through the next cou­ple of years (and the next cou­ple of years will be very tough because of a weak econ­omy and the stretched con­sumer) I think that GM has the poten­tial to cap­i­tal­ize on sev­eral macro-economic trends to restore some of its mar­ket posi­tion. In par­tic­u­lar, on FOX Busi­ness News the fac­tors that I dis­cussed include:

    • High Oil Prices – High oil prices raise the cost of trans­port­ing imported vehi­cles from Asia and Europe to the US. Accord­ing to a recent CIBC study higher trans­porta­tion costs for imported goods acts like a “tar­iff” on imported items and raise their cost. As a result, domestically-produced cars and light trucks are becom­ing more price-competitive rel­a­tive to imported vehi­cles.
    • The Depressed US Dol­lar – The low value of the US Dol­lar tends to make imported goods (like cars) more expen­sive for American’s to pur­chase while not affect­ing the price of domes­ti­cally pro­duced goods. As a result, domestically-produced cars and light trucks are becom­ing more price-competitive rel­a­tive to imported vehicles.
    • Infla­tion in Asia – Infla­tion in China is high (8%+ per annum). Infla­tion in Viet­nam is even higher. Other coun­tries in Asia that pro­duce auto parts and raw mate­ri­als for the Japan­ese and Korean auto­mo­bile man­u­fac­tur­ers are also expe­ri­enc­ing high infla­tion. High Asian infla­tion makes imported goods from Asia more expen­sive for American’s to pur­chase with­out affect­ing the cost of domes­ti­cally pro­duced goods. As a result, domestically-produced cars and light trucks are becom­ing more price com­pet­i­tive rel­a­tive to imported vehicles.
    • Domes­tic cost sav­ings and pro­duc­tiv­ity – The US auto­mo­bile man­u­fac­tur­ers have made enor­mous progress in improv­ing pro­duc­tiv­ity and labor costs. More­over, GM in par­tic­u­lar has more or less solved its pen­sion and health­care cost prob­lems. A mate­r­ial dis­ad­van­tage in labor pro­duc­tion costs no longer exists between the US man­u­fac­tur­ers and their Asian com­peti­tors. Today, the Wall Street Jour­nal wrote an arti­cle on the pro­duc­tiv­ity of US auto­mo­bile man­u­fac­tur­ers in which they assert that the play­ing field has been “lev­eled” between the US auto­mo­bile man­u­fac­tur­ers and their Asian rivals. As a result, domestically-produced cars and light trucks are becom­ing more price-competitive rel­a­tive to imported vehicles.

    Since the US auto­mo­bile man­u­fac­tur­ers have a lot of rea­sons to believe that they can com­pete on price with their Asian and Euro­pean com­peti­tors, the ques­tion of GM, Ford and Chrysler regain­ing mar­ket share comes down to whether or not they are pro­duc­ing the type of vehi­cles that American’s want to drive. In the case of GM, their new vehi­cles seem to be high qual­ity and sell­ing well (within the con­text of a ter­ri­ble mar­ket for car sales). The new Cadil­lac CTS and the new Chevro­let Mal­ibu appear to be win­ners that com­bine qual­ity, styling and value. More­over, GM is begin­ning to use its tech­nol­ogy to improve gas mileage on con­ven­tional vehi­cles and is intro­duc­ing 8 hybrids in 2008 and 16 hybrids in the next 4 years. More­over, the Chevy Volt is one of the most excit­ing new vehi­cles to be launched in decades. GM is turn­ing “green” faster than any other auto­mo­bile man­u­fac­turer and has the tech­nol­ogy to fol­low through on its plans. Ford, on the other hand, has much more work to do to con­trol costs than GM. How­ever, Ford also has vehi­cles that are both good qual­ity and get­ting closer to what con­sumers want to pur­chase. As an exam­ple, Ken Bel­son of the New York Times reported that the Ford Escape Hybrid is the new vehi­cle of choice for New York City cab dri­vers. In New York, all of the approx­i­mately 13,000 taxis will a have to aver­age at least 30 miles to the gal­lon by 2012 and the only option for cab dri­vers to com­ply with the law is to pur­chase hybrids. And, the Ford Escape is the hybrid of choice with a mar­ket share of 83% of the New York City hybrid cab fleet. The per­for­mance of the Ford Escape Hybrid has been very good despite the gru­el­ing pace of New York City taxi cabs. As I said on FOX Busi­ness News, I think I am in a minor­ity in think­ing that if the US auto man­u­fac­tur­ers make it through the cur­rent down sales cycle with­out going bank­rupt, the future looks pretty bright for them.

    Below are two video clips from FOX Busi­ness Net­work where the auto­mo­bile man­u­fac­tur­ers were dis­cussed
    [flv:060308_1.flv 325 255]

    [flv:060308_2.flv 325 255]

    [flv:060308_3.flv 325 255]