Tuesday, August 05, 2008


If you were lucky enough to have added to your CAL position at under $7, you may be asking, What do I do now that the price is above $15? The answer is BUY MORE!

We have been waiting for the break in oil prices for two years. Take advantage!

Will oil bounce? Yes, but from how low?.

Will airlines make a lot more money now that fares have been moved up and oil prices moved down? Yes!

Are oil prices going to go "all the way back down"? Not immediately.

How far down will they go? A tricky question that cannot be answered precisely.

There has not been a "true" recession, at least not an "old timey recession". A home builder or a Hummer salesman would strongly object but the underlying strength of the world wide economy has remained robust. If there was or was not a recession, what matters is that growth, while slowing around the world, has not stopped.

The implication is the demand for oil is going to continue to grow.

What the economic slow down has permitted is the chance for the energy market to "catch up".

High prices have been around long enough for adjustments to be made. Many of these adjustments will not be "taken back". The waiting list at the auto show rooms for hybrid vehicles is gradually being filled. All sorts of small cars are now available; Smart cars are now being advertised. Once purchased, the average car stays on the road 17 years, about twice as long as when I bought my first car. The fuel saved per car is small in the short run but huge in the long run.

When Amazon put the Kindle on the market in 2007, it quickly sold out. In April of 2008, it became available again. One can buy one now and forever more get "free" electronic delivery of books, magazines and newspapers. The buyers of electronic media reduce the number of trees harvested, the number of trips to book stores and libraries and the number of UPS deliveries. The savings to the consumer is about half the cost of books plus the cost of delivery minus the cost of the reader spread over the cost of purchases. The total fuel savings per page is a significant and the number of pages saved is going to sky rocket.

Those who have moved closer to their place of work are not likely to move "back to the suburbs" at $3 per gallon of gas.

However, we must not forget that 100's of millions of more people will move up to the middle class over then next 20 years. The demand for energy is not going to go away.

The marginal cost of production of energy has risen sharply, but it is a far cry from $120 per barrel. Saudi Arabia is still pumping oil that cost only $5 per barrel to lift but the cost to increase the production is probably in the $25 to $40 per barrel range. In Brazil, no one knows yet what the cost will be to produce from deep ocean wells that are beneath a layer of difficult salt but my wild guess is in the $35 to $70 range. It is known that oil produced from tar sands in Canada is coming in below estimates. As I recall, the cost was estimated as high as $65 per barrel originally but some fields are producing for less than $45 with the hope of lower future costs. After a "hot" nuclear power plant is built in Alberta, production costs should fall.

The marginal cost of nuclear is coming down. I need to do some homework to build firm numbers, but the equivalent cost per barrel of oil is quite low. A few years ago, the wholesale cost of dirty coal electricity was about 4 cents per kilowatt. The cost for oil was not a great amount higher but it has made sense to save oil for use as transportation fuel I vaguely remember that the wholesale cost is now up to 8 cents before accounting for the cost of using clean coal techniques. For sake of argument, lets assume a total marginal cost of 12 cents, which would make nuclear only about one third the current cost. One third of the current price of oil is $40. Add in increasing construction costs and $55 to $70 becomes a reasonable approximation.

The above $35 to $70 calculations for nuclear, tar sands, and deep water oil is rougher than a popcorn cob but it serves our purpose here. The 36 nuclear power plants under construction now, will only gradually come on line (4 this year). The 90 some on order will start coming on line in 5 years (however, China expects to have the construction time down to 2 years after a few more plants are completed).

Based on the rough calculations above, I expect oil to make it back to the $55 to $70 range within 6 years. How does this guesstimate compare to history?

Adjust for inflation, in terms of the 2000 dollar, the price of oil ran from $38 per barrel in January of 1979 to $85 in March of 1980. The peak was short lived. By October of 1980 the price was off 14% from the peak, at $73 per barrel. The following are a few key prices in the years that followed: $75 December 1980, $52 Feb 1982, $65 June 1982, $50 Jan 1983, $57 June 1983, $42 Dec 1984, $48 Nov 1985, $20 Jan 1986, $12 Dec 1998, $105 March 2008.

The total drop from $85 to $12 was 85%! History does not repeat itself but it does rhyme. Just before the recession of 1990-91, oil traded at $22 in June 1990. It zoomed to $46 in just 4 months and peaked at $46 in October. It was back down to $25 by February o1991. This spike was in response to the invasion of Kuwait by Iraq. The last run of oil from somewhere in the $100 area to the $147 peak was in response to the threat of war with Iran. This threat is waining quickly. Iran is being given chance after chance of accepting a huge package of benefits in exchange for ending its pursuit of nuclear bombs. On a "second track" Iran is being punished severely until it agrees to end its pursuit of nuclear weapons. Most importantly, the agreement to suspend pursuit of nuclear weapons will include the agreement to end support of terrorist.


The American people are gradually being sold on the benefits of opening up energy markets just when the economic slow-down is reducing demand and just as the tensions of war are quickly fading. At the rate we are moving now, within a month or two, democrats and republicans will be stumbling all over each other to get to the front of the parade toward more energy supplies. When 10-year out oil futures were selling for $147 even the country of Mexico got into the act. It takes a serious financial commitment to drill deep in the Gulf of Mexico, by pre-selling oil, as yet to be discovered, Mexico has dramatically reduced its risks. Someone needs to give some of our congressional representatives a lesson in economics. The speculators who bet on high oil prices in the future are the very folks that lower our oil costs. If speculators (investors) know that drilling is permitted in fertile areas, the price in the futures market will be reduced. It will not take 5, 10 or 20 (Obama) years for OCS oil to lower prices. A partial reduction will occur immediately.

Last quarter, under duress, CAL produced positive cash flow of about $500 million. This quarter a lot of that cash will be used but the performance in these circumstances is remarkable. Over the next several years, as oil retraces its steps, CAL is going to make a lot of money. Assuming the congress permits its petition for antitrust exemption in regard to a set of partners, profits will really soar. The globalization of our economy has just started. Cloud computers are making it all the more easy for business to be conducted anywhere in the world. On full margin, one can almost make 500% returns on 100% moves and 2500% returns on 200% moves.

What do I do now? Buy more!