Saturday, December 10, 2005

Kuwait preparing for international oil field competition - Dec. 10, 2005

Kuwait is yet another oil producing country ready to let foreign expertise boost output (others include Libya, Russia, Syria, Iran and Qatar; to name just a few). Kuwait expects to boost production by more than 300,000 barrels per day over the next five years. Kuwait also plans to build a 600,000 barrel per day refinery.

Drop by drop, new supplies are coming. One theory, I believe to be true, is, that deep in the bowels of the earth, oil is being constantly "manufactured". This is not to say that it is being made as fast as we use it but it does suggest that peak oil production will not be reached for many more years. There are substantial supplies of sour crude already discovered but not being pumped because refiners have been happy to spend less on refining the sweet stuff. New refineries will be geared to handle more of the sour crude.

Right now, the trick is to "get over the hump". We have had to "get over the oil hump" many times for more than 100 years. Supply and demand does not reach an equilibrium price in the case of agriculture products and commodities (one major reason we pay farmers not to grow stuff is to try moderate the price swings, unfortunately another major reason is politics). The pattern, traced by the crossings of the supply and demand curves, is called a spider web because it never meets in the middle. It simply takes a few years after the equilibrium price is passed before enough investment is made to catch up, once the catch up process is started, it continues until there is too much production. No one knows what that equilibrium price is but obviously it was passed somewhere along the way from $12 per barrel oil in 1999 and $70 per barrel oil in 2005. It will be passed again on the way down.

It will be interesting to watch the financial results of the companies that are converting coal to liquid. I believe these companies will make nice profits as long as oil is more than $40 per barrel. If they do, then expect to see many more coal to liquid plants if oil stays above $40. Interestingly enough, the price should become more stable when the use of abundant coal is the low cost product.

When peak oil production is reached, unless some other technology proves to be more efficient, the cost of fuel produced by the most efficient coal to liquid technology will largely set the new price. My good sources over at Econobrowser suggest that tar sand oil is not going to replace more than a few million barrels per day. I accept their contention for at least the intermediate term. However, there are trillions of barrels of tar sand oil that will eventually be worthy of mining. Wind power and corn power are far less efficient that coal power; do not count on these sources except to the extent that well meaning but poorly informed environmentalist and politicians dictate.

I should acknowledge that many fuels are worthwhile in certain limited and typically small scale incarnations. For example, several beer plants are now reprocessing spoiled beer into ethanol. Solar is good when a small amount of power is needed in a place where the cost to run an electrical wire is high. Hydrogen may work out well but most likely only after nuclear plants are providing large quantities of excess electricity at night.

The F-T coal to liquid technology, used by Hitler to fuel German tanks, was invented around 1920. South Africa is one of the biggest users today. The US has joined with 6 other countries to invest in a research project to discover if the process can be made more efficient. The beauty of coal to liquid is that it pollutants are removed during the processing. Bechtel (a private company) builds power plants that use this clean coal to gas process. Japan has passed laws that dictate the use of clean technology so this process is being studied.

Investors should remember to buy cyclical stocks such as oil drillers when they are not making money and to sell them when they are. The only thing that will make oil drillers move up much from here will be a surprise in the peak price of oil. The market price of most energy companies already discounts the current price of oil.

Another way of saying the above is that one should not invest in an industry when a large amount of new capacity is about to come on line. I lost count of new refineries under construction or on the drawing board, but it is a large number. Some, such as the Viet-Nam refinery, is being built exclusively to serve local markets. However, others such as the one in Portugal, is being built to export virtually all of its production, in this case to the US.

Drop by drop, little by little, inch by inch; I am reminded of the old Three Stooges Gag. It is not a threat but a reality that more and more black gold will be found while it trades at $50 or more per barrel. Refineries are under construction, indeed, too many are under construction. The crack spread is going to virtually disappear in a few years; speculators may want to play the cold weather game, investors should under weight energy stocks!