Tuesday, October 27, 2009

Economic Correction Disease; Byron King on the Risks that Come Along With Peak Oil

Celebrating A Decade of Reckoning
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The Daily Reckoning
Tuesday, October 27, 2009

  • Dollar down, gold up...and other apparent oddities in the markets,
  • How far off is $700 oil? Our resident geologist drills into the data,
  • Plus the swine flu "emergency," frisking grandma and plenty more...
  • ---------------------------------------------------------------

    From Buenos Aires, Argentina, Bill Bonner reports...

    It's a delight to be back in Buenos Aires. It's springtime. The sun is shining. The birds are singing in the trees. What more can you ask for?

    Another national emergency! Terrorism...the banking crisis...now Swine Flu.

    Why it is an emergency, we don't know. Our sister, living in Virginia tells us that several of her grandchildren have come down with the Swine Flu. It doesn't seem to bother them anymore than any other flu.

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    But every emergency is an opportunity. The feds don't want to waste it. Instead, they swing into operation with a rescue plan. It will end up costing billions...hundreds of billions...or maybe even trillions. We don't know what they've got in mind. But we know what will come of it. It will end up extending the power and influence of the government. So far, the feds are the only real winners from any of these crises. Federal outlays, as a percentage of GDP have shot up from less than 20% of GDP in 2000 to more than 26% in 2009.

    Will it do any good? Public health is not central banking. And it's not economic planning. Force everyone to wear a surgical mask and maybe lives would be spared. Or, maybe not. Without the immunity of occasional bouts of flu, who knows? Maybe people would be more susceptible to the next disease. The American Indians were almost wiped out...because they had no immunity to European diseases.


    Ain't nature amazing? Disease works like an economic correction. It winnows out the weak...and it toughens up survivors. Allowing people to get sick is a little like allowing them to go broke. It keeps the whole system from softening up...from becoming more vulnerable. It protects people from moral and biological hazard. In other words, it's the correction that really provides protection...the disease itself, not the cure. Or, to put it another way, it's the crash that is beneficial, not the rescue.

    David Einhorn, one of the few people to make money in the crash of sub- prime debt:

    "The financial reform on the table is analogous to our response to airline terrorism by frisking grandma and taking away everyone's shampoo. It gives the appearance of 'doing something' and adds to our bureaucracy without really making anything safer."

    The Wall Street Journal reports that even bankruptcy can be a good thing. "Household Debt Can Hasten Recovery...when it goes unpaid," says a headline.

    The whole idea of a correction is to wash out mistakes. If people can pay their debts down, the mistakes are corrected. The system is strengthened. If they can't, the process of correction can happen faster. Bad debts are written off quickly. Then, a real recovery can begin. Either way, the system comes back in better shape.

    Too bad the feds are getting in the way!

    A decent correction should carry off those who made the biggest mistakes - in the present case, the firms on Wall Street that wagered billions on a bigger and bigger bubble. But instead of letting them go broke, the feds rewarded them.

    Wall Street profits are a 'gift' from the state, says George Soros.

    But wait, what kind of gift is this? If you give $100 to your neighbor, that's a gift. But what if you tax your neighbor on the left $100 in order to give the money to your neighbor on the right? That's a gift too...but of a special kind. You're 'redistributing the wealth,' you might say.

    And what if you do a quantitative easing? You know, you print up a $100 bill and give it to your neighbor? That's a gift too.

    Yeah, thanks a lot.

    Meanwhile, the recession is said to have come to an end in the US. GDP growth is positive, say the papers. But if this is a recovery, let's hope it comes to an end soon.

    Existing house prices continued to fall in September.

    Unemployment continued to worsen. "Signs of recovery don't extend to jobs," says the WSJ.

    More thoughts on the state of the empire below but first, today's essay...

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    The Daily Reckoning PRESENTS: How far off is $700 per barrel oil...and what might that mean for a global economy addicted to it? If the credit crisis gave Mr. and Mrs. Main Street anything to cheer about it was cheaper gas station visits. But, with oil touching an intra-day high of over $81 per barrel yesterday, any permanent reprieve at the pump looks unlikely.

    In today's column Byron King, editor of Outstanding Investments and The Energy & Scarcity Investor, gives you the inside scoop on where oil is likely headed from here...

    Peak Oil - The Risks
    By Byron King
    Pittsburgh, Pennsylvania

    Eighty-five million barrels a day.

    That's the world's current production of crude oil...and that may very well be close to the world's PEAK production of crude oil. Although the recession caused a temporary decrease in consumption, demand is already bouncing back toward pre-crisis levels. Too bad production isn't.

    "Can't we get more than 85 million barrels?" some folks are bound to wonder. Let's look into that...

    A couple weeks ago, I attended the 2009 international conference of the Association for the Study of Peak Oil and Gas (ASPO), out in Denver. Here's the long and short of it. We're in trouble. With a capital "T," and that rhymes with "P," and that stands for Peak Oil. By every measure, the world's output of crude oil peaked between 2005 and 2007.

    Yes, the worldwide total output of what we generically call "oil" has risen - slightly - in recent years. But that's because there are increasing volumes of natural gas liquids (NGLs) in the mix, plus unconventional oil like what the global marketplace obtains from Canada's oil sands. But the production of oil - actual oil - has peaked already. The future of conventional petroleum output is downhill, even with the future output from the deep-water offshore discoveries.

    Unconventional Hydrocarbons

    "There's no such thing as West Texas Intermediate [WTI] oil anymore," Peak Oil apologist, Matt Simmons, moaned to the ASPO conference attendees. Instead, the pipeline crossroads like Cushing, Okla., have become little more than "crude oil pharmacies."

    In other words, as the quality of the crude from the traditional U.S. oil patch continues to degrade, oilmen must mix and match their product with "sweeter" forms of crude if they hope to sell it as the premium- priced WTI. Thus, operators at Cushing take whatever oil they can obtain from one place, plus whatever oil they can obtain from another place. They mix and match, and blend it all with synthetic crude from Canada. Maybe they add some imported oil juice and then send it down the line as WTI.

    Along these same lines, Venezuelan economist Carlos Rossi stated to ASPO his analysis of oil trends in the U.S. "You are worried about your foreign oil imports now," he said. "You in the U.S. import about 65% of your oil today. You don't like it. But if you follow the clear trends, by 2025, you'll be importing about 92% of your oil. You'll like that even less." No doubt.

    The market meltdown and world recession of the past year has bought some time. But the planet is still staring at an energy problem that's coming down the tracks like a runaway freight train.

    Sure, there's a lot more oil "out there"...as in WAY out there - 150 miles offshore, beneath 8,000 feet of water and 20,000 feet of rock and salt. Yes, that offshore resource is out there, but it's super hard to extract.

    And so what? Aren't the world's oil companies busy developing these massive offshore deposits? Yes, but this development will take decades. It'll take time and capital and expensive cutting-edge technologies, some of which are barely commercially viable.

    Future energy supplies have never been more uncertain, according to Simmons. It's difficult to say with specificity how bad things are, he says, because the data are so poor on a worldwide basis.

    "Look at what happened with the bad information we had, or didn't have, with the financial institutions over the past couple of years," Simmons said at the recent ASPO Conference. "With our energy data, it's worse. We're in for some shocks that will change our lives in ways that'll rival Pearl Harbor."

    Things could go wrong with energy supplies in any of a dozen places, according to Mr. Simmons. In Venezuela, the output of the state oil company PdVSA is declining at alarming rates due to political interference and underinvestment. In Nigeria, the low-grade civil war could quickly morph into a large-scale civil war. In Iraq, according to Mr. Simmons, "They're in the dark about how to rebuild their oil industry."

    Closer to home, Simmons expects net oil exports from Mexico to vanish within 24 months or less. This event will play havoc with U.S. refiners on the Gulf Coast. Mexico has simply delayed for too long its effort to explore, drill and rebuild its fast-depleting oil resources. Mexico is going to have to scramble to salvage something from its looming energy disaster.

    Actual and Predicted Crude Oil Production

    But even without a supply shock, Simmons believes that the mere inevitability of declining production will cause oil to hit $200 a barrel by the end of next year. Longer term, Mr. Simmons expects to see oil at $500-700 per barrel. "People need to understand how expensive it is to obtain oil," said Simmons.

    Much of the world's energy infrastructure is old and rusting and will require several trillions of dollars to replace - if it can be replaced. Furthermore, new technology is coming on line slower than most people anticipate. The deeper, more challenging environments are sucking down technology and money, and yielding less than expected in many cases. According to one study, only eight out of 100 major energy projects came in on time, were within budget and yielded the expected volumes of oil and natural gas.

    The stark fact is that oil is going to get a lot more expensive and the bull market in oil will be firmly in place for a long time. Smart investors would take advantage of any corrections or dips to get themselves buckled-in for the ride.


    Byron King,
    for The Daily Reckoning

    P.S. Despite this dark vision from Matt Simmons, subscribers to my Outstanding Investments newsletter are well positioned to profit going forward in the OI portfolio. I've been aware of the energy predicament for more years than I care to recall. Whether or not you can get excited about oil over $500 a barrel will depend on which side of the trade you'll be when it happens.

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    How does their scam work? It's a crafty "triple-swindle" just clever enough that most Americans won't even see it happen... until it's too late.

    The short of it is, every three days, these flim-flam artists use this strategy to secretly suck wealth out of your savings account.

    Nobody's immune.

    And if you don't do something now to protect yourself, you risk losing even more... starting with the next government-backed "swindle" event, scheduled to happen in an little as three days from right now...report continued here.


    And finally today, back to Bill...

    Our old friend John Mauldin answered last week's note. Our point was that our children face a different world than we did. From what we can make out, it will be a tougher world. Everything was looking up with the baby boomers. Especially in the lives of the luckiest of them - your editor and John included. Is everything still going up? The US economy? The power and wealth of the US empire? And how about our children? John and I started out with nothing to lose. Our children can slip down as well as slide up. John has today's Daily Endnote for us. Please enjoy...

    It's More Than Half Full.

    Ok, Bill, let's review those wonderful days from whence we sprang, so fraught with the advantages of having nothing. So potent with opportunity. It was the middle of the '70s when we started our careers. Inflation was high and rising. The Soviets were seen as a major threat. Japan was beating our brains out and buying everything, even if nailed down (like Pebble Beach and New York skyscrapers). I had to borrow money at 15% (or more) to buy paper in order to meet customer demands for printing. And guess what? The banks got into trouble and called loans willy-nilly. (My bank even called my mother and threatened her to pay my loan - against written agreements - and she did. Evil sons of bitches. The more things change... And they delightedly did fail! Not that I hold a grudge.)

    There were multiple successive and deeper recessions. Gold was rising as the dollar was seen as a joke. Howard Ruff (a good friend to both of us when we were starting out!) and almost every newsletter writer were telling people to buy gold and freeze-dried food to protect themselves against a near certain economic, if not apocalyptic, catastrophe. Unemployment was high and rising for a decade.

    The correct answer to the question, "Where will the jobs come from?" back then was "I don't know, but they will." And it is the correct answer today.

    In 20 years, no one will want to come back to the halcyon days of 2005. Our kids (all 13 of them) are getting ready to live through what will be the most exciting period in human history. There will be a century's worth of change, measured by the standard of the 20th century, just in the next ten years, and then we will double that pace in the next ten after that. Medical miracles that will mean our kids and grandkids will live a lot longer than their dads, although I intend to be writing well into my 80s, like our mutual hero Richard Russell.

    There will be whole new industries developed in the US. How do I know that? Follow the money. The rest of the world spends a fraction on research and development that we do. Where do you go if you are looking for venture capital?

    Do I care if the Chinese and the "developing" worlds are far better off, relatively speaking, than the US in 20 years? Not a whit. Good on them. I hope they make discoveries and inventions and new businesses that benefit us all. But we are not going into some long dark night. We, and our kids, get to choose how we respond to what is the reality of the day.

    Our nation had to almost hit the wall in 1980 before a Volker could come along and force us to take the pain of recessions to beat back inflation. And we will have to come perilously close to the wall this time before we take action as a nation. Way to close for comfort. Maybe you are right, and we have a soft depression. I hope not, but even so, the world will be better, far better, in 20 years, with far more opportunities than today.

    It was not fun starting new businesses in the '70s and early '80s. But we did. I remember coming to Baltimore and being (literally) afraid to get out of the car to visit your offices in the slums. But that was what you could afford. A far cry from the chateau in Ouzilly.

    I lived in a small mobile home. Tiffani was born there, and we converted part of the kitchen to be her bedroom. (Yes, I was white "trailer trash.") But I got up every morning just like you did and killed as many alligators as I could. The rest had to wait till the next day.

    And that is the legacy our kids have. They know what it is to wade into the swamp every morning. Never quitting. In thinking about this, you may be the father I respect the most. You have raised your kids to be multi-lingual children of the world. What a work ethic. How did you get them to scrape window shutters at your chateaus? (I actually saw this, and my kids marveled.

    Thereafter I threatened to make them go live with you when they did not act right!)

    You have given your kids the opportunity to follow their dreams, even demanded that they do so. And such dreams they (and mine) have. Will they succeed? Who knows? But they will go at it with gusto, in a world with more opportunities than you and I ever imagined 40 years ago. And, oh boy, were we optimists back then. How else could we have done what we did? If we believed the rhetoric that the world was coming to an end, would we have dared to venture out?

    You cannot have raised your kids to be such bold adventurers without instilling in them a certain high level of optimism. I am going to out you, Mr. Bonner. You present yourself to your readers as a bona fide end of the world pessimist. But you are a really and truly a closet optimist. Your whole business empire (and what an empire it has become!) is based on finding people who are optimists, in the sense that they think they can actually get people to send them money for what they write. Which they do! Even if it is to read why the world will come to an end, which it thankfully never does.

    You are right in this: it is personal gumption that makes or breaks us. There are those who started out with less than we did (hard to imagine but true) and made a lot more. And there are those who started out with far more and made less. But there are very few who are happier than either of us. Or luckier.

    Our kids? It is not the times which dictate the man (or daughter!), but the response of the man which dictates his own time. Today has a brighter future for someone young than any other time in history, whether they are in the US or Brazil or China. They just have to seize it.

    And as our kids do just that, and as the millions of kids of those who read us do so, and the billions of kids who are just now getting ready to bust loose all work to achieve their dreams, the world is going to be a far more fantastic place. Smooth ride? Not a chance. We didn't get one, and in thinking through history, there have not been many smooth rides. Why should we think we will get any better? Our kids will just have to live with our generational (and individual) iniquities, government debt and all, and figure out how to master their own fates. But if I had a choice to take the '70s or today? In less than a heart's beat I choose today. And I bet you would too!


    John Mauldin
    for The Daily Reckoning
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    "THE GREAT AMERICAN RECOVERY RP-OFF" Brace yourself for what's about to go down as the BIGGEST FINANCIAL SWINDLE in world history.

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